Weingarten Realty Investors
Q2 2018 Earnings Call Transcript

Published: 31 Jul 2018

[Operator:]

Good morning and welcome to Weingarten Realty Inc.'s Second Quarter 2018 Earnings Call July 31, 2018. My name is Brandon, and I'll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Please note this conference is being recorded. And I'll now turn it over to Michelle Wiggs. Michelle, you may begin.

[Michelle Wiggs:]

Good morning and welcome to our second quarter 2018 conference call. Joining me today is Drew Alexander, President and CEO; Johnny Hendrix, Executive Vice President and COO; Steve Richter, Executive Vice President and CFO; and Joe Shafer, Senior Vice President and CAO. As a reminder, certain statements made during the course of this call are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These statements are based on management's current expectations and are subject to uncertainty and changes in circumstances. Actual results could differ materially from those projected in such forward-looking statements due to a variety of factors. More information about these factors is contained in the Company's SEC filings. Also, during this conference call, management may make reference to certain non-GAAP financial measures such as funds from operations or FFO, both core and NAREIT, which we believe help analysts and investors to better understand Weingarten's operating results. Reconciliation to these non-GAAP financial measures is available in our supplemental information package located under the Investor Relations tab of our website. I'll now turn the call over to Drew Alexander.

[Drew Alexander:]

Thank you, Michelle, and thanks to all of you for joining us. I'm pleased to announce another good quarter. We continue to produce strong results which is a testimony to the quality of our portfolio and the resiliency of neighborhood and community shopping centers with grocers and merchants selling basic goods and services. We also benefit from the best tenant diversification in our segment which somewhat mitigates the risk of tenant failures. For instance with Toys“R”Us, we only had four locations which is manageable and the dramatic improvements we've made to our portfolio over the last seven years are tenant quality and location strength are quite strong. Further, we have a great team of outstanding professionals and I thank them sincerely for our accomplishments. As to capital allocation, we continue to follow market signals. Our disposition program has been highly successful. During the quarter, the company closed 77 million of dispositions, and an additional 13 million subsequent to quarter. Year-to-date, we closed dispositions totaling 358 million and have an excess of 120 million currently under contract. We continue to believe the disposing of assets in the bottom portion of our portfolio where we can sell at or near the property level net asset value is the right strategy when our stock is selling at a significant discount to NAV. While conditions can change rapidly, the current environment seems to favor further dispositions activity. Accordingly, we've increased our 2018 disposition guidance to a range of 400 million to 550 million. These disposition proceeds give us the ability to fund our new development and redevelopment projects, pursue quality acquisitions, repurchase debt and common shares and fund a reasonably large special dividend at year end. Basically, we're position to take advantage of whatever opportunities present themselves going forward while maintaining our strong balance sheets. While dispositions impact FFO, we believe this is the best long term strategy for our shareholders given the current market conditions. Our new developments and redevelopments are progressing nicely which will provide future earnings growth. West Alex, Central Arlington and the Whitaker are on track. Recently we started demolition to make way for the Driscoll at River Oaks. Our thirty 30 high-rise at our prominent River Oaks shopping center here Houston. We did experience a slight delay in wrapping up some of the permits and coordinating tenant work and utilities, which delayed our start a bit, therefore our estimated stabilization slid from the end of 2021 to the first half of 2022 as noted in the supplemental. The walkability scores for this project are outstanding and we're quite excited about transforming this asset to live, work, play. Our redevelopment program is robust and continues to produce very strong risk adjusted returns generally over 10%. As an example we're beginning construction on 20,000 square foot building on vacant land at two different Texas projects. These are both low risk, high return offering. As a future new developments, we continue to work on projects that are being very cautious with our risk profile. We've many other redevelopment projects in the pipeline, it will continue to provide excellent returns on the invested capital and we continue to work on those with great focus. A solid quarter, Steve, the financials.

[Steve Richter:]

Thanks Drew. Good morning, everyone. I am pleased to report another very solid quarter. Core FFO for the quarter ended June 30, 2018 was $0.57 per share compared to $0.61 per share for the same quarter of the prior year. Core FFO for 2018 benefited from increased space rents, increase expense reimbursements and higher bad debt recoveries. Additionally, interest expense was lower due to the reduction of debt outstanding with disposition proceeds from 2017 and 2018. However, these increases were more than offset by reduced operating income from the dispositions in both years. Dispositions reduced FFO by $0.08 per share for the quarter. A reconciliation of net income to core FFO is included in our press release. Our balance sheet is stronger than ever. With our disposition proceeds we paid off our $200 million term loan in two $100 million tranches, the second of which closed early in the second quarter. We have also repurchase $600,000 of unsecured bonds and $10.4 million of common shares an average price of $26.09 per share. Year-to-date, we have repurchase $14.3 million of bonds and $18.6 million of common shares at an average price of $27.10 per share. At quarter end, our net debt to EBITDA was a strong 5.1 times and debt to total market capitalization was 31.4% supported by a well-laddered maturity schedule that has no significant maturities until 2022. Our great liquidity and strong credit metrics provide significant flexibility to pursue opportunities that arise. As our earnings guidance, we are increasing net income per share to a range of $2.52 to $2.60 and NAREIT FFO per share to a range of $2.37 to $2.43 per share. We are reaffirming core FFO guidance for the year. Given the strong competition for quality centers and aggressive pricing, guidance has been decreased for acquisition. And as Drew touched on earlier, we are increasing guidance for dispositions. All of the details of our guidance are included on Page 10 of our supplemental. Johnny?

[Johnny Hendrix:]

Thanks Steve. We're pleased with our performance in the second quarter and focused on continuing to deliver great results for our shareholders. Leasing velocity remained steady, overall rent growth was 10.2% highlighted by new lease rent spreads over 21%. Tenant fallout was modest, we increased occupancy from a year ago to 94.6%, same property NOI with redevelopments was 2.7%, and our redevelopment program continues to produce very strong risk adjusted returns. Since the last call, the company attended recon in Las Vegas. This is the annual meeting of the retail real estate industry. We had hundreds of meetings and overall the mood and expansion appetite for retailers was better than expected. The industry definitely has challenges but the retail apocalypse narrative has been replaced with discussions that are more realistic. Our transform portfolio has very desirable locations real retailers want to occupy. Weingarten's shopping centers are primarily and highly sought after urban markets with good incomes, strong population densities and higher than average education levels. Most of our properties are in business friendly, low tax states that will enjoy outsize population growth for years to come. We continue to see good demand for our space from clothing retailers like Burlington, Ross and T.J. Maxx. Other categories expanding include craft, home furnishing, business, service, entertainment and specialty supermarkets like Sprouts and Lucky. I expect we will continue to maintain strong occupancy for years to come. I want to update you on a couple of bankruptcies. First, Toys“R”Us has closed all four locations they had with us. The Argyle lease has not been rejected yet, but we expect it will be soon. The four leases represent 160,000 square feet and $1.8 million in annual base minimum rent. Each of the spaces is categorized as occupied at quarter end and there has been no impact yet for loss rent. We're negotiating with prospects for all four locations and I think these spaces will be generating run again in 12 to 18 months. My expectation is replacement rents for the three properties, Cypress station, Argyle and Bunker Hill will be about the same. The lease we bought at Palms has tremendous upside. So overall, this should be a long term positive for Weingarten. The Southeastern foods bankruptcy is now complete. We had to Winn-Dixie locations and one Fresco y Mas. Southeastern foods has emerged from bankruptcy and affirmed leases for two locations. They sold the third to an independent supermarket, Ideal Food Baskets, who is currently refurbishing the store and should open soon. As a result, we will not lose any rent or occupancy from this bankruptcy. We closely monitor the retailers on our watch list and do not believe there is a significant risk that further bankruptcies will affect us this year. We executed 210 new leases and renewals during the second quarter. We signed 79 new leases representing $5.4 million in base rent. This included a home goods and two Burlington stores. We also leased two fitness facilities, restaurants along with medical and other service type tenants. We are pleased with the rent growth this quarter, particularly with 21.4% new lease spreads. It's important to remember rent growth is based off a small denominator. So one quarter can easily be skewed by one or two leases. Year-to-date, the overall spread is around 8%. And this is consistent with our expectations for the rest of the year. Year-to-date, our same property NOI with redevelopment is a good 2.3%. That's in line with our projections we used for our guidance so far. We expect to finish the year insider same property NOI guidance of 2.55 to 3.5%. At the same time we want to acknowledge the margin for error built into the budget is limited and significant negative surprises over the next five months would be impactful and achieving the top end of the range could be challenging. We have about 580,000 square feet of space that is leased and commenced. This represents over $13 million in annual base minimum rent. Much of that will come online over the next several months and will be a big boost to same property NOI, particularly in the fourth quarter. Weingarten's redevelopment program continues to generate very good risk adjusted returns. Excluding the Driscoll at River Oaks, we have 14 properties under redevelopment and an anticipated investment of $78 million. The incremental returns will be over 10%. Most of the projects are multi-tenant outparcel buildings. Entitlements and tenant approvals do take a lot of time, but once these projects commence construction, there is very little risk. While we did not purchase any new property during the second quarter, we continue to be very active pursuing the acquisition of great shopping centers in our target markets. We continue to see supermarket anchored centers in coastal markets command cap rates in the range of 4.25% to 5.50%. Cap rates in other top 50 markets for great supermarket anchored shopping centers has been in the 5% to 6% range. Power center pricing seems to have a significantly wider range and depending on tenancy are trading around 6% to 8%. We look forward to continuing to meet the challenges ahead. Drew?

[Drew Alexander:]

Thanks Johnny. Our job is to position the company to maximize the long term value for our shareholders and we remain focused on that goal. The overall perception of retail real estate has improved modestly, REIT valuations continue to be depressed, especially the retail REITs even after the recent slight run up in stock prices. The disconnect between the value of good shopping centers in the private markets versus the value of the public retail REITs remains causing us to continually reassess our strategy. The management team at WRI has been through many real estate cycles and has experienced the dramatic changes in the retail world. This cycle like all the others is different and we will respond accordingly with our eye on that long term value creation goal. Our strong balance sheet continues to improve and we're well positioned to fund our future capital requirements, while still maintaining the dry powder necessary to react to other growth opportunities that will undoubtedly arise. Great people, great properties and a great platform includes great results. I thank all of you for joining the call today and for your continued interest in Weingarten. Operator, we now be happy to take questions.

[Operator:]

Thanks Drew. We'll now begin the question-and-answer session. [Operator Instructions] And from Citi, we have Christy McElroy, please go ahead.

[Katy McConnell:]

Good morning. This is Katy McConnell on for Christy. Can you talk a little more about your decision to increase net disposition guidance just based on transaction market trends just being quite currently? And then directionally, what's your expectation for net transaction activities?

[Drew Alexander:]

Good morning, Katy, it's Drew. As we said in our prepared remarks and I think as we talked about in our conference is it's really about the market signals that you know we see this pretty significant disconnect between the value of properties to private buyers versus where the retail REIT stocks are and it just seems to us that the right long term strategy is to sell if we can sell the bottom portions of the portfolio you know at the property level NAV, does as we as we communicated you know indicate that we will have a rather large special dividend other than that acquisitions is very well that take advantage of future opportunities you know fund our new development redevelopment properties, keep our balance sheet strong and you know if the stock price were in range, do some stock buyback. So it's again you know really about the market signals you know honing the map, focusing the geography, you know selling some of the weaker property. So we are still seeing cap rates generally for what we're selling in the middle sevens. You know and as we indicated, looking at what we have in the pipeline, we thought it was appropriate to increase guidance. As to next year, it's a little hard to say at this point, we haven't done any budgets and given that the whole strategy is around the market conditions, we don't know what market conditions are going to be like. You know we'll certainly continue to follow the signal but you know it's hard to estimate next year. But you know estimating things my guess is 2019 will be a lower number than 2018.

[Katy McConnell:]

Okay, great. Thank you.

[Operator:]

From SunTrust, we have Ki Bin Kim. Please go ahead.

[Ki Bin Kim:]

Thanks, good morning, everyone. So you're on track to sell about half a billion of assets, your balance is in great shape and you don't have any pressure to sell deleveraging standpoint. So my question is how do you balance cash flow per share growth versus optimizing NAV and looked at the long term NAV decision should be the same as at the cash flow position, by the near term closing NAV gap selling assets does put cash flow per share growth under some pressure in the near term? And maybe unfairly, put Weingarten in a slight penalty box in the mindset of some investors, so how do you balance that tipping point?

[Drew Alexander:]

Good morning, Ki Bin, it's Drew. You know that's an excellent question and as you know say in your question, it is a difficult you know thing to balance, it's something that occupied a good amount of time at our board meeting yesterday because you accurately observe you know there is some pressure on FFO. Hopefully, we've also been clear that the properties that we're selling you know trigger gains and you know consequently you know some of the money does go you know out to a special dividend. That said as we tried to address in our prepared remarks, you know we think real estate is a long term business and we think our responsibility as management is to manage for that long term. And again to improve the property, to de-risk assets, to sell off remote geography, make us more assumptions from a management perspective, to de-risk from tenant, know issues that you know maybe problems multi-years. While it is some short term pain you know we think it's long term gain and we think it's the right long term thing to. So as I said before, based upon what's working, we increase guidance for 2018, we'll have to see what market conditions exist in 2019, as again the strategy is reacting the market conditions, which are ever-changing.

[Ki Bin Kim:]

Is there - I know you mentioned that you're looking to tone down the pace of that next year. Is there a point from a balance you standpoint where it just becomes too dilutive and your leverage goes up five and it just becomes a little bit too expensive to be delivering?

[Drew Alexander:]

I'm sure there is but at this moment, we're again looking at some pretty decent discounts to NAV in the ability to sell things in the lower portion of the portfolio at NAV and it just seems the right long term thing to do. We funded a lot of but still have a decent amount of our new development pipeline to fund. We also have a lot of redevelopment opportunities in our pipeline that we're working on. As well as we're very active in acquisitions across the entire footprint of the company. As Johnny said in his remarks, we do see things very, very competitive for the quality centers, in the qualities that we want to buy. So a lot of things that go into factoring the balance of short term and long term, but we tend to more focus on the long term and the NAV cognizant and other short term to FFO but trying to do the right long term thing.

[Ki Bin Kim:]

Okay and if I could squeeze one last one in because that is accounting question, with the new accounting lead standards that are set to kick in 2019, have you guys formalized and estimated on the FFO - on your FFO how much your expense?

[Steve Richter:]

Good morning, Ki Bin. This is Steve. We're still reviewing and we're working through the details of the new accounting from announcement. However, this one we do expect the G&A will be affected by $8 million to $9 million or somewhere in the $0.06 to $0.07 range. I'd also note WRI has an extensive in-house legal department which we believe is very efficient and cost effective that prepares and negotiation all our leases which is the largest component of the decrease in capitalization. So again, we're not totally finished but that's where we are thinking is currently.

[Ki Bin Kim:]

Okay. That's good point, I mean it does fairly penalize companies with scale. All right. Thank you.

[Operator:]

From Bank of America we have Craig Schmidt. Please go ahead.

[Justin Devery:]

Hi, this is Justin Devery on for Craig. I wanted to address a topic that's come up quite a bit lately which is how should we be thinking about higher construction costs as it pertains to current or maybe more importantly future development?

[Drew Alexander:]

Sure, Justin, good mornings, it's is Drew. So I think it is an important distinction to make as to current we're in pretty good shape we've got guaranteed max price contracts with contractors, we bought or pre-bought a lot of the materials. So I think as to the three big projects, River Oaks and the two in Virginia, we're in very, very good shape. As to the broader question of the future, I think it's an excellent question that if something that is sort of beyond the scope of Weingarten Realty, it's much more of a national geopolitical gets into a lot of questions about tariffs and steel prices and lumber, gets into labor issues, immigration policy and lots and lots of things. But I would say it is definitely an issue, we have a lot of friends in the construction business as well as the activities that we're looking at the pricing that we're doing on, again mostly our redevelopment. But it's definitely something that we're factoring in. The nice thing is except for the big three projects, everything we're doing in small floater building, most of what we're doing small floater building. So if there are some construction increases, we can increase the rent. As to the developments a decent pretty good percentage is residential in very strong markets. So again if there are construction price increases and there shouldn't be because most of that is locked in. We can likewise increase those units. So we're very cognizant you know it's a very good question a very good issue that we're wrestling with. And it's really across the whole geography, obviously in Houston and parts of Florida we're still seeing a little effects of the hurricane repair but in other strong markets from Seattle, Washington to Washington D.C. construction prices are an issue.

[Justin Devery:]

Thank you, that's helpful. And one other one for me. Should we be thinking about Toys any differently than Sports Authority bankruptcy just in terms of demand for releasing space or the time it takes to get a new tenant in place?

[Johnny Hendrix:]

Hey, Justin. This is Johnny. Really all I can speak to the four properties that we have and I would say generally when you look at the spaces, I think there are better spaces and better shopping centers than we had with Sports Authority. And I think one of the leases are lower rents than we had with sports authority. Construction time is probably going to be about the same, construction cost probably up a little bit, given the market today. When you factor in again Palms, it's likely that Palms will eventually turn into a larger redevelopment. So again we have a tremendous amount of upside there. We've got a many, many tenants and even different users that are wanting to access that great property. So again that will be quite different than anything we experience with Sports Authority.

[Justin Devery:]

Great. Thank you, guys.

[Johnny Hendrix:]

Thank you.

[Operator:]

[Operator Instructions] And from Green Street Advisors, we have Vince Tibone online. Please go ahead.

[Vince Tibone:]

Good morning. Can you guys provide some color on expense recoveries in the quarter that seem to provide a pretty big tailwind do same property NOI growth?

[Steve Richter:]

Good morning, Vince, this is Steve. The same store reimbursable does primarily driven by the improvement in occupancy over Q1. We get rebuilt a little bit of the Texas margin tax and other than timing, there was really nothing unusual in there. I can't move around a little bit from quarter-to-quarter.

[Vince Tibone:]

So even for the rest of the year there will be kind of continued year-over-year positive expense recoveries kind in the back half?

[Steve Richter:]

Yeah, I don't think anything going forward that that's going to dramatically shift. Again it's mostly driven by what occupancy looks like. We do have the difference between signing commence is still pretty strong out there that we should have that improvement as we move through the year.

[Vince Tibone:]

Make sense, thank you. And then just one more for mean kind of a just a follow-up on the construction cost point. Can you provide a little bit more detail into kind of what annual cost increases are included or incorporate into the current underwriting, are there natural projects or are you forecasting 3% to 5% construction cost decreases in these property stabilize or anything you could provide to give us a little more confidence that some of these projects won't be experiencing cost overruns over the next few years, I am on bit residential side.?

[Drew Alexander:]

Understand Vince, it's Drew. Good morning. Yes, there are some cost increases, there are some contingencies and again the vast majority of all the material costs are bought out, so that part is locked in and contractor all of the big three projects have guaranteed my ex-price contracts. So between the contingencies, the contract and the buyout of materials, I think that we are in good shape. But as I said in the earlier question, things are moving around and there are a lot of other questions in the broader geopolitical world.

[Vince Tibone:]

Okay. Thank you. That's all I have.

[Drew Alexander:]

Thank you.

[Operator:]

From Capital One Securities, we have Chris Lucas. Please go ahead.

[Chris Lucas:]

Good morning, everybody. I just wanted to follow-up back on the disposition guidance increase I guess. Maybe Steve if you were kind of halfway through the year, I wonder if you have any sense as to sort of what we should be thinking about in terms of special dividend versus flexibility for either debt repayment or stock buyback based on the stuff that's close so far this year and then sort of what you're expecting for the back half?

[Steve Richter:]

Good morning, Chris. That's a very difficult question to answer from the perspective that we obviously don't know what will close between now and the balance of the year. We've signaled, we do have a liability today for what we've already closed. That's probably an excess or is an excess of last year's dividend, special dividend. But again what happens between now and in the balance of the year is really on asset-by-asset basis as you probably are aware, some locations have a lot higher gain percentage than others. So it's very difficult to figure out exactly what that looks like going forward.

[Chris Lucas:]

Okay. And then as it relates to the pool that sort of potentially left to be sold this year. I mean the stuff you sold in the second quarter tended to be smaller centers that were more power centers in the first quarter, I guess just curious as to what the mix looks like for the back half of the year potentially?

[Drew Alexander:]

Morning, Chris, it's Drew. The issue is that we are taking advantage of an opportunity because of this big disconnect and we're moving forward when we get pricing that we feel is advantageous at or near NAV. So we're always working on a lot more than we ever expect is going to happen which is part of why it's really hard to frame a special dividend. So broad brush I would say there are still some smaller properties, there's still some power centers, we continue to own the map, we've sold two centers in Kentucky this year and working on the other two. They are good center supermarket anchored but it's just increasingly clear to us as a publically being in Kentucky, it's inconsistent with Wall Street goal. So it is, I would say a continuation of the kinds of properties that we've sold looking at the quality, looking at the risk. But has been observed, market conditions change. We can slam on the brakes and stop because we don't to do it for the delivering, it's totally about this disconnect between the public and the private and taking advantage of that. One have to think that want to do, one of these days that changes but in the meantime, it's the right long term thing in our view to take advantage of it.

[Chris Lucas:]

So I guess Drew, because I think about sort of the plan going forward is if this disconnects days as there are point where you are either continuing to sell assets to and distributing out the gains or is there a size that you feel like you can operate under given the public company size issues?

[Drew Alexander:]

Yeah, great question and I do think there are some points that you reach some difficult inflection things and that's part of what I said before that while it is an opportunity and we do intend to take advantage of it, that's part of why I asked in the next year would be less than what we just knew the guidance to because there are as you say a lot of factors that go into it, the farther down the road one gets on.

[Chris Lucas:]

Okay. And then last question for me. Johnny just on the acquisitions front. Your cost to capital is improved a bit obviously the dispositions give you some freedom in terms of playing the sort of 1031 money. But I guess I'm just curious as to what are you seeing in the marketplace that gives you some confidence that you guys might actually come out on top on a on an active bid?

[Johnny Hendrix:]

Well not a whole lot. I mean I don't think we're going to we're going to be the winner in a lot of active bids situations. Where we can apply our platform where there are some issues that we think we can resolve that we can live with is really where we have in advantage and especially in the markets that we're in that we have already have boots on the ground. Again we reduce guidance for acquisitions and it's going to be tough along the way. We do have a small property under contract now that I think that we will close in a couple of things that we're working on. But again most of these are no bid situations that will be very difficult for us, Chris.

[Chris Lucas:]

Thanks a lot. Appreciate your time this morning.

[Johnny Hendrix:]

Thanks you.

[Operator:]

[Operator Instructions] And from Suntrust we have a follow-up from Ki Bin Kim. Please go ahead.

[Ki Bin Kim:]

Thanks. Quick accounting question on the under market lease write-off that cost a onetime income. I know it's on your Core FFO, but discretion how the mechanics work? Is it just because the Toys“R”Us leases were ended or bankrupt, went to bankruptcy or whatever it is that cost it but does that necessarily mean that your view of the market rent has changed at all or is that just to me too exclusive things?

[Joe Shafer:]

Hey, Ki Bin. This is Joe Shafer, the Chief Accounting Officer. Actually in your piece that you put out this morning, you actually described it pretty well. And at the time we bought homes the ramp for Toys“R”Us is under market. So we ended up with a liability on our balance sheet and then when Toys goes bankrupt that liability needs to be written-off. And that's typically what you do with any lease without there, to terminate you look at all the intangibles that are out on your balance sheet, you flush them through the income statement.

[Steve Richter:]

Ki Bin. This is Steve. Just a just a follow-up. It depends, that's recorded at the inception of the acquisition. It has no really driver as to what the market rent may be today. But this evaluated at the very front end and it's not adjusted as you go through time.

[Ki Bin Kim:]

Right. That's why I thought. I just wanted to clarify that on the call. And thanks for doing the research.

[Steve Richter:]

Thanks.

[Operator:]

Okay. No further questions at the moment. Drew, I'll turn it back to you for closing remarks.

[Drew Alexander:]

Thank you, Brandon. And just for everybody on the call, we read everybody's research and we enjoy our relationship with all our analyst friends. So - and if any of you have any other questions this afternoon, we will be around. We appreciate your interest in the company very much. Thank you, Brandon. Thank everybody. Hope everyone is having a great summer and wish you all the best.

[Operator:]

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