Eastgroup Properties Inc (EGP) 2004 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarterly earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (OPERATOR INSTRUCTIONS). As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. David Hoster, President and CEO. Mr. Hoster, you may begin your conference.

Good afternoon and thanks for calling in for our first-quarter, 2004 conference call. We appreciate your interest in EastGroup.

Keith McKey, our CFO, will also be participating in the call.

Since we will be making forward-looking statements today, we ask that you please listen to the following disclaimer covering these statements.

The discussion today involves forward-looking statements. Please refer to the Safe Harbor language included in the Company's news release announcing results for this quarter that describe certain risk factors and uncertainties that may impact the Company's future results and may cause the actual results to differ materially from those projected.

Also, the content of this conference call contains time sensitive information that is subject to the Safe Harbor statement included in the news release is accurate only as of the date of this call.

Thank you. Operating results for the first quarter met the upper range of our guidance. Funds From Operations were 60 cents per share, compared with 61 cents per share for the first quarter of 2003.

In analyzing the two periods, it should be noted that last year's results included 2 cents per share from gains on the sale of securities and that the 2004 per-share result was negatively impacted by the timing of the investment of the proceeds of our direct placement of common shares last November.

If the 2003 securities gains are backed out, this year's first-quarter FFO would've been up by 1 cent per share.

From my standpoint, the most significant first-quarter operating statistic is a continuing trend in positive same-property operations. Same-property results in the first quarter increased by 3.5 percent on a GAAP basis, which included straight-lining of rents. Without the straight-lining, same-property quarterly results improved by 1.8 percent. This was the third consecutive quarter of positive results for both GAAP and cash-basis statistics.

Improving occupancy levels continue to more than offset the decrease in rents experienced with leaseholders. On a GAAP basis, our best major markets were Phoenix, which was up 14.9 percent, Orlando, up 11.9 percent, and Jacksonville, up 10.7 percent.

The market is significantly worse for Memphis, down 19.4 percent, San Francisco, down 10.0 percent, and El Paso, down 6.2 percent.

We have been pleased with our leasing progress so far this year. Although we finished 2003 at 92.0 percent occupied, we had originally projected occupancy to fall below 90 percent in the first quarter due to several short-term leases related to the holidays and anticipated move-outs of scheduled expirations. Strong leasing activity in March resulted in our finishing the quarter at 91.9 percent occupied.

At December 31, we had 14.5 percent of square footage in the portfolio scheduled to expire in 2004. This rollover total has now been reduced to 9.4 percent as of today.

Occupancy at quarter end in our four core states of Florida, Texas, Arizona and California was 93.4 percent as compared to 84.4 percent in our non-core markets.

Looking at first-quarter leasing statistics, we renewed or released 67 percent of the 1.1 million square feet that expired and leased another 476,000 square feet of vacant space.

Combining both renewals and new leases, we experienced the following -- average lease length was 3.1 years; average lease size was 13,800 square feet; there was an average decrease in rents on a cash basis of 9.7 percent, consisting of a 14.5 percent decrease on new leases and a 4.6 percent decrease on renewals; and the average cost of tenant improvements was $1.10 per square foot over the life of the lease. These statistics are very similar to those for the fourth quarter of last year.

An analysis of the reasons customers did not renew their leases shows that, in the first quarter, approximately 46 percent of the square footage vacated was due to bankruptcy or closing of the business. Twenty-three percent moved from the sub-market and 16 percent was the result of the customer purchasing the building.

From a statistical standpoint, six of our markets reported improved industrial occupancy figures for the first quarter. One was slightly worse, Dallas, one unchanged and four have not yet reported results.

Looking at direct experience in the field, our best first-quarter activity was in Los Angeles and Dallas. Our largest increases in vacancy were in San Francisco and Fort Lauderdale. Memphis continues to be our weakest city for both our portfolio and its overall industrial market.

During the first quarter, our development program increased from eight properties to ten. At March 31, seven properties containing 538,000 square feet were in lease-up and three with 208,000 square feet were under construction. These ten developments contain 726,000 square feet with a projected total cost of $42.6 million. This represents an average cost of $4.3 million and 75,000 square feet per property. Our average projected cost per square foot is $57. The ten properties are currently 41 percent leased and are geographically diversified in three states and five different cities.

In March, we began construction of two new developments. Sunport V, adjacent to the Beeline Expressway in Orlando, will contain 63,000 square feet and will increase our Sunport project to 308,000 square feet with one additional site available for development.

Palm River South, which will contain 79,000 square feet, is located in the East Tampa submarket. It is the first phase of a two-building complex, which is adjacent to our Palm River Center and Palm River North buildings, which have a total of 356,000 square feet.

We plan to begin construction site improvements in the first two buildings of our South Ridge development in Orlando in late June or early July. We also hope to start additional buildings in the third quarter at World Houston, Techway Southwest in Houston and Executive Airport Commerce Center in Fort Lauderdale.

Leasing activity at our development properties has increased during the past 45 days, and we're optimistic about improved occupancies over the balance of this quarter.

As we repeatedly state, our development program has been and will continue to be a major contributor to FFO. The development starts this year are laying the foundation for FFO growth in 2005 and 2006.

During the first quarter, we previously reported the acquisitions of two properties in separate transactions. In January, we purchased the 100,000 square foot Blue Heron Distribution Center II in West Palm Beach for a price of $5.7 million and an adjacent 1.56-acre development parcel for $450,000. The property, which is currently 50 percent leased, is adjacent to our 110,000 square foot Blue Heron I.

In March, we also purchased the 125,000 square foot Kirby Business Center in Houston for $4.2 million. The property is located in the South Loop 610 submarket near Alliance Stadium and the Texas Medical Center complex. It is 100 percent leased to two tenants.

Currently, we're looking at several potential acquisitions but do not now have any under contract. The acquisition environment continues to be difficult with limited attractive business distribution type product being offered for sale.

We presently have two small properties and a parcel of land under contract to sell.

I now turn the call over to comments from Keith, our CFO.

Good afternoon. Debt-to-total capitalization was 31 percent at March 31, 2004, compared to 38 percent a year ago. For the quarter, the interest coverage ratio was 3.7 times and the fixed charge coverage ratio was 3.3 times.

Floating rate bank debt increased 18.8 million during the quarter. The primary reasons for this were repayments on fixed-rate debt of 5 million, development costs of 2.6 million, and acquisitions of 8.1 million net of a mortgage assumed. Our floating rate bank debt amounted to 6.3 percent of total market capitalization at quarter end.

This month, we sent a package to various mortgage lenders for a $25-plus million fixed mortgage rate loan. We are evaluating proposals now.

In looking at FFO, FFO per share for the first quarter was 1 cent per share, below last year's results. Favorable factors were greater occupancy with corresponding greater property expenses to pass through and property income from acquisitions and development. The property operating expense to property operating revenue improved from 30.1 percent in 2003 to 27.8 percent in 2004.

Increased occupancy affects this result in two ways; it brings in more rental income and increases the amount of property expenses we can pass through to customers. Also, bad debt expense for the first quarter was $53,000, less than 1 cent per share, compared to 2 cents per share the same period in 2003.

Lease termination fee was minimal, less than 1 cent per share in both 2004 and 2003.

Unfavorable factors were no gains on securities, compared to 2 cents per share in 2003, and greater G&A costs in 2004. Increased G&A was due to lower development activity, resulting in less costs capitalized, compensation expense, and outside accounting costs due to new rules and Sarbanes-Oxley.

In March, we paid our 97th consecutive regular quarterly dividend. The quarterly dividend of 48 cents per share equates to an annualized dividend of $1.92 per share and the 1.1 percent increase marks the 12th consecutive year of dividend growth.

Our FFO payout ratio was 80 percent for the quarter.

FFO guidance for 2004 remains the same as our original guidance on an FFO per-share basis. FFO per share for 2004 is estimated to be in the range of $2.42 to $2.54, and earnings per share is estimated to be in the range of 86 cents to 98 cents per share.

Now, David will make some final comments.

In summary, we are the most optimistic about EastGroup's future as we have been for the past three years. We are in the early stages of experiencing the benefits of growth in the U.S. economy and believe that EastGroup is well positioned to take advantage of the opportunities this offers.

Last year's capital transactions have provided us with an even stronger and more flexible balance sheet. Leasing activity is generating positive same-property operating results, and our development program is poised to make an increased contribution to FFO growth in the future.

Our strategy is simple and is working -- quality, multi-tenant buildings clustered around major transportation features in growth markets.

I will now turn the call over to questions, and Keith and I will be happy to answer whatever you might have for us. Thank you.

Thank you, sir. (OPERATOR INSTRUCTIONS). Our first question comes from John Kempf (ph) of UBS.

Good afternoon. It's John Kim with Keith. It looks like some of the expected development costs for a couple of your properties have increased this quarter by about 8 percent, and these are the ones in Fort Lauderdale and Tampa. Can you comment on why these expected costs increased?

We are adding or placing extra tenant improvements in the space above what had originally been budgeted for these properties, and some or all of that will be recouped in higher rents. But we generally are budgeting 12 to 15 percent office-buildout, and if the prospects need more than that, the costs are going to go up and hopefully the rents will correspondingly increase.

Okay. Can you comment on the leasing activity at World Houston 20?

That one has been a bit frustrating. We are, I guess, almost a year into the lease up-period with note leases signed. It's a building that probably needs to be broken down into two parts, which would roughly be 30,000 square feet each. That has not been a size that we've seen a lot of activity in.

Actually, we have some renewed activity in just the last two weeks there. Like I say, that's -- at World Houston, we've been seeing smaller tenants, so that one has been frustrating but we hope to have some better news to report the next conference call.

Okay. Keith, you mentioned the G&A costs increasing in this quarter. Can you comment on how much of that was due to Sarbanes-Oxley?

We think, for the year, that that's going to increase probably $150,000.

So 150 out of the roughly 470?

No, that's for the year. (multiple speakers).

Okay. I just had one final question. The TIs per square foot per year of the lease term was about 59 cents this quarter, and that was little bit higher than what you had last year at 54 cents. Can you comment on what you think it will be for the rest of the year?

On a combined basis, it was $1.10, which is roughly the same number it was for the fourth quarter last year. Last year, we averaged I think it was 93 cents a square foot for the life of the lease. Our hope is it's going to come down a little bit, but we don't have any plans or budget anything less than what we are experiencing right now.

Okay, are markets dictating still pretty high TIs?

I would say that, when you look at what you provide as a concession in different markets, it's generally in slightly lower rent or a number of months free rather than too much adjustment on the TIs. The TIs -- our biggest swings are in the type building where the lease is occurring, where there's a high office buildout, like in Santa Barbara, that they can be 3 or $4 a square foot, and the bigger industrial spaces are going to be loose change and this is just really where it comes out on average.

Tony Howard from Hilliard, Lyons.

Good afternoon, David and Keith. Go back to the G&A question. It was up 35 percent year-over-year and also up fairly sharply sequentially. You mentioned several reasons why, but I'm not real clear whether you expect the first quarter to be a good run-rate, going forward, with all of these other expenses coming in online.

Well, it looks like the run-rate is going to be higher than we had hoped it would be because of all the new rules. It's looking like it may be in the 6 to 6.2 million on run-rate. The first quarter had, on the development costs, we hope to capitalize more with development activity stepping up in the later quarters, so that should counterbalance some of that. But with the new accounting pronouncements and new internal control procedures and other things stepping up, we think there's going to be more.

Okay. Also following along with the prior question, as far as on Page 13 of the supplement, I'm curious. Kind of sequentially, the average lease size of new leases has gone up and the average size of the renewals has gone down. Is that just a quirk in the timing, or is that a trend you're seeing? What kind of consequences may that have?

I don't think there's any trend that we could identify there, Tony, right now. I just think that happens to be where we are this quarter. If you go back to the yearly average, you are right; it was 15,000 and the yearly average for 2002 was 15,000, and in the fourth quarter, it was 13.5. I think we need to go another quarter or two to see if there is any trend there. If there is a trend, I'm not sure what it says at this point -- maybe, simply, that it confirms what we've been saying for awhile, that the real activity is in the smaller spaces; the smaller tenants are the ones that are out signing new leases today rather than the bigger users. But I think we need another quarter or two to determine whether that's a trend.

Okay. You mentioned that you are still having experience in a difficult market on the acquisition front. Given that rates have gone up some lately but where they've been historically, it seemed like there might be a lot of people willing to sell, given that fear of a rising-rate environment.

I hope that's true. There are a number of larger industrial packages that are scheduled to come out over the next couple of months. What we haven't been seeing is many of the one-off type properties that we bought last year and earlier this year in the marketplace. People just seem to be holding onto industrial properties. Industrial owners are the ones that tend to be longer-term, more-stable owner/operators. I think a second factor is that people look around and say, "Well, I can get top dollar for my real estate today, but what to do with the money after I pay taxes on it, or how do I find a reinvestment property?" The same issue that we're looking at, but our hope is that a number of these packages that are scheduled to come on the market soon will have some attractive assets that we will be in a position to bid aggressively on.

Okay. A final question, and it seems like I ask this every quarter, what are you going to do about Memphis?

(LAUGHTER). We're working very hard to increase the occupancy there. I think we have bounced off the bottom from the same-store we were down in the first quarter because last year's first quarter, we had a little over a month of a very large tenant who exited the market. So in future quarters, I hope we will be talking about at least slight increases in same-property results there.

One of the two properties that we have under contract to sell is a small building in Memphis to a user. So, we would like to be able to exit that market a little more quickly than we seem to be moving, but as properties are in a good position to sell, we're starting to offer them. We hope to announce at least one small sale there in the next quarter.

Okay, thank you.

(OPERATOR INSTRUCTIONS). Art Havener from A.G. Edwards.

Thank you. I have a question on the same theme of finding out what's going on from a trend standpoint. Are you finding that the length of vacancy after a tenant moves out -- is that expanding or contracting? Are you finding that the same vacant space is the problem space, if that makes sense?

If you look at the average that -- when we're signing leases, the average is a little over six months and has been that way for a number of quarters. Some of the more difficult spaces, in the more difficult markets like Memphis, have -- if you look at the spaces that are vacant and the average amount of the number of months that they've been vacant, giving no credit for what was just leased, we are at the highest we've ever been at a little over 11 months. But that has bounced around over the last five or six quarters from 9 to 11 percent, so it's really not changing that much.

What we are seeing, Art, is that markets are better in general but they are certainly not strong yet. The positive is I heard a leasing agent describe the other day is that the prospects out there today have a space need and most are going to sign a lease to meet that need. They are either new to the market or they are expanding within the market. A year to 18 months ago, an awful lot of the prospects were simply out shopping to use you as a comparable in the renewal of their current lease. So, the prospects out there are real, live customers and the goal is to get them to sign with us rather than with somebody else.

There still is not a real sense of urgency in the marketplace that we hope to see as time goes on because there are too many alternatives; prospects move more quickly as soon as they start to worry that their first couple of choices are about to disappear and that has not been the case so far. But that is really going to be when the tide turns.

So, if I understand it, you don't have any perpetual vacant-space problems; it's just that some markets are slower to re-lease the vacant spaces?

That's correct.

Now, help me with the historical perspective. You made an interesting comment about the smaller tenants are signing spaces and in past economic cycles, I thought the smaller tenants generally started leasing space at a more mature part of the economic cycle. Is it different this time?

I don't think that has really been the case. We found the smaller spaces turnover more because they tend to be entrepreneurs, small private/small business, not your big Fortune 1000 companies. They turnover more, but there are more of these entities that are starting up, more of these entities that are starting to need new space based on home building, just general growth in the markets in which they operate. So, historically for us, we've seen the activity increase in the smaller spaces; we have less rent deterioration with the smaller spaces, less free rent and less TIs, so we view it as somewhat of a verification of our strategy.

Okay. I think you mentioned, in the first quarter, about 46 percent of your increased vacancy was due to bankruptcies. I could be wrong but -- (Multiple Speakers).

Yes, or smaller tenants generally just closing the door.

Okay. Is that unusually high, or is that normal?

It seems a little bit high compared to what it had been in the past, but all it takes is one or two tenants to affect the statistics. Until we look at another quarter or two to see if that is the same, I don't think that is a trend. One example is a space in Orlando, where a tenant filed bankruptcy and we reduced the amount of space they were going to have and had another tenant take it without missing a day of rent. So, it doesn't mean that it's going to cause us downturn. I think this -- I say we need to look at another quarter or two to see if there's anything there, but it has not affected our loss reserves in any way, as you could tell from Keith's report.

Kind of sticking with the optimistic signals that we're getting, are you able to kind of look into your crystal ball and try to figure out how successful you think you can be in renewing expiring leases this year?

Our leasing trendline is kind of wild. As I mentioned to you, we finished '03 at 92 percent. By the end of February, we were down to about 90.6 percent and in one month, shot back up almost to 92 percent. We project falling back down into the low 90s in the middle of the second quarter and then starting back up again. We have some large move-outs that we've known have been coming for quite a while in New Orleans, and I think that's going to affect those figures. Then, we project improving from there out the rest of the year.

What we're seeing, though, is just more people looking, more proposals out and a steady signing of leases. It's not in any one market; it seems to cycle, but just continued positive activity and a general note of optimism in all but a couple of markets.

Great. Thank you very much.

Gary Boston from Smith Barney.

Good afternoon. It's Gary with John here. David, in terms of looking out to the balance of '04/'05 and you look at the rent and how they are rolling, is this quarter a pretty good sort of guide in terms of where you think things are going to roll to, the kind of down 9 percent on a cash basis or couple of percent on a GAAP basis?

I think so for at least the next six months and probably through the rest of the year. In talking to people in the field, there's still too many alternatives in almost every submarket, and if you want to lease space, you have to be able to compete with some of the lower-rent landlords, and you can't be tough on the rent. Our goal is to lease the space, so I'd like to see, I'd like to hope for but I don't expect any short-term improvement in the roll-down on rents.

It looks like next year's roll is similar in terms of -- it's about -- I'm doing the math right here -- 490, 485 a foot. So if you are not looking for any market, field market appreciation in rents this year, then it would seem like, at least heading into next year, you're going to be in a similar position.

I would hope by then we would start to see rent moving back up a bit, and it's a mindset in the marketplace. If everybody expects free rent or lower rents and they can get it, then you're going to have to give it. As those alternatives start to reduce and prospect playing tough (sic) and they miss out on their first and second choice for a space, I think that can turn pretty quickly. It's just really what the sense is in the market and it is still just too loose right now to say exactly when it's going to change, but most of the markets are having positive absorption. If that continues, it doesn't take a lot to turn the tables.

All right. A question for Keith, just on some of your information you published -- on Page 12, which is your CapEx schedule, where you go through the different lives and everything on the CapEx that you are doing, what's the difference between that first grouping of what you're calling capital expenditures, in terms of the TIs and leasing -- the TIs there versus the -- is just the stuff down below just the leasing commission piece?

Yes.

Okay, I just wasn't getting it. In terms of the acquisition space, I mean, I think that, on the last call when you sort of laid out your guidance for the year, you had about $10 million in acquisition assumptions, for '04. You've already hit that number.

Right, correct. What we assumed was that we would have 10 million for half the year, so another way to look at it is (indiscernible) have 10 million in place by July 1. We did a little over 40 percent of that in March so that we had a jump on that. We don't have anything under contract today that says that we can have it closed by July. I hope we're going to do better than that but it's not anywhere near being booked yet, so we're still trying to just be very conservative from that standpoint.

We also, many times, have bought good assets, as you know, with vacancy and -- just like the building, Blue Heron II, that we bought in January. It's 50 percent occupied; it's yielding -- I think it's about 3.5 percent at 50 percent occupancy. It takes awhile to lease that kind of space and have the tenant actually -- with tenant improvements in -- paying, and so there's a time delay on that. So, we just try to be conservative with those projections.

On the Houston asset, it's just closed. What was the yield on that?

If I recall quickly, on a straight line basis, it was 9.5 percent. Yes, it was about -- on a cash, it was a 9 or a 9.1. That's at 100 percent occupancy, which it is.

In terms of the roll there, is there any near-term exposure?

Not for four years.

(OPERATOR INSTRUCTIONS). Ken Avalos from Raymond James.

Good afternoon. This is Paul Puryear. A couple of things -- first off, is there any risk of seasonality as a factor in this sort of modest pickup that you've seen?

I don't think so; that's not the impression that we received from our people actually out on the ground in the various submarkets. It has been -- I don't want to say steady but improved for most of the year, and there have been some dips in each submarket, but it seems to come back in terms of prospects out there. We're not to the point where we can really be excited and have two or three prospects for an individual space, like it was maybe three or four years ago, but we continue to sign leases and so it is certainly a better environment than it was six or twelve months ago, so hopefully we are not being overly optimistic.

Thanks. Could you give us a little more color on the Hayward market, sort of the whole Northern California picture, what you see there, how that unfolds?

I think we've been saying, for a quarter or two, that Hayward seems to have bottomed out in terms of vacancy and rents. On rents rolling down, the rents went up so much there that the roll-down is bigger than it would be under other circumstances and other markets. We've had a good bit of roll-over there. We've signed a some leases, we've got a couple vacancies, so we seem to be fairly stabilized.

What's hurting us we call the San Francisco Bay area but we have a two-building complex a little over 100,000 square feet in Milpitas. That's all but dead down there, from our standpoint. We're just not seeing -- these are two warehouse buildings in somewhat of an R&D, service center/FLEX (ph) marketplace, and we just had very, very little traffic. We've budgeted that complex to be vacant for the entire year.

So you don't see any immediate light at the end of the tunnel here?

Certainly not in Milpitas -- Hayward, we're seeing activity. We don't see rents moving back up yet, but there are people out leasing space, customers expanding. We had a long-time customer at Hayward increase from 20,000 square feet I think to 120,000 square feet right at the first of the year, so leases are being signed there.

One more thing, and you might have touched on this already, but could you just talk about asset pricing and sort of what do you think happens here, given that we've sort of seen a reversal in the interest rate expectations?

I'd like to think that the one-off type investments, which we have been able to find in the past, are going to have maybe a little more attractive pricing for us as a buyer because we tend to be competing with another buyer who's going to borrow money to acquire that asset so that their yield criteria is going to be affected.

In terms of the bigger packages, I'm afraid that a lot of the pension fund advisory money was raised with very low expectations on yield compared to what we've seen historically, until just recently. That's not going to change overnight. There still seems to be an awful lot of institutional money chasing industrial real estate and not even just high-quality industrial real estate but B quality also, as long as it is in a package of 25 million or more. I don't think that's going to change for awhile. But I'd like to think there is going to be a little more movement in the prices for the $10 million asset and below.

Yes, okay. Any guess as to when that could happen? (LAUGHTER).

(LAUGHTER). Again, it's going to be just subject to what comes on the market when, and in what submarkets. I mean, California -- people seem to still have some funny money out there and cap rates are crazy. Some of that flows over into Arizona at times and Nevada. It's submarket-specific, or market-specific, but not enough time has passed to be able to give you any real color on it. That's just personal opinion.

Okay, thanks.

I'm showing no further questions in queue, sir.

Well, again, thank you all for calling in and as always, Keith and I are available for any questions that weren't asked or that might come up in the future, so please don't hesitate to call us. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. That concludes the program. You may now all disconnect.