Industrial Logistics Properties Trust (ILPT) 2018 Q2 法說會逐字稿

Good morning, and welcome to Industrial Logistics Properties Trust Second Quarter 2018 Financial Results Conference Call. At this time, for opening remarks and introductions, I would like to turn the call over to Olivia Snyder, Manager of Investor Relations. Please go ahead.

Thank you, and good morning, everyone. Thanks for joining us today. With me on the call are President and Chief Executive Officer, John Popeo; and Chief Financial Officer, Rick Siedel. In just a moment, they will provide details about our business and our performance for the second quarter of 2018. We will then open the call to your questions.

First, I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company. Also, note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on ILPT's beliefs and expectations as of today, Friday, July 27, 2018, and actual results may differ materially from those that we project.

The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission, or SEC, which can be accessed from our website, ilptreit.com or the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statements.

In addition, we will be discussing non-GAAP numbers during this call, including normalized funds from operations, or normalized FFO, and cash-based net operating income or cash basis NOI. A reconciliation of these non-GAAP figures to net income and the components to calculate cash available for distribution, or CAD, are available in our supplemental operating and financial data package, which also can be found on our website.

And now I will turn the call over to John.

Thank you, Olivia. Good morning, everyone, and welcome to the second quarter earnings call for Industrial Logistics Properties Trust, or ILPT. ILPT is an industrial REIT that went public in January 2018 and owns 267 primarily warehouse and distribution properties, with 28.8 million square feet located in 25 states.

After the end of the second quarter, around 60% of ILPT's annualized revenues come from 16.8 million square feet of industrial lands located on the island of Oahu in Hawaii. We continue to be optimistic about our future rent growth prospects in Hawaii, but most of ILPT's external growth is still expected to come from acquisitions on the Mainland.

ILPT's Mainland portfolio includes 41 buildings, with 11.9 million square feet located in 24 states that are 100% leased with an average lease term of around 8 years as of quarter end. Our Mainland Properties are relatively new, and the majority of Mainland rents are from investment grade rated tenants or tenants that are subsidiaries of investment grade rated companies, and we have no material near-term lease expirations on the Mainland.

Mainland industrial property values have risen dramatically in recent years due in no small part to growth in e-commerce. Industrial property net absorption continues to outpace deliveries in most markets, contributing to the steady rise in industrial occupancy rates to around 95% today. Based on recent reports, e-commerce sales represents close to 10% of total retail sales, with many predicting continued growth in market share. We still think these industrial market dynamics may translate to continued demand and increases in rents for our existing portfolio of industrial properties when leases roll over in the future.

And despite current market dynamics that continue to drive cap rates lower, especially in some of the top-tier markets around the U.S., we've been successful in closing on one property during the second quarter. In addition, we have one property under contract and 2 additional properties in various stages of diligence that we hope to close before year-end.

During the last week in June, we acquired a 240,000 square foot warehouse and distribution facility in Doral, Florida for $43.1 million at a cap rate of approximately 5.1%. This facility is absolute triple net leased for 10 years to Hellmann Worldwide Logistics Inc., a global third-party logistics company that has occupied the building as their U.S. headquarters since it was constructed in 1996 and further renovated in 2001.

The cross stock building has 24-foot clear heights and includes 66,000 square feet of freezer and cooler space and 109,000 square feet of dry warehouse space. Hellman Worldwide runs their U.S. headquarters operations out of the 65,000 square feet of office space at this property. Hellman was founded in 1871, and is one of the largest logistics servicing companies in the world.

We also have a 221,000 square foot distribution facility under agreement to purchase for $29.3 million, located in Upper Marlboro, Maryland. The property was constructed in 2016, with 32-foot clear heights and modern column spacing and dock capacity. The property is located approximately 10 miles from Washington, D.C.'s Capital Beltway with ready access to Route 301 and I-95, and leased for just over 12 years to a strong credit tenant that chose this location for its distribution reach to D.C., Baltimore and other Maryland locations as well as Virginia and the Carolinas. The cap rate for this property of approximately 5.2% reflects the high quality of construction and design and strong location for general distribution.

We have 2 other properties in various phases of diligence located in the Harrisburg, Pennsylvania and Minneapolis, Minnesota market areas. The aggregate purchase price for these properties amounts to around $48 million, with an average cap rate of around 5.4%. These 2 properties are near major population centers, with solid highway access. We will provide further details on both of these properties during our third quarter earnings call if they pass diligence and are put under agreement or acquired by then.

To quickly summarize our acquisitions efforts. We have 3 properties that I just reviewed that are in various stages of diligence, plus 1 property that we closed in late June, in all, totaling around $120 million. We've reviewed around 70 deals since January. We bid on around 2 dozen deals and we've won the bid on 4. Assuming we close the 3 pending deals by drawing down on our revolver, we still expect to have around $340 million of acquisitions capacity on our revolver, and we still expect to have a relatively low debt-to-EBITDA ratio.

As discussed last quarter, ILPT still seems to be trading at one of the largest discounts to analysts' NAV estimates among the industrial REIT peer group. Since the last earnings call, we participated in 4 non-deal roadshows in New York, Boston and Chicago, and we continue to do our best to educate the market about the quality of our portfolio and our growth prospects.

We'll continue to drive the value proposition of ILPT in future earnings calls and at investor conferences. We're hopeful to see an increase in our normalized FFO trading multiples to levels more consistent with our industrial REIT peers as we prove out our Hawaii internal growth proposition, and as we acquire properties on the Mainland.

In a minute, Rick will provide a detailed overview of leasing activities and financial results for the quarter. But in summary, same property occupancy remains above 99% and cash basis NOI increased by over 3% over the prior year period. Normalized FFO was $0.39 per share, down $0.03 per share from last quarter. The decline reflects seasonal percentage rent, totaling almost $1 million that we received during the first quarter of 2018.

As a reminder, we receive annual percentage rent during the first quarter of each year, so the related decline in revenue in the second quarter of each year is always expected. In addition, second quarter per share results are based on the full 65 million shares issued during our IPO in mid-January.

We had no acquisitions to report during our first quarter earnings call, which took place in late April, which leads us to believe that some of the consensus models may have overestimated acquisitions. Leasing spreads for the quarter were a solid 34.5%. All in all, we think it was a strong quarter. We look forward to the full earnings impact in the third quarter from our $43.1 million acquisition that closed on June 27, plus the possibility of the full earnings impact in future quarters from pending acquisitions discussed earlier.

I'll now hand the call over to Rick Siedel to provide details on this quarter's earnings. Rick?

Thanks, John, and good morning, everyone. I'll begin with an overview of leasing, and then continue on to our financial results. Portfolio occupancy as of the end of the second quarter was 99.1%, a 50 basis point decrease from the prior year and an 80 basis point decrease from last quarter. This decrease is primarily the result of our lease termination of one former 214,000 square foot tenant in our Campbell Industrial Park in Hawaii that we mentioned on our last call.

During the quarter, we executed new and renewal leases totaling 218,000 square feet, all at our Hawaii properties, at rents that were 34.5% higher than previous rents for the same space. The average lease term is over 11 years and leasing capital per square foot per lease year was $0.22.

We also executed one rent reset in Hawaii for approximately 34,000 square feet of land at a rental rate that was 18% higher than the prior rate. We continue to be encouraged by our leasing results and the potential growth we may achieve when over 50% of our Hawaii leases mark-to-market either through rent resets or as leases roll over over the next 5 years.

As John mentioned, we have no significant near-term lease expirations on the Mainland and just 17,000 square feet of leases scheduled to expire during the remainder of 2018 in Hawaii. Our hope is that rents will continue to increase in Hawaii at rates consistent with our historical performance and generate meaningful internal growth for ILPT.

Moving on to the financials. Normalized FFO for the second quarter of 2018 was $25.6 million or $0.39 per share. Adjusted EBITDA for the quarter was $29.5 million. Subsequent to the end of the quarter, we declared our first full regular quarterly dividend of $0.33 per share or $1.32 per year.

Our normalized FFO payout ratio is comfortable at 84.6%. Total revenues for the second quarter of 2018 increased by $815,000 to $39.4 million, representing a 2.1% increase over prior year results. The increase primarily reflects lease renewals and rent resets at our Hawaii properties.

Same property cash NOI increased by approximately $1 million, representing a 3.3% increase over the prior year, primarily as a result of contractual rent increases and leasing activity. Hawaii same property cash NOI increased 2.3% over the prior year, reflecting increases in rents from renewals and releasing along with resets.

As mentioned last quarter, we continue to incur some fees for additional security and cleanup costs related to defaulted tenant move-outs that occurred during the first quarter. Excluding those charges, the increase in Hawaii same property cash NOI for the current quarter would have been 4.1%.

Mainland cash NOI increased 4.8% over the prior year, reflecting a decrease in repair and maintenance expense from the prior year period and an increase in rent from an expansion project with FedEx that was completed in the third quarter of 2017.

Operating income increased by 40 basis points or $90,000, reflecting lease activity mentioned earlier, partially offset by increased general and administrative expenses related to our status as a stand-alone public company in 2018.

In the second quarter, our recurring capital expenditures, which include leasing commissions, tenant improvements and building improvements, totaled $535,000. Leasing commissions accounted for the majority of these expenditures and represent the cost to re-lease a vacated space in Hawaii following the prior tenant's default.

The increase in interest expense over the prior year reflects average borrowings on our revolving credit facility. The average interest rate on our revolver is based on LIBOR plus a spread, which amounted to approximately 3.4% at quarter end. We continue to believe this low initial cost of debt capital and $415 million of drawing capacity gives us an opportunity to acquire new industrial and logistics properties and meaningfully enhance future earnings.

We ended the quarter with $15.6 million of cash on hand and just $335 million outstanding on our $750 million unsecured revolving credit facility. Debt to adjusted EBITDA was just 3.3x and adjusted EBITDA to interest expense was 8.3x. We have only one property encumbered by secured debt, and we believe our balance sheet is very well positioned for growth.

That concludes our prepared remarks. Operator, we're now ready to take questions.

(Operator Instructions) And today's first question comes from Bryan Maher of B. Riley FBR.

Two questions. We have the Hawaii lease resets and some expirations picking up in 2019. And given what we're seeing currently this year, seemingly a little bit of occupancy friction. Can you talk about how we should think about that next year as those rents expire or reset? And then I have another question on acquisitions.

So we're very optimistic about our growth prospects in Hawaii. We had one large tenant in the Campbell estate that vacated the premises in the second quarter. But keep in mind, that only accounts for roughly $80,000 per quarter, so it's going to have a very little impact on total earnings coming from Hawaii until we get that re-let, and it just may take a few quarters to get that re-let.

As far as 2019 resets go and lease expirations, it's a big year of something like $12 million to $15 million of revenues are expected to turn during that year. We still anticipate significant roll-ups when those leases are either re-signed or reset. The market dynamics in Hawaii, particularly at our Honolulu properties, are still very solid. Unemployment in Hawaii is still below 2%. It's still the strongest industrial market in the nation, so we're very optimistic.

Okay. And then as far as the acquisitions go, the information you gave us on the 2 potential ones was definitely helpful. But can you talk about what you're seeing in cap rate differentials between some of the primary markets, Northern New Jersey, major gateway markets, and the secondary and tertiary markets, and how you feel about those differentials kind of from a risk reward standpoint?

So what we're seeing is still a very robust market. There's a lot of activity going on, particularly in the top-tier primary markets, including Dallas, Chicago, Atlanta, Northern New Jersey, Inland Empire, but the market's absorbed close to 50 million square feet this past quarter. The projections are, for the whole year, around 200 million square feet of new products is in the construction pipeline. And the consensus among the industry is that that 200 million square feet will be absorbed.

We have seen a little bit of cap rate compression in the secondary markets. It does sort of feel like in the primary markets cap rates may be stabilizing. We were very happy to have landed the deal down in Doral, Florida. It fits all our primary criteria, and we think we got it at a very competitive cap rate of around 5.1%. But it fits all those key criteria. It's within several miles of a population density of almost 3 million people, it's close to a major seaport, the airport and major trucking routes.

(Operator Instructions) Today's next question comes from Brian Hawthorne of RBC Capital Markets.

Just a first question kind of on the markets. Are there any markets becoming more or less interesting to you guys?

Actually, that's a great question. I'm a little intrigued by the prospects of entering the Phoenix industrial market. And part of the reason is, it's just so expensive to acquire a property in Inland Empire today. But what's interesting about the Phoenix market is it's only about a 5.5-hour drive to Long Beach and you've got a very deep labor pool. That's one of the things that owners and operators of properties in Inland Empire are really struggling with today, especially people that are running fulfillment centers. So that just happens to be one we may look at.

I still think Chicago, Dallas, those markets are still solid markets, despite the fact that that's probably where most of the development is going on today. We are actually looking at a handful of properties in the pipeline today in those markets. Of course, it's going to be very competitive. In addition, we're still looking at markets similar to the markets we're currently doing diligence on with a couple of properties we're hoping to close, including the DC and Baltimore areas.

We're also looking in Harrisburg, Pennsylvania, which we think is a very strong distribution hub. A lot of companies want to be there. We want to be there. We're very hopeful that diligence will play out well for a property that we're currently looking at. And we'll hopefully have that property under contract or we'll hopefully own it by the end of the third quarter.

Okay. And then any thoughts on terming up the credit facility?

I think -- this is Rick. I think we've got plenty of options there. No immediate rush with the pipeline, as John just described. I think we certainly have some time. But given some of the headlines about -- in trade and interest rates and everything else, I don't know that we're in an immediate rush. But I think when the time comes, we've got lots of options available to us. We can work with our banks. We can look to issue some notes. We only have one property encumbered by secured debt right now, so that's possibly an attractively priced option as well. So again, I think at this point, we don't really have any need to do it, but we continue to look at the balance sheet and try to be opportunistic and feel pretty good about where we are today.

Sure. Okay. And then just on that, any impacts you see from the current trade talks?

That's a good question. And fortunately, we don't have a whole lot of manufacturing exposure. And I think, at least, initially, a prolonged trade war will primarily affect manufacturing. But ultimately, if cooler heads do not prevail, it'll affect pretty much all business. And a reduction in demand for imports will, of course, have an impact on demand for warehouse space, could disrupt the supply chain and could have an impact on earnings power in general, which will also have an impact on warehouse and distribution space.

But we haven't seen a whole lot of impact from the trade -- the potential trade war, other than a lot of news especially today. And recently, we're hearing about stockpiles of meat and soy, and I even heard today lobster fishermen in our neck of the woods here in Boston are feeling the pinch now from the impact of tariffs. And I also understand that some of the experts are tempering their expectations for economic growth for the second quarter based on everything going on. But again, we're hopeful cooler heads will prevail. I still think there's enough tailwinds for industrial properties, primarily focused on trends in e-commerce to weather any short-term impact from what's going on today.

And our next question today comes from Jamie Feldman of Bank of America Merrill Lynch.

So I guess when we think about the Doral acquisition, it has traditional warehouse but it's also got, I think, you said 65,000 square feet of office, 66,000 square feet of freezer and cooler. Can you just talk about your appetite for more, I don't want to call it mixed use because it's still more of an industrial focus, but like assets that aren't traditionally just distribution warehouse assets as you guys continue to focus on growing the portfolio and acquisitions.

Yes. I mean, Jamie, I think that the primary focus is close proximity to population centers and easy access to main highway distribution routes. This property fits pretty much all of those key criteria. It's interesting. It's an older building and it's got a lower clear height. But in addition, what this property has going for it is its proximity also to high-end retail, new hotels and high-end residential. So our expectation is Hellman, it's one of the largest worldwide third-party logistics companies, it -- that's all it does is logistics, it's got a network -- a worldwide network.

This property is, really, you can think of it as a gateway to Latin America. When I went down and toured this property just prior to our acquisition, it was bustling, a lot of activity, including a lot of activity coming in from foreign locations and then going out to Latin America. So a very active property.

I think the -- it is unusual to have an industrial property with over 20% of office space. But in this case, I think it's a real positive because of the fact that it does serve as Hellman's U.S. headquarter facility. When we look out at some of the other properties that we're looking at, it's really more pure distribution with very little REIT -- very little office. I mean, we're talking maybe 5% to 7% of the total facilities for the other 3 properties that we're looking at is office. They're all single tenanted. They're all in what I consider great locations. Again, high concentration of population and very, very close to major highways routes. I mean we're excited about the prospects of buying a property in Harrisburg, Pennsylvania. Eastern and Central Pennsylvania seems to be one of the hottest markets around right now. And we really like this Upper Marlboro proposition, again, very close to I-495 Beltway, easy access to D.C., Baltimore even up into Philadelphia, but also access down into Virginia and the Carolinas.

Okay. And then can you talk about leasing prospects to backfill the Campbell vacancy and it sounds like, I think you said $80,000 of NOI. But still, what does that pipeline look like? And then are there other pending vacancies we may see going forward?

Yes. So this is Rick. We do have that vacancy. It's actually going to require a little bit of cleanup work. Nothing of an environmental nature, just more debris left behind that the team is going to be clearing up to get it ready to be re-leased. We often talk about the Hawaii portfolio and how valuable it is, but there is a pretty distinct difference between our Honolulu properties and the Campbell Industrial Park where 80-plus percent of our revenue and the value is really closer to Honolulu. So typically, historically, it's taken a little bit longer to lease up properties out in Campbell. But again, we're still encouraged by the prospects that the team on the ground has.

We had 2 tenant defaults that we talked about last quarter. One in the Damon Estate or the Honolulu properties, and then this one. The other one has already been re-leased. It was -- we signed it towards the end of the quarter, it was like a 61% of roll-up after the prior tenant defaulted, so really just a home run. And we've got a great team there and we're really pleased with how fast they were able to get that re-tenanted. Again, we do expect Campbell to take a little longer, but it's just less material from a dollar perspective. So it is what it is.

And what do you think the cleanup cost will be?

The team is still kind of working through that. Some of it -- in some cases, it's like some concrete chunks that are left behind. There's an opportunity to possibly grind it up and leave it where it is or truck it away. Obviously, trucking it away is the more expensive option. But again, we've got the team kind of working through that and figuring out what the best way to proceed is. So again, right now, it's 214,000 square feet of vacancy. We're still over 99% occupied. The portfolio is in great shape overall.

Okay. I guess what I'm asking is do you think we'll see like a meaningful charge or hit the expenses or something from this?

No. I mean, we had overall growth of 3.3% cash NOI. That included some $320,000 of security and cleanup, just starting the process to figure it out. So no, nothing particularly material. But again, given that we're still a fairly small company, a few hundred thousand tends to move the needle a few percentage. So no, we'll try to give you that color. But overall, we feel really good about it.

All right. And then, I guess, just to ask your tenant watchlist today. Are there other names on it, still?

The portfolio is performing very well right now. I mean, we have one tenant that was somewhat newsworthy, that's American Tire Distributors. A lot of analysts and investors have asked us quite a few questions. And this is a tenant in our, I guess, top tenant list. They account for just over 2% of revenues. And the news reports indicated that they may have lost a couple of key names or tire manufacturers, but this is a large company. It's got a big reach. It's got a lot of distribution facilities throughout the country. There's nothing that would lead us to believe that this tenant will vacate our properties.

But regardless, we have a good handle on the market condition in the 5 markets that these properties are located. And they're all pretty good markets, some better than others. But one of the properties is in Albany, another in Columbus, Ohio. These are 2 pretty strong markets, particularly for where our properties are located.

And just sort of talking things over with our leasing and asset management group that if these properties were, for some reason, to go vacant, and it is worth noting that the lease expirations for these properties aren't until 2023 and 2024, but if they were to go vacant, it's probably only going to take us 6 to 12 months to re-lease the majority of these properties.

And another thing worth noting is, all of our -- we actively manage all of our properties through RMR's property management division. When properties go vacant, we lease them. That's what we do here and it's not something that concerns us in the least. The only reason I bring this up again is because a few investors have specifically asked. But again, we have no reason to believe that we'll have any long-term issue with this tenant at this time.

Okay. And did you say you have reserved against them or you have not reserved against them?

We have no need to reserve against them today.

Okay. All right. And it sounds like there's nobody else on the watchlist at this point.

That's correct. It's a pretty solid tenant roster, including Amazon of course on the Mainland.

And ladies and gentlemen, this concludes the question-and-answer session. I'd like to turn the conference back over to the management team for any closing remarks.

Again, we're very happy to report the closing of our first acquisition this quarter in a top-tier market, plus several solid prospects in the acquisition pipeline. We're hopeful that acquisitions momentum and prospects for continued rent growth at our Hawaii properties will translate to meaningful earnings growth in the next few quarters. Thank you, everyone, for joining today's call.

Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.