Pennsylvania Real Estate Investment Trust
Q3 2019 Earnings Call Transcript

Published: 30 Oct 2019

[Operator:]

Thank you for standing by and welcome to the PREIT Third Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions].I would now like to hand the conference over to your speaker today, Ms. Heather Crowell, Executive Vice President of Strategy and Communications. Thank you. Please go ahead.

[Heather Crowell:]

Good morning, and thank you all for joining us for PREIT's third quarter 2019 earnings call.During this call, we will make certain forward-looking statements within the meaning of federal securities laws. These statements relate to expectations, beliefs, projections, trends, and other matters that are not historical facts and are subject to risks and uncertainties that might affect future events or results.Descriptions of these risks are set forth in the company's SEC filings. Statements that PREIT makes today might be accurate only as of today, October 30, 2019, and PREIT makes no undertaking to update any such statements.Also, certain non-GAAP measures will be discussed. PREIT has included reconciliations of such measures to the comparable GAAP measures in its earnings release and other documents filed with the SEC.Members of management on the call today are Joe Coradino, PREIT's Chairman and CEO; Bob McCadden, our CFO; and Mario Ventresca, our Incoming CFO. Joe?

[Joe Coradino:]

Thank you, Heather, and Mario welcome to the call.Before I begin my remarks, let me take a moment to introduce our incoming CFO, Mario Ventresca. Mario has been with PREIT for 25 years, holding a variety of roles in the organization. Most recently, he led our disposition program and oversaw asset management and operations, helping us to institute a more rigorous process in reviewing transactions. All along he has been an asset to the company and I look forward to working with him as we chart our path forward, welcome, Mario.This is a challenging year to be clear, our strategy is working, our future is bright. Our results this quarter reflect a difficult environment largely as a result of bankruptcies and anchor transitions. We are impacted by $10 million in bankruptcy-related closings on an annualized basis, affecting the year by an incremental $6.5 million over 2018.These tenants can and will be replaced with better merchants. But this can't be accomplished in just a quarter or two. We acknowledge we didn't predict the pace or level of tenant fallout. However, we have taken deliberate and decisive action in situations where tenants were reorganizing and have taken back space favoring short-term vacancy over a long-term commitment to an underperforming retailer at below market rent.Our 2019 results were impacted by an accelerated pace of store closings. We anticipate being back on track for growth in 2020. And with this expect to cover our dividend.We are in a unique position to capitalize on the work we have done and harvest the returns when the capital is invested. We've strengthened our portfolio with a solid line-up of creditworthy new anchors and a diverse tenant mix. Now it's primarily a leasing game, where we’re focused on filling the space impacted by bankruptcy, attracting retailers with our quality portfolio, and high barrier to entry markets.We leased 13 department stores in less than three years. We've brought in a diversified tenancy to allow our customers to do more that suits their lifestyle.In seven years, we’ve transformed our tenant base. Over 50% of our non-anchor space is dedicated to dining, entertainment, health and wellness, and off-price tenants. That compares to just over 25% in 2012.Since our last call, we have changed the face and future of PREIT. We opened our three major projects Fashion District, Woodman Mall, and Plymouth Meeting Mall, two of which will take their places as trophy assets. We've generated traffic growth from the introduction in new tenants. Over 1 million people have visited Fashion District since its opening in September, and traffic is up over 40% at Woodman Mall and over 20% at Plymouth Meeting Mall since their openings.We know that our ability to demonstrate earnings growth and meaningful balance sheet improvement following a multi-year redevelopment program is paramount. And we're keenly focused on driving revenue and improving our balance sheet.With $12 million in signed leases coming online, we’re delivering on our new investments, while at the same time, experiencing erosion in revenue from bankruptcies. With sales in our portfolio at an all-time high, inching closer to 550 per square foot, we expect to benefit from the momentum we have created for the company from the opening of our three major projects.In Philadelphia, we opened Fashion District, a truly new experience in retail and entertainment space. We're looking forward to the opening of catalyst entertainment offerings, and an active holiday season. We just announced the addition of Primark, Kate Spade and Sephora, evidencing the team's ability to secure highly sought after tenancy. The project is 80% leased, with leases out for an additional 6% of the space and a rapidly expanding list of prospects.In light of our early success, the project is oversubscribed with prospects. We’re being extremely deliberate and curating the remaining 15% of the space with brands and experiences that will solidify the project as a truly iconic destination in retail real estate, and a must-see for our 43 million people visiting the region each year.The expansion wing of Woodman Mall formally opened on October 12 with the addition of Von Maur, Urban Outfitters, a new prototype William-Sonoma, local tenants made in Michigan and Paddle North, Black Rock Bar & Grill and Tricho Salon. These tenants will be joined by Cheesecake Factory on November 5, and White House Black market and Sephora in 2020. Tenants are beating sales projections on a strong opening with traffic up over 40%.We will capitalize on the momentum here to generate NOI growth in 2020 as we complete the lease-up of the expansion wing to cement this asset as a top producer in our portfolio, and the leading fashion and dining destination in Western Michigan.At Plymouth Meeting Mall, Burlington, Dick's Sporting Goods, Miller's Ale House, Roll by Goodyear, and Edge Fitness have opened in the locations of the former Macy's named one of the top 10 retail experiences by Change Storage. This new lineup of convenient and sought after tenants will be joined by Michaels, Restored Cryotherapy and Solar Salon in the spring of 2020. Traffic into the mall is up over 20% as these new anchors begin to change shopping patterns and attract new customers, as we anticipated.We expect this will be the next property to add an apartment community further strengthening this award winning project. The completion of these redevelopments will strengthen PREIT’s Foundation and set the stage for a more stable portfolio over the long-term. Our current portfolio benefits again in 2020 from the completion of our anchor repurchasings at Dartmouth and Valley Mall and the opening of Yard House and Studio Movie Grill at Willow Grove Park. We are now poised to attack the leasing of our portfolio in a more aggressive manner using a fresh perspective. The mall is no longer the ubiquitous business model and we have fine-tuned our approach to sourcing local and regional businesses and digitally native brands.We're expanding our new business team, which follows on the heels of having consolidated the specialty leasing team into permanent leasing, which has allowed us to fill 83% of the stores impacted by bankruptcy on a short-term basis and have developed a new approach to filling spaces impacted by impending store closures on a permanent basis.As we look to releasing space impacted by bankruptcies, in light of the extended timeline for delivering the NOI to organically delever our balance sheet, we've modified our capital allocation strategy to reduce spending across all facets of the business and are in the market to source efficient capital, which Mario will cover in his remarks. Mario?

[Mario Ventresca:]

Thanks, Joe.I’m excited and energized by the opportunity to move into the CFO role at PREIT. As a long-time member of the team, I appreciate the confidence the company has shown in me and look forward to a bright future.We were at a tremendous inflection point for our company, as we are positioned for growth across our platform, having been ahead of the portfolio improvement curve, delivering sector leading results on multiple fronts, including dispositions, anchor repositioning, redevelopments, and re merchandising of our properties.As Joe touched on, we've created a dynamic portfolio, one that we're evolving to serve the unique demands of a rapidly changing customer base. We are experiencing strong demand for our well-located and closed regional mall space.Our backlog of executed leases for future openings is significant with 62 tenants, 537,000 square feet, and approximately $12 million of annualized revenue yet to come on to our rent role. We've added retailers such as Burlington, Dick's Sporting Goods, Von Maur, Yard House, Urban Outfitters, which all significantly improved the credit quality underlying our cash flows.As Joe mentioned, we are focused on delevering the balance sheet. We are prioritizing our most efficient capital sources; those that raise the most capital, with the meet the least amount of earnings dilution.On the multifamily land sale front, our significant presence in the Philadelphia and Washington D.C. markets with their strong economic fundamentals and strengthening demographics provide our properties in these markets with several distinct advantages that are being recognized by multifamily developers.As a result, we are currently engaged in a bid process with over a dozen qualified participants through the sale of multifamily land at seven of our properties. We’re encouraged by the robust interest in the properties and expect to document transactions with successful bidders by year-end.Through the normal course of our anchor repositioning and asset redevelopment programs, we have created significant value in outparcel development. Generally, these transactions are triple net long-term leases with solid credit experienced operators. Given today's aggressive valuation for these types of assets, we are in a position to recognize positive cap rate arbitrage, between the trading cap rates for enclosed regional malls and those with a net leased outparcel. This spread is especially pronounced in our secondary market, large trade area dominant properties. With these factors as the current backdrop, we have identified these dispositions as an efficient source of capital and have prioritized them accordingly.We have letters of intent on the sale of three single tenant assets that we expect to close by year-end and with additional transactions that are currently being evaluated.During the quarter, we transferred Wyoming Valley Mall to the special servicer through a deed in lieu process. This transaction is in keeping with our portfolio and balance sheet improvement strategies. Currently, we have no material near-term debt maturities, and have a plan in place to expand our capital base.We have been active in the capital markets during the year having closed on approximately $100 million in transactions with another $10 million under contract. These transactions exemplify the creative approaches we are implementing to manage our balance sheet. They run the gamut from vacant land parcel sales, to creating incremental borrowing capacity by deceiving secured debt in favor of increased capacity on our bank facility, expanding an existing term loan to asset sales, including outparcels and a mortgage that we took back on a non-core asset sale. These initiatives speak to the creativity and focus of our finance team. I am pleased with the progress we have made and look forward to our future.With that, I will turn it over to Bob McCadden.

[Bob McCadden:]

Thanks Mario.Last night we reported FFO of $0.62 per share and FFO as adjusted of $0.23 per share. Non-recurring items accounted for $0.41 per share of FFO in the quarter, $0.38 from the Wyoming Valley transaction and $0.03 from net insurance recoveries.Same-store NOI excluding lease termination revenues was 5.8% lower than that of the 2018 quarter. During the quarter, we saw four tenants including Forever 21, have filed for bankruptcy. In light of F21 scale in terms of store size and presence across the malls throughout the country this filing was particularly impactful to the sector. In our portfolio, they operate 14 stores and 219,000 square feet and generate annual revenues of approximately $6.5 million. Through the end of the third quarter, in total, we had 83 stores impacted by bankruptcies and 454,000 square feet generating approximately $16 million of annual revenues.Compared to last year, lost rent from bankruptcies and associated bad debts was $2.6 million for the quarter. There may be additional store closings and/or rent concessions in the future, as these tenants work to the bankruptcy process and negotiate modifications.Partially offsetting this revenue loss were the incremental revenues generated through anchor replacements and other large format tenants that have opened in 458,000 square feet since the beginning of 2018. In the third quarter, these new tenants contributed about $700,000 of new revenues to the portfolio and $2 million year-to-date. Annualize these new tenants will contribute $5.5 million in new revenues.Occupancy at our same-store core malls showed sequential improvement to 94.4% despite the impact of store closings, as we opened anchor replacements at Plymouth Meeting Mall during the quarter.Average renewal spreads in our wholly-owned portfolio were 9.9%, 13.2% for small shop tenants, and 6.5% for large format spaces. When including leasing transactions from our joint venture properties, renewal spreads for the quarter were 2.2%.Other items impacting FFO results for the quarter include lower NOI from our same-store properties of approximately $2.2 million due to lost revenue from anchor closings and related co-tenancy claims by other tenants and the sale the Whole Foods at Exton.Corporate revenues were lower this year because we sold a Wiregrass mortgage note and terminated a third-party management contract. The 2018 period also included the last tranche of historical tax credit revenues at Fashion Districts.Under the new lease accounting standard, we expensed $1.4 million of previously capitalized internal leasing costs and $4.2 million year-to-date.During the third quarter, we spent approximately $66 million on our anchor replacement and redevelopment program. As of September 30, we had commitments for construction contracts and tenant allowances, including our share of Fashion Districts of approximately $83 million. Those expenditures will be made through the balance of this year and into 2020.In our release last evening, we revised our earnings guidance. We now expect FFO of between $1.37 and $1.44 per share and FFO as adjusted to be between $1.08 and $1.14 per share.Net income attributable to common shareholders is expected to be a loss between $0.31 and $0.38 per share.Key drivers accounting for our changing guidance include lower land sale gains. In light of conducting a more competitive process for the sale the multifamily land, we've listed more bids in the interest of maximizing value, which results in a lower anticipated closing timeline. At the mid-point of our guidance range, land sale gains are now expected to be $4.3 million, a decrease of $5.3 million or $0.07 a share.We also are forecasting lower lease termination revenues. Previously we guided to a mid-point of $3.5 million based on our historical experience and potential lease terminations that were in our pipeline. We now expect lease terminations of approximately $1.5 million a decrease of $2 million or about $0.03 a share.We reduced our same-store NOI guidance due to the impact of additional bankruptcies in the third and fourth quarters, lower than expected revenues from our common area program and delays in the opening of certain stores among other factors.And finally, our guidance was favorably impacted by the inclusion of the gain from the Wyoming Valley transaction.This wraps up our prepared remarks. So with that we will open up for questions.

[Operator:]

[Operator Instructions].And your first question comes from the line of Ki Bin Kim from SunTrust. Your line is open.

[Ian Gaule:]

Hey, good morning. This is Ian on for Ki Bin. Joe, same-store NOI guidance implies a ramp in 4Q, can you just touch on how confident you are with two months left in the year and any other additional color you can provide around that?

[Bob McCadden:]

Yes, I think all three of us mentioned the store openings that occurred in the third quarter that gives us the momentum to carry through to the fourth quarter. And I think we mentioned in the second quarter call, we expect that the impact of the bankruptcies to really peak in the third quarter, which obviously was reflected in our results. We filled a large number of those vacancies created by bankruptcies early in the year with combination of temporary tenants and permanent tenants. A lot of those stores will open -- have opened or will open in the next month in anticipation of the Holiday season.

[Ian Gaule:]

Okay. And then on the additional bankruptcies you mentioned, which retailers caught you by surprise? And have you added any new tenants to your watch list for 2020?

[Joe Coradino:]

Well, I mean, we were obviously surprised by Forever 21. In so far as we had negotiated a deal that we were, we understood we keep them out of bankruptcy and then they filed and obviously all bets were off. So that was the key sort of points that that we were surprised by. I think as relates to a watch list I don't think we want to give a list of names on our watch list, but we continue to monitor a number of retailers and look to replace them as the opportunity presents itself.

[Operator:]

And your next question comes from the line of Michael Mueller from JPMorgan. Your line is open.

[Michael Mueller:]

Hi, couple of questions. I guess, first of all, Joe, when you talk about being back on track for growth in 2020 and beyond, does that statement hold true if we're stripping out the anticipated land sale gains next year and this year, so ex-land sale gains, do you think you still have positive FFO growth next year?

[Joe Coradino:]

Yes, we do.

[Michael Mueller:]

Okay. And then second question, I know, you talked about the traffic numbers at Fashion District. But can you talk a little bit about what you're hearing from the retailers about actual sales versus budgets and just kind of any integral chance so far?

[Joe Coradino:]

Sure. It's mostly, it's mostly anecdotal and color because obviously given its location, we stay close in touch with retailers. But as we mentioned, traffic's been great. Retailers are reporting strong results. During the opening week, 87% of the retailers reported sales ahead of expectations, with some retailers reporting results that were triple and double their initial projections. So all things considered, the property is doing phenomenal business. I am not sure how some of the food operators actually keep enough food inventory to sell to the crowds that are there on, and I'm not joking about that. So businesses -- business at Fashion District always could be better, but it's great.

[Operator:]

Your next question comes from the line of Vincent Tibone from Green Street Advisors. Your line is open.

[Vincent Tibone:]

Hi, good morning. You mentioned some desire to improve the balance sheet, it doesn't sound like mall asset sales are part of that plan. I mean, I'm just curious why is that the case and how do you expect to materially change the balance sheet and leverage profile without asset sales or an equity raise?

[Joe Coradino:]

Well, we did mention that we are doing our outparcel sales as part of improving the balance sheet. But our first and foremost goal is to sell non-income producing assets. And that's the residential land, we think, we have, a real advantage in terms of our -- particularly our Washington D.C. and Philadelphia properties that we have the opportunity to do a significant amount of residential there on unused land. And as a result that that in the outparcel sales are sort of first order of business.We've been in and out of discussions regarding JVs on malls, and we are cap rate sensitive as opposed to cap rate agnostic, which were a little bit more when we were selling off lower quality assets. So it's not something that's off the table. But I think in the order of priority, step one is the residential land. And again, as we mentioned in our script, there has been a robust interest. We have over a dozen perspective buyers bidding for that with 30 buyers sign confidentiality agreements. That's number one.At the same time, we're pursuing some outparcel sales. And as they’re concluded, coupled with a very rigorous effort on minimizing capital expenditures, we will look at where we are and think about what next steps are necessary, if any, to improve the balance sheet because we'll also see a natural de-levering occur as a result of our ramp up of Fashion District and Woodland and Plymouth Meeting and Dartmouth and Valley.

[Vincent Tibone:]

Okay, yes, that makes sense. So few follow-up on that, what is the potential amount of proceeds like rough ballpark you think from let's say, low income producing or no income producing assets that you mentioned like, is it in excess of $100 million, is it something much rather trying to get a sense of how much that could mean --

[Joe Coradino:]

I'm sorry, go ahead and finish.

[Vincent Tibone:]

No, no, go ahead. I'm just trying to get a sense of like, how much do you think you could really raise from the kind of residential group basically like residential land plays or outparcel sales?

[Joe Coradino:]

Well, given that we are asking for best and final offers on residential. I'd rather not get too specific on that but certainly it’s -- it's north of $100 million.

[Vincent Tibone:]

Okay, that's helpful. And then just one more on the JV comment I'm just curious if your conversations have changed over, let's say, the last six months or a year with potential buyers and how they're underwriting malls or how maybe some of the cap rates, you're seeing for maybe, let's say the top half of your portfolio like any color on the private market would be helpful.

[Joe Coradino:]

Well, I think the color I could give you is we're seeing a higher level of interest than we had certainly previously. With regard to cap rates, I don't think I have enough information to provide you with any specificity other than there are more people knocking on our door than certainly six months ago.

[Vincent Tibone:]

Interesting. Who are those -- are you able to share kind of the capital sources there? Is this foreign money, is this U.S. institutions, maybe private equity. I'm just curious, who are the new players in the bidding --?

[Joe Coradino:]

Put checks next to the first two you mentioned.

[Operator:]

Your next question comes from the line of Christy McElroy from Citi. Your line is open.

[Christy McElroy:]

Hi, good morning, guys. Thank you. Just on the resi land. Given that you're closer to a transaction there, is pricing still in line with the expectation that you mentioned a quarter ago about $150 million to $300 million of proceeds. And if you go to documents by year-end, at what point in 2020 would you expect to close?

[Joe Coradino:]

Well, again, Christy, much as I'd like to give you specificity, we are literally going to document -- going to pick horses in the next week or two and are pretty deep into negotiation. So I wouldn't want to specify an amount. We expect to execute documents this year and move to closing next year.

[Christy McElroy:]

Is it fair to say that it's kind of coming in, in line with your prior expectations?

[Joe Coradino:]

Again, I'd rather not get into a specific discussion with you, but we are not unhappy.

[Christy McElroy:]

Okay. And Joe, you commented previously, and I think there's a couple questions on this, that you in the context of your future growth expectations 2020 and beyond, you made the comment that you expect to cover the dividend and I just wanted to sort of understand that comment. I know that some of that near-term will come from asset sales purchase in regard to getting a sense for more recurring operational cash flow. How do you sort of weigh the pros and cons of maintaining the payout at this level which right now is pretty well above AFFO or FAD on a recurring basis and sort of on that basis at what point would you expect to cover your dividend with operating cash flow?

[Joe Coradino:]

So, as we've said, we expected to reach our peak, which were currently experienced. Our fourth quarter does see improvement to our current FAD payout ratio. And with the $12 million in leases coming online and SDP stabilizing based on the information we have, we're expecting to fully cover the dividend in 2020.

[Christy McElroy:]

With operational recurring cash flow and that that includes land sale gains generated from the transaction right?

[Joe Coradino:]

They were from operational cash flow including land sales.

[Christy McElroy:]

Okay. Just lastly, you've looked into the sale of your JVs stakes in the Power Centers in the past. Just with some liquidity coming back in the market for Power Centers, is this something that you would consider again, just in the context of your comments on asset sales?

[Joe Coradino:]

Sure. We are always looking for creative ways to raise capital. So as far as we're concerned, the Power Centers, our interest in new Power Centers are for sale, as -- as we've talked with you before about, there's a certain complexity associated with that. In terms of the nature of the buy cells, without digging too deep into that, that's been somewhat problematic. Those deals go back to actually before the merger of the Rubin organization in PREIT. So they're not necessarily optimal from our perspective.

[Operator:]

Your next question comes from the line of Caitlin Burrows from Goldman Sachs. Your line is open.

[Caitlin Burrows:]

Hi, good morning. Maybe just one other quick one on the land sales, if you can say how many different separate transactions you're expecting whether it's all one big one or multiple?

[Joe Coradino:]

Caitlin, that’s a good question. We're going to do the number of transactions that maximizes the value of the land that we're selling. Just sort of generally answer to that question, it could be one buyer, it could be as much as three.

[Caitlin Burrows:]

Got it. Okay. And then another follow-up on the dividend, I guess you mentioned in the earnings release creatively addressing the balance sheet. So I guess with respect to the dividend in particular, how willing are you guys to creatively address the dividend going forward and create one-time liquidity such as land sales versus something that was potentially more organically sustainable? And what metrics would you be looking at to know that you're at a organically sustainable level?

[Joe Coradino:]

I don't understand the question.

[Caitlin Burrows:]

So you mentioned that in 2020, the dividend is going to be covered and land sale contributions are going to contribute to that, but that's more one-time in nature. So then if we go out to like 2021, what metrics do you think we should be looking at to know if the dividend is still sustainable?

[Joe Coradino:]

We -- we cover in 2021.

[Caitlin Burrows:]

On cash flow?

[Joe Coradino:]

Yes.

[Caitlin Burrows:]

Okay. Then I guess moving to Forever 21. I know in the past, you guys had mentioned that the size of your stores was smaller, so the expected impact was going to be smaller. Obviously, some things have changed since then. So I guess, thinking about the potential timing of the impact there. When do you think you will be impacted by closures or rent adjustments?

[Joe Coradino:]

Well, we're in the midst of negotiating with them right now. I mean, it's when I sit right now like every day. So I'd rather not get into too much detail, only to say that one of the impacts from it will be that we're going to look to take some stores back primarily because we have tenants to replace them, which is new and different than it was before. And obviously there's also going to be in the remaining stores, some rent release involved.

[Caitlin Burrows:]

And then in terms of Destination Maternity, could you just say what your exposure there is and the outlook for those locations?

[Joe Coradino:]

We have two stores, so it's pretty -- one is in a joint venture, so I guess if you wanted me to be really specific, I have one-and-a-half stores.

[Caitlin Burrows:]

Got it, okay. And then last topic is just on debt covenants. I think there's multiple ratios that are nearing some of the limits including consolidated liabilities to gross asset values. So given the now, expected receipt of land sale proceeds in 2020, where do you expect those metrics to trend over the next several quarters and what happens if you do cross one of those requirements?

[Bob McCadden:]

So Caitlin, I think we've probably communicated for at least a year that we'd expect that the fourth quarter of 2019 to be the peak stress period for most of the covenants. So we would expect, again with the income coming online and land sale gains in 2020 expected actually see those ratios improve over the next couple of quarters. So at this point, we don't anticipate breaching those any of those covenants.

[Operator:]

And your next question comes from the line of Michael Mueller from JPMorgan. Your line is open.

[Michael Mueller:]

Hey, I tried to get out of the queue and just couldn't figure out how to do it. So I'm good, thanks.

[Operator:]

And there are no further questions at this time. I will turn the call over to Mr. Coradino for some closing remarks.

[Joe Coradino:]

Thank you. Thanks for turning the call back to me and thank you all for being on the call. But before I end the call, I want to take a moment to thank Bob McCadden for his 15 years with the company. It's been quite a ride. I tell people I've traveled more with Bob McCadden than most anybody on various NDRs and Investor Conferences. And I really want to thank him for being a partner along the way and working as a true professional to transition the role of CFO to Mario Ventresca. So thank you, Bob.

[Bob McCadden:]

Thank you all.

[Joe Coradino:]

With that, I will end the call. See you all in LA.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.