Fibra Uno

Fibra Uno, short for Fideicomiso de Inversión en Bienes Raíces, is an old acquaintance of ours. We have invested in its shares early last year, together with a few peso-denominated Mexican bonds, after the Trump election.

As everyone knows, Trump´s elections sent Mexican shares and currency down to the dumps. We took advantage of this movement and acquired some shares of the Mexican REIT for a bargain and we were able to realize an overall 22% gain in a very short period of time.

So, fast forward 18 months and here we are, with FUNO´s shares down big time, partially because of AMLO´s recent decision to cancel the plans for construction of a new airport in Mexico City. Mexican bond yields were up on Monday and hit a high not seen for many years – this movement cascaded into Mexican shares and FUNO did not managed to escape. And it shouldn´t, as the company is a play on real estate and real estate is very dependent on interest rates.

FUNO is the largest Mexican REIT, owning more than 550 properties throughout Mexico. It is actually present in every single Mexican state (worth mentioning, Mexico has 31 states), with over 8 million m2 of properties divided in retail, industrial and offices. FUNO is the only Fibra that has an investment grade status.

In terms of GLA (gross leasable area), FUNO´s breakdown is 38% retail, 48.5% industrial and 13.5% office and in terms of revenues, the breakdown is 51% retail, 26.5% industrial and 22.5% office.

Wal Mart is FUNO´s largest tenant, contributing to just over 9% of its revenues. The second tenant comes in at just 3.8%. Their client list is nothing short of great, with names like McDonald´s, Santander, Amazon, Fedex, Bimbo, DHL and Deloitte, to name a few.

The occupancy rate is surprisingly high, standing at almost 95% and office is the segment which has the highest vacancy rate, at 15%. We also have some comfort in the terms, as the average maturity of the leases is 4.5 years. As FUNO´s properties are prime ones in excellent locations, we see no problems in the renewing of the majority of the leases.

Also, something very intelligent (in our opinion) that they do is to rent their properties slightly below the current market rate (yes, you read it right, FUNO prices its properties at 10-15% lower than the market rates) – in case of a bear market – and they have gone through a few over the years – most tenants will not have incentives to leave, so the properties are not vacant.

The rents are inflation-linked and FUNO was able to increase its rents last year above the inflation rate – more precisely, 290bps above it. We like that. Pricing power is very important and FUNO has got it as it owns prime properties throughout Mexico. Besides, the inflation this year in Mexico has been high and we believe we will capture this “additional” yield next year.

FUNO still has room to increase its debt, currently at MXN75.5 billion (US$3.8 billion, approximately). There was an increase from last quarter (MXN72.9 billion), due mostly to another debt issue to finalise the work-in-progress of the new properties mentioned below. As it has to distribute 95% of its profits, the REIT had to recourse to more debt (and equity early this year) to finalize construction and increase its portfolio.

Most of FUNO´s debt is in MXN (61%) and only 39% is USD-denominated. When we say it has only 39% of its debt in USD-denomination, it´s because the company´s revenues are protected against currency devaluation, as the USD-revenue to interest expense is 1.85 (meaning that the company generates US$1.85 of revenue per each US$1 of interest expense). So, a small to moderate devaluation of the peso is not exactly bad for them.

Circa 30% of FUNO´s revenues are pegged to the US Dollar, and this makes it cheaper for American (and other) companies to pay for it. Besides, as we mentioned above, as rents are 10-15% lower than the market, with the peso devaluation, these companies are getting a boost in their results and have less bargaining power when it comes to renegotiating the leases.

70% of the debt is fixed, against 30% floating, but the surprising news is that the unsecured debt is 90% of the total debt – this leaves them room to gear up in case a terrific opportunity arises. Loan-to-value is low, at 32% and the debt-service coverage ratio looks comfortable above 2. Leverage is OK, still has room for more and management wants to use it opportunistically. We like that. The first big debt maturity is due in 2022.

FUNO is developing another 740,000 m2 of properties which should bring over MXN2 billion in additional revenues. Some of these properties will be ready by year-end and should start generating revenue as soon as early 2019 – so we should see an uptick on the dividends very soon. According to management, in the last call, 70% of these properties are already pre-leased. FUNO expenses interest on developments instead of capitalizing them, and we like honesty when it comes to reporting. We believe most competitors capitalize those expenses.

FUNO was founded in 2010 by 2 families, Attié and El-Mann, famous Mexican investors, and they remain owners of FUNO (circa 30%). These families also control Fibra Uno Administración, the company that manages FUNO. There might be a conflict of interest in this position, as the manager earns a fee every time there is an acquisition. But, so far, so good.

FUNO has other sources of income and it´s bringing more revenues to investors. Early in 2007, it entered into an agreement with HELIOS, a consortium of pension funds, to execute the development of the MITIKAH project, in South Mexico. FUNO has invested MXN3.66 billion in the project using already existing real estate, and the pension funds contributed with MXN3.8 billion – FUNO charges a management fee and performance fee for the project.

The team has been together for many years and is very experienced in real estate in Mexico, having gone through many ups and downs in the economy (as you would expect from an emerging market).

The company is buying back shares in the open market and it aims to buy up to 5% of its outstanding shares. It has done 1/3 of the order so far (the CFO has stated that the company has bought back circa 67 million shares of the 200 million authorized) and the program is automatically renewed once the 5% threshold is reached.

The interesting way that they are doing this buyback is through cash generated by the “recycling” of some properties. They are selling some of their assets in which they think they have achieved solid gains and using this cash to buy back shares. As an example, those mentioned properties have been sold for an NAV equivalent of MXN50, whilst the market price of FUNO´s shares is below MXN22. This way, one can look at these transactions and see that they are selling for MXN50 and buying back for less than MXN22! It is an easy way to improve EPS and return capital to its shareholders in an effective manner.

People who have been reading our posts over the last few years know how much we are against the current share buybacks that are happening in the markets – they have been devised to game the market through a false EPS number. In FUNO´s case, it is the exact opposite and the numbers will show it.

Mexico has outperformed emerging market equities year-to-date and domestic risk has increased. It is likely then, that it underperforms its peers – at least in the short-term. We are aware of that.

The risks of our strategy are known to investors. They are the same for real estate companies all over the world, but it´s good to remember that there are earthquakes in Mexico and a real estate company is particularly subject to this phenomena. But Mexico has a new risk, which may cause distress in the markets: AMLO.

The market is still debating about the airport referendum, extrapolating its results into the future and, as expected, extreme conclusions have come up. We are talking about the use of reserves for the government´s benefits (like what happened in Venezuela and Argentina), the extension of president´s term, etc.

So, before we follow the market and extrapolate its vision for what is happening in Mexico now, let´s recapitulate. López-Obrador has run for president a couple of times before and, as everyone knows, both were unsuccessful attempts. He became famous internationally after losing his first presidential election in 2006 by a mere 0.38% of the votes and alleged electoral fraud.

AMLO is a left-wing politician and markets were a bit jittery about it. But we did not see that after this election. AMLO´s party won a majority in Congress (both lower house and Senate) with a proposal to crack down on corruption, reduce privileges, etc. The risk of having a left-wing president and a left-wing Congress is not something to sneeze at. There are examples in Latin America of countries that had a left-wing president and a left-wing Congress and the outcomes were definitely not good.

One could even try to trace a parallel between Lula in 2002 and AMLO in 2018, but we believe Lula suffered a lot of pressure from the market before taking charge and in the beginning of his mandate, whilst the market has been calmer towards AMLO. So, with no pressure, AMLO was “free” to do what he really wanted – at least for now.

The referendum about the airport, per se, was an example of what not to do. An extremely biased event, conducted by the MORENO party (AMLO´s party), with questions formulated in a specific way to get the desired answers, only 2% of the people voted, there was no need for registration (the same person could vote many times), etc, did not go down well with the market.

We could mention many other events, like the construction of 1 or 2 refineries, the speeches (he sometimes posts them on Twitter), the budget, and a few other idiosyncrasies of the new government (minimum wage increase, price control of a few products, etc), but let´s look at the real situation as it stands today.

The situation in Mexico is not one of a crisis and there is no crisis on sight. Mexico is extremely dependent on the US economy, and the US economy, despite being on the 10th year of the so called recovery (meaning that a recession is due), is still doing fine. The inflation rate is a little above its target (3%), the Central Bank has not hiked  rates since June and it will probably have to do it soon – but not by too much (maybe up to 8.5%, from 7.75% currently), the external accounts are OK and the fiscal situation is not horrible.

So we believe the market is getting to see who the real AMLO is and it is not happy about that. Analysts and entrepreneurs are pessimists about the situation and they believe there´s more to come. The participation of foreigners in the Mexican internal debt is relatively big, reaching almost 35%, which may cause concern.

These are the risks and we believe, although very pertinent, that the markets might be a bit stretched to the negatives. Again, the Mexican situation is not that bad and the market might be extrapolating it too much to the downside.

FUNO is trading at 57% of its reported book value (it is, in fact, way less than 50% of its real NAV) and has a quarterly dividend yield of 2.5% (bringing the yearly return to 10%). We believe it is an interesting investment and we get paid 10% per annum whilst we wait for the market to reassess the risks and price it closer to NAV.

This text reflects the opinion of the author and does not constitute a suggestion, recommendation, indication and / or investment advice. No investment decision shall be made on the basis of the information presented herein, and the investor shall be solely responsible for any decision he may make.

The author acknowledges that there are risks associated with the asset mentioned above, including loss of capital, so that it may not be suitable for all investors.

The opinions expressed in this publication are based on judgments and estimates and are therefore subject to change without the need to communicate or update investors about it.

The author has purchased and is engaged in purchasing the asset mentioned in this publication for its proprietary portfolio and / or for the portfolio of clients under his management.


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