Eastgroup Properties Inc (EGP) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the EastGroup second quarter earnings conference call. Please note that this call may be recorded. I will now turn the program over to David Hoster, President and CEO.

Good morning, and thanks for calling in for our second quarter 2007 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 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's 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 second quarter met the mid-point of our guidance range. Funds from operations were $0.74 per share as compared to $0.69 per share for the second quarter of last year, an increase of 7.2%.

For the first six months of 2007, FFO was $1.46 per share compared to $1.39 for the same period of last year, an increase of 5.0%. Excluding land sales, the increase was 7.4%. Please note that we calculate funds from operations based on NAREIT's definition of FFO, which excludes gain on depreciable real estate.

We continue to achieve solid same-property net operating income results in the second quarter with an increase of 5.2% without the straight-lining of rents, and with straight-lining, same property quarterly results improved by 3.5%. This was the 16th consecutive quarter of positive results of both measures.

On a GAAP basis, our best major markets for same property results in the quarter after the elimination of termination fees were El Paso, which was up 34%, South Florida up 9%, Orlando up 8%, and Tampa up 6%. The trailing same property markets were Dallas down 7% and the San Francisco area down 5%. The differences were basically all due to changes in property occupancies in the individual markets.

Occupancy at June 30 was 95.6% compared to 94.0% a year ago, and we were 97.6% leased at quarter-end, our highest level since 2000. Our California assets were 99.5% leased and Florida was 98.8%. Our leasing statistics for the second quarter illustrate the generally solid real estate fundamentals in our markets. Overall, of the 1.3 million square feet of leases that expired in the second quarter, we renewed 66% and released another 26% for a total of 92%. In addition, we leased 340,000 square feet of previously vacant space.

As you can see in our supplemental information, we continue to achieve good rent growths in the second quarter, both for cash and GAAP calculations, increases of 3.2% for cash and 10.3% with straight-lining of rents. Our average lease length for the quarter was 4.5 years, which is longer than usual and reflects our efforts to increase this statistic.

Tenant improvements were $1.78 per square foot for the life of the lease or $0.40 per square foot per year of the lease. This figure is slightly higher than normal due to an above-average number of service center leases and the splitting up of several large spaces for multiple tenants.

At June 30, our development program had increased to $1.9 million square feet with a total projected investment of $132 million. Five of the properties were in lease up and 12 under construction. Geographically, the developments are diversified in five states and eight different cities and overall are currently 40% leased. During the second quarter, we transferred seven properties into the portfolio with a total of 495,000 square feet and a combined investment of $35 million. These properties are 98.5% leased.

Also during the quarter, we began construction of Beltway Crossing V with 83,000 square feet in northwest Houston, Sky Harbor, a five building complex with 261,000 square feet in Phoenix, and South Ridge 12, a 404,000 square foot build-to-suit in Orlando. These three have a projected total investment of $48 million. For the full year, we expect to have development starts of over $110 million with a total of approximately 1.8 million square feet.

Our development program has been, and we believe will continue to be, a creator of significant shareholder value. We are not a merchant builder. We are not developing to generate immediate gains through the sale of newly created assets. Our goal as a developer is to add quality, state-of-the-art investment investments to our portfolio and thereby increase total returns to our shareholders in both the short and longer term.

If we sold the development properties that were transferred into the portfolio during the second quarter, we estimate that we would've generated approximately $18 million or over $0.75 per share of FFO before taxes and approximately $0.50 per share of FFO after taxes, but these assets, which would be difficult or impossible to replace, would not be part of our future growth.

During the second quarter, we acquired two small buildings, both of which are adjacent to existing EastGroup assets. Country Club Commerce Center 2 in Tucson contains 45,000 square feet and was purchased for $4.1 million. Industry Distribution Center 3, which is 28,000 square feet, was acquired for $3 million and offers a potentially interesting redevelopment and expansion opportunity. Both buildings are 100% leased to single customers. These transactions bring our acquisitions for the year to a combined $1 million square feet for the total investment of $51 million.

On the disposition side, our 152,000 square foot depth one building in Memphis is currently under contract with the sale expected to close in September. This transaction will leave us with only 112,000 square feet and a net investment of just over $2 million remaining in the Memphis market.

Keith will now review a number of financial topics.

Good morning. As David stated, FFO per share for the quarter increased 7.2% compared to the same quarter last year. Lease termination fee income was $36,000 for the quarter compared to $49,000 for the second quarter of last year. Bad debt expense was $212,000 for the second quarter of 2007 compared to $218,000 in the same quarter of last year. Not much difference between those.

FFO per share for the six months increased 5% compared to the same period last year. Lease termination fee income was $51,000 for the six months of 2007 compared to $234,000 in the same period last year. Bad debt expense was $361,000 for the six months of 2007 compared to $336,000 for last year.

Debt-to-total market capitalization was 33.6% at June 30, 2007. This percentage is higher than previous quarters because of the lower stock price but still at a conservative level. For the quarter, the interest coverage ratio was 3.6 times and the fixed charge coverage ratio was 3.3 times, both showing improvements to the same period last year.

Our floating rate bank debt amounted to 9% of total market capitalization at quarter end. We had two mortgages that matured in 2007 totaling $14.2 million. Both of these mortgages have been repaid and we have signed an application on a new mortgage for $75 million. The non-recourse note will have a 10 year term, 20 year amortization, and a fixed interest rate of 5.57%. This loan is scheduled to close in August.

In June, we paid our 110th consecutive quarterly distribution to common stockholders. This quarterly dividend of $0.50 per share equates to an annualized dividend of $2.00 per share. Our FFO payout ratio was 68% for the quarter. Rental income from properties amounts to almost all of our revenues, so our dividend is 100% covered by property and net operating income. We believe this revenue gives stability to the dividend.

FFO guidance for 2007 was narrowed to a range of $2.99 to $3.03 per share and earnings per share is estimated to be in the range of $0.98 to $1.02. The FFO midpoint was increased from $2.98 per share to $3.01 per share. This increase reflects both a lease termination fee that will be recorded in the fourth quarter and strong operations.

Now David will make some final comments.

We continued our positive development operating momentum during the second quarter and expect it to carry through the balance of the year and into 2008. This past quarter was our 12th consecutive quarter of increased FFO as compared to the previous year's quarter and our 16th consecutive quarter of positive same-property operating results. Our development program continues to expand and generate above-average yields, and our balance sheet remains strong and flexible for future opportunities.

Keith and I will now take your questions. Thank you.

[OPERATOR INSTRUCTIONS.]

We will take our first question from [Ron Shay] of FBR Capital Market. Please go ahead.

Good morning, David and Keith. I'm here with Paul Morgan, as well. Could you comment on what could cause you to believe the internal growth through [inaudible] rate in the second half of this year? Is this due because of the slow occupancy gains or is there anything else in that guidance?

No, Ron. It's what you're pointing out that in the third and fourth quarters of last year our occupancy jumped to 95.6% third quarter a year ago and 95.9% in the fourth quarter and those are just hard numbers to beat by a big margin going forward, so we expect some deceleration in the same property operating results, although we certainly expect them to be clearly positive.

Okay, and could you comment on the lease momentum at World Houston? Building 22, you know, seems to progress very nicely, but could you talk about the activities on 24 and 25 and maybe, you know, give some update on the supply and demand dynamics in the stock market?

First of all, just the individual assets, 24 and 25 are both still under construction and we've had good activity on 24, but no signed leases yet. With a tremendous amount of rain in Houston in early and late spring, the construction is -- I guess we probably lost 2.5 or 3 months, so we're behind schedule on completing those buildings, and generally, we don't sign leases till we're either almost complete or about complete. And I think it's another month we'll have 24 done, 25 -- they're working on the roof now, so still plenty of time on leasing those two up.

There is a lot of new development occurring along Beltway 8 on the north side of Houston, and we've been talking about this for probably three or four quarters. So far, it has not slowed down our activity at World Houston and we think it's just a very strong location and the quality of the park that we've created there that continues to draw prospects.

Okay. You didn't mention your expectation for acquisitions for the second half of the year. Can we read that as you're not expecting any more acquisitions in the second half and could you comment on the strength of the acquisition deal flows, as well as the capital trends?

The deal flows seemed to have slowed down a bit after a lot of activity right at the end of last year and the beginning of '07. We took any acquisition assumptions out of the fourth quarter, which we, I think, had some in there before. And part of that reason is one, we don't have anything under contract today to buy, and secondly, even if you buy a lot in the fourth quarter, it takes a huge number to move the FFO figures for the balance of the year at all, so just being conservative and the fact that it -- even if we do have an acquisition, it probably won't make much difference to FFO this year. We took that out of our assumptions.

What about any kind of trends in the capital area, you know, given the recent spikes in the [inaudible] spreads? Do you see any upward pressure on the capital rates?

I wish we did. We've not seen any at all. In fact, we've seen continued downward pressure on cap rates. And I think part of that is related to the markets where we've been bidding on assets. We're not trying to compete in California where the cap rate's already below any numbers we want to fool with, but what we're seeing is cities like Orlando and Charlotte that were viewed as secondary or tertiary markets have attracted a lot of institutional capital because there haven't been assets for sale and the cap rates are a little bit better than what are seen in some of the other markets. So cap rates there have very quickly been driven down. We're seeing transactions in Orlando below 6% cap rates, which is a new low and somewhat surprising, but institutional capital is now pushing hard in both Orlando and Charlotte.

Okay. Great. Thank you.

Thank you.

We will take our next question from Jonathan Litt of Citigroup. Please go ahead.

It's actual Michael [Dillerman]. Hey, David.

Good morning.

Can you talk a little bit about the Oak Creek project in Tampa, what the prognosis is on leasing, as well as on the buildings for sale?

On the leasing, we have had lots of lookers and just haven't on -- this is on Oak Creek V -- lots of lookers and nobody signed up, although we hope to report something at this time on a new lease, but that's not happened yet. So, we're optimistic that that activity will turn into leases very soon. On the two little buildings that we're holding for sale, there have been very little activity on those.

Now, if you sell those, you're going to book those gains into FFO or --

Yes. We've built those two buildings in our TRS figuring that there was more opportunity for sale than leasing, and if we end up leasing them instead of selling them, we'll probably roll those into the portfolio in one form or another. But, our Plan A is to sell them to users or investors.

And what sort of level of gains is included in guidance on those?

Zero.

Okay. So that may -- if you do sell them, if there's -- you would book some sort of gain and guidance would be lifted or FFO would come in higher.

Correct.

Can you give a little more color on the $800,000 lease term fee in terms of, you know, what's it being driven by, the square footage, the annual rent, and just a little more color on the transaction?

It's a large tenant in Houston that had an out on their lease. They changed their whole corporate structure on how they were going to store drilling records and oil and gas and lease documents. It's going to all be outsourced, so they wrote a big check to -- this is at TechWay 1 in southwest Houston -- to get out of their lease and it was roughly 100,000 square feet. We've already had some activity interest in leasing portions of the space, but nothing's been signed yet.

As part of that lease termination fee, there's a write-off of straight-line rent receivable and then I guess we lose one or two -- one month of rent this year and that's all built into our guidance.

And it's -- the $800,000 is net of the write-off of the straight-line?

Correct.

And the -- what was the annual rent on the space?

That's a good question. I'll just have to get back to you on that one. I don't remember.

Okay. And just lastly on stock buybacks, I know we've had the conversation before and you've worked really hard to get market cap up to a billion. Given where your share price is, you know, have we crossed over the barrier where, you know, trading at an [eighth] implied cap rate starts to become a little bit more attractive relative to acquisitions and pushing up the development yield?

It's certainly more attractive than it was before, but we haven't hit the point where we think it makes sense for us for a number of reasons, one that you mentioned that EastGroup over the years has fought so hard to get an equity market cap of over a billion dollars and our average daily volume up, which it's now well over 100,000 shares. We think that offers a lot more opportunities for institutional and fund ownership of EastGroup. So, that makes us hesitant to shrink the equity market cap or reduce the daily volume unless it's just a screaming bargain.

Secondly, we continue to have yields on new development above the implied cap rate for the Company or the FFO yield on the stock, but as I said, there's obviously -- there's some number that -- where it becomes such an attractive investment that we would buy back shares. We did that -- I guess it's now almost ten years ago, but haven't done it since.

And you have an authorization in place or you'd have to just go to the board?

Yes. We have an authorization in place.

Okay. Thanks.

Thank you.

Okay, we will take our next question from [Kebin Kim] of Credit Suisse. Go ahead, please.

Hi. Good afternoon. Just had a quick question. You cited that your weakness in Dallas and San Francisco is related to occupancy changes. Is that very specific to a certain tenant, or is it more of a sign of a weakness in the market?

Actually, it's a little bit of both. We had a 59,000 square foot tenant in our Shady Trail building file Chapter 7 and close their doors almost overnight, and that bumped up our vacancy there. And then we went through a period that really, I guess, goes back to probably the fourth quarter of last year into the first quarter of this year with very slow activity on some of our vacancies and then a couple of those were related to road construction and the possible condemnation of one of our buildings because of a road expansion. But the activity is not great, but it certainly picked up and we've signed some leases on some spaces that were vacant for a while. But -- so I would say we're stabilized there, but not excited about where we are.

Okay. And one more question. I noticed there's a pretty big difference between your GAAP market-to-market on leases signed versus cash. I'm guessing that's quite a difference in rent escalations. Could you remind us, you know, a typical lease, what type of escalations do you underwrite?

Over 70% of our leases have escalations of one sort or another in them. In Florida, because of the strength of all our markets, we generally get an annual bump and it's usually 3%. In Texas, we hit bumps, but they're usually every two years or in the middle of the lease, but overall, our average lease bump is 3%.

Thank you.

And we get lease bumps in California, too.

Okay. Thanks.

We will take our next question from Mitch Germain of Banc of America. Please go ahead.

Good morning, guys.

Good morning.

Can I ask Mike's question a different way? Are you expecting -- in Houston for the lease term, are you expecting to see a roll up in rents?

We are continuing to raise rents in Houston. Our statistics show that during the quarter that we had a reduction in rents in Houston, but that was related to a specific lease or two leases. We did a build-to-suit for a tenant at World Houston. We knew their rent was above market due to the extra TIs that were in the space, and so that when we did our rent calculation for the build-to-suit, we built the present value of what we were losing in that rent into the calculation, so although we had a drop in the rents for the two tenants that went into that World Houston 2 space, we got a 9.9% cash yield first year on the build-to-suit, which is certainly above average for build-to-suit. If you take out that -- those two World Houston Building 2 leases, we would've had over 11% rent increase in Houston overall, so we're still experiencing strong market there. I think as of today, our 3.7 million square feet are 99.3% leased. So, even though there's a lot of new construction occurring, our locations are performing very well.

Great. And just to refresh me, you've got about 130 million of developments, you know, in lease-up or underway right now. I mean, where's your comfort level as to, you know, this sort of volume that you feel most comfortable with given your, you know, current balance sheet flexibility?

We could go higher, certainly, and would like to. We're restricted just on how we evaluate new developments, and so much of our development is subsequent phases of a development that was started earlier. So, we've had a nice jump from last year's totals of 75 million starts to 110 this year. I wish I could say we were going to jump to 120 or 130 next year, but I just don't think that's going to happen, not because we're restricted from a balance sheet standpoint, but just from an opportunity standpoint.

Got you. And last question regarding land, and specifically in the markets you reference where you're seeing a continued compression, are you seeing land depreciating at a higher pace in those markets, as well?

Yes, and there's certain markets where it's almost -- well, it is, from our standpoint, impossible to buy land at today's prices and build to hold for investment. Broward and Palm Beach County area is one. Greater Los Angeles is another. The people that tend to be building there either have a much lower cost of capital, and sometimes I can't figure out how they calculate it, than we do or they're building for sale, either sale to users or sale to institutions so that they can justify it. But land prices for industrial are clearly up, and -- but we still have been able in most of our markets to -- but not all -- find new land. And if you include the land that we currently have under contract in a couple of markets, assume we close those, we have the potential to build over 4 million square feet of new EastGroup type product.

All right. Thank you.

Thank you.

We will take our next question from Nap Overton of Morgan Keegan. Go ahead, please.

Good morning. The calculation that you shared with us about an estimate of $0.75 before tax and $0.50 after tax for the gains, the kind of foregone big gains on developed properties had you sold them, what kind of capitalization rate did you use to make those calculations on those properties?

We are developing on 100% occupancy basis a cash first year yield of about a 9.5, 9.6, 9.7. Just in my calculation, I used 9.6, and I assumed that we could sell these properties at 6.25 to 6.5 so that there would be about a 3.5% spread.

Okay. All right, and you answered my other question in your answer to that one, so thank you very much.

Okay. Thank you.

And we will take our next question from Paul Adornato of BMO Capital Markets. Please go ahead.

Thanks. Good morning. The broader stock market seems to be very concerned with the outlooks of the economy and particularly the consumer. I was wondering if you could give us your view and your tenants' view on the economy and also mention if there are any tenants that seem to be particularly exposed to consumer spending or the single family market.

I think we have a major advantage when you talk about the economy given the four primary states and then add Charlotte, our newest market, are in high growth areas that continue to experience an economic expansion. Florida, even though there's been a real downturn in home building, multi-family building, commercial building seems to be up, so the economy seems strong. Houston, for example, just saw a statistic earlier this week that in the 12 months through last May, Houston created over 88,000 jobs. So, I think most of the markets we're in continue to be very strong, and we're not seeing any real pullback from prospects or current tenants, customers looking to expand. So, it still remains positive. Now, you read all the national press and we keep looking over our shoulder and every Monday we have a leasing call with all our asset people and one of the questions we address is are you seeing any pullback? And so far, that's not happening.

And based on your years of experience in the business, what might your expectations be, you know, six months, a year from now?

I think it's safe to say we're going to have a recession at some point because everything cycles, but we're not seeing any -- as I say, any pullback at this point. So, we're fairly confident the way things are going, at least in our primary markets in the sunbelt. The 12 months ahead still looks pretty good. Beyond that, you know, with elections coming up and all, it'll be difficult to tell, but right now we're not seeing anything that would scare us. Lots of things worry you. We don't see anything scaring us.

Okay. Great. Thank you.

Thank you.

[OPERATOR INSTRUCTIONS.]

And we will take our next question from Paul Puryear of Raymond James. Go ahead.

Hey. Good morning, David and Keith.

Good morning.

A couple of questions. David, if you do the math on the cap rates on your new development and assume you could flip it out on the sixes, that implies a value, I think, of about $100 a foot, so if you build it for seven, is there a market out there for that property of $70 a foot? Is there a market of $100 a foot?

We're seeing that happening, Paul. I'll give you an example. In Orlando, we don't see a lot of transactions, but in Orlando, there's a 700 and some thousand square foot package of 20-year old I would say semi-bulk type buildings that they're a stone's throw from our South Ridge development, major tenant with about 30% of the space is moving out in 12 months. Their rent is not below market. We disliked the portfolio so much we didn't bid on it. It sold for under a six at 72-plus dollars a square foot.

So, if your stock, I think, is trading at about $60 a foot, where would you put the replacement cost on your portfolio?

That's not something that we talk about. It's well above where we are, but we don't put out [NAV] numbers or replacement cost numbers. We let you all calculate that.

Well, it sounds like somebody's willing to pay you $100 a foot for something you built for $70, which is -- which I find really interesting, but I guess another question, David, would be what are you seeing from an escalation standpoint on your construction contracts?

They seem to have stabilized. We're still seeing in some places the concrete going up, but in most cases, everything is stabilized. And a recent contract in Texas came in below a contract we did about four to six months ago. Subcontractors are hungrier for business, so we're not worried about those costs going up right now.

And what about land?

Land is a lot more expensive than it was 12 or 24 months ago, and it's hard -- it's very difficult to find good industrial land because anybody that owns it would rather sell it for another use and get more money for it. But, we are seeing in a couple of instances where residential land might go back to industrial, but only time will tell on that. But, we've not seen prices on industrial come down -- on industrial land come down, that's for sure.

Very good. Good quarter. Thanks.

Thank you.

It appears we have no further questions at this time, and I will go ahead and turn the program back over to David Hoster.

Again, thanks to everybody for calling in. And as always, please don't hesitate to call Keith or me with any questions that come up as you go forward or anything that you didn't think we covered thoroughly enough. Thank you.