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Edited Transcript of TERRA13.MX earnings conference call or presentation 26-Jul-19 3:00pm GMT

Q2 2019 CI Banco SA Institucion de Banca Multiple FF/00939 Earnings Call

MEXICO, D.F. Jul 31, 2019 (Thomson StreetEvents) -- Edited Transcript of CI Banco SA Institucion de Banca Multiple FF/00939 earnings conference call or presentation Friday, July 26, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alberto Castillo Chretin

Fibra Terrafina - Chairman & CEO

* Carlos Gomez Espinosa

Fibra Terrafina - CFO

* Francisco Martinez

Fibra Terrafina - IR Officer

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Conference Call Participants

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* Andrea Lara Cid Antúnez

Signum Research - Stock Analyst

* Fernando Froylan Mendez Solther

JP Morgan Chase & Co, Research Division - Analyst

* Francisco Chávez Martínez

BBVA Corporate and Investment Bank, Research Division - Team Leader & Chief Analyst

* Roberto Waissmann

Banco Bradesco BBI S.A., Research Division - Research Analyst

* Vanessa Quiroga

Crédit Suisse AG, Research Division - Head of Mexico Equity Research & Co-Head of the Housing & Infrastructure in LatAm excluding Brazil

* Wilfredo Jorel Guilloty

Morgan Stanley, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good morning. My name is Dana, and I will be your conference operator today. At this time, I would like to welcome everyone to the Terrafina Earnings Conference Call. (Operator Instructions)

Thank you for your attention. I will now turn the call over to Francisco Martinez, Terrafina's Investor Relations Officer. Please go ahead.

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Francisco Martinez, Fibra Terrafina - IR Officer [2]

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Welcome to Terrafina's Second Quarter 2019 Conference Call. We are pleased to have with us today from Terrafina, Mr. Alberto Chretin, Chief Executive Officer; and Mr. Carlos Gomez, Chief Financial Officer. Mr. Chretin will be taking us through the company's overview and operating review and Mr. Gomez will review the financials.

Before we begin, we would like to refer you to the forward-looking statements as per the note in the quarterly report. Any information expressed or implied during the call may include forward-looking statements which could involve certain risks and uncertainties. Terms such as estimate, project, plan, believe, expect, anticipate, intend and similar expressions may identify such statements. Listeners are cautioned that forward-looking statements made during this call or by the company's management may change based on various important factors not under the control of the company. These comments represent the company's judgment at this time of the call. The company disclaims, however, any intent or obligation to update these forward-looking statements.

Thank you for your attention. And at this point, I will turn the call over to Mr. Alberto Chretin for his remarks.

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [3]

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Good day, everyone, and thank you for joining us today as we review results for the second quarter of the year. Let me begin by saying that Terrafina performed well during the second quarter as we continue to report high-quality metrics. Our highlight for this quarter include a 95.5% occupancy level, driven by robust manufacturing activity in the northern region that remains responsible for the most relevant manufacturing-for-export markets in Mexico.

We are mindful of the challenging macroeconomic situation and paid close attention to all key economic indicators but had not seen any major impact on our operations. The U.S. economy remains solid, underpinned by strong consumer confidence which over time should be positive for our export manufacturing portfolio. However, we believe that the fallout from recent trade tensions between China and the U.S. could create opportunities for additional development opportunities in Mexico and generate more demand for expansions and build-to-suits.

By contrast, we are certain that Mexico will continue to be a key trading partner for the U.S. given the strong manufacturing synergies and attractive cost savings provided by its skilled, competitive workers. We expect the U.S. Congress to approve USMCA in coming months, which will cement Mexico's place as the USA key trading ally alongside Canada.

As a matter of fact, in May, Mexico's exports to the U.S. grew by 9%, for the first time, surpassing China's export activity, which has been decreasing since early 2019. This growth in exports will likely lead to a pickup in investment in Mexican manufacturing-for-export sector to the benefit of Terrafina.

Manufacturing represents 73% of Terrafina's portfolio by asset type and 62% of total GLA is concentrated in the Northern region of Mexico, where most of the industrial activity takes place. This underlines that the company is well-positioned for growing manufacturing exports and gradually insulated from the slowdown in Mexico's domestic non-manufacturing sector.

Occupancy and rental rates by region remained stable and we do not anticipate any major changes. As long-term followers of Terrafina will know, the switching cost to moving location in the manufacturing sector are relatively high given the cost of moving machinery and equipment. This is in contrast to lower switching cost in lighter activities, such as e-commerce. As a result, our rent and occupancy levels tend to be relatively stable even in difficult times.

Our total leasing activity reached 3.2 million square feet, supported by 2.2 million square feet of renewed GLA with a 7-year weighted average contract duration. New leasing contracts accounted for 932,000 square feet, where 82% was in the manufacturing-for-export sector and the remainder in the logistics sector. Our expirations cadence consisted of 15 contracts, 6 of them were not renewed mainly due to consolidation. Additionally, the largest property vacated already has an LOI with uptake and occupancy levels back to the 90s in the Bajio region.

Our average renewal rate remains at a healthy level, and we expect it to be in the high 80s by the end of 2019. As we have mentioned before, these have been a key differentiator in the resale market. We have always sought to anticipate our tenant needs by executing a disciplined (inaudible) and our third-party managers who seek to keep tenant satisfaction at optimal levels.

As for our rollover activity going forward, it will be significantly lower for the second half of 2019 as only 6.7% of our total GLA expires. We have been in close consultation with our tenants who have indicated their interest in remaining in their existing spaces, a good indicator of Terrafina's continued positive results going forward.

We consider our client base to be one of the most attractive in the industry with a combination of weighted average remaining leases of 3.5 years, a 12-month average renewal rate of 89% and broad diversification. Our largest client represents 3.3% of the total annualized base rent while the top 10 represents only 17.5%.

Terrafina continued to make progress in its development strategy with a 248,000 expansion for a tenant linked to manufacturing for exports in the electronics sector. The final agreement was signed on June 20. This property is expected to generate a development yield of a stabilized NOI of approximately 10%.

Moreover, we will continue analyzing specific build-to-suit projects and expansions that will bring additional benefits to Terrafina with attractive double-digit development yields in the range of 10% to 12% as we continue to see growing demand for new space from existing tenants.

Historically, Terrafina has followed a disciplined growth strategy, analyzing and executing new development opportunities in a selective manner. We are pleased to report that we have identified an attractive pipeline for 2020 to keep growing our profitability. The pipeline will focus on supporting our existing tenants growth needs by providing new space close to their operations.

Given these attractive growth opportunities, Terrafina will follow a disciplined capital allocation policy, via a close monitoring of appropriate metrics so as to generate additional liquidity and finance future expansions and build-to-suits. Specifically, the company will review its distribution policy starting 2020 as well as initiate a massive recycling strategy following the identification of various asset for sale.

We expect to generate significant savings as well as benefit from lower maintenance CapEx following the reduction in the overall age of the portfolio. Part of these resources will be from -- part of these resources from the asset sales will be used to pay down debt and keep our LTV at sound levels.

Finally, Terrafina is constantly analyzing alternatives to maintain an efficient and cost-effective capital structure. To that end, Terrafina issued a 10-year senior unsecured international bond of $500 million with an order group that was more than 4.5x oversubscribed. The proceeds were used to finance the 79% of the outstanding 2020 (sic) [2022] notes that were tendered and the rest to pay down our existing term loan facility. Carlos will provide more details on these transactions.

In summary, we believe Terrafina is uniquely well-placed in the FIBRA sector due to our high-quality client base focused on the growing industrial North of the country and a dominant position in the manufacturing-for-export sector that provides stable rates in U.S. dollars and high occupancy levels. We believe our strong results in the second quarter of 2019 demonstrated the benefit, and we expect the rest of the year to be similarly positive.

That's all for me. Thank you. Carlos, please go ahead with the main financial highlights for the quarter.

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Carlos Gomez Espinosa, Fibra Terrafina - CFO [4]

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Thank you very much, Alberto. And thank you to all of the participants on the call for joining us today. I will begin with a brief review of our financials for the second quarter of 2019.

Please note that all figures discussed are in U.S. dollars, however, Mexican peso figures are also found in the report for your convenience. Additionally, NOI, EBITDA and FFO key figures exclude noncash items as well as nonrecurring and transactional related expenses, the latter of which are only included as part of the AFFO.

To begin, let me discuss on our recent liability management strategy as we executed a tender offer for our 2022 bond with a high level of response and a successful USD 500 million bond issuance. It is important to highlight that this issuance was debt-neutral as the company did not issue in U.S. money, so the proceeds were used to pay down debt. This was comprised of 79% of the 2022 outstanding bond, which is the total amount tendered, and the remainder of the issuance was used to pay down part of our term loan. At the end, the company managed to extend its debt maturity profile with a more competitive coupon of 4.962% that will generate savings in the short term.

Now moving to our financial highlights for the second quarter, Terrafina's rental revenue decreased by 0.5% year-over-year to reach USD 47.3 million. At the NOI level for the second quarter 2019, this figure reached USD 47.2 million with a 94.1% NOI margin. And EBITDA was USD 42.2 million with an EBITDA margin of 84.2%.

With regards to FFO levels, USD 29.5 million were generated in the second quarter of 2019 with an FFO margin of 59.4%. The FFO decrease can be mainly explained by higher financial expenses as part of the interest rate hikes seen in the past which increased by approximately $400,000 our total expenses for the quarter. Finally, AFFO levels reached USD 25.1 million with an AFFO margin of 50.2%.

And we saw a large leasing activity during the second quarter accounted for 3.2 million square feet, therefore, leasing commissions increased by USD 1.5 million when compared to the second quarter of 2018. Tenant improvements were lower compared to the first quarter of 2019, reaching USD 1.5 million. And we expect TI within the range of USD 0.20 to USD 0.25 of CapEx budget for the total GLA which translate to USD 8 million to USD 10 million for the full year.

Moving on to the balance sheet. As of June 30, 2019, Terrafina had a cash position of USD 58.8 million. Terrafina also had USD 250 million of unused capacity in its revolving credit facility which could be utilized at any moment. With reference to total debt, Terrafina had USD 1 billion in debt by the end of the quarter and a 41.1% LTV and a 3.6x debt service coverage ratio, which is in full compliance with the bond covenants.

Thank you for your time and attention. At this point, I will ask the operator to open the line for the question-and-answer session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Vanessa Quiroga with Crédit Suisse.

The next question comes from [Alberto] (sic) [Roberto] Waissmann with BBI.

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Roberto Waissmann, Banco Bradesco BBI S.A., Research Division - Research Analyst [2]

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Given that you're currently developing 248,000 square feet expansion in Bajio region, which is currently the region that presented the weaker performance in terms of occupancy, could you please give us your thoughts on how you expect Bajio demand going forward?

And my second question is regarding leasing activities. You folks had really strong leasing activities for the quarter. Could you tell us a little bit more, how are you seeing the leasing activities for the beginning of the third quarter? If this is remaining strong? And how do you expect this for the full year '19?

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [3]

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Roberto, sorry for that, but we're having trouble to hear you. Could you speak up a little louder and repeat the question please? Thank you.

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Roberto Waissmann, Banco Bradesco BBI S.A., Research Division - Research Analyst [4]

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Better now? Or no?

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [5]

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No. Actually, it's the same.

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Roberto Waissmann, Banco Bradesco BBI S.A., Research Division - Research Analyst [6]

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Okay, I'll try to call again, then I can ask another question.

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [7]

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Now it is better. Now we can hear you better. Thank you. You can go ahead, please.

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Roberto Waissmann, Banco Bradesco BBI S.A., Research Division - Research Analyst [8]

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Okay. So my first question is regarding the expansion in Bajio region. You're currently -- development 248,000 square feet expansion in the Bajio region, which is currently the region presenting the weaker performance in terms of occupancy. So could you please give us your thoughts on how you expect Bajio's demand going forward?

And the second question is regarding the leasing activities. You had really strong leasing activities for the quarter. Could you tell us a little bit more how are you seeing this leasing activity for the beginning of the third quarter? And how do you expect this leasing activities going forward for the full year '19?

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [9]

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Yes. Thank you. In terms of the expansion in Aguascalientes, we expect these to enhance the occupancy in the Bajio. And in addition to that also, we have one of the expirations that we had in the Bajio, it's also -- we already have an LOI for that expiration. So we think that the Bajio region, we expect that the occupancy in the Bajio region to increase and to reach the 90s before the end of the year.

In reference to the second question...

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Roberto Waissmann, Banco Bradesco BBI S.A., Research Division - Research Analyst [10]

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The leasing activity for the third and fourth quarter...

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [11]

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Yes, the leasing activity for the third and fourth quarter. We have only about 6% to -- about 7% of the portfolio is going to be rolling over in the second quarter of -- on to the second half of the year. So we expect leasing activity to continue its momentum. We may have also some leasing activity also with the -- ahead of the expiration. So we expect the -- that the activity to be positive, and that -- and -- but again, not as robust as it was during the first quarter, which was the main reason why we had these high commissions during the first half.

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Operator [12]

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Our next question comes from the line of Jorel Guilloty with Morgan Stanley.

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Wilfredo Jorel Guilloty, Morgan Stanley, Research Division - Equity Analyst [13]

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I have 2 questions. My first question is regarding both your retention rate and your effective rent. So we saw that the retention rate was about 80% in 2Q and we've noted that it was 90% in 1Q and 90% in 2Q last year. So I was wondering is this a one-off, the fact that you have this 10% delta in retention rates?

The second question is also looking at effective rates. So you guys have a higher signed lease rate than the effective rate. And the effective rate that we calculate is around, if I'm correct, about 4.75%, which is flat quarter-on-quarter. I'm just wondering, how should we think about the narrowing of the -- of that difference between the effective rent that you're getting today and the lease rate that you have signed? Is this something that we should expect to narrow over the next 6 months? Year? So those are my 2 questions.

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [14]

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Thank you. Well first, in reference to your first question, I think that the retention rate that we have had in Terrafina has been very good, and you have said correctly, a bit above 90%. I think that this quarter, particularly, we had 15 expirations and we renewed 9 of them. So we had 6 that were not renewed. And I think on a positive note on that, we can tell you that the 2 of the high square footage spaces that were not renewed, we retained LOI for them.

But in this quarter specifically, as I mentioned, we had 15 expirations and 9 renewals. If you remember last quarter, we had 27 expirations, and we renewed 21, so it was also 6. So to answer your question, I think that, no, I will expect the retention rate to be in the high 80s or 90%. And we've been very successful at renewing lease expirations, especially because we are in the manufacturing-for-export sector, and we expect the retention rate to be very high.

In terms of the effective rent, you're right, the way we calculate the average rent per square foot in our portfolio, is based on the contracts that we see that's on -- as we start maturing on the executions of those new rent or new -- those new contracts, we expect the gap between the effective rent and the contracted rent to be reduced.

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Operator [15]

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Our next question comes from the line of Francisco Chávez with BBVA.

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Francisco Chávez Martínez, BBVA Corporate and Investment Bank, Research Division - Team Leader & Chief Analyst [16]

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My question is regarding the strong leasing activity during the quarter. What is the rationale behind doing early renewals? Is this because of market dynamics or the tenant needs? Or this is a strategy of Terrafina to do early renewals?

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [17]

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Yes. Thank you, but just -- well these -- the early renewals are always driven by the tenants. The early -- our tenants want to secure control of their facilities. Let me give you one example. It's a manufacturing company that has some contracts with their customers. And part of the due diligence for them to have that business means they need to prove to their customers that they have control of the facilities. And that's why many times, they trigger an early renewal. And we are really pleased to do that because that means that we have an opportunity to extend the length of the contract. And at that time also, it is an opportunity to do some enhancements to the building and also perhaps improve the rent. Other times, means that the tenant wants to do an expansion or wants to do some TIs to the building. And they want to extend that lease of the contract and have control of the operation and amortizing investment that they may do on that facility. So in summary, the early renewals, most of the time, are driven by the (inaudible) from the tenant.

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Francisco Chávez Martínez, BBVA Corporate and Investment Bank, Research Division - Team Leader & Chief Analyst [18]

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Okay. Very clear. And a second question, if I may, is on this strong pipeline for next year for potential expansion -- sorry, developments. Can you give us any color on the impact that this may have on your distribution policy?

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [19]

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Yes. As I mentioned a while ago, we are going to review our distribution policy. Since the IPO, we've been distributing 100% of the AFFO. And we think that because of that robust pipeline that we have for expansions for next year, we are going to review our payout ratio in that -- and we want to fund some of those expansions with the proceeds from that reduction in payout ratio.

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Francisco Chávez Martínez, BBVA Corporate and Investment Bank, Research Division - Team Leader & Chief Analyst [20]

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Okay. But for the second half of this year, the payout will continue at 100%, right? 100%?

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [21]

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That is correct. That is correct. We are going to continue this. We want to continue to distribute 100% of the AFFO for the remainder of the year. If we do anything with the payout ratio, it will be at the -- for the 2002 -- 2020 operation.

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Operator [22]

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(Operator Instructions) Our next question comes from Froylan Mendez with JPMorgan.

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Fernando Froylan Mendez Solther, JP Morgan Chase & Co, Research Division - Analyst [23]

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Firstly, on the asset sales that you mentioned, can you give us some color on the size, the timing, maybe the location? And if this is a portfolio, or a single asset that you're seeking to sell? That's my first question.

And secondly, on your comments regarding the reduction -- the potential reduction in the payout ratio. Can you explain us the rationale of why doing it now?

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [24]

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Yes. On the first question, the asset sale. We identified already a portfolio in the range of about $100 million to $150 million. So it is a portfolio. And the timing for that will be during the next year, perhaps even the first half of 2020. But this is -- has been so far a moving target in terms of identifying the portfolio. But it is in the range of $100 million to $150 million.

And that -- and in terms of the reduction of the payout ratio, it's going to be for leasing -- well, what's your question on the payout ratio, please, again?

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Fernando Froylan Mendez Solther, JP Morgan Chase & Co, Research Division - Analyst [25]

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Why are you thinking on reducing it now? What has changed that you are now thinking about reducing it now? Despite it's not this year, but why are you thinking about that potential change at this moment? What is driving that decision?

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [26]

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Yes. Very good. Thank you. The rationale behind that is because we have this very robust pipeline for expansions for next year. And that -- and then -- and we will use the proceeds from this payout reduction to fund some of those expansions that we have anticipated for next year. And the reason why we're doing it now is because, in the past, you remember, when we did the follow-ons in the past, we always had -- a portion of that was for development, and we used the portion of that for that reason. And I think we're reaching a point now that, of course, we don't have any raising of capital activities in the horizon. And we feel that it's the time for doing -- for doing it now, precisely to fund those projects that I just mentioned.

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Fernando Froylan Mendez Solther, JP Morgan Chase & Co, Research Division - Analyst [27]

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And in those expansions, how much GLA do you think these investments could add from this payout reduction?

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [28]

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Well, that is -- we feel that it is going to be -- it's not going to be -- given the amount of space that we think that we're going to be doing for expansion, about 1 million square feet and that -- and we feel that we're going to fund that with -- it may be some with our revolving credit facility, or -- and also with the reduction in the payout ratio.

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Operator [29]

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Our next question comes from the line of Andrea Lara with Signum Research.

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Andrea Lara Cid Antúnez, Signum Research - Stock Analyst [30]

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I just want to know, when can we expect a recovery in the EBITDA and the AFFO margins?

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Carlos Gomez Espinosa, Fibra Terrafina - CFO [31]

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So as we mentioned during the call, we had some higher activity on -- especially on the renewal, on the early renewals of our tenants. So we had a very strong activity and high commissions on the last quarter. So since this was well high above the previous quarters, and this impacts directly the AFFO since the activity -- since the renewal activity will not be as strong in the second half of the year, we would expect it to have a significant improvement in the second half of the year.

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [32]

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Let me just add that we expect to have NOI margins on the low 90%. Based on a -- as you know, there are some seasonality in every quarter, but the company has a forecast to reach the low 90s on the NOI and the low 80s for the EBITDA margin.

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Operator [33]

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Our next question comes from the line of Vanessa Quiroga with Crédit Suisse.

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Vanessa Quiroga, Crédit Suisse AG, Research Division - Head of Mexico Equity Research & Co-Head of the Housing & Infrastructure in LatAm excluding Brazil [34]

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Terrafina team, I have a couple of follow-ups. The first one is on what happened with the leasing activity and the concentration that you had of leasing activity in the quarter. Is this something that you think could be normalized going forward and be managed more smoothly? Or is this something that you think is natural? Or that is not an issue for the -- for your management of clients?

And the second question is regarding the payout ratio. I couldn't hear your answer on that. If you think that you will be adjusting the payout ratio on AFFO for distributions in future periods, like next year.

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [35]

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Yes. In terms of the leasing activity, yes, we have -- and I think that we continue to have very robust leasing activity throughout the year. But let me point out that the first half of this year, we had -- we renewed 3 of our largest tenants, and that was the reason why we was -- it was so high also in terms of the leasing commissions. But we feel that the renewal of the expirations is going to continue to be in the 90s and the leasing activities going to continue to be normal throughout the operations of Terrafina.

And then going to your second question in terms of the reduction of the payout ratio, we think that the payout ratio will help us to fund some of these expansions that I just mentioned, and we will deploy that reduction in the payout ratio in 2020, not during this year.

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Operator [36]

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Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to management for closing remarks.

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Alberto Castillo Chretin, Fibra Terrafina - Chairman & CEO [37]

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Thank you all for your attention here today. We look forward to speaking with you all again and keeping you updated on the latest developments of Terrafina. Have a good day.

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Operator [38]

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This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.