Washington Prime Group Inc.
Q3 2017 Earnings Call Transcript

Published: 26 Oct 2017

[Operator:]

Good day, ladies and gentlemen and welcome to the Q3 2017 Washington Prime Group Earnings Conference Call. [Operator Instructions]. Also as a reminder, this conference call is being recorded. I'll now like to turn the call over to your host, to Lisa Indest. You may begin.

[Melissa Indest:]

Good morning and welcome to WPG's third quarter 2017 earnings call. During today's call, we will make certain forward-looking statements as defined by the Federal Security laws. These statements relate to expectations, beliefs, projections, plans, and other matters that are not historical and are subject to the risks and uncertainties that might affect future events or results. For a detailed description of these risks, please refer to our earnings release and various SEC filings. Management may also discuss certain non-GAAP financial measures. Reconciliations of each non-GAAP financial measure to the comparable GAAP measure are included in our press release, supplemental information packet and SEC filings, which are available on the Investor Relations section of our website. Members of management with us today are Lou Conforti, CEO, and Mark Yale, CFO. Also on the call to join us for Q&A, following prepared remarks, are Paul Ajdaharian, Head of Open Air Centers; Josh Lindimore, Head of Leasing and Gregory Zimmerman, Head of Development. Now I'll turn the call over to Lou.

[Louis Conforti:]

Thanks, Lisa and good morning everybody. Third quarter was best illustrated by several financial, strategic and operational actions, which strengthened our balance sheet, furthered our objective of tenant diversification and advanced our hybrid town center mandate, which now constitutes 70% of the assets we describe as enclosed. Occupancy was basically flat for the third quarter at 92.3%, albeit a 1.4% decline in comp NOI warrants further explanation. So let me take a shot at it. The decline was primarily attributable to previously reported bankruptcies and quite frankly, a judiciousness on our part to focus upon those tenants whose presence actually benefits our assets. I will talk a little bit about -- more about that in a moment. Breaking it down, comp NOI growth for Tier 1 assets decreased by just 60 basis points. Open Air, Paul, once again rocked it, increased 3.4%, and Tier 2 decreased 9.1%. While any shortcoming whatsoever, as you guys who know me, drives me crazy, as long as it's within an anticipated minimal variance and results from our being deliberate about properly curating tenants, I am confident our measured approach is going to serve our assets, our tenants and our shareholders in the long run. It's important to emphasize our stability over that long run. Comparable NOI, from 2014 through 2017, has changed by less than 1%, notwithstanding, and this might be master of the obvious, a very difficult retail environment. Occupancy releasing spreads -- releasing spreads and tenant allowance have been as flat as a pancake during this time frame, and our average lease term has been in excess of 7 years during each reporting period. Our bottom line is simple, stable leasing volume, lease terms, tenant allowances and rental rates equate to stable cash flows. Second, and as important, we are transforming our retail venues into hybrid town centers that matter. And my comment about deliberate -- about being deliberate when it comes to curation, it's just not lip service. Through my 16 months here, 1 fact has become glaringly evident. Our resources, which includes both time and money, are better spent for those tenants which serve to invigorate our assets. Make no mistake, and kudos for Josh and Greg and Paul and everybody and thank you all -- this might only just take a second, thank you everyone at WPG who works and are behind for us. We leased a heck of a lot of space, 3 million this year as of September 30. And as importantly, 48% of it was to lifestyle-oriented tenancy. What we will not be doing is taking the easy way out by accommodating undifferentiated tenants in over-concentrated categories. We continue to address our Tier 2 assets in a no-nonsense fashion. We handed the lender back the keys to Valle Vista Mall, whereby a $40 million mortgage was extinguished. We agreed to sell Colonial Park Mall for $15 million, as Greg and his team couldn't justify marginal capital spend. We also negotiated a $55 million discounted payoff of the mortgage collateralized by Southern Hills Mall, an asset of Tier 1 quality, which was hampered by excess leverage of nearly $100 million. In effect, we bought this dominant secondary market asset for a 13.5% cap rate, which was a 600 basis point improvement over its leverage yield of 7.5% while it was encumbered. Another transaction which evidenced our ability to act upon arbitrage opportunities was the sale of outparcels leased to restaurant operators for proposed contract for proceeds of $67.2 million. This sale equated to a mid-6% cap rate. The company also continued to strengthen our balance sheet and demonstrate access to capital, as is exhibited, and thanks to Mark and Lisa, by our $750 million 7-year senior unsecured notes issuance. As we previously stated, it was imperative to address the financial wherewithal of the company and we have accomplished this mandate with minimal dilution. Redevelopment continues according to -- continues according to schedule and on budget, and I can only tell you that Greg Zimmerman and Eric and our entire construction and development team just continues to perform above and beyond. We currently have 61 active projects underway, ranging between $1 million and $16 million. Our 9.5% direct return on invested capital threshold on these projects is absolutely intact and we actually expect these transformative projects to add even more value when the derivative impact is taken into account. i.e. breathing life into a haunted corridor, beleaguered by a zombie, you guys can fill in the blank. It only inures to our benefit when we are able to revitalize an asset via a prudent redevelopment. Last, new initiatives are also well underway. Our eCommerce platform, Tangible, is now under construction and should be operational in the first 4 assets during the fourth quarter. Our Shelby's candy store joint venture likewise. Our first common area local craft brewer is opening within 30 days. In addition, other common area utilization, including entertainment and food and beverage are all moving forward. I really believe that a common area utilization is going to be the Holy Grail of this business we're creating and viewing dynamism and kinetic versus static. And every time we do something interesting, the immediate results pursuant to guest count, to guest traffic, is measurable. It's important to note, we're accomplishing these -- the aforementioned, this common area stuff, with minimal capital and we expect these initiatives to not only be profitable, they are going to serve to reinvigorate our asset. Our message, as always, it's straightforward. Protect our shareholders from industry volatility with a rock-solid balance sheet; respect our demographic constituencies by not offering the same old same old; focus on dominant secondary marketplace assets; make common area anything but common and as always, grind it out. Thanks. And Mark, you are up.

[Mark Yale:]

Thanks Lou, and good morning to everyone. Let's now move on to a review of our balance sheet, where we had another solid quarter with respect to reducing leverage, and enhancing the company's overall liquidity. We finished the quarter with over $70 million of cash on hand, including our pro-rata share of our JVs and $900 million of capacity on our undrawn credit facility, giving us nearly $1 billion of available liquidity as of September 30, 2017. Subsequent to quarter end, we transitioned Valley Vista Mall to the servicer, executed on a $55 million discounted payoff on Southern Hills, an unencumbered Westshore Plaza, a Tier 1 enclosed property in the Tampa area. Accordingly, as we look at our upcoming mortgage debt maturities, we only have approximately $20 million, encumbering 2 open air centers coming due through the end of fiscal year 2018. In August, we also executed on a successful $750 million senior unsecured notes issuance, in which the net proceeds were used to take out shorter-term unsecured bank obligations. Accordingly, we were able to extend the average weighted maturity of our unsecured debt by over 1.5 years when compared to the end of the prior quarter. We'll make even further progress when coupled with the expected recast and extension of our credit facility and related 2015 term loan, which is currently in process. With respect to our overall leverage position, the company's net debt-to-EBITDA was around approximately 6.5x as of quarter end. When factoring in the Valle Vista give-back and the Southern Hills discounted payoff, we're expecting the ratio to fall to within 6.3x to 6.4x range by year-end. Finally, we continue to improve the quantity and quality of our unencumbered pool. By adding West Shore and Southern Hills to the group, we currently have nearly $320 million of NOI being generated from unencumbered properties, or 57% of our total property NOI. Additionally, over 80% of our unencumbered NOI is from the open-air centers and Tier 1 enclosed properties. Now let me turn to our quarterly financial results. Our FFO for the third quarter was $0.37 per diluted share. When neutralizing for the additional interest expense associated with the August unsecured bond offering, our reported FFO per share would have fallen within our guidance range going into the period. We did see NOI performance below our expectations for the quarter, driven primarily by 2017 bankruptcy activity and a downward adjustment to our real estate tax recovery estimates for the year. In yesterday's earnings release, we did formally update our FFO guidance for fiscal year 2017 to a range of $1.63 to $1.67 per diluted share. We had previously disclosed that the incremental interest expense from the August bond offering would result in $0.04 of additional dilution in 2017. This impact was partially offset by the positive contribution of now retaining Southern Hills via the discounted payoff, resulting in net $0.02 reduction at the mid-point of our previous guidance. We also introduced FFO guidance for the fourth quarter 2017 in the range of $0.44 to $0.48 per diluted share. The company is now expecting comparable NOI to decrease no more than 1% over full year 2016, reflective of the current bankruptcy environment, which we believe has peaked when considering the high level of activity over the last 18 months. This implies 4% growth from our open-air portfolio and close to flat performance from our Tier 1, resulting in expected combined growth of approximately 1% from these properties for the year. We're expecting an approximate 7.5% decline from the Tier 2 assets for the full year. Remember, when factoring in the exit from Valley Vista and the expected move up to Tier 1 of Cottonwood, Mesa and Southern Hills, we will have approximately 85% of our NOI represented from our Tier 1 in open-air properties. So with that, I'd certainly open the call for all your questions.

[Operator:]

[Operator Instructions]. Our first question comes from Ki Bin Kim of SunTrust.

[Unidentified Analyst:]

This is Ian [ph] on for Ki Bin. First question, how are the early conversations going with renewals and I guess, just what are you hearing from tenants more generally?

[Louis Conforti:]

This is Lou Conforti. That is such a multi-textured question, I don't even know how to deconstruct it and answer. Those tenants that are acting in dynamic, interesting fashion, we continue to -- I gave you statistical renewals, albeit, I think you wanted a more kind of generalization.

[Unidentified Analyst:]

Yes. A generalization would be great, just high level what you're expecting, or better or worse?

[Louis Conforti:]

Well, we don't expect any longer. And that's been the problem with this darned industry, quite frankly. We are being proactive in modulating in thinking about portfolio construction, getting certain retail categories right-sized and increasing others. So those that we want, we are going to be extraordinarily accommodative and those that we don't, commensurately less so.

[Unidentified Analyst:]

Okay. And then just 1 other. This is just again just a more general question. Are you seeing a lot of tenants that were formally long-term tenants, long-term leases, switching to month-to-month or is that not really a thing?

[Louis Conforti:]

Josh, what do you think?

[Josh Lindimore:]

No, I mean, what you're seeing is you're seeing, to Lou's point, the tenants that we want to keep are staying long term and the tenants that we are looking to divest ourselves, we are looking closer month-to-month.

[Mark Yale:]

And in Lou's prepared remarks, he mentioned the average length of the lease, which has not changed over the last couple of years. So we see no change in that trend from that perspective and we continue to move the ball forward.

[Operator:]

Our next question comes from Caitlin Burrows of Goldman Sachs.

[Caitlin Burrows:]

I was just wondering, when you guys mentioned that almost 50% of your leasing this year went to lifestyle tenancy, is that just non- apparel and shoes, or could you give us some more details or examples of what falls into that category?

[Louis Conforti:]

Food, beverage, entertainment, so 869 deals in 2017, 48%, so roughly half. Food, beverage, entertainment, furniture, fitness.

[Mark Yale:]

Furniture.

[Louis Conforti:]

So the stuff we want.

[Caitlin Burrows:]

And then, I guess, I'm just wondering, when you look at the leasing spreads that have been in a flattish range. This quarter they got to down slightly. When these new uses are filling versus the uses that used to be there, how do you balance getting that occupancy versus their ability to kind of pay up for the rent?

[Louis Conforti:]

The minimal variance -- so if you look at -- it has been -- relet spreads were negligibly down. So we don't see any apparent trend going forward. I mean things have been as we mentioned, have been rock steady quite frankly for -- going on 4 years now. So we are not seeing any deterioration in term and relet spread -- releasing spreads and we're not paying to take in tenancy, we had tenant improvement, tenant allowances. And we spared the statistical data, which should be -- which is in our supplemental to back that up. And I'm glad you brought that up, because I cannot overemphasize the stability -- our operational stability, combined with what Mark and Lisa have done from the financial wherewithal standpoint over the last year in this company. And again, our opening charter was to provide you guys with resistance to any exogenous or industry shock. We've done it, we've done it, and we're doing things that are very different in this business, because the old way doesn't work any longer.

[Caitlin Burrows:]

Got it, okay. And then, Mark, I know you did mention this in your prepared remarks, but I was trying to listen and take notes and think about questions or something. So just in thinking again about the same store NOI shift for the year now versus where it was last quarter, could you just talk about -- well, A, the guidance is down 1% -- essentially flat and then you guys mentioned in the prepared remarks that you expect it to fall no more than 1%. So is it more that you -- does the 1% seem more realistic than the flat and kind of what's new since the summer?

[Mark Yale:]

I think it really has to do with the performance during the third quarter. We continue to work through with the bankruptcies, being very deliberate in terms of making the right decisions. If you look at the shortfall in the third quarter that's really carrying over. We had that range of flat to 1% and we believe we will be within that range. And certainly there is some variability, especially as you get into the first quarter, that could move you a little bit. But it's really the third quarter that drove that, and we look to see, and certainly believe we're going to see stability as we get to the fourth quarter and you look at what -- what would be implied. That's where we're going to be.

[Louis Conforti:]

Let me add one more quick thing, and I think Mark you were spot on as usual. We are going to take the easy way out and lease to undifferentiated tenants, or be accommodative to undifferentiated tenants, because that is -- because if you -- we continue to have robust guest visitation, great occupancy, but I'm sometimes befuddled that we continue to do as well as we do within -- this is ubiquitous with the offerings that we're providing. So we are going to be, and I take portfolio construction, anybody that knows me, very seriously and it manifests itself in our assets. So if it takes a quarter longer and to lease to that right tenant mix, we'll be darned if we don't do that. And I know that's [indiscernible] in the industry, but too bad. This is why we set up the financial wherewithal we have over the last year, with an investment grade balance sheet. And quite frankly, people are hankering middle America, and middle America can be coast to coast, but in our fair part of the bell curve are hankering for interesting stuff.

[Caitlin Burrows:]

Got it. And I guess just 1 more point on that, on the idea that if you need to wait a little bit longer to get the right tenant that, that is the long term best solution. Have you seen that it is taking any longer, just generally, now versus, say, a year ago or 6 months ago to get that right tenant, to get them leased and to have them actually move in and open up?

[Louis Conforti:]

A little bit, but it's not because of an unwillingness of a tenant, it's because, quite frankly, this industry didn't know how to look and didn't know how to coefficient weight what we need and what we don't need. So I guess -- you know me well [indiscernible] I get riled about stuff like that, because every time we do something right, the immediate impact is so darned positive. So, yes, does it take a little longer? Yes, but we got to figure out for what we're looking, which we've done both quantitatively as well as, God forbid, common sense, or from a practical standpoint.

[Operator:]

Our next question comes from Christine McElroy of Citi.

[Michael Bilerman:]

Hey Lou, it's Michael Bilerman, how are you? So you talked about the common area being the Holy Grail. And I am just curious how you think about adding more stuff to the common area and not making it overcrowded, A, as sometimes customers don't like that, but also impacting inline retailers too that find that there's a lot of competition outside their space, and how you are going to balance those things?

[Louis Conforti:]

I guess, I have a big smile on my face. That will be the absolute -- absolutely and unequivocally highest grade problem we have when our robust common area utilization kind of hits the inflection point of overcrowded. But 1 way we're addressing it is a lot of rotational. And the bottom line is we need more kinetic in common area, we need more movement, we need more entertainment. And all this quite frankly has a very commensurately, very interesting risk-adjusted return on invested capital, because every time we do something like this, we see sponsorship opportunities. Quite frankly, we see our inline folks inure the benefit. So, in summary, there's a rotational aspect. Having a robust common area, as opposed to that some do, throwing some lighted ball up against the wall and another dude selling a T-shirt that has poop on it, you know what, that's over, that's over. And it's an embarrassment to both us and our guests.

[Michael Bilerman:]

Thinking about the Tier 2 assets, so you're down to about 87% occupancy. What would the standard deviation be within those 21 assets? Like what's that bottom tier of the Tier 2 assets? What are they occupied versus the top quartile?

[Louis Conforti:]

Well, do you want to address? Mark is going to answer this -- best way to be unencumbered and I incur you separate those two.

[Mark Yale:]

Yes. First of all, I think the answer to your question in terms of occupancy, I don't think there is a huge difference, I think the occupancy is pretty consistent within that group, It's not like we have a bunch properties at 60% occupancy. So we were in the 80% in that portfolio, and I don't think the standard deviation is that significant from the top to bottom. I think what Lou was inferring is, just is important to understand that, about half of that NOI that we have, we do have debt in place, we have a debt yield of around 11%. So not saying that's ultimately going to be the outcome for these properties, but we do have a footer on value. At this point, other than Colonial Park, where we made a decision that we weren't comfortable allocating additional capital, we are looking at the other assets and we'll continue to work them, but it's an evaluation and facts and circumstances property by property. When we do allocate capital, though, certainly the return threshold is a bit higher in that Tier 2 versus the Tier 1.

[Louis Conforti:]

And opposed to just talking about it, over the last 1 year, either sold or keys back need a little -- I might get it off by 1, but we are 13 or 14 properties down, which we made the prudent analysis that it didn't -- those assets didn't warrant a marginal unit capital from our standpoint.

[Michael Bilerman:]

And what you're saying is that tenants have come to you wanting potentially lease space, perhaps at very reduced rents. And you've made the decision to say, you know what, I don't want another teen apparel, I don't want another this use, that use. It's just not worth it. I'll leave the store vacant and I'm going to go out and try to find another tenant. I'm trying to really understand what the volume...

[Louis Conforti:]

Yes. I mean from a temporal aspect, it's pretty condensed, because over the last year, we've been adamant about searching out, and the statistics really proven it with 48% of 869 store openings or 3 million square feet of lease signings in front of me, have evidenced that stuff and stuff we want. So, yes, we can go on being $0.40 long -- $0.42 long junior fashion and accessories. It's a disservice to those junior fashion and accessory retailers that we like or that the public like.

[Operator:]

[Operator Instructions]. Our next question comes from Floris van Dijkum of Boenning.

[Floris van Dijkum:]

Lou, question for you in terms of the shopping center or strip center portfolio. The leasing spreads, the re-leasing spreads were actually negative. If I look at all of the shopping center peers, Kimco, Weingarten, the ones that have reported so far, they obviously had significantly higher leasing spreads. Why should we not be concerned about that number for you guys?

[Louis Conforti:]

I am going to have Paul take a crack, but let us deconstruct that number and see if it was based upon 1 or 2 extraordinary circumstances. Paul?

[Paul Ajdaharian:]

Lou, you're exactly correct. This is Paul. Yes, it was based on just a couple of boxes that brought down the spreads, it was not a trend, it was just an example of the number of deals or the construction of the deals.

[Floris van Dijkum:]

Can you give us, like, an example of that just to put it into context?

[Paul Ajdaharian:]

We had a box in one of our smaller open-air centers that was 80,000 foot box. And based on the market and we made the decision that the -- we know it was a little less than the present range.

[Floris van Dijkum:]

Okay. Then the other question I have for you guys...

[Louis Conforti:]

Floris, what was Kimco's same store NOI? I'm just -- I haven't looked at it yet. Just out of curiosity.

[Floris van Dijkum:]

I believe it was 2.8, but their leasing spreads were on average 16%. One of the other things...

[Louis Conforti:]

I am sorry, what was our same store NOIs in open-air?

[Floris van Dijkum:]

It was higher.

[Melissa Indest:]

It was higher.

[Louis Conforti:]

I am sorry. Okay, go on.

[Floris van Dijkum:]

The other question I have is regarding your tenant sales. We've seen now a number of quarters in a row of falling tenant sales, including in your Tier 1, I think they were down 2.2%. I'm curious, because obviously in your enclosed or mall properties, there has been historically a pretty good relationship between sales and rents. How are you looking at this? And is that tenant sales number different in your JV with O'Connor or not? Are those assets behaving differently than the rest of your Tier 1 assets?

[Louis Conforti:]

Let us get -- admittedly I do not know. Let us get back to you.

[Melissa Indest:]

I think you could also look too, Floris. I mean, you can look at the occupancy costs, which is staying very healthy. So I think that's probably a more important way to look at it than I would look at the sales trend. The occupancy costs are still holding very consistent quarter-to-quarter -- year-over-year.

[Louis Conforti:]

And what we found when we chatted and we've been on kind of a retailer tour, the idea of us of residing in a WPG asset is a pretty worthwhile -- it makes a lot of sense, given our generally lower occupancy costs. And I don't want to e range it, but you can look and -- whether it's 300 basis points to 400 basis points or 200 basis points to 300 basis points, in some instances, which is meaningful. So Lisa is spot on. That occupancy cost is an increasingly relevant metric.

[Operator:]

[Operator Instructions]. As there are no further questions in the queue at this time, I'd like to end today's call. Thank you, ladies and gentlemen for attending today's conference. This concludes the program. You may all disconnect.

[Louis Conforti:]

Thanks everyone.