Fibra Macquarie

Mexico has good demographics and its low-cost manufacturing should benefit from the China trade war and NAFTA (h/t Peter Zeihan).  So I've been digging around for Mexican Industrial REITS.

Basics on Mexico

The only things I know about Mexico are from TV.

So let's starts at the beginning.

Inflation: Mexico has had bouts of high inflation.  

Although its now under control, the steady inflation rate of 3-5% is higher than developed countries.  Since everyone in Mexico has experienced inflation, most rental leases are either tied to the CPI or in USD.  So peso inflation is not directly an issue for investors.  But when you see a peso denominated rate-of-return (interest rate or cap rate), mentally deduct 3-5% from it to account for inflation.  Mexico's official interest rate is 4%.

Property rights: foreigners can own freehold property, except perhaps up to 50km from the coastline or 100km from the border.

Crime: the drug war started in the 90's and has worsened since the Cartels splintered.  The level of violence is like something out of a movie and is unimaginable by people living in Asia/Europe.  Sometimes powerful gangs are welcomed as law enforcement.  The government does not control some areas of the country.

Fibra Macquarie

Properties,  Tenants and Leases

Fibra Macquarie has around 230 industrial and retail properties throughout Mexico:

Mostly industrial.  In 2020, 82% of the revenue and 88% of Net Operating Income (NOI) was from Industrial.  From the above map, around 1/3 to 1/2 of the industrial properties (by GLA) are near the US border.  They don't have much in Mexico city. 

83% of their NOI is denominated in USD.  98% of industrial leases are triple net (p13).  Over 70% of their industrial tenants are light manufacturing (p18).  38% are from automotive (p10).  This is a play on NAFTA, not e-commerce.

Fibra Macquarie did not list their properties or tenants in their annual report.  Their website has a browse properties page, but only shows vacant ones.  I probably can't evaluate 200+ Mexican industrial properties anyway.  Theres some talk of their properties being older than other REITs - the average age of its industrial building is said to be 15 years (p70).

The scant information I have on their tenants is from their 2019 Annual Report: the largest industrial tenant accounted for 3.9% of industrial rent.  The top 10 largest tenants contributed 25.8% of industrial rent.  Most REITs list their top 10 tenants proudly, but its strange I couldn't find any here.  What are they hiding?

WALE is short at 3.5 years.  Management stated that for leases expiring next year, current rent and market rent is similar, and they are not expecting any change (40:10).

Management and Incentives

The REIT is managed by an external party (Macquarie México Real Estate Management), who owns 4.8% of the units.  They get paid (p273 in Adobe Acrobat):

• 1% of the REIT's market cap, annually.  
• Plus an additional bonus of 10% of the amount of "total return based on market cap" (over a 5% hurdle plus inflation rate), payable every two years.

The first is OK, but not great.  The fee is reasonably cheap.  I thought it may encourage reckless issuing of units to fund dilutive expansion.  But this has not happened - they have instead bought back units over the past 5 years.

The second is OK, since it based on market cap.  As I read it: excluding issuances and buybacks of units and dividends.  Its reasonably aligned with shareholders.

As a plus, they are not paid any extra for making new leases, construction, acquisitions or disposals.

Overall, their administration fees are reasonable, aligned with shareholders, and easy to understand.

Mexican Fibras generally have high management fees and complex/distorted incentives:

Source: MGR Global Research: Initiation of Coverage: Upsite (p10)

Cashflows, FFO and AFFO

FFO is usually lower than CFO:

To get AFFO, they subtract future (non-cash) costs  from FFO.  Around 14-20%.  Mostly for property maintenance or improvements, with a little for leasing commissions and platform costs. Straight line rent is negligible:

The terms are defined on slide 39 here:

Source: 4Q2020 Supplementary Information, slide 39

In summary, they are generating cash, and provisioning 14-20% of their FFO.

Pipeline and Growth

Their last big property purchase was announced in 2016.  Since then, growth has come from expansions and redevelopment (p27):

The 11.6% cap rate sounds really high.  Maybe we should mentally deduct 3-5% from it, I'm not sure.

Management stated that they expect to be able to add 1 to 1.5m GLA a year, funded via retained FFO, new loans and opportunistic asset sales (34:50).  Thats an increase in GLA of 2.5 to 4% a year.

Seems like they continue with their slow, low-risk growth strategy of "extend and redevelop".

Debt

Net LTV is 36.4%.  Their Regulatory LTV is slightly lower at 35%.4% (p35).  The maximum is 50%.

All their loans are fixed (p36).  Some use properties as collateral: 30% of their properties are encumbered.    97% of their loans are USD.  The interest rate is pretty high, averaging over 5%.

A lot of their loans expire in 2024 (p34), loan expiry is a bit too concentrated:

All their loans are interest only, but they have being slowly paying off debt over the past 5 years.  

Management anticipates debt may rise in future to fund the development pipeline.  Short term, LTV may rise into the low 40s. (34:00).

Risks

A big tail risk is a sudden USD depreciation.  71.8% of their leases are denominated in US Dollars.  If the USD was to drop 30-40%, lets say in 2-3 years, their revenue would follow.  Their costs will be the same, except for interest, whoch is the largest cost.  If the USD dropped by 40%, I model that their 2020 operating profit before tax would drop by 40% too.  The company would survive.  The short WALE works in their favour, in this case.

Other risks are:

• I do not know the quality of the properties or tenants
• I do not know the property cycles in their local markets.
• It takes a year or two to build an industrial property, so there is no moat in this business.
• Mexican political risk.  The drug war.
• 3D printing disrupting manufacturing.  EVs disrupting automotive.

Valuation

2020 AFFO was 2.59 pesos per certificate.  Projected 2021 AFFO is 2.27 to 2.32 pesos per certificate.  So at its a price of 26 pesos, its trading around 10 times earnings (AFFO), with a 7% yield (80% AFFO payout ratio).

Conclusion

• Excellent financials, and cheap.
• Biggest long term risk is Mexico, especially the drug war. Historically, holding Mexican stocks and pesos has been a losing game.  Maybe this will change.  Like China in 2001.
• Biggest short term risk is the lease expiries, and I know nothing about their properties or local property cycles.

In the end I bought some, its 5% of my portfolio.

Misc

Mexico's Withholding Tax is 10%.   It should be zero for Singapore residents (p7), I'll need to check if Interactive Brokers applies this later.

Other links:

• Detailed pre-covid 2019 report on Mexican Fibras by BTG Pactual.
• Short 2014 write up in Value Investors Club (free registration required)