Eastgroup Properties Inc (EGP) 2012 Q4 法說會逐字稿

Good morning, and welcome to EastGroup Properties' fourth-quarter 2012 earnings conference call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during our Q&A question.

(Operator Instructions)

It is now my pleasure to introduce David Hoster, President and CEO.

Good morning, and thanks for calling in for our fourth-quarter 2012 conference call. We appreciate your interest in EastGroup. Let me apologize upfront for not being as sharp as I think I usually am on these calls. I have been in bed with the flu or a very, very bad cold for the past two days, but did not want to miss the fun of an earnings conference call. Keith McKey, our CFO, will also be on the call, and also participating will be John Coleman in Orlando; Brent Wood in Houston; and Bill Petsas in Phoenix, who have called in from the field to back me up. Please do not hesitate to direct questions to them. 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 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, subject to the Safe Harbor statement included in the news release, is accurate only as of the date of this call.

Thank you. The fourth quarter was productive for EastGroup. We finished 2012 with a total shareholder return of 28.8%. Funds from operations of $0.78 per share for the fourth quarter met the midpoint of our guidance, and represented an increase of 1.3% as compared to the same period last year. This was the seventh consecutive quarter of FFO growth when compared to the previous year's quarter. Same property cash operating results were positive, also for the seventh consecutive quarter, although GAAP results were slightly negative. Occupancy increased to 94.6%, our highest level in 18 quarters. We started two new developments in the fourth quarter, and four additional buildings since year-end. We acquired five buildings in Dallas and sold a Tulsa property, and we have continued to take advantage of the attractive debt and equity markets.

Looking at property operations, same property net operating income for the fourth quarter was up 0.9% on a cash basis and down 0.2% with straight-line rent adjustments. For the year, the increases were 1.8% and 0.8% respectively. Occupancy at December 31 was 94.6%, our highest level since the second quarter of 2008, a span of 18 quarters. It represented a 30 basis point increase from the end of the third quarter, and a 70 basis point gain over the end of 2011. During the first two quarters of this year, we expect occupancy to drop by about 200 basis points and then increase back to approximately 94.5% for the third and fourth quarters. Our California markets were the best, at 98.2% leased, followed by our Texas markets at 97% leased. Houston, our largest market, was 5.1 million square feet, with 98.7% leased and 98% occupied. Phoenix and Jacksonville were our only core markets below 93% leased.

Leasing activity in the past 30 days is the best we've seen since the beginning of the recession. Companies that have held back due to the election, tax law unknowns or the fiscal cliff, seem to have decided they finally have to make future space needs, in spite of what is going on in Washington. In the fourth quarter, we renewed 58% of the 949,000 square feet that expired in the quarter, and signed new leases on another 33% of the expiring space, for a total of 91%. We also leased 329,000 square feet that had either terminated early during the quarter, or was vacant at the beginning of the quarter. In addition, we have leased and renewed 713,000 square feet since December 31.

For the quarter, GAAP rent spreads on renewal leases were up 6.2% but down 6.5% on new leases. Cash rent spreads were negative 2.8% on renewals and 11.6% on new leases. Average lease length was 3.7 years, which was our average for the year. Tenant improvements were $1.93 -- $1.93 per square foot for the life of the lease, or $0.52 per square foot per year of the lease, which was above our average, due to leasing to higher-quality tenants who required higher than normal improvements but were willing to pay a higher rent, as well as the lease-up of older vacancies that had required some extra work.

In mid-December, as previously reported, we acquired Valwood Distribution Center in northwest Dallas for $40.8 million. The five multi-tenant business distribution buildings contain a total of 722,000 square feet, and are currently 95% leased. Two the buildings were constructed in '97, '98 and three in '86, '87. This purchase increases our ownership in Dallas to 0.1 million square feet. For the full year, we acquired 878,000 square feet of new properties in three separate transactions, for a combined investment of $51.8 million. In late December, we closed the sale of Braniff Distribution Center, with 259,000 square feet in Tulsa, for $10.3 million, generating a gain of $4.5 million. Braniff was our only asset in Tulsa. During 2012 we had three sales transactions, with a total of 444,000 square feet, at combined prices of $17.9 million, which generated gains of $6.5 million.

In 2013 we project acquisitions of approximately $30 million during the second half of the year. We currently do not have any operating properties under contract to purchase or sell. During the fourth quarter we began construction of two additional Houston buildings, with a projected total investment of $16.5 million. World Houston 37 will contain 101,000 square feet, and World Houston 38, which is a build-to-suit, will have 129,000 square feet. Also during the quarter we transferred Beltway Crossing IX, which has 45,000 square feet and is 100% leased and occupied, to the portfolio.

For the full year, we initiated development of nine projects containing 757,000 square feet, with a combined expected investment at $54.8 million. Eight are in three different locations in Houston, and the ninth is in Orlando. Of the Houston developments, four are build-to-suits. For the year, we transferred four properties with 273,000 square feet to the portfolio. They are currently 97% leased. With the increase in new construction in 2012, we will experience an increase in development property transfers to the portfolio in 2013 and 2014.

In the fourth quarter, we purchased 4.1 acres in Dallas for 404,000 square feet -- excuse me, for $404,000, as part of our Valwood acquisition, and also 29.4 acres in Northwest Houston for $3.3 million, both for future development. For the year, we had a total of six land purchases, with 110 acres, and an investment of $13 million. These parcels are in Houston, Tampa, Chandler, Denver, and Dallas, and provide the potential to develop almost 1.5 million square feet of new industrial assets. Since the beginning of this year, we have already begun construction of four buildings, with 251,000 square feet, and a projected total investment of $19.6 million. Two are in Houston, and one each in San Antonio and Orlando. We have also transferred World Houston 33, with 160,000 square feet, and Southridge XI, with 88,000 square feet, to the portfolio. They are 100% and 83% leased and occupied, respectively.

As of today, EastGroup's development program consists of 16 buildings, with over 1 million square feet, and a total projected investment of $83 million. For the balance of this year, we see the potential for additional development starts of $25 million to $45 million. EastGroup's development program has been, and we believe is becoming a significant creator of shareholder value again, in both the short and longer-term. To date, we have developed one-third of our current portfolio, adding over 10.4 million square feet of state-of-the-art warehouse space in our core markets. Since 2010, all of our developments are being built to LEED standards, and we are pursuing formal LEED certification. Keith will now review a number of financial topics, including our earnings guidance for 2013.

Good morning. FFO per share for the quarter increased 1.3% compared to the same quarter last year. Lease termination fee income net of bad debts increased FFO by $74,000, comparing the fourth quarter of 2012 to 2011. FFO per share for the year increased 4.1% compared to 2011. Lease termination fee income net of bad debts decreased FFO by $266,000, or $0.01 per share, compared to 2011. During the fourth quarter we sold 667,755 common shares under our continuous equity program, at an average price of $52.51 a share, with gross proceeds of $35 million. We have added a new schedule on page 13 in the supplemental package that details our sales of common shares from the continuous equity program.

Our outstanding bank debt was $76 million at year-end, and with the new bank lines of $250 million, we would've had $174 million of capacity at December 31. The new credit facilities consist of a four-year, $225 million unsecured facility with a group of nine banks, with options for a one-year extension and $100 million expansion. Currently, the interest rate is LIBOR plus 1.175%, with an annual facility fee of 0.225%. Also in January, we renewed our $25 million unsecured working capital facility for four years on the same terms as the $225 million facility. Debt to total market capitalization was 33.6% at December 31, 2012, compared to 40.9% at December 31, 2011. For the year, the interest and fixed charge coverage ratios were 3.5 times. The debt to EBITDA ratio was 6.5 for the year.

In January of this year, Fitch Ratings affirmed EastGroup's issuer default rating of BBB with a stable outlook. Also in January, Moody's assigned an issuer rating of BAA2 with a stable outlook. This is the initial rating by Moody's, and we are pleased with the result. With these ratings, we plan to primarily issue unsecured debt for future financings. In December, we paid our 132nd consecutive quarterly cash distribution to common stockholders. This quarterly dividend of $0.53 per share equates to an annualized dividend of $2.12 per share. This was the Company's 20th consecutive year of increasing or maintaining cash distributions to its shareholders.

Our dividend to FFO payout ratio was 68% 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. FFO for 2013 is projected to be in the range of $3.10 to $3.20 per share. Earnings per share is estimated to be in the range of $1.02 to $1.12. A few of the assumptions we used -- our occupancy rates are projected at average 93% to 94.5%, acquiring $30 million of properties in the second half of the year, a mortgage of $34.5 million at December 31, 2012, matures during the year, with an interest rate of 4.75%. We have been active in selling shares under our continuous equity program. In addition to the $111 million sold in 2012, we project selling an additional 1,265,000 shares in 2013 -- the $111 million was dollars in 2012. We believe we have a strong balance sheet and we favor a conservative approach to financing our acquisition and development programs.

Some of the negatives for 2013 are the sale of Braniff at the close of 2012, and that will cost us $0.01 per share. The new bank lines cost $0.01 per share. We believe that the new rate is favorable to the market, but we had a very attractive rate of 85 basis points over that, that we started a number of years ago. The G&A increase cost $0.03 per share, due to increased compensation, and past compensation plans that are still being expensed on vesting schedules. If we have more development activity, the G&A expense will decrease. The 2013 FFO per share midpoint is $3.15, which is an increase of 2.3% compared to 2012. Now David will make some final comments.

We are in somewhat of a transitional year. Occupancy is up, but we now need more pricing power with rents, which should come with our strong leasing activity. Our development program is picking up steam, but there is obviously time delay between construction starts and customers moving in. Our acquisitions always seem to come in the second half of the year, and exceed what we projected, but we have seen a continuing compression in capitalization rates. Our balance sheet is strong and flexible, and our good debt ratings should help in future financings. As a result of all this, we believe we are well-positioned for future growth. Keith and I, and the three fellows in the field, will now take your questions.

(Operator Instructions)

Craig Mailman, KeyBanc Capital Markets.

Maybe, Dave, we could start with one of your final comments here about 2013 being a transitional year, and needing rent growth. I'm just curious, looking through the different markets, you guys are pretty well-leased here. I know we've talked about it in prior calls that it is really the -- you guys are just trending ahead of the markets. Are you guys seeing that gap between your occupancy and market occupancy starting to narrow, and making you feel better about the potential for rent growth in 2013, maybe second half? Or is it still -- is it still pretty soft, and you guys are dialing back your expectations about what you can do?

No, I -- the occupancy in our core markets, every market except Las Vegas, where we only have one complex, had an occupancy increase in the fourth quarter. So, we think that gap is closing a bit. The good news is that we are way up in occupancy, the bad news is that we need the markets to, as you point out, improve a bit before we have significant pricing power. And we had a lot of same property operating result growth for a couple of years, with strong occupancy increases, and starting the year at 94.6%, we don't see much of an increased opportunity, and project our average occupancy in 2013 is exactly the same as what we had in 2012. So things are trending in the right direction, but they never move as quickly as you'd like them to.

That is fair. Then, just on the -- your comments about the 200 basis occupancy drop in the first half of '13, some of that is likely seasonality. Are there big known move-outs that we need to know about, and maybe if there are just the timing on that?

We have an unusually high number of move-outs in Jacksonville, and there was some seasonality, some -- about average for us, and some larger move-outs in Tampa. But as I mentioned in my introductory remarks, that will hit us in the first and second quarter, but we expect to be back up to where we finished the year at the end of the third and in the fourth quarter, given the leasing activity that we see today.

And you said leasing activity was the best in the past 30 days; is it broad-based across all your markets? Are there any tenant silos that are moving that more than others or is it just, as you said, people finally making decisions?

I -- we're having more showings and putting out more proposals than we have in years, and it is pretty much broad-based. Right now, over the last 30 days, our Tampa markets seemed to be lagging some of the others, but we think that's just a blip. But, we had our bi-weekly leasing call, and everybody was very positive in terms of the activity that they are seeing and the leasing that is occurring. We had hoped to have some more leases signed before this call, but there are a good many in process. As I say, we are pleased with what is going on.

Any uptick in housing related tenants yet or --?

Very slightly that we are seeing, especially in Texas, where the housing markets are all strong, that they are housing-related, but nothing so much that we can get excited about it yet.

Okay, and then just one last quick one. Just given the improving --?

I have been -- I should have said it before, a number of callers have said I let people ask too many questions, so --

I will go back in the queue.

Okay, thanks.

Jamie Feldman, Bank of America.

This is actually [Giseng] with Jamie. I just wanted to follow-up on the commentary earlier about market rents. Can you guys give an update about what you're expecting for leasing spreads in 2013, and when you expect them to turn positive?

We ended the renewal leasing spreads positive for '12, and I would hope that would continue in '13. It's -- the more I thought about it, I think the less important we determine the spreads are on leasing vacant space, and some of our peers don't even give that statistic. Because, for example, if the space has been vacant for over a year, leasing a vacant space is extremely positive, obviously, to FFO, and it really doesn't make any difference whether the spread is positive or negative, but we report it that way.

Another example that I've given to a number of people in the past is, let's just say we have to two 25,000 square foot vacancies next to each other, and one of them, the rent of the previous tenant from a year ago was $5 and the other space the previous tenant was paying $3, because it was a short-term lease signed after the recession started, and the market rent is $4. If we put them in the space on the right, we report a 20% drop. If we put them in the space on the left, we report a 33% increase. But since they were both vacant, it's good for the bottom line. So, that is hard to say. I keep putting off when I think everything is going to report to be positive, but it will be no earlier than later in the year, and maybe even the beginning of next year. But I think the renewal rates are the ones that are a better indicator of where FFO is going to go.

Thanks, David, that is helpful. Just one more on the development pipeline. Can you talk a little bit more about how much more the development pipeline can grow? What projects are included in the 2013 estimates? And what is the potential for exceeding the $45 million that you've guided to?

I think the upside could be two times that, but that is probably a little bit optimistic. So I would hope that we would do $75 million to $80 million in starts, but as you've heard me say in the past, everything is based on leasing of what is in the pipeline now. But we would hope to start at least one more property in the first quarter, and probably won't have as many starts in the second quarter until -- maybe till the end of the quarter. But it could be $75 million to $80 million, at the upper end $90 million. We do not include any projected build-to-suits in those numbers, because they somewhat come out of the blue, and you can go a year without doing any or have a whole group in a row, like we signed last year.

Okay, so the guidance is just spec?

Yes, the guidance is spec, and it is $45 million.

Okay, thank you, David.

Blaine Heck, Wells Fargo.

Just to follow-up on that discussion on development, what is the governor on your decision to go ahead with the development projects? Do you look for rents that will get you to a certain target yield? I think you guys are at about 8.5% on average right now, or is it more of a decision based on whether or not you think there is deep enough tenant demand in a certain market to fill the space?

It is all the above, plus some others. We are obviously pro forma-ing a rent we can achieve that will give us our spec building a yield at 100% occupancy, north of 8%. We are looking at what first generation space is either available in the market today, or will be coming online very soon. And then most of our developments are additional phases in existing parks, and so we look at what kind of demand we see in that park, are we turning people away, and what type -- what level of rents are we receiving in that park, and do they justify a good -- an attractive pro forma rent?

So, I guess asked a different way, if you had a reasonable certainty that the tenant base was there, would you guys be open to going below, say, an 8% yield?

We certainly would on a build-to-suit, but right now, probably not on a spec building, except in -- I don't want to say never, because there are always going to be some exceptions to that, but more than likely it will be at least an 8%.

Okay, fair enough. And then just one other, the same-store NOI guidance you gave, was that cash or GAAP?

GAAP.

And where do you think the cash would shake out relative to that?

0.3 positive to 2.3 positive.

Okay, great. Thanks.

Mitch Germain, JMP Securities.

David, with regards to your development pipeline, is there a certain threshold in terms of size that you are willing to accept at this point, or given where you are in the cycle and the success you've had, are you willing to just continue to grow that in the near-term?

Every development is looked at individually, and the decision made on it, and I don't think we are anywhere close to hitting any upper end that would make us uncomfortable starting new developments. And we have, because of what's been going on in Houston, for us a record number of build-to-suits, which makes it a whole lot easier to have new starts. So we've got a way to go before we worry about having too much risk.

Got you, and with regards to your comment, which referenced how leasing activity was the highest, I mean obviously some of that attributed to a backlog of tenants that were delaying their leasing decisions. How would you have characterized 4Q leasing levels or prospect activity to where you are today? What sort of increase are we talking about?

I would just be guessing if I put a percentage increase on it, but it's up a good bit. You have to have prospects you are showing space to, for them to ask for an RFP or proposal, and you have to be putting out or responding to RFPs before you start signing leases, and -- but it all begins with people looking at your spaces, or talking about development leasing in first-generation space. Particularly in Texas, Houston and San Antonio, our activity is surprisingly high in buildings where we don't have any -- even have the shell completed, so I think that is a real positive. We are getting spoiled from that standpoint.

Thank you.

Michael Bilerman, Citigroup.

This is actually [Kevin Varian] with Michael Bilerman. We were just wondering how the acquisition pipeline is looking, if you dive into what you're seeing in those markets and maybe what the cap rates and what people are underwriting in rent growth, and so on?

We've always had the experience of the first quarter being slow. I think an awful lot of the institutional owners who are generally going to own the properties that we'd be interested in are deciding in the first quarter what to sell, who list it with, and so there is a whole lot -- a big increase in offerings that you see at the end of the first quarter and in the second quarter. As to cap rates, obviously the low interest rates that people can borrow at today have helped bring down those cap rates, but for the first time in memory, the cap rates in Dallas and Houston have gone below a 6% for the highest-quality assets. In markets like Tampa, that I guess you would call secondary markets, but that we like to buy in, the cap rates in 12 months have dropped probably anywhere from 50 to 75 basis points, because I think people are looking at some of those secondary markets or A- markets to get a little bit better yield, and a little less competition on buying.

So we are always optimistic that we are going to find some good acquisitions to fill in where we can't build, and we always project them in the second half of the year, because that seems to be when they happen. And I guess over the last number of three years, we've probably projected $25 million to $30 million in our numbers, and have done twice that. But it usually happens later in the year, so it all's a wash on earnings and a guidance standpoint.

Okay, and just one last question. You mentioned that the $75 million to $80 million in upside for the potential starts for the year, I guess where -- are most of those located you see in Houston, or can you see other areas where those projects could be coming online?

No, we see additional starts in San Antonio, that market has become very strong, and right now nobody else is building there. Some of the other institutions have pulled out of that market, but a strong economy, a lot of new manufacturing there, and the energy, oil and gas boom, in -- has created a whole new group of prospects for us. We have two attractive pieces of land in Chandler, which is south Phoenix, more of the R&D area. Intel has massive operations there that they are expanding. We hope to be under construction there. We bought a little piece of land in Denver that is right next door to our Rampart III. We tried to buy it three or four years ago, and somebody else bought it, and we bought it for less money last year, and want to build there. And we are eager to do some construction in Charlotte. We think there is a demand for first-generation space. So those are all -- well I mentioned Orlando, also, but those are all markets where we see potential starts.

Okay, thank you very much.

John Stewart, Green Street Advisors.

David, what was the cap rate on the sale in Tulsa?

Looking -- the building was 100% occupied, so I always look at a cap rate at 95% occupancy. I think it was a 8.5% at that number, but since it would've been 100% if we held it, in terms of how it affects future FFO, it was a 9% yield.

Okay. And on the $30 million of acquisitions that you've potentially dialed into guidance, where would you -- you didn't necessarily guide to a cap rate, but where would you be comfortable, or where might we think about yields on investment in the second half?

Mid-to-high 6%, although we always buy more than we think were going to, the cap rates tend to be lower than we projected.

Okay.

And I would hope we would be able to look at some good acquisitions in Charlotte. San Antonio is a market we want to grow in, I think the cap rates will be a little more attractive there. And we want to continue to grow in Dallas, and it is hard to do development there for a whole variety of reasons, so I think our growth in Dallas will come from acquisitions.

That is helpful, thank you. And then just wanted to try to reconcile some of your comments, I guess specifically on cap rate compression, and what -- do you see a disconnect? What are people underwriting in terms of rent growth? Because when we look at the stats that you're reporting and the guidance you're giving in terms of where we see rents headed, what are people underwriting in terms of rent growth?

Good question, I don't know. All I can do is, when we underwrite a potential acquisition and then see what somebody else paid, is look at the current rent roll adjusted to what we believe market rents are today, and view it as a going-in cap rate on that basis. So I don't know what other REITs or institutional-type buyers are using for their assumptions.

What are you using on the deals that missed (inaudible) on?

Pardon me?

What are you using on the deals that you maybe bid on in the fourth quarter and didn't win?

We just use market rates. We look at the first year, or if the rates are way below market or there is vacancy, then we maybe would look at the first two or even three years, but we are a cash flow buyer not an IRR buyer, so we don't dial in rate increases or rent spikes, or worry about exit cap rates. We're just an old-fashioned cash-on-cash buyer.

Okay, thank you.

And it appears we have no further questions at this time.

Okay. Thank you all for your interest in EastGroup. Keith will be in the office to answer any questions that you might have. Anything he can't answer, I will try to catch up with you later in the day or tomorrow. Again, thanks for your interest in EastGroup.

This concludes today's program. You may disconnect at this time. Thank you, and have a great day.