Phillips Edison & Firm, Inc. (NASDAQ:PECO) This fall 2022 Earnings Name Transcript February 10, 2023

Operator: Good day, women and gents, and welcome to Phillips Edison & Firm’s Fourth Quarter and Full 12 months 2022 Earnings Convention Name. Please observe that this name is being recorded. I might now like to show the decision over to Ms. Kimberly Inexperienced, Head of Investor Relations. Please go forward, ma’am.

Kimberly Inexperienced: Thanks, operator. I’m joined on this name by our Chairman and Chief Govt Officer, Jeff Edison; our President, Devin Murphy; and our Chief Monetary Officer, John Caulfield. As soon as we conclude our ready remarks, we’ll open the decision to Q&A. After as we speak’s name, an archived model will probably be revealed on our Investor Relations web site. As a reminder, as we speak’s dialogue could comprise forward-looking statements concerning the firm’s views of future enterprise and monetary efficiency, together with ahead earnings steering and future market circumstances. These are based mostly on administration’s present beliefs and expectations and are topic to varied dangers and uncertainties as described in our SEC filings, particularly in our most up-to-date Kind 10-Okay and 10-Q.

In our dialogue as we speak, we’ll reference sure non-GAAP monetary measures. Info concerning our use of those measures and reconciliations of those measures to our GAAP outcomes can be found in our earnings press launch and supplemental data packet, which have been posted to our web site. Please observe that we have now additionally posted a presentation with extra data. Our warning on forward-looking statements additionally applies to those supplies. Now I’d like to show the decision over to Jeff Edison, our Chief Govt Officer. Jeff?

Jeffrey Edison: Thanks, Kim, and thanks, everybody, for becoming a member of us as we speak. The PECO workforce in 2022 delivered one other yr of robust progress with same-center NOI rising by 4.5%. We proceed to learn from a lot of constructive macroeconomic developments that drive neighbor demand and assist our progress, together with hybrid work, migration to the Sunbelt and inhabitants shifts that favor suburban markets. These demand elements are additional amplified as a result of restricted new provide is being delivered to the market. We completed an excellent deal in 2022 and have so much to be happy with. On the macroeconomic stage, the yr offered many challenges with document inflation, rising rates of interest and world battle. Nevertheless, the sustainability and consistency of our progress is a testomony to our differentiated and centered technique of completely proudly owning grocery-anchored neighborhood purchasing facilities and the energy of our built-in and skilled working platform.

As we assess our enterprise as we speak, we’re optimistic concerning the well being of our neighbors and the energy and variety of our neighbor combine. Our workforce in 2022 delivered document highs in occupancy of 97.4% and mixed leasing spreads of 18.1%, our improvement exercise offers enticing risk-adjusted returns on funding and sustainable and significant contributions to our same-center NOI progress. Our acquisitions are performing very effectively, and our pipeline continues to develop. We closed on an asset in January with extra underneath contract and in negotiation. We noticed the market energy shifting to the client and with our platform, expertise and capital, this could place us effectively to seize extra alternatives. Our facilities are situated in markets which are rising and have a powerful aggressive benefit with our grocery anchors.

We have now grown our money flows and dividend distributions. We have now an excellent steadiness sheet, low leverage and suppleness to be each affected person and opportunistic. We couldn’t have completed these outcomes with out the laborious work of our PECO associates. I’d prefer to thank the PECO workforce for all of their efforts. As we sit up for 2023, we stay centered on delivering long-term progress. Our gross-anchored neighborhood facilities proceed to learn from structural and macroeconomic developments that create robust tailwinds and drive robust labor demand. These developments embody inhabitants shifts from the city to suburban markets, the rise in hybrid work the renewed significance of bodily areas in final mile supply, wage progress and low unemployment and low provide and lack of latest development.

The resiliency of our neighbors, mixed with the aforementioned tailwinds and place PECO effectively for all financial environments as a result of following, our necessity-based neighbor combine, our rightsized format, our well-positioned areas in rising markets our document excessive occupancy and continued robust labor demand. Our robust credit score neighbors and diversified combine, the shortage of publicity to distressed retailers. Our steadiness sheet and our proficient and cycle-tested workforce. After we take into account our pricing energy created from continued retailer demand at excessive occupancy, mixed with these aforementioned tailwinds and the resilient necessity-based focus of our neighbors. We imagine our progress technique generates extra alpha with much less beta. Whereas John will present particulars of 2023 steering later, I’d prefer to spend a couple of minutes strolling you thru the parts of our long-term progress.

We imagine our portfolio can ship natural same-store NOI progress of three% to 4% on a long-term foundation. The parts of this progress embody continued will increase in occupancy, which can contribute 50 to 100 foundation factors. Rental progress, which can contribute 100 to 125 foundation factors by means of new and renewal leasing spreads and contractual hire will increase, which can add 75 to 100 foundation factors and redevelopment and improvement exercise, which can add 75 to 125 foundation factors. This will get us to our 3% to 4% long-term progress. Past the robust inside progress, we stay centered on accretively rising our purchasing middle portfolio. These investments are core to PECO’s long-term exterior progress technique, and we proceed to be effectively positioned to capitalize on alternatives as they come up.

We’re conservatively guiding to $200 million to $300 million in internet acquisition this yr with the aptitude and the leverage capability to accumulate extra if enticing alternatives materialize. We beforehand elevated our focused return for brand spanking new acquisitions to an unlevered IRR of 9% or above. We plan to take part available in the market once we can obtain this return goal whereas exercising the identical diligence we’ve at all times exercised. We’re discovering these alternatives as we speak. Due to this fact, with our mixed inside and exterior progress drivers, we imagine PECO can ship mid-to excessive single-digit FFO per share progress on a long-term foundation. I’d now like to supply a fast replace on the proposed Kroger and Albertsons merger from PECO’s perspective. We proceed to imagine that the merger is constructive for PECO and for our facilities and for the communities that we — that our facilities serve.

We have now 33 shops with an overlapping model inside 3 miles that might doubtlessly be impacted. These shops have common retailer gross sales of $35 million or $620 per sq. foot. This compares to PECO’s common of $6.42 per sq. foot. These are all productive grocery areas with robust gross sales and well being ratios. These facilities are additionally very important elements of their communities. We imagine all 33 areas will stay productive grocery areas whatever the final final result of the merger. This merger course of will take time to unfold, however we stay constructive on the impression it is going to have on the belongings that we personal. I’ll now flip the decision over to Devin to supply extra shade on the working surroundings. Devin?

Picture by Heidi Fin on Unsplash

Devin Murphy: Thanks, Jeff. Good afternoon, everybody, and thanks for becoming a member of us. As Jeff talked about, the PECO workforce is inspired by the continued constructive developments that we’re seeing in our grocery-anchored portfolio and within the general working surroundings. We realized robust inside progress in 2022, which is mirrored in our monetary outcomes. Lease portfolio occupancy elevated by 30 foundation factors sequentially from the third quarter and by 110 foundation factors year-over-year, reaching an all-time excessive of 97.4%. We nonetheless see some occupancy upside in our portfolio. And when that driver of progress is not accessible, we imagine that will probably be changed by incremental hire progress. We’re seeing that transition as we speak as our hire spreads have elevated above historic ranges.

All through 2022, our neighbors demonstrated resiliency and efficiently managed many challenges, together with inflation, provide chain points and labor shortages. Regardless of these challenges, our neighbors proceed to put money into their shops, their know-how platforms and the general buyer expertise. Comparable new and renewal hire spreads for 2022 had been robust at 32. 2% and 14.6%, respectively. Excluding anchors, renewal spreads had been 17.7% within the fourth quarter. Our leasing pipeline stays robust and reveals no indicators of slowing. Probably the most energetic neighbor classes embody medical, quick-serve eating places and well being and wonder. We’re seeing constantly robust neighbor demand throughout all geographic areas. We proceed to have glorious success retaining our neighbors, whereas rising hire at enticing charges.

Our fourth quarter retention charge was 92%, forward of the historic common of 87% during the last 5 years. As Jeff talked about, this issue is a big contributor to our hire progress over time. Our retention means no downtime and fewer tenant enchancment prices. Our TI spend on renewals during the last 5 years averaged lower than $2 per sq. foot. We even have been profitable at driving increased contractual hire will increase. On common, our new and renewal in-line leases executed within the fourth quarter had annual contractual hire bumps of two.4%, one other contributor to our long-term progress. Along with our robust rental progress developments, we proceed to deal with and develop our pipeline of ground-up outparcel improvement and repositioning initiatives. In 2022, we stabilized the best variety of these initiatives that the PECO workforce has ever delivered in a single yr.

These initiatives delivered over 300,000 sq. ft of area and add incremental NOI of roughly $5 million yearly. These initiatives present superior risk-adjusted returns and have a significant impression on our long-term NOI progress. In 2023, we’ll make investments $50 million to $60 million in ground-up outparcel improvement and repositioning alternatives with common estimated underwritten cash-on-cash yields between 9% and 11%. We proceed to see the numerous advantages of PECO’s grocery anchor portfolio with our wholesome mixture of nationwide, regional and native retailers. Greater than 70% of our rents come from neighbors providing necessity-based items and companies, and our high grocers proceed to drive robust recurring foot visitors to our facilities. We’re presently seeing a resilient client regardless of the harder macroeconomic backdrop.

We imagine our incentives are much less impacted by an financial downturn as a result of greater than 70% of our rents come from necessity-based items and companies. Our commerce areas provide favorable demographics with median family incomes of $77,000, which is roughly 9% increased than the U.S. media. The demographic energy of our commerce areas is strengthened by the continued demand from retailers for area at our facilities. In a recession, shoppers will proceed to frequent the grocery retailer, the barber, the native quick-serve restaurant and different necessity retailers. Our single non-grocery neighbor is T.J. Mac at 1.4% of ABR. And all different non-grocery neighbors are lower than 1% of ABR. PECO had no publicity to luxurious retailers, workplace or theaters and really restricted publicity to distressed retailers.

The highest 10 neighbors presently on our watch checklist signify simply 2% of our ABR. As a reminder, our mixed publicity to Mattress Tub & Past and Occasion Metropolis is minimal. These two retailers signify 10 and 20 foundation factors of ABR, respectively. 26% of our ABR is derived from native neighbors. 64% of our native neighbors rents come from retailers providing necessity-based items and companies. Our native neighbors are profitable companies run by hard-working entrepreneurs. The acute credit score and are much less inclined to company chapter attributable to weaker performing areas. A neighborhood neighbor sometimes receives much less capital firstly of their lease, accepts extra Peco-friendly lease phrases, excessive retention charges and achieved renewal spreads much like nationwide neighbors.

Importantly, they differentiate the merchandise combine that our facilities provide our prospects. Our native neighbors are resilient and have been in our facilities for 8.8 years on common. In accordance with CoStar’s current world Predictions report, grocery shops and important retail are among the many most resilient retailers throughout recessions. Throughout the pandemic, grocery shops and the foot visitors to those facilities recovered at a sooner charge than that of different retail areas. Because the pandemic, the emptiness unfold between grocery-anchored and non-grocery-anchored facilities has widened. Grocery-anchored facilities are effectively positioned to take care of these decrease vacancies, which we’re experiencing in our portfolio. We anticipate these favorable developments to proceed to learn PECO’s well-located, grocery-anchored neighborhood facilities in 2023 and past.

We have now added slides to our investor presentation on these current CoStar insights. In abstract, the PECO workforce stays optimistic concerning the present robust working surroundings and the continued constructive momentum we’re experiencing throughout leasing, redevelopment and improvement. As well as, our wholesome neighbor combine and grocery-anchored technique positions PECO effectively for continued regular progress. I’d now like to show the decision over to John.

John Caulfield: Thanks, Devin, and good morning, and good afternoon, everybody. I’ll begin by addressing fourth quarter outcomes, present an replace on the steadiness sheet after which stroll by means of some highlights of our preliminary 2023 steering. Fourth quarter 2022 NAREIT FFO elevated 43% to $71 million or $0.54 per diluted share. This outcome benefited from a rise in rental earnings and diminished normal and administrative bills. Fourth quarter core FFO elevated 22% to $74 million or $0.56 per diluted share pushed by elevated income at our properties from increased occupancy ranges and robust leasing spreads in addition to decrease property working prices and normal and administrative bills. Our fourth quarter 2022 same-center NOI elevated to $91 million, up 2.8% from a yr in the past.

This enchancment was primarily pushed by increased occupancy and a rise in common base hire per sq. foot, pushed by our robust renewal and new leasing spreads, which was partially offset by decrease collectibility reserve reversals within the present interval when in comparison with 2021. Throughout the quarter, we acquired two grocery-anchored purchasing facilities and 1 outparcel for $52 million, and we offered 1 purchasing middle in 1 outparcel for $25 million. Our internet acquisitions for the yr was $226.5 million. Subsequent to quarter finish, we acquired one extra grocery-anchored purchasing middle for $27 million. From a steadiness sheet perspective, we ended the yr with over $700 million of borrowing capability accessible on our $800 million credit score facility, and we have now no important debt maturity till the second quarter of 2024.

Between the free money move generated by our portfolio and the numerous capability accessible on our revolver, we’re assured in our capacity to fund our progress plans, which is a vital place to be given the present capital market surroundings. Our leverage ratio continues to be robust on account of our robust earnings progress in addition to our prudent steadiness sheet administration with our internet debt to adjusted EBITDAR of 5.3 occasions as of December 31, 2022, in comparison with 5.6 occasions at December 31, 2021. At year-end 2022, our debt had a weighted common rate of interest of three.6% and a weighted common maturity of 4.4 years. Roughly 85% of our debt was mounted charge. We proceed to watch the debt capital markets for the correct alternative to increase our maturity profile.

Our variable charge debt permits us to take care of flexibility such that we are able to entry the bond market or financial institution market with out prepayment penalty and our low leverage reduces the impression of charge volatility to our earnings. We anticipate addressing our 2024 maturities together with long-term funding for our anticipated 2023 acquisition quantity later this yr. We imagine persistence is prudent as we proceed to gauge the attractiveness of the market. Turning to steering. Please make sure to evaluation the incremental element added to our press launch, which we have now additionally added to our supplemental. Beginning with our same-center NOI progress, we’re guiding to a spread of three% to 4% progress from our portfolio in 2023. This progress is aided by our leasing exercise in 2022 with elevated occupancy and favorable hire spreads in our improvement and redevelopment exercise.

Included on this vary is the destructive impression of normalizing our anticipated uncollectible reserves to historic ranges of 60 to 80 foundation factors of income. Our preliminary core FFO per share steering vary is $2.28 to $2.34. Our inside progress is aided by an incremental carry from our 2022 and anticipated 2023 acquisitions, partially offset by incremental curiosity prices. As we glance to 2023, we anticipate roughly $86 million of curiosity expense on the midpoint. Our acquisition pipeline is wholesome, for 2023, we’re guiding to accumulate between $200 million and $300 million of belongings internet of disposition exercise to additional optimize our inside progress. We plan to proceed to selectively recycle belongings with proceeds being deployed into high-quality, higher-growth belongings.

As Jeff talked about, we imagine we’re effectively positioned for long-term progress and we’re delivering robust inside and exterior progress. Importantly, we have now the flexibleness to be affected person and pursue accretive alternatives as they come up that can present significant NOI contribution in 2023, 2024 and past. And possibly most significantly, as we take into account the financial uncertainties, we proceed to have one of many strongest steadiness sheets within the sector permitting us the flexibility to stay on offense and pivot shortly in response to altering market circumstances. We imagine our technique has traditionally and can proceed to prospectively generate glorious risk-adjusted returns. Our ends in 2022 are not any exception. With that, we sit up for taking your questions.

Operator?

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Q&A Session

Operator: We’ll take our first query as we speak from Craig Schmidt, Financial institution of America.

Craig Schmidt: Thanks. The place will PECO’s whole occupancy and small store occupancy by the top of 2023?

Jeffrey Edison: John, do you need to take that.

John Caulfield: Positive. Thanks for the query, Craig. So we nonetheless imagine that we have now room to develop our occupancy. Presently, we’re at 99% plus on the anchor. So we’re down to some areas there. So I believe that half holds nonetheless, however at 93.8% on the in-line, we nonetheless imagine we have now about 150 foundation factors that we are able to develop that. And I might say that’s in all probability over the subsequent 12 to 18 months.

Craig Schmidt: Nice. After which simply on the adjustment for collectibility of three.5 to 4.5 versus 2. Once I have a look at your portfolio, I see little or no publicity to bankruptcies and retailer closings, what’s driving you to this increased quantity?

John Caulfield: Sure, Jeff, I’ll take that one once more. So actually, what you see in ’22 being lower than that was the ultimate quantity of reversals from earlier years coming by means of. As we glance to it, we’ve mentioned that this portfolio has delivered 60 to 80 foundation factors of uncollectibles annually. And in order that’s actually the rules for that. I imply we imagine it’s going to be constant from one yr to the subsequent, however that’s — on this portfolio, that’s what our expertise has been.

Craig Schmidt: Nice. Thanks.

Operator: We go subsequent now to Haendel St. Juste at Mizuho.

Ravi Vaidya: That is Ravi Vaidya on the road for Haendel St. Juste. Hope you guys are doing effectively. Are you able to focus on your determination to purchase an asset with comparatively decrease occupancy versus the remainder of your portfolio? What kind of upside do you see there? And is that this going to be extra of a focused technique going ahead with regard to exterior progress?

Jeffrey Edison: Ravi, thanks for the decision and respect you being on as we speak. So we’re — One of many issues we did during the last 30 days, actually 60 or 90 days, have a look at our value of capital. And as that’s going up, we’ve really adjusted our unlevered IRR from 8% of the IPO to 9% as we speak. And one of many issues that we’re on the lookout for are alternatives the place we are able to have progress number of other ways within the properties that we’re shopping for. And the place we see lease-up occupancy is a kind of alternatives and choose areas on choose properties, however we’re ways in which we are able to discover properties with extra progress potential than actual steady flat, type of returns over time. So sure, I believe you may anticipate us to be extra energetic in that market, however as you understand, it’s — the market’s bought some fairly large bid ask unfold as we speak. And so we do anticipate that quantity will probably be somewhat slower choose the primary half of the yr.

Ravi Vaidya: Received it. Thanks. That’s useful. Only one extra right here. As regards to leasing, it’s been a really — leasing demand could be very robust, and it’s been very energetic, however how sustainable do you assume the present leasing spreads are, particularly with spreads over 30% like how wholesome are the retailers are from an occupancy value ratio standpoint to have the ability to maintain these continued increased the leasing spreads.

Jeffrey Edison: Devin, do you need to take that?