Pennsylvania Real Estate Investment Trust
Q1 2013 Earnings Call Transcript

Published: 23 Apr 2013

[Operator:]

Good day, ladies and gentlemen thank you for standing by. Welcome to the Pennsylvania Real Estate Investment Trust First Quarter 2013 Earnings. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions) I would now like to turn the conference over to Ms. Heather Crowell. Please go ahead, ma’am.

[Heather Crowell:]

Thank you, and good morning, everyone. During this call, PREIT 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, April 23, 2013 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. It is now my pleasure to turn the call over to Joe Coradino, CEO of PREIT.

[Joseph F. Coradino:]

Thank you, Heather. Welcome to PREIT’s first quarter 2013 conference call. I cannot remember a year beginning with this much activity for our company. We had a strong quarter. We delivered solid operating results, sold non-core assets, acquired an integral piece of real estate as a vehicle for future growth, refinanced property-level debt, visited with 27 existing and potential investors on four non-deal roadshows and last week executed a new corporate credit agreement. As you can see, we continue to make progress on the strategic objectives we previously outlined; balance sheet improvement, operational excellence, elevating portfolio quality, and positioning for growth. The new credit facility validates everything we’ve been doing. Our successes are building on one another. Before we get into the details, let me provide you with our scorecard for our 2013 operating goals. Goal 1; reduce bank leverage to less than 60%. Today we sit at 55.3%. Goal 2; increase comp store sales above $400 a square foot. Today we are $381 per square foot. Goal 3; drive non-anchor occupancy over 90%. Today we sit at 89.9%. Consistent with our expectations, the majority of our occupancy gains came from our core growth group of properties. Goal 4; generate same store NOI growth in excess of 2%. During the first quarter we exceeded our goal at 2.6% and achieved 3.5% growth, excluding lease terminations. Goal 5; achieve renewal spreads greater than 3%. Q1 renewal spreads were 4.9%. We are making meaningful progress in all areas of our business. Our first quarter performance was impacted to an extent by modest sales increases, driven by mixed economic indicators, including improving employment, housing consumers’ access to capital. These positive factors were tempered by unseasonably cold weather in our markets, payroll tax increases, concerns over the international economy and shift in consumer confidence. So while the consumer continues to shop, we expect moderate sales growth for the balance of the year. In the aggregate, we sold three properties for $123 million, with another under contract for $75 million. These transactions helped to improve the quality of our portfolio, while at the same time serve to reduce our leverage. Not only did our metrics improve as a result of these dispositions, but they allow us to have more balanced discussions with retailers and to prioritize our capital needs going forward. We also brought two additional assets to markets; South Mall in Allentown, Pennsylvania and Beaver Valley in Monaca, Pennsylvania. We’d previously removed Beaver Valley from the disposition target list, but have seen positive economic development from Marcellus Shale and believe now is the appropriate time to capture the value and sell this asset. Last week we acquired 907 Market Street, the final piece in an assemblage of three blocks of real estate in downtown Philadelphia, at the confluence of the Transit Center, the Convention Center and the Historic District in the fastest growing residential CBD in the U.S. and one of the largest employment markets in the country. It’s important to note, we are approaching the potential redevelopment of the Gallery of Market East in a careful and measured fashion. We’ve been studying both successful and unsuccessful urban developments throughout the country and analyzing the data in order to understand the potential for this project. Obtaining tenants, securing public funding and most importantly, underwriting a project with appropriate risk adjusted returns are all prerequisites standing redevelopment at this site. Not withstanding the potential redevelopment based on the purchase price of under $140 per square foot, we believe there is upside to this asset, particularly with the Kmart lease expiring in August of 2014. On the capital markets front, the major news is last week’s announcement related to the execution of our new credit facility. We’re very happy with the terms we are able to secure in this transaction and believe that the 14 participating banks recognize the improvements we have made from a portfolio, operational and balance sheet perspective. Noteworthy terms of the transaction include a move from secured to unsecured, an increase in the facility amount to $400 million including an accordion feature up to $600 million, an initial term of three years with the right to two one-year extension options, an interest rate of LIBOR plus a range of 150 basis points to 205 basis points depending upon the Company’s leverage. As a result, we see immediate 95 basis points borrowing rate reduction. The cap rates used to calculate Gross Asset Value are as follows; 6.5% for properties with sales per square foot of more than $500 and 7.5% for all other properties. The results of this transaction in other recent debt repayments have yielded a bank leverage ratio of 55.3% as of the end of the quarter, surpassing our near-term objective of 60%. We also refinanced $230 million in property-level debt so far this year. On those transactions we reduced our average interest rate by 150 basis points to 3.93%. We also repaid the mortgage on Moorestown Mall, which is unencumbered today. In the first quarter, we drove leverage down, generated same-store NOI growth, delivered positive renewal spreads, and increased occupancy. We believe these accomplishments provide a platform for achieving our vision for PREIT, one with a strong balance sheet, a quality portfolio with a presence in major market and consistently strong operational performance. We are looking forward to next month’s ICSC convention in Las Vegas with attendance expected to exceed 2012 levels. We anticipate a productive meeting. We have a long list of appointments with national and international retailers with a robust open device. And with that, I’ll turn the call over to Bob McCadden, to give you more color on the financial performance of PREIT for the first quarter and our revised 2013 guidance. Bob?

[Robert F. McCadden:]

Thank you, Joe. It’s been a very productive quarter and I’m pleased to report the details. Our team is focused on improving our Company’s performance as evidenced by our first quarter numbers and our upward revision to 2013’s FFO guidance, which I’ll touch on later. With that as a backdrop, I will now provide you with the details of our first quarter results. FFO, as adjusted, was $25.9 million or $0.44 per diluted share for the quarter ended March 2013, reflecting net adjustments of $1.7 million for employee separation expenses, the accelerated amortization of financing costs and interest rate hedging gains. This compares to $25 million or $0.43 per diluted share during last year’s quarter. Same store NOI for the first quarter was $67.2 million, a $1.7 million or 2.6% increase over 2012’s first quarter. Excluding lease termination revenue, same store NOI was $67 million, which was a $2.2 million or 3.5% increase over the prior year’s quarter. A number of factors impacted our operating results for the quarter, including the sale of the two malls and one power center. These property sales resulted in gains totaling $33.3 million in the 2013 quarter. The sold properties in Christiana Center, which is under agreement of sale, generated $3.6 million of NOI in the first quarter of 2012 and $1.3 million in the March 2013 quarter. The improvement in same store NOI resulted primarily from increased rental revenues driven by improvements in occupancy and higher average rental rates. As of March 31, 2013 non-anchor occupancy on our same-store retail properties increased by 220 basis points to 89.9%, while total retail occupancy increased by 170 basis points to 93.4%. Average gross rents for small shop tenants in our same store mall properties were up 1.2% as compared to in place rents as of a year ago. Our operating margins were impacted by a $1.3 million or 10% increase in real estate taxes and a $500,000 increase in snow removal costs. In the quarter, we recorded employee separation costs of $1.3 million, accelerated the amortization of $900,000 of deferred financing costs, had a gain or a hedging effect in this of $500,000. The net impact of these items was $0.03 per share. Interest expense for the quarter excluding various charges and credits was $30.3 million or $4.2 million lower than last year’s quarter. This improvement reflects lower average borrowings and lower average rates. Average borrowings were $265 million lower than last year and the effective interest rate on our borrowings during the quarter was 5.78%. Outstanding debt at the end of the first quarter, including our proportionate share of partnership debt, was $2.04 billion, a decrease of $324 million from March of 2012. After taking into account the mortgage financings completed in the first quarter and a lower rate found at the new credit facility, our factored interest rate on current borrowings is approximately 5.3%. At the end of the first quarter, 92.4% of our debt had fixed rates over swap to a fixed rate. This year’s quarter included dividends on preferred shares of $4 million related to the 2012 preferred share issuances. G&A expenses for the quarter were $8.9 million, which represented a $1.0 million reduction from last year’s first quarter amount. The lower level of G&A expenses reflects reduced headcount and other corporate cost savings. On the leasing front, we executed 96,000 square feet of new non-anchor transactions and 217,000 square feet of non-anchor renewal transactions. For these renewals we generated an increase of 4.9% compared to expiring gross rents. We have completed fewer non-anchor renewal transactions as compared to the first quarter of last year driven by the increased term on our renewals that has significantly reduced the number of tenants in Holdover. On the anchor and box front we executed two renewals for 96,000 square feet with a combined uplift of 5%. We have been notified by Steers that they will not renew their lease at New River Valley Mall in Christiansburg, Virginia. We have signed a Letter of Intent with a notable national anchor to replace them and anticipate a fourth quarter 2014 opening. Comp stores sales continue to improve and were $381 per square foot at the end of the quarter. We have six properties reporting sales of over $400 per square foot and are particularly pleased with the continued growth of our Cherry Hill Mall, which now post sales of over $644 per square foot and Willow Grove Park where with the openings of Nordstrom Rack, J.C. Penney and Apple have driven traffic and consequently sales, which were up 3.8% to $410 per square foot. If we exclude the non-core mall properties, which are being market for sale, sales per square foot would have averaged $392. We are increasing our earnings guidance for 2013 to give effect to improved NOI growth, the purchase of 907 Market Street and interest savings resulting from the new credit facility. We expect the GAAP earnings per diluted share will be between $0.81 and $0.89. Including the expected gain on the sale of Christiana Center, we expect FFO per diluted share to be in the range of $1.96 to $2.04 per share and FFO as adjusted to be in the range of $2 to $2.08 per share. To arrive at FFO as adjusted, we anticipate additional employee related separation costs of $1 million in the June quarter in addition to the FFO adjustments overly reflected in the first quarter. The assumptions underlying our revised earnings guidance are generally consistent with those set forth in February. Aside from the completed 2013 sales of Paxton Towne Centre, Phillipsburg Mall and Orlando Fashion Square, the purchase of 907 Market Street and the pending sale of Christiana Center, our guidance does not contemplate any other material or property dispositions or acquisitions. In addition, our guidance does not assume any capital market transactions. With that, we’ll open it up for questions.

[Operator:]

(Operator Instructions) And our first question comes from Daniel Busch with Green Street Advisors. Please go ahead.

[Daniel J. Busch:]

Thank you. Just looking at the leasing activity for the quarter, it looks like about 100,000 square feet were signed. I was looking at the tenant improvement. It looks like it was about 20% of the gross rent. That seems a little bit higher than in the past quarters. Can you give us a little color on what type of tenant or what type of leases were signed during the quarter and why that TI is a little bit higher?

[Joseph F. Coradino:]

The simple answer to the question is it’s just primarily restaurant driven. There were several restaurants signed during the quarter. In addition, a couple of the restaurants were actually building new GLA, expansion GLA, but the cost of that expansion is included in the tenant allowance number.

[Daniel J. Busch:]

Okay. And then, looking at the lease exploration schedule, I don’t know if I’m missing something, but the lease is set to expire in 2012. In prior they went from 3.7%, I guess, last quarter up to 6% this quarter, won’t make that number increase and I guess following up on that is, what’s going on with the leases that have already expired and how you guys are addressing that?

[Joseph F. Coradino:]

The reason what happened in the last quarter is that effectively we had a lot of leases that expired in the January 31 time period. So if you look at our history of Holdover leases, they typically have been, if you were to go back to March of 2012, same period, comparable period, we had 941,000 square feet of leases in Holdover and generally typically relate to portfolio transactions, many leases and there we are negotiating as part of a package which may include leases that have yet to expire. So if you look at that we’re down about a third from where we were a year ago on a comparable basis. We’ve about a third less leases in Holdover.

[Daniel J. Busch:]

Okay. So we should look over year-over-year as opposed to the sequential.

[Joseph F. Coradino:]

Right.

[Daniel J. Busch:]

Okay. And then finally, I don’t know if you mentioned it Bob, but Christiana Center still is being held for sale. What’s holding that transaction up and going through?

[Robert F. McCadden:]

Yes, essentially it’s financed with the CMBS mortgage. So it’s up to the CMBS mortgager to approve the assumption of the mortgage. It should be, I would think, within the next two, three weeks the way we have their approval and we’re anticipating closing some time around mid-May.

[Daniel J. Busch:]

Okay, great. Thanks guys.

[Operator:]

Our next question comes from Ben Yang with Evercore Partners. Please go ahead.

[Ben Yang:]

Hi, good morning, thanks. You guys have made some positive comments on Plymouth last quarter, specifically that financing is available for the right buyer. Is that still the case today, it really in light of them recently with J.C. Penney?

[Joseph F. Coradino:]

Yeah, from our perspective it is still the case. Obviously we sold two malls that had the J.C. Penney as a tenant, and I think while the story for J.C. Penney, you could put a negative spin on it. I think to an extent you are seeing the potential for the success of J.C. Penney. I feel more comfortable now than I felt previously and I think buyers are not showing the way. We now have two additional assets on the market for sale and we’re optimistic.

[Ben Yang:]

So you feel more comfortable about J.C. Penney of that base or maybe some recent conversations we had with the new management there or is it based on (inaudible)?

[Joseph F. Coradino:]

We have had recent conversation with them, but that’s not what it’s based on. It’s based on really, I got to know Mike Ullman when he was running J.C. Penney previously. When you think back he is really the guy behind Sephora, he is the guy behind Mango. I mean he really started the shop-in-shop concept. My sense is that one; and he can sit through some of Ron Johnson’s ideas around shops-in-shops and pick the best from that, from that group, the Home Store, et cetera, Joe Fresh, et cetera number 1, I think. Number 2, though that he is a merchant and I think he is focused on a) energizing the workforce, getting newer capital structure a little more stable to be able to execute this plan. So I feel better about J.C. Penney given some of the particulars I’ve reviewed with you and I think the capabilities of Mike Ullman.

[Ben Yang:]

Okay. Fair enough. Sticking on J.C. Penney, are there main cotenant for some of the other department store anchors and maybe some of the retailers had involved or are they typically not a main cotenant?

[Joseph F. Coradino:]

It depends on obviously more in the particular center, but in some centers we have them as a main cotenant.

[Ben Yang:]

I mean, do have any thoughts on just throughout the entire portfolio, how much occupancy and rent might be at risk based on the co-tenant inside the J.C. Penney?

[Joseph F. Coradino:]

Yes, Ben, we don’t have, I mean, I don’t know if I can give you that specifically, but, we’ve talked about New River Valley Mall as a place where we’re going to lose this year, and using that as a proxy for other properties in the portfolio we’d probably be looking, if we didn’t replace that anchor about a $300,000 impact to reduce rents on that property. That might, again, serve as an illustration of what impact it might have.

[Ben Yang:]

Okay. Fair enough. I know it’s hard to quantify now, but would you say that risk might be contemplated as a level, your mall at this point or is it kind of spread out through even maybe some of the premier properties again in the portfolio?

[Joseph F. Coradino:]

Actually, Ben we’re having a hard time hearing you, I guess you’re on speaker phone.

[Ben Yang:]

No, can you hear me now?

[Joseph F. Coradino:]

Yeah, we can hear you.

[Ben Yang:]

Sorry about that. Yeah, if I want to quantify specially but can you maybe generally say that co-tenancy risk contemplated at the low end of the portfolio or just kind of (inaudible).

[Unidentified Company Representative:]

Michael, go ahead and put your speaker on.

[Joseph F. Coradino:]

I don’t think it’s particular to the lower end. I think it’s hard to say at this point, but that doesn’t strike me as being specific to the lower end.

[Ben Yang:]

Okay. And then, just final question, is your same store guidance, is that unchanged, is it still 1.5%, 3% at this point or have you revised that at all?

[Robert F. McCadden:]

Yeah, I think we’re probably skewing towards the higher end of that range.

[Ben Yang:]

Okay, great. Thanks guys.

[Operator:]

(Operator Instructions) Our next question comes from Michael Mueller with JPMorgan. Please go ahead, sir.

[Molly McCartin:]

Hi. It’s actually Molly on for Mike, and just one quick question. Can you guys walk through the next step for the Gallery and if there is any timetable associated with that?

[Robert F. McCadden:]

Well, as we mentioned on the call, we’re pretty happy that we’re able to acquire the sort of last piece of the puzzle if you will in 907 Market. At this point, we believe we’ve got a great piece of real estate given some of the particulars surrounded with Philadelphia’s growth trajectory from a residential perspective, and the fact that it sits between the Convention Center and the Historic District over the Market East train station, delivers about 18 million to 19 million commuters a year in and out of the Gallery. So having said that, our real goal right now is step one; we’ve got to identify tenants, right. Any transformation or any re-development of the Gallery is going to require that we execute transactions with key anchor tenants, so there is an effort around that right now and we will be highlighting the Gallery and focusing on it in Las Vegas. The other pieces of the puzzle that are being worked on right now include a public financing, working through public financing. We’ve received, at this point, in excess of $30 million in public grants. We see that number, necessary number probably being upwards to triple that number and that’s being worked on right now. So the point of it or the point all is that we are in the preliminary stages around, it’s driven by tenancy, financing, and really moving forward when we have a comfort level that we can deliver the kinds of returns that we need to deliver based on having executed deals with tenants to occupy the property.

[Molly McCartin:]

Okay, great. That’s all for me. Thanks guys.

[Joseph F. Coradino:]

Thank you.

[Operator:]

Our next question comes from Quentin Velleley with Citigroup. Please go ahead.

[Quentin Velleley:]

Hi. Good morning. At the Investor Day, you spoke about a possible opportunistic equity rise to delever. I know you’ve been reaching a lot of your goals in terms of asset sales and you’ve got the other assets on the market and FFO guidance doesn’t appear to have an equity rise in it, but I guess for shares above $19 is an opportunistic equity rise still on the table or you’re really not thinking about that at the moment?

[Robert F. McCadden:]

Well, take a step back for a moment, Quentin. We’ve made significant progress in reducing leverage at this point depending upon how you look at leverage, but if you had to market cap at Gross Asset Value, but if you look at it the debt plus preferred/EBITDA, we’re pretty much in line with our peers, if you look at the recent Green Street. So we’re at 8.1, GGP is at 9, RAS at 8.2, Glimcher 7.8, Macerich 8.1. Having said that we want to continue to de-lever, we think we’ve got a couple of tools at our disposal, right, clearly improved operating performance, asset sales and certainly the point you mentioned around equity and we’re going to continue to monitor the market and be opportunistic in considering when we go to the equity market.

[Quentin Velleley:]

Okay. Perfect. Thank you.

[Operator:]

Our next question comes from Nathan Isbee with Stifel. Please go ahead.

[Nate Isbee:]

Yeah. Hi, good morning. Just going back to the Gallery of Market, I know it’s still early in the process. Can you talk about from a dollar perspective what you’re looking at in terms of growth of this project, incremental dollars?

[Robert F. McCadden:]

Hi, Nate. It’s a little too early to start to talk about that and go back to the comment I made around tenancy. A lot depends on what kind of tenant we end up securing, which helps to define the project. For instance, if we were to secure a high-fashion luxury department store as an anchor that would end up having it be one kind of a project. Conversely if we were to secure more of a discount or popular price department store or some kind of a non-traditional retail anchor, large food market et cetera. They would really define the project differently. It would impact the capital spend fairly dramatically. So I think at this point it would be premature to start putting numbers out there.

[Nate Isbee:]

Okay. And as you look at the Kmart box, is there any scenario where you’re tying that up or are you pretty sure that you’re going to be picking that as a traditional anchor for that whole part?

[Joseph F. Coradino:]

Yeah, actually that’s one of the comments we made in the script. The Kmart comes available in August, the 14 and under several of our scenarios it’s a breakup, right. It’s a breakup where we could realize significant increased rent as a result of taking a department store rent sitting in the low single-digits, and trying to get into a rental stream more consistent with an in line more rental stream that’s [now new]. If you look at average rent in the Gallery right now, we’re north of $40 a foot. So they’re breakup. Given the fact that it’s a middle box, right, I think it blends itself more to a breakup because as a department store you have to lock. There’s no control point. You have an entrance on the street and two mall entrances in the middle. So, we think a breakup is more appropriate. That’s where we’re heading. Now it’s huge anchor tenant step forward and so they take the box. We might change our mind, but right now, we think it’s more valuable card up.

[Nate Isbee:]

Okay. I guess it’s safe that you are not presenting the [same though]?

[Robert F. McCadden:]

Well, certainly not in any kind of a long-term basis. Again, we’re being careful and measured about this. August 14 is not that far away. We don’t think we are going to renew it, but we might renew it for a year, right. We might give him a Holdover over some period of time. But ultimately we want to get that box back. They have no options.

[Nate Isbee:]

Do you have any sense of what type of sales Kmart does at?

[Joseph F. Coradino:]

I don’t. I don’t. I’ve been told it’s a good store for them, but I’m not aware of what their sales are. They don’t have a duty to report.

[Nate Isbee:]

Okay. Thank you so much.

[Joseph F. Coradino:]

Thanks Nate.

[Operator:]

There are no further questions in the queue at this time. Mr. Coradino, please continue.

[Joseph F. Coradino:]

So, thank you for calling in today. We truly enjoy being with you on the call. We continue to execute on our strategy and are making very meaningful progress toward our 2013 goals. We’re committed to continuing to improve our portfolio metrics, close the NAV gap, expand our multiple and drive shareholder value. We look forward to seeing many of you at ICSE, NAREIT and invite you all to our Annual Meeting in May. Thank you very much.