Phillips Edison & Company, Inc. (NASDAQ:PECO) Q3 2023 Earnings Call Transcript

Phillips Edison & Company, Inc. (NASDAQ:PECO) Q3 2023 Earnings Call Transcript November 1, 2023

Operator: Good day, and welcome to Phillips Edison & Company’s Third Quarter 2023 Earnings Conference Call. Please note that this call is being recorded. I will now turn the conference over to Kimberly Green, Head of Investor Relations. Kimberly, you may begin.

Kimberly Green: Thank you, operator. I am joined on this call by our Chairman and Chief Executive Officer, Jeff Edison; our President, Devin Murphy; and our Chief Financial Officer, John Caulfield. Once we conclude our prepared remarks, we will open the call to Q&A. After today’s call, an archived version will be published on our website. As a reminder, today’s discussion may contain forward-looking statements about the Company’s view of future business and financial performance, including forward earnings guidance and future market conditions. These are based on management’s current beliefs and expectations and are subject to various risks and uncertainties as described in our SEC filings, specifically in our most recent Form 10-K and 10-Q.

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In our discussion today, we will reference certain non-GAAP financial measures. Information regarding our use of these measures and reconciliations of these measures to our GAAP results are available in our earnings press release and supplemental information packet, which have been posted on our website. Please note that we have also posted a presentation with additional information. Our caution on forward-looking statements also applies to these materials. Now, I would like to turn the call over to Jeff Edison, our Chief Executive Officer. Jeff?

Jeff Edison: Thank you, Kim, and thank you, everyone, for joining us today. The PECO team delivered another solid quarter of growth with same-center NOI increasing by 3.2% and continued strength in portfolio occupancy and rent spreads. This performance has allowed us to reaffirm the midpoint and tighten the range of our 2023 core FFO guidance. The midpoint represents year-over-year growth of 2.6 %, despite interest expense headwinds of $0.10 per share. We believe we will continue to deliver positive earnings growth despite interest expense and other macro headwinds. The continued strength of our operating performance is attributable to our differentiated and focused strategy of exclusively owning grocery-anchored neighborhood shopping centers anchored by the number one or two grocer by sales in a market, and our ability to drive results at the property level through our integrated and cycle-tested operating platform.

Today, we see a continued strong operating environment, and a transaction market that has improved. The consumer continues to be resilient and our grocers continue to drive strong foot traffic to our centers. We remain 98% occupied, which gives us pricing power. Leasing demand continues to be elevated for our inline spaces, and we have limited exposure to big-box retailers. We have a great balance sheet and are well-positioned for accretive acquisitions. We have seen an increase in deal activity beginning in third quarter as cap rates continue to adjust in response to higher interest rates. Based on our current pipeline, we have increased the low-end of our guidance range for acquisitions. While it’s still a market in transition, we are confident in our ability to close on $250 million to $300 million in net acquisitions this year.

We continue to have a very-disciplined acquisition process. We remain focused on accretively growing our shopping center portfolio at the right price, while achieving our acquisition hurdle of a 9% unlevered IRR. The acquisitions that we will complete in the second half of the year underwrite to a 9.5%-plus unlevered IRR. With PECO’s experienced in-house acquisition team, we are well-positioned to continue to grow our portfolio. The PECO team looks forward to sharing an update on our acquisition strategy, including case studies, our underwriting process and our targets for 2024, during our Investment Community Day on December 14th. In September, Kroger announced the divestiture plan with C&S Wholesale Grocers in connection with the proposed Kroger and Albertsons merger.

We remain cautiously optimistic about the impact on PECO. We continue to believe, it is ultimately a positive for PECO, for our centers and for the communities that our centers serve. While the market still gives the merger a low probability of occurring, should it close and 413 stores are sold to C&S, the impact on PECO is a net positive. C&S has been operating for over 100 years, and they are one of the largest wholesale operators with demonstrated experience in retail operations. We believe the recent announcement is potentially a better outcome for PECO than a new SpinCo that Kroger and Albertsons had considered. Importantly, should the merger occur, the majority of our Albertsons stores will be operated by an excellent operator in Kroger.

If the merger does not occur, our Albertsons anchored centers will continue the strong performance that they have enjoyed to-date. I will now turn the call over to Devin. Devin?

Devin Murphy: Thank you, Jeff. Good afternoon, everyone. And thank you for joining us. Our leasing team continues to convert strong retailer demand into higher occupancy with higher rents at our neighborhood shopping centers. Anchor occupancy ended the quarter at 99.3% leased, representing a year-over-year increase of 40 basis points. Inline occupancy increased 10 basis points sequentially to 94.9%, representing a year-over-year increase of 130 basis points. We believe there is still upside in our inline occupancy, given the continued strong demand for space. As of September 30th, in-place ABR per square feet for our inline neighbors increased 5.2%, compared to a year ago. We continue to capitalize on strong renewal demand, and are making the most of the opportunity to strengthen key lease terms and drive renewal rents higher.

Specifically, for the third quarter we achieved a 16.9% increase in renewal rent spreads. In terms of new lease activity, we continue to have success in driving meaningfully higher rents. New rent spreads for the third quarter increase 26.3%. We expect that leasing spreads will continue to be strong through the balance of this year and into the foreseeable future. PECO’s retention rate remains strong this quarter as well at 93%. An important benefit of high retention rates is that we have much lower TI spend on renewals. In Q3, we spent less than a $1 per square foot on TI for renewals. The exact amount was $0.88 per square foot. On average, our new and renewal inline leases executed in Q3 had annual contractual rent bumps of 2.5%, an important contributor to our long-term growth rate.

The leasing spreads that we are achieving combined with our strong retention rates are clear evidence of the continued high demand for space and our grocery-anchored centers. Our continued pricing power is a reflection of the strength of our strategy and the quality of our portfolio. During our upcoming investor day, you will hear from our operations team leaders on how the PECO team delivers growth at the property level and why we remain confident in our ability to deliver long-term same center NOI growth of 3% to 4% on an annual basis. The team will be prepared to share insights on why our assets are successful, our strategic locations and suburban markets, our right size format, and the other advantages we enjoy in the markets where we operate.

Turning to redevelopment and development. We continue to invest in our value-creating roundup outparcel development and redevelopment projects, which remain an excellent use of our free cash flow and deliver very attractive returns. Year-to-date, we have stabilized 10 projects, delivering over 223,000 square feet of space to our neighbors with incremental NOI of approximately $2.9 million annually. These projects provide superior risk-adjusted returns and have a meaningful impact on our long-term NOI growth. For the full year 2023, we continue to expect to invest $35 million to $45 million in ground up outparcel development and redevelopment opportunities with rated average cash on cash yields on this activity between 9% and 12%. During our upcoming investor day, the PECO team will provide an update on our pipeline of ground up development and redevelopment projects across our portfolio.

PECO continues to benefit from a number of positive macroeconomic trends that create strong tailwinds and drive strong neighbor demand for us. These trends include a resilient consumer, hybrid work, migration to the Sunbelt, population shifts that favor suburban communities and the importance of physical locations and last mile delivery. The impact of these demand factors are further amplified due to limited new supply being created over the last 10 years and going forward, given that current economic returns do not justify new construction. In summary, our differentiated strategy continues to position PECO well for continued steady growth in all economic cycles. This is due to our exclusive grocery-anchored focus on centers anchored by the one or two grocer in a market, our necessity-based neighbor mix, our right size format, our well-positioned locations in growing suburban markets, our high-occupancy with continued strong neighbor demand for space, our high-leasing spreads and retention rates, our well-diversified neighbor mix, our lack of exposure to distressed retailers, our strong balance sheet and most importantly, our well-aligned and cycle tested team.

I'd now like to turn the call over to John. John?

John Caulfield: Thank you, Devin, and good morning and good afternoon everyone. I'll start by addressing third quarter results, then provide an update on the balance sheet, and finally, speak to our updated 2023 guidance. Third quarter 2023 Nareit FFO increased 70 basis points to $72.5 million, or $0.55 per diluted share, driven by an increase in rental income from our strong property operations. Results were partially offset by higher year-over-year interest expense of $4 million as well as a one-time non-cash impairment charge of $3 million related to a third-party investment. Third quarter core FFO increased 50 basis points to $77 million or $0.58 per diluted share, driven by increased revenue at our properties from higher occupancy levels and strong leasing spreads partially offset by higher interest expense.

During the quarter, we acquired Lake Point Market, a grocery anchored center in the Dallas Texas suburbs for $12.9 million. We expect to drive growth by increasing occupancy and enhancing merchandising mix in addition to the potential for development of outparcels. In addition, we purchased a land parcel adjacent to the marketplace at Pabst Farms located in a Milwaukee, Wisconsin suburb. We expect to drive growth through expansion development opportunities. Subsequent to quarter-end, we acquired one property and one outparcel. Mansell Village, an 89,600 square foot shopping center is anchored by Kroger in an Atlanta, Georgia suburb. We expect to drive growth in the asset through occupancy increases and rent growth. As of October 31st, PECO is under contract to acquire additional assets that are expected to close during the fourth quarter of 2023.

This will bring our net acquisition volume for the year to between $250 million and $300 million. In the third quarter, PECO issued approximately 2 million shares under our ATM facility, which resulted in net proceeds of $70.1 million. Our gross weighted average share price was $35.59. Assets acquired year-to-date and currently in our pipeline are accretive to earnings per share at these levels. We were intentional in match funding these acquisitions with equity at a time when our access to the equity market was favorable, while keeping our leverage low. In addition to the recent term loan extensions, this issuance delays our need to go to the long-term debt market, which we believe is currently unfavorable. From a balance sheet perspective, we ended the quarter with approximately $714 million of liquidity, including cash and capacity on our $800 million credit facility.

Our leverage ratio continues to decrease as a result of our strong earnings growth and our equity issuance with our net debt to adjusted EBITDA at 4.9 times as of September 30, 2023. Our debt had a weighted-average interest rate of 4.1% and a weighted average maturity of 4.4 years when including extension options. 82% of our debt was fixed rate. As we look at our floating rate debt exposure, our long-term target is to limit our floating rate debt to less than 10% of our total debt. We are currently in an unusual environment, given the inverted yield curve, wider spreads, and other factors, which is why we are exercising more patience before locking in long-term rates. Our lack of near-term maturities provides us with flexibility to be patient.

That said, we remain focused on all options to meet our long-term target as soon as possible. Between the free cash flow generated by our portfolio and the significant capacity available on our revolver, we remain confident in our ability to successfully fund our growth plans. Turning to guidance. We’ve updated our Nareit FFO and core FFO per share guidance. Primarily due to a one-time non-cash impairment charge related to a third-party investment, we have lowered our Nareit FFO guidance to a range $2.23 per share to $2.27 per share. We have reaffirmed the midpoint of core FFO guidance and tightened the range to $2.31 per share to $2.35 per share. As Jeff mentioned, the midpoint represents year-over-year growth of 2.6%, despite interest expense headwinds of $0.10 per share.

We also reaffirmed our same-center NOI guidance in the range of 3.75% to 4.5%. Importantly, despite the impact of higher interest rates and other macro headwinds, we are delivering earnings growth due to the continued strong performance of our portfolio, driven by leasing spreads, occupancy and high retention. We plan to provide preliminary guidance for 2024 and update on our long-term growth drivers during our upcoming investor day. With that, I'll turn it back to Jeff. Jeff?

Jeff Edison: Thanks John. Before we get to your questions, I’d like to acknowledge the press release we issued yesterday announcing changes to PECO's leadership team. Devin will step down as President on December 31st. At that time, Bob Myers, currently COO, will become President and Joe Schlosser, currently Head of Portfolio Management, will become Chief Operating Officer and an Executive Vice President. This is the culmination of our long-standing succession plan. I would like to extend our sincere gratitude to Devin, who has worked side by side with me to transform PECO into one of the largest owners and operators of grocer anchored neighborhood shopping centers in the country. Bob and Joe are extremely talented, proven leaders and team players, who have been critical to the consistent strength of our operating performance.

They have played an important role throughout the majority of PECO's 30-year history, growing the portfolio into what exists today. Bob and Joe have been with PECO for over 20 and 19 years, respectively. They have successfully managed operations, development, acquisitions and dispositions through multiple cycles. I am confident, they will continue to scale the portfolio from here, and I look forward to continuing to partner with them in delivering long-term growth and value creation. Devin will serve as a Managing Director of Investment Management through his planned retirement at the end of June. During this time, he will work closely with me and the team to ensure a seamless handoff of his current responsibilities. Devin is also in discussions with the nominating and governance committee about joining PECO's Board of Directors following his retirement.

I would also like to highlight the recent appointment of Tony Terry to serve as an independent Director of PECO's Board, effective October 30th. We're delighted to welcome Tony to the Board. With more than three decades of public company business experience, working with senior management and boards to drive growth and innovation, Tony brings a proven track record of strategic planning, corporate and operational finance, regulatory matters, and capital allocation. We're excited to have Tony on our Board. With that, we look forward to your questions. Operator?

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