Eastgroup Properties Inc (EGP) 2006 Q4 法說會逐字稿

Welcome to the EastGroup's Properties conference call. All participants are in a listen-only mode. Later, there will be an opportunity to ask questions during our Q&A session. Please note that this call may be recorded. I will now turn the program over to the President and CEO, David Hoster. You mean go ahead, please.

Thank you. Good morning and thanks for calling in for our fourth-quarter 2006 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 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 or 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 fourth quarter achieved our guidance range. Funds from operations were $0.72 per share as compared to $0.68 per share for the fourth quarter of last year, an increase of 5.9%. These results represent EastGroup's 10th consecutive quarter of increased FFO as compared to the previous year's quarter.

For the year, FFO was $2.81 per share compared with $2.64 per share for 2005, an increase of 6.4%. Please note that we calculate funds from operations based on NAREIT's definition of FFO, which excludes gains on depreciable real estate.

We continued to achieve solid same property net operating income results in the fourth quarter, with an increase of 7.9% without the straight-lining of rents; and with straight-lining, same property quarterly results improved by 6.0%. This was the 14th consecutive quarter of positive results for both measures.

On a GAAP basis, our best major markets for same property results in the fourth quarter, after the elimination of termination fees, were El Paso, which was up 49%; South Florida, up 24%; Jacksonville, up 12%; and San Antonio and Orlando, both up 10%. The trailing same property markets were San Francisco, down 9%; and Dallas, down 6%.

For the full year, our best performing major markets were San Antonio, up 36%; New Orleans, up 13%; and San Francisco and Orlando, both up 8%. On the downside, El Paso was off 10% for the 12 months. The differences are basically all due to changes in property occupancies in the individual markets.

Occupancy at December 31 was 95.9%, the highest in 25 quarters. Florida ended the year at 98.7% occupied, and California was at 99.5%. Our leasing statistics for the fourth quarter illustrate the continuing strength of our markets. Overall, of the 1 million square feet of leases scheduled to expire, we renewed 65% and released another 20%, for a total of 85%. In addition, we leased 252,000 square feet of vacant space.

As you can see in our supplemental information, we continued to achieve strong rent growth in the fourth quarter, both for cash and GAAP calculations. Increases of 5.8% for cash, and 10.8% with straight-lining of rents. Our average lease length was 3.4 years, less than our recent experience. Our average lease size was 19,000 square feet, the same as last quarter.

Tenant improvements for the fourth quarter were our lowest for 2006, with an average of $0.87 per square foot for the length of the lease, or $0.26 per square foot per year of the lease.

At December 31, our development program had increased to 19 properties containing 1.5 million square feet with a total projected investment of $108 million. Seven of the properties were in lease-up and 12 under construction. Geographically, these developments are diversified in four states and seven different cities and overall are currently 42% leased.

During the fourth quarter, we transferred three properties into the portfolio, with a total of 234,000 square feet. Arion 14 in San Antonio, and World Houston 21 are both 100% leased. Techway 3 in Houston is 54% leased. Also during the quarter, we began construction of 40th Avenue and Interstate Commons 3 in Phoenix. ,World Houston 24 and 25, and Oak Creek A and B, two small buildings in Tampa which are being offered for sale to users.

Looking at our development land activity during the quarter, we acquired 5.1 acres in World Houston and 55 acres in Fort Myers in two transactions. For the year, we acquired 95 acres and began construction on 81 acres. At December 31, our land inventory had 272 acres, which should support 3.6 million square feet of new development.

In January, we began construction of Southridge 7 in Orlando and expect to start Sky Harbor in Phoenix later this quarter. Also in January, we moved the 100% leased Santan 10 Phase 2 in Chandler into the portfolio.

Overall, in 2006, we had total development starts of $76 million, an increase over the $54 million for 2005. In 2007, we project new development starts of approximately 80 to $90 million, a total which could be higher based on strong market conditions.

Our development program has been and we believe will continue to be both a creator of shareholder value and a major contributor to FFO by adding quality, state-of-the-art assets to our portfolio. Including development properties in lease-up and under construction, we have developed 29% of our current portfolio.

After 11 months of no property acquisition activity, we closed in December on the purchase of a four-building, 322,000 square foot portfolio in Charlotte, North Carolina, for $19.5 million. The buildings, which were constructed and '87 through '89, are located in the NorthPark Business Park and are 93% leased to 18 customers.

In January, we acquired an additional three buildings in Charlotte for $9.3 million. Westinghouse Distribution Center with 104,000 square feet was built in 1983, and the Lindbergh Business Park I and II with 77,000 square feet were constructed in '01 and '03. Together, the three are 87% leased to eight customers.

Charlotte is a new market for EastGroup that we believe offers an excellent fit with our investment and operating strategies. It is a high-growth Sun Belt Metro area, in which we hope to expand to over 1 million square feet during the next 12 to 24 months.

Also in January, we purchased North Stemmons III with 60,000 square feet in Dallas for $2.85 million. The building which is 100% leased to a single customer is located in an existing EastGroup submarket in Dallas and will complement our current presence there.

Charlotte is our third new market in three years. In 2005, we entered Fort Myers, Florida, with a land acquisition and recently started the constructions of our first two buildings, with a potential to develop a total of almost 900,000 square feet. Two and a half years ago we purchased our first properties in San Antonio, and we now own 1.1 million square feet there, including two buildings currently under development.

After an extended quiet period last year, we're seeing an increased number of acquisition opportunities and are now under contract on potential multi-building purchases in San Antonio and Charlotte and a single building in Denver.

In December, we completed two property sales, which we have been working on for sometime. The 106,000 square foot Crowfarm Distribution Center in Memphis was sold for $2.75 million, generating a gain of approximately $400,000. This reduces our ownership in Memphis to 260,000 square feet and a net investment of less than $5 million. We also sold our 114,000 square foot Auburn Hills R&D building in metropolitan Detroit for $17.85 million, creating a gain of approximately $4.2 million.

For the year, we made significant progress in exiting non-core markets, with total sales of $40 million consisting of six properties with 879,000 square feet and a parcel of land. These five transactions generated total gains of approximately $5.7 million. In 2007 we will continue to dispose of non-core assets as market conditions permit.

Keith will now review a number of financial topics.

Good morning. As David reported, FFO per share for the quarter increased 5.9% compared to the same quarter last year. Lease termination fee income was $6,000 for the quarter compared to $286,000 for the fourth quarter of 2005. Bad debt expense was $133,000 for the fourth quarter of 2006, compared to $310,000 in the same quarter last year.

Also in the fourth quarter, it was determined that an insurance settlement received in the third quarter on hurricane damages was overpaid. EastGroup refunded $125,000 to the insurance company and recorded the amount in other income loss on the income statement in the fourth quarter.

FFO per share for the year increased 6.4% compared to last year. Lease termination fee income was $410,000 for 2006, compared to $1,081,000 in 2005. Bad debt expense was $719,000 for 2006, compared to $951,000 for last year. The effect of lease termination income and bad debts from 2005 to 2006 was a reduction in FFO of $0.02 per share.

Debt to total market capitalization was 25.5% at December 31, 2006. For the year, the interest coverage ratio was 3.7 times and the fixed charge coverage ratio was 3.3 times, in line with past years. Our floating rate bank debt amounted to 1.7% of total market capitalization at year-end.

In October, we closed a $78 million nonrecourse 10-year mortgage loan with a fixed interest rate of 5.97%, as we previously disclosed. In September, we paid our 108th consecutive quarterly distribution to common stockholders. This quarterly dividend of $0.49 per share equates to an annualized dividend of $1.96 per share. Our dividend to FFO payout ratio was 70% for the year.

Rental income from properties amounts to almost all of our revenues, so our dividend is 100% covered by property net operating income. Again, we believe this revenue gives stability to the dividend.

FFO guidance for 2007 was confirmed in a range of $2.93 to $3.03 per share. The projected FFO growth rate in 2007 would have been higher except for two things. In 2006, we had $0.035 per share in gain on land sales; and we are projecting no FFO from land sales in 2007. Also, we decided to sell our Detroit property, which reduced FFO in 2007 by $0.015 a share. We feel this was the correct strategy for the long run.

Earnings per share is estimated to be in the range of $1.12 to $1.22. Now David will make some final comments.

As you can see from our fourth-quarter publications, the quarter was an active and productive one for EastGroup. We reached our highest occupancy in six years, while simultaneously achieving excellent rent growth for both the quarter and the full year. It was our tenth consecutive quarter of increased FFO as compared to the previous year's quarter, and our 14th consecutive quarter of positive same property operating results.

Our development program continues to expand in both properties under development and land in our pipeline. We entered Charlotte as a new market with a December acquisition and followed it up with a second purchase there in January.

Our balance sheet is strong and flexible with a total debt to market cap of less than 26%. Keith and I will now take your questions. Thank you.

(OPERATOR INSTRUCTIONS) Paul Morgan from Friedman, Billings, Ramsey.

This is actually Ron She with Paul Morgan. In the fourth quarter, you started five new spec projects, two in Houston and two in Phoenix. Could you comment on the rationale to starting in this market versus others? Because we have seen some occupancy increases in these markets and the supply seems to be increasing. Does this pose any concerns for you?

Without going into too much detail, let me for example talk about World Houston. We are about to finish World Houston 22, which is two-thirds leased at this point. So there is very little new space available in our [Front Park] (indiscernible) product. So that gave us the incentive to go ahead and start World Houston 24, which is slightly bigger, but same type design building, just not having any inventory to offer prospects.

World Houston 25 is a small cross-dock configuration, which will appeal to I think a very different type user than 24. So we think we are offering just a wider range of new space for the marketplace there.

You're absolutely correct, there is a tremendous amount of new competition at Houston's Intercontinental Airport. Just about everyone in our peer group has decided to come and compete with us there. But we think that our timing, as well as having by far the best location, should give us a leg up on competing.

In Phoenix, the two starts are again both geared for multi-tenant, smaller-user facilities. The tremendous amount of building that is going on in Phoenix right now is primarily geared to the bigger box type tenants, big distribution users. So we think that we will have a good niche there and will not be competing with the vast majority of the space coming online.

Okay, great. Just to follow on the Phoenix, could you comment on the yields on the two new products there? It seems like they are a bit lower than most of your other projects. Is it mainly because of the higher land basis there?

Well, it is a combination of things. The higher land cost is, of course, one of the factors. The other is it is just a very competitive market. As you have heard me say many times before, one of the things we are looking at on building a spec building is achieving a 150 to 200 basis point spread between our pro forma yield and what the finished leased-up product would sell for. There has been a tremendous compression of cap rates in Phoenix, so that we believe we are getting at least the 200 basis point spread, maybe more, in those properties, even though the yield to us in the long run -- long run being leading up to stabilization -- will be less than what we are doing in some other cities.

Okay, great. Thank you very much.

Michael Bilerman from Citigroup.

This is [Erwin Guzman] with Michael. Regarding the three dispositions during the quarter, can you comment on cap rates?

The Detroit or Auburn Hills property was about an 8 cap rate. It was a strange building that we picked up in a merger a number of years ago. It had a single tenant longer-term lease with, at that point, too short a term to sell. So that we renewed the lease and then tried to select a good time in the market to sell it, and sold it to a net lease type buyer.

The Crowfarm in Memphis was about a 9 cap rate, slightly under 9, depending on how you look at it. We sold it to an institutional buyer who had bought some other properties in Memphis from us. We had signed a lease on the building in September, the tenant moved in, in I think it was October; and that got us in a position to market the building successfully.

For the $10 million of dispositions that you're projecting in '07, how far along would that put you in terms of cleansing the portfolio? In other words, how much more is there left to sort of prune out?

I don't think that you are probably ever done in upgrading the portfolio through; the old term, recycling the capital. We always have a list of properties that given market conditions we would like to sell and redeploy the assets in either development or new acquisitions, where we think we have a lot more upside. So that is a never-ending process.

The $10 million is just a rough projection that we came up with because it is all going to depend on market conditions. We might not sell any; and we could sell 25 or $30 million. We ended up selling more in '06 than we had planned just because we saw a good opportunity to do it, as Keith mentioned, in selling the Detroit facility.

Do you know which markets you are targeting for those dispositions?

We still have three buildings, one very little one, in Memphis, and our goal is to sell all three of those buildings, eventually. But one has just achieved 100% occupancy that we will be putting on the market. The other two need to have a little bit of leasing, because Memphis is not one of those markets where you sell on the upside. You have to be selling cash flow.

We have a building in Oklahoma City that occupancy is up, but it's not really stabilized from a leasing standpoint with longer-term leases. As we are able to achieve that stabilization in that market, that is a building that we would like to sell.

One last question. Are you looking to extend the lease term on some of these new leases? Because it looks like you're getting some pretty decent leasing momentum. Would you look to sort of term that out a little?

We have been trying to do that all year long. The fourth quarter was lower than we have done in the previous quarters of '06. But we are doing better than we did a year or two ago. I think that in terms of the length of the lease, that was a little but of an aberration to have it shorter. And that does not include our development leases, which are all at least five years. So the lease length in our overall portfolio is over five years on the full average.

Okay, thank you.

Actually it is 5.6 years.

Chris Haley from Wachovia.

Congratulations on a nice year. A few analytical questions if I can. Keith, you mentioned the $0.035 gains on land sales; you have none in the year budgeted for your FFO guidance. How about termination fees?

Termination fees were budgeted at zero.

For 2007?

Right.

Okay. Can you update us on the -- so it's $10 million of sales; I'm sorry, I may have missed the number in terms of budgeted or, including your guidance, new investment dollars? Not excluding development, just acquisitions.

As always, we project -- in our projections are the transactions that have already closed, and then we have added to that roughly $50 million in the middle of the year. We will probably close, we hope, on several properties before the end of the quarter. But being somewhat of a value-add type buyer, I mentioned a building in Denver, it is vacant. So. And the property in San Antonio is about 80% leased now.

So although we will be closing on those before the middle of the year, it is going to take us a while to lease up the space. So we say the middle of the year for the additional $50 million; it's just a way to quantify an awful lot of variables into one assumption.

Okay, so the aggregate amount closed in January plus the $50 million is what?

It would be $62 million, $63 million for the year.

Okay. Looking at the income statement, Keith, and balance sheet, specifically what was this? Can you refresh me? Maybe you went through this, the involuntary conversion?

When we had insurance claims, and the amount of insurance received over our basis in the asset that was destroyed, is the gain on involuntary conversion.

That was third quarter, correct?

That was third quarter.

That is specifically wind damage on roofs in Florida and Louisiana.

Okay, great. Thank you. Then on the debt payments or at least scheduled payments for 2007, about 25, $26 million at over 7% -- plans to fund that? Is there any margin built in or at least refinancing margin built in?

We scheduled in our projections -- let's see what we said. We said new fixed-rate debt of $50 million on August 15 at 5.7%. So we have got only $50 million coming in for the year.

Okay, on the cash flow or CapEx side, can you give us a sense as to what type of expenditures or metrics to assume we are looking at for '07 regarding releasing costs and building CapEx?

On the leasing state for the TIs and the leasing commissions, it should flow through kind of the same per foot on that. Then you get into roof replacement, parking lot replacement, and some of those items; and those are just guesses a lot of times. We are projecting about the same as last year.

Okay.

We were down, as you could see in the statistics, on TIs in the fourth quarter. I would like to be able to say that that was a trend; but more than likely it is somewhat of an aberration that will move back up quarterly in '07. Because we have a number of service center type spaces that we are redoing, particularly in Phoenix. So we will have higher TIs, but much higher rents related to those.

Okay. Final question has to do with the existing competition in Phoenix and Houston and the new public competitor or competition. Looking at the product size that you're offering in your markets, typically between 80 and 120,000 square feet, and the incremental return on investment that you're generating on your developments, generally starting with high 8s to low 9s, could you give us a sense as to what type of rates of return you have looked at or see in the market for larger product, bulk product? And whether or not they are as favorable, less favorable?

Well, we really don't look at that from a development standpoint, because that is not our product type to build. It is different in each market. In many cases, what you see is a package of properties for sale. All you do is hear talk on the street about what the cap rate was; and there is very little breakout of a cap rate for the bigger box versus our multi-tenant product. Service centers flex space is usually broken out at a higher cap rate, but I don't have enough statistical information to give you a solid answer on that, that I could back up.

Thank you.

Art Havener from A.G. Edwards.

Can you give us any idea of what you are looking for in terms of capitalized interest expense for 2007? Either as a quarterly run rate or an annual.

I probably can. Let's see. For '07, we are about in the $6 million range.

Okay.

That depends on development starts and that kind of thing.

And timing of the starts.

It can vary.

Right. Okay, you mentioned that you're buying a property in Denver. Can you give us some color? Is that where we should expect maybe some second half of the year acquisitions, since this is a new market for you?

Actually, we have three properties, four buildings in Denver, going all the way back to '89. We have built two additional buildings to give us -- it's just about 274,000 square feet there. We have just put an increased emphasis on looking in that market, given the fairly strong recovery for industrial space.

Our current buildings are down south of the Tech Center in that southeastern submarket. This building is in that same submarket. It is almost exactly designed how we would do it if we were building it ourselves, and we view it as a development with close to a development yield, with us having lease-up risk and no other development risk on it.

Okay, but you guys consider critical mass in the market of about 1.5 million square feet; is that right?

Yes, over 1 million. Yes. Our goal is to grow in Denver. Our goal is to grow in a number of cities where we haven't been able to buy anything or have not thought it was good timing to do that. But we will continue to look more closely in Denver than we have in the past.

Okay. As your acquisition pace is now picking up, can you give us some kind of idea of how acquisitions have gone in the past couple years? Because you have been announcing acquisition yields on a stabilized basis; and typically the occupancy is a little bit below that. Can you give us an idea how long it takes after you buy a property to get it to stabilize?

Again, every deal is a little bit different. Without having the exact numbers in front of me, I'm comfortable in saying we have hit our acquisition pro forma yields or been very close to them in almost every case at or ahead of schedule.

We bought Alamo Downs in San Antonio two years ago, when it was 40% occupied; and we said that because of market conditions it was going to take us two years to get up to 95%. We did that and we are now at 100%. So we have been pretty good at projecting our lease-ups on that.

Okay, thank you.

Stephanie Krewson from BB&T.

Actually all my questions have been answer. Have a great day.

Thank you. Appreciate your interest.

Paul Adornato from BMO Capital Markets.

David, I think you characterized the current acquisition environment as still being good. I was wondering if you could comment on the presence of private equity and other institutional capital in the types of properties that you're looking for.

A couple comments on that. One, is that what I have seen is the Blackstone kind of equity is not interested in the one-off 5 to $20 million type acquisitions that we are doing. So we are not competing against them. We continually are competing against the pension fund advisors, the big names that everybody is familiar with.

Secondly, as I say, we have a history of, as we have described in the past, buying some properties with some hair on them. Vacancy, like the building in Denver. Or vacancy and some work that needs to be done like the property in San Antonio.

We are comfortable with that lease-up risk in markets where we already have operations. We will take -- we view the risk on that and the hassle to get it done and stabilized as well worth it, where an awful lot of other people are looking for something cleaner.

Then finally, industrial is not a type product where you can buy it, slap it in the face with some paint, clean up a lobby, raise the rents, and flip it. Industrial just doesn't operate that way. So it doesn't have some of the excitement that apartment buildings or office buildings have. So it is harder to buy, do something quickly, and flip; so it is not as appealing to a lot of the private equity people.

Okay, thank you.

(OPERATOR INSTRUCTIONS) Chris Haley from Wachovia.

David, when you see what is occurring in the market on the investment side, recognizing that you're buying assets that have a little hair on them versus stabilized assets, can you give us a sense as to -- when you look at Charlotte versus a Houston versus a Phoenix, the institutional market yield parameters, and maybe longer-term total return or IRR parameters that you're aware of or you are competing against?

Phoenix and Houston are primary investment cities for just about all of the institutions. So the capitalization rates as a result are lower than in what I would call some of the secondary or tertiary markets.

One of the things that seems to be changing -- and maybe it's just because of the level of capital chasing real estate investments -- is cities like Orlando, which a couple years ago was a secondary market, is now a primary market, resulting in significantly lower capitalization rates.

So what we are trying to do is have a mix of value-add, a mix of just where we can outperform a bit because of our location, of where the whole market is going to rise because of the growth in the population and jobs. We view Charlotte as a secondary market that has been a little slower to come out of the recession. Recovery is anywhere, I would say, a year and a half or two years behind some of the other Sunbelt markets. So we think this is a good time to be there.

Although they are more institutions bidding than there were a year ago there, the cap rates have not gone below 7% as they have in Orlando and have been in markets like Houston and Phoenix. So we just try to have a mix within the Sunbelt to achieve an overall strong return.

As a follow-up, are there any other markets besides Orlando that have shown up more in primary market lists, have moved from secondary to primary market?

I think Houston has picked up significantly. In terms of you see some of the people that have sold out of the market and then come back, because of the strength in the market. It has gotten a lot of publicity not just from the energy, but from the growth in the Port, the growth in the Medical Center, stabilized economy, one of the faster growing cities in the country.

So I guess it was sort of a primary, maybe primary-minus, and now it is a full-blown primary market today. Out by the airport, basically every one of our peer group is there now.

So when you think about one of the reasons you might see your initial returns compressed is the longer-term growth expectations have accelerated, which maybe moves Orlando down on an initial yield, but keeps it constant on a relative long-term rate of return.

Orlando is interesting because we have pretty much been able to maintain most of our development yields there. But the acquisition yields have gone so low that it's been years since we bought anything there. It is a market where we have determined that the way for us to grow profitably is through building our own buildings for long-term investment. So that is really what happens.

We have not bought anything in Phoenix for a couple of years because of that, and now have two buildings under construction and hope to start a whole five-building complex in the next 60 days there. So when the cap rates get too low on existing properties, it pushes us into growing with the higher yield development programs.

Can you indicate to us whether or not -- have you have adjusted your longer-term [growth] expectations for some of these markets to allow for you to pay down in terms of yield and still generate an attractive long-term total return? Or are you seeing the market do that? Your competitors do that?

We have certainly seen the market do that. We look at a variety of different factors when we are evaluating a purchase, and one is just our cost of capital -- with a nice cushion -- compared to what we are buying. We are not buying or building in any market where we don't anticipate either the overall market or our submarket or both having positive long-term prospects for population and job growth. That is why we are in the Sunbelt.

Right. Okay, great. Thank you.

(OPERATOR INSTRUCTIONS) We have no further questions in queue.

Thank you very much everybody. As always, Keith and I will be available to talk to anyone about any topics we didn't cover, or any other issues that we didn't clarify appropriately. Thank you.

This concludes today's teleconference. You may hang up at any time.