Eastgroup Properties Inc (EGP) 2004 Q3 法說會逐字稿

Good day. All sites are now in the conference room in a listen-only mode. At this time, I'd like to go ahead and turn the program over to our speaker, Mr. David Hoster, President and CEO of EastGroup Properties. Go ahead, sir.

Thank you. Good afternoon, and thanks for calling in for our third-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 describes 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 third quarter met the upper end of our guidance, with funds from operations of 64 cents per share. This was an increase of 21 percent over the 53 cents per share for last year's third quarter, which included a 9 cent per share write-off of the original issue cost of our Series A Preferred stock. If the write-off is added back to the 2003 results, the increase in FFO was 3.2 percent for the third quarter of this year.

FFO for the 9 months was $1.84 per share compared to $1.74 per share for the same period in 2003, an increase of 5.7 percent. Last year's results included both the write-off of the preferred stock cost and a 2 cent per share of gains on securities. Please note that we continue to calculate funds from operations based on NAREIT's definition of FFO, which excludes gains on depreciable real estate.

In analyzing third-quarter operations, we were especially pleased with the strong growth in same-property operating results. We achieved an increase in same-property operations of 4.5 percent on a GAAP basis, which included straightlining of rents. And without the straightlining, same-property quarterly results improved by 5.8 percent. This was the fifth -- I repeat, the fifth -- 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 for the lease rollovers.

On a GAAP basis, our best major markets were Memphis, which was up 19 percent; Los Angeles, up 14 percent; Orlando, up 10 percent; Phoenix, up 9.9 percent; and Houston, up 9.4 percent. The markets significantly worse were the San Francisco area, down 16.5 percent; Dallas, down 9.8 percent; and Fort Lauderdale, down 9.3 percent. Both the same-property increases and decreases are primarily due to swings in occupancy levels between the two periods.

Occupancy at September 30 was 92.1 percent. This represents a 70 basis point increase over June 30, and our highest level of occupancy since the fourth quarter of 2002. Our strongest leasing results have been in our Florida markets, which, at the end of the quarter, were 97.3 percent leased, with Orlando, Jacksonville, and Tampa all between 97.5 percent and 98.9 percent. Occupancy at quarter ended in our four core states of Florida, Texas, Arizona, and California and was 93.2 percent as compared to 86.4 percent in our non-core markets. For the third year in a row, we expect to continue to experience improving occupancy in the fourth quarter and then a decline in the first quarter of next year. This is a result of the number of holiday-related short-term leases and known moveouts extending leases into early 2005.

Looking at third-quarter leasing statistics, we renewed or released 84 percent of the 763,000 square feet that expired and at least another 386,000 square feet of vacant space. Combining both renewals and new leases, we experienced the following. Average lease length was 3.3 years, which reflected recent quarterly results. Average lease size was 13,700 square feet, which was normal. The average cost of tenant improvements was $1.59 per square foot for the life of the lease, or 49 cents per square foot per year of the lease. And this represents a small increase. And there was an average decrease in rents on a cash basis of 4.5 percent, consisting of an 8.7 percent decrease on new leases and 0.6 percent increase on renewals. This was the lowest decrease in rents since the first quarter of 2003. On a GAAP basis, it was the first quarter of positive rent growth since mid 2002. An analysis of the reason customers do not renew their leases shows that in the third quarter, approximately 80 percent of the square footage that was vacated was due to the customers' changing space requirements, and 11 percent was the results of bankruptcy or a closed business.

During the third quarter, we transferred two development properties with 157,000 square feet to the portfolio -- Sunport IV in Orlando, with 63,000 square feet, is 86 percent leased. And Techway II in Houston, with 94,000 square feet, is 43 percent leased. We're currently negotiating with good prospects to fill the balance of both buildings.

At September 30, our development program consisted of 7 properties, 1 in lease-up which is 100 percent leased, and 6 under construction. They represent 467,000 square feet, with a total projected investment of almost $30 million, and are currently 27 percent leased as a group.

In late August, we began construction of site improvements in the first two buildings at our SouthRidge development in Orlando, which will eventually contain 760,000 square feet when fully built out. We also started construction of our third and final building at Executive Airport Commerce Center in Fort Lauderdale. These three properties represent a total projected investment of approximately $12.7 million, with 166,000 square feet.

Our development program continues to be geographically diversified in 5 different cities. Our average development is 67,000 square feet, with an investment of $4.2 million, or $64 per square foot.

Overall, we have been experiencing an increase in leasing activity at our development properties, both the ones still in the development pipeline and those that were recently transferred to the portfolio with some vacancy. Orlando and Houston have been particularly strong over the past 30 to 45 days.

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.

In the first week of July, we acquired Interstate Distribution IV for $3 million. Located in the Walnut Hill/Stemmons Freeway submarket of Dallas, it is a 46,000 square foot business distribution building which was constructed in '02. It is 100 percent leased to 9 tenants.

In August, we entered the San Antonio market with the purchase of Alamo Downs distribution center for a price of $8.4 million. Alamo Downs is a two-building business distribution complex containing 253,000 square feet which was constructed in two phases in 1986 and 2002. It is currently 59 percent leased to 7 tenants. This acquisition is one of our typical value-add investments which, when leased up, will generate an above-average yield.

We see the potential for growing our ownership in San Antonio over time between 1 and 2 million square feet. We also believe that a portfolio of properties in San Antonio will complement our ongoing operations in Houston, Dallas, and El Paso.

As reported in last quarter's conference call, we sold the 18,000 square foot Sample 95 Business Park III in Pompano Beach in early July. The $2 million sales prices generated a gain of $1.3 million.

In August, we sold the 104,000 square foot Bicount (ph) distribution center for $2.35 million and reported a small gain. Bicount is a 43-year-old manufacturing-type building in the Brookhollow submarket of Dallas.

In October, we sold a 4.4 acre parcel of undeveloped land in Tampa for $422,000. Currently, we have another small Tampa land parcel and a warehouse in Memphis under sales contracts.

Keith will now cover a variety of financial issues.

Good afternoon. Our balance sheet remains in excellent shape. Debt to total market capitalization was 33.1 percent at September 30, 2004, compared to 37 percent a year ago. For the quarter, the interest coverage ratio was 3.8 times and the fixed charge coverage ratio was 3.4 times. Our floating-rate bank debt amounted to 5.2 percent of total market capitalization at quarter end.

In September, we received the funds from a 30.3 million non-recourse first mortgage that we described in the last conference call and reduced floating-rate debt with the proceeds. Our 3-year bank line expires in January 2005, and we're well on our way to renewing this credit facility. We believe that we will be able to lower costs from the present terms.

The increase in FFO per share for the third quarter compared to the same quarter last year was the first increase since the fourth quarter of 2001 ten quarters ago.

Now for a little detail on the income statement. As occupancy has increased, the real estate operating expense to operating revenue ratio has decreased. The expense to revenue ratio for the third quarter was 28.4 percent compared to 29.6 percent last year. Bad debt expense was 156,000 for the third quarter compared to 158,000 last year but still below last year's bad debt for the 9 months.

Lease termination fee income was $19,000 for the quarter compared to 216,000 last year. Other income increased $55,000, primarily due to fees from third parties. The gain on involuntary conversion of $154,000 represented insurance proceeds from a tornado claim to replace two roofs. The increase in G&A costs continue to result primarily from compensation expense and outside accounting and legal costs due to compliance with the Sarbanes-Oxley requirements.

In September, we paid our 99th consecutive quarterly dividend. This quarterly dividends of 48 cents per share equates to an annualized dividend of $1.92 per share. Our FFO payout ratio was 75 percent for the quarter. FFO guidance for 2004 was narrowed to a range of $2.48 to $2.50 per share, and earnings per share is estimated to be in the range of 98 cents to $1.

Now David will make some final comments.

In summary, we are pleased with the continuing positive trends in operations achieved in the third quarter. Occupancy is up, with every one of our markets experiencing improved leasing interest and activity. Same-property operating results have been on the plus side for 5 consecutive quarters. The decline in average rental rates appears to be close to an end.

Our balance sheet continues to be strong and flexible. Our development program has an increasing pipeline. And we're well positioned for future growth. Our strategy is simple and straightforward, and it is working.

Keith and I will now be happy to answer any questions anybody might have.

(OPERATOR INSTRUCTIONS) Paul Morgan, FBR.

Could you comment on any particular reason behind the jump in the TIs in the current quarter?

We looked at that in detail, as you might guess. And I think that it does not represent a trend and is somewhat of an aberration, due to the fact that we had a larger-than-usual number of spaces that had been subdivided when we lost a tenant to be re-leased to 2 or more tenants, and as a result, had to put in higher TIs. For example, if you have a 50,000 square foot space where you have lost your customer, and you re-lease that to 225s, it usually means that you are adding offices and 1 or more restroom packages in the second lease for the second user, and that ups the TIs. So that is what we think was the reason for the higher TIs in the third quarter.

So you would expect it to return to a more normalized level?

We sure do.

In terms of the development pipeline, is there any color you can give on the timing of converting some of the land holdings into starts maybe in the fourth quarter or over the course of the next year?

We have some land in Chandler, Arizona that we hope to begin construction on in the first quarter of next year. We hope to also begin construction of our Blue Heron III, which is going to be a service center building in Palm Beach. Since Sunport Center V is 100 percent leased, we are in the process of designing the last building in that park, that complex, Sunport Center 6. We would hope to start that in the first quarter of next year. And the balance of additional starts are really going to depend on the leasing pace of the properties that are now under construction.

Okay. My last question -- in terms of G&A, you talked about the Sarbanes-Oxley implementation. Is that mainly involved in the implementation, or would we expect that to be basically a good run rate just in terms of the extra work you have to do on an ongoing basis?

We think that this year will be more than a continuing run rate. This year is documenting internal controls, testing those more. And there's a lot of things that we will be able to carry over to next year. So we hope next year, it will be less than this year. Now how much less, we haven't narrowed that down yet. But hopefully, it will be better.

Bill Crow, Raymond James.

Nice quarter. A couple of questions. You indicated that you believe the rent and rolldowns are close to coming to an end. As you look out at your lease expiration schedule for next year, is this -- should we start to expect positive same-store rent growth 2 half of '05 or earlier than that, later than that -- where do you see it coming out?

We would certainly hope that it would be in the second half of '05. We are still now finalizing budgets for next year, so really don't have good enough statistics to speak too definitively on it.

Certainly, in the first two quarters of next year, we see some leases that will have rent rolldowns. The question is whether the ones where we will be finding increases is going to offset those. I guess really what we're trying to say is that the trend has been to the good for a number of quarters now. And we could still have another quarter in there that would be unusual with a couple of markets, where there would be more possibility of rolldowns. But we would hope that we would be past that by June 30 of next year.

Great. Generally speaking, could you comment on what sort of development activity you are seeing kind of across your markets just generally? Is there a pickup in new development -- not by you, but by the industry in general? Or no change, or what are you seeing out there?

It's been encouraging from the standpoint that we really have not seen a lot of new development in most of our markets. Orlando and Tampa seem to be relatively quiet compared to where they were before, as well as certain parts of south Florida. Houston is slower than it has been in the past. Phoenix -- we're seeing a good bit of new development there. Phoenix seems to be like Dallas. The city is -- as soon as there's the slightest scent of increase in demand, the supply jumps back up. But so far, it's been encouraging from our standpoint of building our type product.

Chris Haley, Wachovia Securities.

Good afternoon.

Chris, we appreciate your renewed interest in EastGroup -- picking us back up for coverage.

You're welcome. I look forward to hearing good news out of you guys, just like I did for this quarter. Congratulations.

Thank you.

I have several questions. Greg is here with me. Keith, did you say your year-end occupancy goal was 93 -- is that correct?

Our budgeted amount has been less than that. But we are outperforming our internal budgets from that standpoint.

We created at the beginning of this year a goal to be above 93 percent at December 31. And we haven't talked too much about it internally yet. But if we keep up the trends, we probably wouldn't budget it. But we'd have an internal goal of 95 percent at the end of '05.

Yes. Okay, with that in mind, Greg and I have some questions in terms of run rate following the sales and expense ratios. My first question, and then I'll hand it over to Greg, is if you get to 93 percent plus occupancy, Keith, what would you expect your operating expense ratio to look like based upon more reimbursement levels, etc.?

I think the best we have ever done is high 25 point something (ph) before, and that was like 3 years ago. So we're at 28.6 now -- I would think around 28 percent.

Okay. Greg?

Looking at the discontinued ops, how much of that was from the properties you guys sold in the current quarter? And does that include -- you guys mentioned a possible sale in Memphis. What exactly is in that?

The discontinued operations -- we have disposed of all of those properties. And the items that are left are two pieces of land. And World Houston is one of them. And then in (multiple speakers) Florida Sable (ph) .

We do not show any operating properties in held for sale or discontinued operations until there is at least money at risk. We have had so many changes when deals fell apart that we tightened our criteria a bit just make it less confusing to the reader. So as I say, anything in held for sale or discontinued operations is something where it's closed or money at risk.

And then on the development side, you guys in the last supplemental had Stanton 10 (ph) scheduled for a conversion in this quarter -- I think August was the date on that. That was pushed back to January. Could you comment on that a little bit?

The city of Chandler, Arizona is probably even worse than the city of Tempe in terms of getting approvals for construction which includes TIs. And our user there had some complicated TIs that we had gone round and round with the city of Chandler on in order to try to keep the costs down and still keep the customer happy. And so we had some delays in obtaining our building permit for that. Our goal is to get the user in in December, but it might drag to January.

Still looking at your guys guidance, what do you have replacing that revenue from that profit being stabilizing in Q3? Is that just assuming higher occupancy across the rest of the portfolio?

There are enough ups and downs that it's basically higher occupancy.

And then, also, keeping on the development side, Sunport 5 -- you guys have listed as 100 percent leased, converting in January of '05.

Correct.

But you have the projected occupancy at 0 percent in that quarter. Why would you stabilize that early if there's 0 percent occupancy then?

Good question. That's probably wrong, because what happened is we were bouncing back and forth on actually when that customer was going to take occupancy. And it's now going to be in the latter part of January. And so that's a -- good catch.

Thanks for clearing that up. And then finally, there's a large rollover, I guess, for the portfolio in California next year. Would you guys mind talking about kind of what's going on in that market currently and what you're looking for next year? Is there rent rolloff in those properties, or --?

Los Angeles, if not the strongest industrial market in the country, is right up there. So that to have a higher percentage rollover there -- I think we have some real potential for increasing rents.

We've been 100 percent almost all of this year, so it will -- and we know we're going to lose a couple of customers there. So it's good news and bad news -- we'll probably have some downtime for a number of months, but we believe we'll be able to increase rents as those leases turn.

How do you guys look at the interaction there between the downtime -- what are you looking for, what are you expecting, and what kind of magnitude on the rollout?

We have not finalized our budgets on what we're going to be doing out there in '05 yet. So next call, I will be able to give you that number.

Okay. Do you have any sense of where the market is now and where the in-place rents are?

No. I would just be speculating on the different ones, so --

Fair enough. That does it for me.

Jonathan Litt, Smith Barney.

Hi, guys -- it's John Stewart here with Jon Litt and Crew Palreval (ph), as well.

David, with regards to your occupancy forecast, it sounds like you may pick up another 100 basis points in the fourth quarter. And then you mentioned that it might dip down in the first quarter of '05. Can you give us a sense of the magnitude for the decline in the first quarter?

Again, not finalized our '05 numbers or even gotten close to doing that, so (technical difficulty) to be able to speak on those figures. But right now, we have 4 leases with over 100,000 square feet that we know are holiday-related. And we're working on 2 more, with almost another 100,000 square feet that could occur in the fourth quarter.

We have a liquor distributor -- not surprisingly, in New Orleans -- who needs holiday space. Wal-Mart in a number of locations -- another supplier to retail stores, and then our usual standby the Post Office. So there is possibly 1 percent of occupancy just in those holiday leases.

As I say, there are a number of other leases that we expected to lose the tenant in the late third or early fourth quarter, and they have extended into the first 3 months of next year. So there is a chance we could keep 1 or 2 of them, but we're just trying to be conservative and not have people believe that a 93 percent or close to it occupancy rate at 12/31 is a good run rate to start from in '05. And as you know, we're pretty conservative on how we put out projections.

Sure. I understand and appreciate that color. Just with respect to Wal-Mart real quickly, I noticed that they moved into the top 10 on the tenant list.

That's because of their short-term leases (multiple speakers)

What is your same-store NOI growth forecast for the fourth quarter?

Don't have a specific number given a whole lot of different things that are still moving parts. But probably pretty close to where it was for the third quarter and maybe even a little bit higher because of the higher occupancy.

All right. And then beyond that, would you expect the internal growth rate to continue to accelerate if you think you're going to pick up another couple hundred basis points of occupancy next year?

Again, I don't have the '05 numbers completed. But that's certainly going to be our goal. We operated for 12 or 14 quarters around 97 percent occupied, give or take a little bit. And so it's been very frustrating to be down in the low 90's. So we think as a minimum, we need to be back up to 95 percent by the end of next year or soon thereafter.

Can you give us the cap rates on the acquisitions during the quarter?

Interstate in Dallas was a low 9 (ph). Alamo Downs is about 5 percent going in. And once it achieves 95 percent occupancy, that will be a mid 10.

Okay, thank you.

And we budgeted that at least 12 months out. But again, it's contributing to earnings. And as we say, it will give us an above-average yields when leased up.

Scott Sedlak, AG Edwards.

Can you comment on market rent levels in some of your core markets?

A lot of the answer to that is who you talk to in the individual markets. A little bit of an overgeneralization, but we find that the smaller spaces that the rents are either flat, or we're achieving some upside in them. The bigger the space, the less likely we are to avoid a downturn or a negative rent growth on re-leasing the space.

One of things that makes it very difficult in industrial real estate to say exactly what the rent is is have to you have to look at a specific submarket. And then if there are 5 spaces that are very similar, and 1 person is feeling desperate and drops their rent to attract that tenant that was out there looking, it can distort what the market rents are.

But the one with the biggest drop in rents right now continues to the San Francisco Bay area, just because the rents got so high there and there's such a high vacancy.

Okay. I know you commented specifically on the L.A. or California market in terms of '05 expirations. You guys do have a fair amount of expirations in 2005. It appears to have kind of increased slightly from the previous quarter. Can you kind of discuss any prospects that you might have just in general?

The number of short-term extensions that we signed in '04 has been the reason that our '05 expirations have increased. There are still a lot of users out there who are nervous about where their business is going and are willing to risk not locking in a lower rent today in order to have more flexibility 6 to 12 months from now. And as we as an owner have more pricing power and more prospects for individual vacancies, we will be able, I believe, to obtain a little extra length in leases.

Okay.

So I think that that's going to come with improved market conditions.

Okay. Did you guys provide the same-store occupancy number? I'm sorry if I missed it.

No, we don't provide that, because -- what we do is provide the quarter-end occupancy, not what an average occupancy or economic occupancy is over the 3 months of the quarter.

All right. And then how many acres do you guys have in your land bank right now?

Okay, we have 142 acres with an initial cost of roughly just $15 million -- a little higher than that now, because of capitalized costs. And we can build about 2 million square feet with that.

We are looking, though, at another -- right now either under contract or discussions -- about another 120 acres where we could add another million 3 (ph) to a million 5 (ph) in additional development square footage. So we are actively building our inventory in the markets where we want to be doing future developments.

It's harder and harder to tie up good industrial land. A lot of local governments don't like industrial. It doesn't create a high tax basis. It doesn't really create a lot of jobs. And they're noisy, polluting 18-wheelers around. So if a local community can change the zoning to a higher use, they're eager to do that. So as I say, it's harder and harder to find good industrial land that is our infill type site development.

We're also seeing a good bit of industrial land being converted to other uses -- multifamily, in particular. Sellers can generally receive more money for that. We're seeing that in Tampa. We're seeing it on the west side of Phoenix.

Sri Nagaraj (ph), UBS.

You mentioned in your conference call just a few moments ago that 80 percent of the tenants who left you were changing space requirements. Could you --

Yes; that's a little bit of a distorting number from the standpoint -- we had a large 3PO (ph) user who lost his customer. And he didn't need the space anymore. So he moved out. And because we didn't have that much turnover, that distorted the number to make it appear higher than it would have under normal circumstances. So most of that, as I say, was a third-party logistics company that lost their business, so they didn't need the space anymore.

Okay. Within the 9 months in 2004, would you say that the changing space requirements category -- would you say that your tenants are increasing space or decreasing space across the board?

Right now, the trend has become positive. So we are talking to more customers about expanding than contracting.

Just a question regarding your and World Houston 20 -- I know that we talked about it before in previous conference calls about the configuration of World Houston 20 into the 30,000 square feet involved (ph). Are you planning to reconfigure this at some point, or is it feasible at all?

We before said that we believe the larger users were going to be coming back into the market, and that has happened. We have more activity on that building in the last 30 days than we have had in 6 to 12 months.

Our World Houston development -- over 60 percent of the users there are related to airfreight or freight forwarding, air cargo. And their business is good. And so we are seeing expansion. We are optimistic about the interest that's now being shown in World Houston 20.

Since the last call we, in World Houston 19, had a customer expand. We signed a new lease, and have another lease out for signature to take that building to 100 percent. And our World Houston 16, where they are just finishing the roof right now, we have a proposal out there that we are negotiating that would take a third of the building. So the World Houston activity has picked up significantly in the last 30 to 60 days.

Okay. One final question. Could you just remind us if there are any additional acquisition or disposition assumptions in your guidance for 2004?

No. We're working on -- still far off on a couple of acquisitions. But if we're able to close those this year or early next year, it won't affected '04 numbers to any extent. Anything we do today will be a bonus for '05.

It appears we have no further questions. I will then turn it back over to you, Mr. Hoster, for any closing comments.

Again, thank you very much for your continuing interest in EastGroup. Keith and I are available for any questions that might not have been covered here that you would like to call us directly on. And we look forward to talking with you next quarter. Thank you.

This concludes today's teleconference. You may now disconnect.