Kite Realty Group Trust (KRG) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2016 Kite Realty Group Trust earnings conference call.

(Operator Instructions)

I would now like to introduce your host for today's conference, Ms. Maggie Daniels, Director of Investor Relations. You may begin.

Thank you, Vicky, and good morning everyone. Welcome to Kite Realty Group's second-quarter 2016 earnings call. Some of today's comments contain forward-looking statements that are based on assumptions and are subject to inherent risks and uncertainties. Actual results may differ materially from these statements.

For more information about the factors that can adversely affect the Company's results, please see our SEC filings including our most recent 10-K. Today's remarks also include non-GAAP financial measures. Please refer to yesterday's earnings release available on our web site for reconciliation of these non-GAAP performance measures to our GAAP financial results.

On the call with me today from the Company are Chief Executive Officer John Kite; Chief Operating Officer Tom McGowan; and our Chief Financial Officer Dan Sink.

Now I would like to turn the call over to John.

Thanks, Maggie. And good morning, everyone.

During the second quarter we continued to execute on our core objectives and progress closer towards our three year road map of goals. The details of our results can be found in the press release and supplemental, but before diving into the specifics, I would like to discuss the transaction cost incurred during the period.

In the second quarter, we expensed $2.8 million in cost relating to a potential transaction that we ultimately elected not to pursue. Consistent with our long-standing corporate policy, we do not comment on market rumors or potential transactions.

Because of this, we will not be answering any questions about the specific transaction. I will, however, use this opportunity to reiterate statements that I have made in past regarding our underwriting process and how we approach transactions.

We have several objectives that we analyze internally and with our Board to evaluate potential opportunities, including pro forma portfolio metrics, risk mitigation, and capital allocation, to name a few. These objectives include some primary goals such as first, enhance our portfolio's asset composition and net asset value; second, maintain or improve our balance sheet metrics, and third; grow our free cash flow per share.

We don't intend on executing on any transaction that would jeopardize or run counter to these strategic objectives. In the past I have been asked if our Team is interested in growing for the sake of growing. I can't think of a more tangible example to refute this concern than what has happened in the second quarter.

Although we did not move forward with this particular transaction, I would like to take a step back and look at the execution and success of our two most recent transactions: the $300 million Nine-Property portfolio acquisition in 2013, and the $2 billion Inland Diversified merger in 2014.

First, we used both of these earlier transactions to enhance our portfolio's asset composition. We were able to expand our presence in several key markets including the Northeast, Texas, and the Southeast which enhanced the quality of the portfolio as we grew our ABR by approximately 16%. This was further improved by the quick sale of the 15 lower tier assets within the Inland portfolio in tertiary markets for approximately $320 million, which we managed to complete at the same cap rate established for the entire merger. Our first goal was achieved.

Second, we used both transactions to improve the Company's balance sheet. We financed both of these opportunities with stock and asset sales to further drive down our net debt-to-EBITDA by two [terms], yet we manage today remain neutral to earnings. The Inland merger was specifically structured to retain pre-merger sale proceeds from noncore assets to pay down debt. Our second goal was achieved.

Lastly, our projections and models were structured with the focus on growing free cash flow which we increased from approximately $2 million annually to over $50 million annually following these two transactions. This translates into free cash flow per share growth of nearly 7.5 times. Our third goal was achieved.

Now I plan to use the balance of this call to highlight our second-quarter performance and provide you an update on our three-year road map. To start, we continue to focus on our efficient corporate culture, and maintain the strong pace from the first quarter, as we hit an NOI margin of 75.4%, our highest in over 10 years while holding steady our modest G&A to revenue ratio.

We continue to proactively refinance and reduce our debt and view redevelopment as our best use of capital at this time, both of which I will discuss in detail shortly. Our Team hustled again this quarter to bring our recovery ratio in at just over 90%.

We anticipate our recoveries will hover around this level in the near term as we have successfully implemented new lease terms including fixed CAM language, as well as continued expense control at the properties. As an example, nearly 90% of the leases we executed in the second quarter included fixed CAM language.

That takes us to operational excellence and execution. Excluding the 3-R initiative our same-store NOI grew 3.6% during the quarter. As I mentioned on our last call, both our 3-R initiative and the Sports Authority bankruptcy will impact our same-store growth metrics in the short term, but create significant value over the long term. We estimate that the 3-R initiative will continue to impact our same-store growth up to 100 basis points per quarter, while the Sports Authority bankruptcy we estimate to have an 80 basis point impact per quarter as well. Overall we had modest Sports Authority exposure relative to the industry with only three locations.

We were out-bid by a tenant at our Portofino location in Houston and are currently working with them to restructure the lease. The other two locations in Florida were rejected from the bankruptcy at the end of June. Our leasing team is focused on securing new tenants at both of those locations within the next 9 to 12 months.

Turning to leasing, I touched on our successful effort to shift to fixed CAM, but we have also had a number of other important accomplishments during the quarter. Our goal of being 90% leased in our small shops remains one of our largest near-term drivers of organic NOI growth. We finished the quarter at 88.3% leased in the shops, which is a 210 basis point increase compared to this period last year. We also delivered and opened several new anchor and junior anchor boxes, including three ULTA stores at Northdale Promenade, Belle Isle, and Tamiami Crossing.

With respect to development, we substantially completed two of our three development projects in the second quarter. Tamiami Crossing in Naples, Florida is now 100% leased with all six junior anchors fully operational as the asset transitioned into our operating portfolio. PetSmart, Michaels, and Ross all opened since the first quarter, joining Stein Mart, Marshalls, and ULTA. We substantially completed and transitioned Phase II of Holly Springs Towne Center located in the MSA of Raleigh, North Carolina, into our operating portfolio at over 90% leased. The second phase is anchored by Bed Bath, DSW, and a soon to be opened Carmike theater, which has been delivered to the tenant and fixturing is under way. The theater is scheduled to open this fall.

This leaves us with one ground up development project which is the second phase of Parkside Town Commons in Raleigh, North Carolina. The first phase is 100% leased and occupied, with the final anchor opening occurring earlier this month. Since the first quarter, we have either signed or opened nearly 30,000 feet of new shops in the second phase of the project.

Turning to redevelopment, we continue to progress on our 3-R initiative which includes a total of 23 projects across our in-process and our pipeline. As discussed on our last call, we anticipate continuing to shift assets from our list of opportunities to our under construction category over the next 12 to 18 months.

Looking ahead to the next several quarters, we expect the impact of the 3-R initiative on our same store growth to fluctuate as we ramp up construction on several assets. During the second quarter, we commenced construction on three additional assets including Tarpon Bay in Naples, Florida; Shops at Moore in Oklahoma City; and Hitchcock Plaza in Aiken, South Carolina.

At the end of the second quarter we had eight assets under construction for total projected cost of between $40 million to $47 million with returns expected between 9% and 11%. We continue to have a healthy pipeline of 3-R opportunities which includes 15 assets for a total estimated cost of $90 million to $110 million. Assets will be added to the list once we determine a viable redevelopment plan and the project has been approved internally, meeting return and capital allocation requirements.

Our balance sheet and capital position remain steady during the quarter. We continue to reduce our secured debt exposure and bolstered our unencumbered asset pool, which drives financial flexibility. In June we funded the additional $100 million relating to the seven year term loan, which along with other loans was used to repay $46 million of property level secured debt maturities, and other existing indebtedness, including two of our premiere Publix anchor shopping centers in Naples, Florida.

Since the quarter ended we have also refinanced $700 million of unsecured bank facility by extending $200 million of our $400 million term loan for an additional five years, and refinancing our existing $500 million line of credit through 2020. As part of these refinancings we were able to renegotiate certain bank terms which significantly improved our borrowing base calculation, lowered our interest rate, and extended the overall term of our debt maturities.

Finally, we are currently in process of refinancing our two project-specific construction loans at Delray Marketplace and Parkside Town Commons, and expect these to be fully completed during the third quarter. After these transactions are completed, our secured debt maturities are extremely manageable.

We will have less than $125 million of CMBS maturing through the end of 2020. We expect roughly half of these maturities to be funded with our intended asset sales during the back half of this year, and the balance will be repaid using cash and liquidity.

As of quarter end, our liquidity position stood at over $400 million with full capacity on our revolver and more than enough cash to cover our minimal secured debt maturities over the next several years. While the staggered maturity schedule and free cash flow is exceeding our plan, we remain focused on reducing our net debt-to-EBITDA from 6.9 times to our stated goal of the low 6s. That said, our planned 2016 asset sales and incremental NOI of approximately $11 million from our existing development, redevelopment, and transitional projects brings our leverage down approximately 40 to 50 basis points. We remain committed to our investment grade balance sheet and further strengthening our balance sheet metrics.

We are raising the lower end of our 2016 full year guidance for FFO as adjusted by $0.02 for a new range of $2.04 to $2.08. We are also adjusting our same store NOI assumption to 2.5% to 3% to account for the Sports Authority bankruptcy and our 3-R initiative as we continue to commence construction on new projects quarterly. This results in a short-term impact to a metric in exchange for long-term NAV accretion and shareholder value creation.

Thank you very much for your time, and we are available for questions, Operator.

(Operator Instructions)

Our first question comes from the line of Christy McElroy with Citi. Your line is now open.

Hi, good morning, everyone.

Good morning.

John, you have made no secret of the fact that you do want to grow the Company over time. When you look at the market's reaction to just rumors of those efforts to try to grow, what impact did that have on how you think about the Company strategically?

What signal do you think that the market was giving? How do you think about idea of growing the Company versus potentially selling into a larger entity to maximize shareholder value?

Well, Christy, I think when you look at -- when we look back at it and look at what was out there and what we read and what the rumors in the market were, I don't think we were surprised at all by the reaction. I think it is difficult for investors when they don't know exactly what is going on.

So, you know, assumptions are made and we understand -- after what we read, we understand the reaction. I think it doesn't -- and certainly when you look at -- it is kind of why we discussed the transactions that we have done in the past, and the success of those transactions as it relates to the strength of the Company, the balance sheet, and growing our free cash flow per share so that we can re-invest into the business.

I think it is certainly understandable due to what was thought -- due to what people thought was potentially happening. So I don't really think it changes much other than to say we're focused on doing smart deals that create shareholder value whether that be through internal redevelopment or whether that be through transactions like Inland or the [Oxit] transaction.

But we're not going to do deals that don't meet those characteristics, and I think it is why you saw what happened in the quarter. That's the point we were trying to make is that we're looking to do smart deals, not just any deal.

And so does it put you off, you know -- in terms of thinking about your growth strategy, does it put you off potentially doing another bigger deal as opposed to one off acquisitions and redevelopment? And how does the increase in your stock price this year impact your view of your cost of capital today?

Well, to the first question, look, our job is to create value the most efficient way we can within this organization, and so it doesn't put us off. It just reaffirms how we think, which is that we are trying to find opportunities that make sense from a value perspective and make sense from our ability to add more value to them.

So, you know, size isn't really what we are thinking about. It is can we get assets at a discount that we can make better? And that is what we did in those last two transactions and that's what we would have attempted to do in this transaction that didn't come to fruition because of those things, right, because we want to achieve and we want to manage risk.

So I think to that extent -- again, I understand how things went, but the reality is as we look at the landscape, we love the properties that we own. We want to continue to own properties like this, and we want to add value to them.

In terms of the stock price, we look at it, it is part of our -- it is obviously part of our capital allocation thought process. So it does matter, and it matters in terms of how we look at the value. But it is not what we focus on every minute of the day as the stock is more closer toward what we feel is a fair value. That is certainly helpful in how we look at the world, but it doesn't mean that you run out and try to do something just because of a particular stock price.

I think we are always looking at the longer term, and we're looking at the assets and do these assets make sense, do they improve the quality of our base, and can we grow them? That's more what we are looking at.

Thank you.

Thank you.

And our next question comes from line of Collin Mings with Raymond James. Your line is now open.

Hey. Good morning.

Good morning.

First question for me just as it relate to the improved stock price, how are you planning on approaching the ATMs just to help fund the redevelopment pipeline and potentially accelerate some of your plans to help lower leverage?

Well, as you know, as we said we continue to want to fund our pipeline through our free cash flow, and right now that's matching up pretty nicely because our annual spend does not exceed our free cash flow. We don't -- we wouldn't look at accelerating a project just because the stock might be in a particular place.

These projects have to -- they have to meet the timelines that make sense in terms of where we are to manage the risk for every project. So it really isn't about the capital side as much as it is the risk side.

We don't want to overextend in this area. We have seen what that can do. We will do this in a measured way, and we would much prefer to fund stuff with free cash flow than any outside capital.

So we are always aware of it, and we are probably more focused on our balance sheet strength than we are accelerating our redevelopments. As I made clear, we want to continue to delever the Company. So that's what we are focused on.

Okay. And then, just as far as in the guidance, you trimmed disposition guidance a bit. Can you maybe touch on what drove that, and just your updated thoughts as far as the timing of asset sales?

I think just as we get through the middle part of the year and how the timelines for these things to happen, I think what we are really doing is probably saying that $25 million of the potential dispositions won't happen this year and may happen next year.

But we still think we will meet the revised guidance of dispositions and we want to execute at the right price. We're not going to push ourselves into executing just to meet a range.

Okay. And then just last question for me just going back to Christy's question, is there anything else, John, in the pipeline that you are actively engaged in that you think could result in a similar type of transaction charge if it doesn't materialize?

Well, I mean look, I think it is our job to always be reviewing what is happening in the market and to be reviewing opportunities. So we never stop reviewing opportunities. This was obviously significant and so this -- to say there's something of that significance right this second, no.

But we're going to continue to review opportunities and we are going to continue to say if there's something we can find that we can add value to at the right price, at the right capital structure, we will look at it. And I think it is clear that we will also look at things and walk away from them if they don't meet those characteristics.

So I hope that is what the take away is, is that we are very focused on doing things that create value in the right way. We're not just focused on doing something to do it.

Appreciate the color, John.

Thank you.

(Operator Instructions)

Our next question comes from the line of Todd Thomas, KeyBanc Capital Markets. Your line is now open.

Hi, good morning. This is Drew Smith on for Todd today.

Morning.

Just on the topic of guidance -- good morning.

Just curious what was baked into the low end that gave you the confidence to lift the range by $0.02? And then additionally, just a little bit about the Sports Authority boxes, maybe if you could give us some color in terms of the timing and costs for re-tenanting those, that would be great.

Thanks.

I think when you look at bringing up the low end of guidance, obviously the first two quarters we were at $0.52, and as we look at it throughout the rest of the year, with our bad debt reserves that we originally had budgeted as well as the interest expense and some of the clarity we get around potential closures and the acceleration of openings and then our 3-R pipeline, I think that gave us a great comfort to bring up the bottom end.

So the Sports Authority and that particular -- those two closings obviously affected some of the same store NOI range as well as the percentage leased range, but overall as we looked at the year we felt comfortable about trimming the -- bringing in the range, especially with how we performed in the first two quarters.

As it relates to the Sports Authority re-leasing, look, we are only talking about two locations. And this is what we do, and we do it well. We are looking at multiple opportunities at both locations and really focused on the merchandising mix as it relates to the balance of the shopping center.

That's why we mentioned in the remarks that over the next year to year and a half we anticipate that we would execute on those two boxes because we want to take the appropriate time and not just rush into any deal, although we are actively talking on both to make the right deal.

Tom, do you want to add to that?

Yes, I think the positive for us is we have two large shopping centers here, and they both have very strong tenancy in terms of the other anchors inside the Center. That allows us to track the type of tenancy that we want. And without question, in Tradition we are a little further along. We are actually into real negotiations with the tenant, which is very encouraging since we just got this back in June.

In Colonial we are really focused on entertainment uses and are working on a long list of opportunities. So in terms of being in this process for a very short period of time we have a great deal of confidence of getting through this.

That's helpful. Thank you.

Thanks.

And our next question comes from the line of Vineet Khanna with Capital One Securities. Your line is now open.

Yes, hi folks. Good morning. Thanks for taking my questions.

As you mentioned in your prepared remarks you have undertaken two significant transactions in the last few years. You have made a lot of progress in improving the balance sheet. At this juncture, why consider another significant transaction, and why do you think Kite is prepared from an organizational and balance sheet perspective to really digest another significant transaction?

We aren't doing another significant transaction right now, but to your question, we are prepared because we have executed exactly how we laid out the plan when we did those two transactions. And unlike others, when we closed on those transactions we had no hiccups. In fact, we excelled and the Company became stronger because of both of those transactions.

So the point that we were making is that we have done deals that have improved the portfolio and improved the balance sheet. When you look at the balance sheet today from where it was, it is significantly stronger and more flexible than it was prior to those two transactions. And I mentioned that we grew our free cash flow per share, mind you, 7.5 times in that period of time.

That's why a Company like ours would look at a transaction and it is why we would pursue something like that because it makes a lot of sense. However, if we are looking at a transaction, as we have this past quarter, and we get to the point where we deem that those things would be in jeopardy in any way, then we won't do that transaction, which is why this is what occurred.

So I think we are very capable of doing these things, and as I mentioned our operation -- our operating efficiency is the best in the business. That's why we're able to do these things. I think we feel very comfortable with our capabilities, but we are most focused on managing risks that -- it is around these deals to make sure they're the right deals.

Great, great. And then now I guess shifting too the portfolio itself. You are within striking distance of your 90% mall shop goal. So do you think that goal can sort of move higher, and if so where maybe do you think you can go? And then maybe you can just talk about shop demand in general?

Well, goals will always move higher, but we need to hit this one first. We're at 88.3%, we want to be at 90%. We are very focused on it. There's a lot of upside there for us in terms of NOI, cash flow, and earnings growth. Very profitable business in small shop side of our business.

That's our focus, is to hit that and try to maintain it. I would say maintaining ratio would be something we would want to do. But yes, we think we can continue to excel here. We think our portfolio is capable of reaching that.

But by the same token we don't just put tenants in spaces to try to achieve that goal. We turn down tons of deals every month based on us not being comfortable with a particular tenant. It is really more about high quality leasing than just leasing.

I would also say the second half of that equation ties back to something we spent a lot of time on, and that's tenant retention. From an asset management standpoint we spend hours and hours trying to figure out the best ways to retain our tenants, and we have been very successful with that.

But those two go hand in hand in terms of reaching that goal. You not only have to lease but you have to retain. We are focused on both accounts.

Sure. And then just one last quick one for me. How much is left to sell at Eddy Street Commons, and when do you think that revenue will subside?

On the first phase we are down to very few units remaining, and only a handful. So when you look at that there's a profit sharing portion to this basically arrangement we have with the builder. So we have a couple units to sell, and then we will look at the end, and then there's potentially some additional profits that we will be able to book as it relates to that.

Just to point out that we call it any street residential sales, but it has been a fee income stream since 2010. I think it is very important to point out. It is almost like a seven year lease that has been in place that keeps providing additional cash flow every year. So it is winding down, but it has been a great source of earnings and cash flow for the period of time since 2010.

Great. Thanks for taking my questions.

Thanks.

(Operator Instructions)

Our next question comes from the line of Alexander Goldfarb with Sandler O'Neill. Your line is now open.

Good morning out there.

Good morning.

Hey. So just, John, if you look back over Kite, originally you guys were developers, and then as of late you have been, you know, on the acquisition side with the two large portfolios you mentioned. And obviously you spend quite a bit of time looking at the deal during the quarter. As you think about growth for the Company, do you feel like the driver of growth really is more from -- on the external side is more from acquisition, or do you think that development will once again play a role?

You mentioned that you are down to one development. I am just curious from your experiences over time, if you think that acquisitions are better risk reward for growth, or if it is development, or maybe it is neither? Maybe just more internal focus and more redevelopment is really where the growth will come from?

Well I think, Alex, that these things are situational. So everything we look at, we look at on its own merit. So as I mentioned in the call, I think right now our focus is on redevelopment in the portfolio that we have and that we're adding value to, and we're funding in a very efficient way. And the returns are high.

That said, it doesn't mean that you don't -- when you are focused on that you don't look at anything else. You are always looking at what you can do to -- that's going to create the most value per dollar.

So I think it is hard to say that we're going to limit anything. I think what we're going to do is we're going to continue to do what we have been doing, which is growing free cash flow, improving the balance sheet, and being in a place where we're very flexible to adjust and adapt to the macro environment.

I mean, we are in an environment that is pretty shaky when you look at what's going on in the world. So we got to be ready to adapt and pivot to that, and that is what you think about when you look at anything.

When we spend $1, we're going to think about all those things as it relates to that $1. It doesn't mean that we won't -- that we would exclude any particular thing, but it means that we're going to be reviewing it with that lens of caution around the macro. So --

So John, in other words -- if I hear what you are say, it doesn't sound like we should at all expect the development -- ground up development as part of Kite. It doesn't sound like that will be a growing part of the business. It sounds like more will be redevelopment and then the acquisitions as they come up. Is that fair to say?

I think it is fair to say that large scale ground up development right now in our view does not pencil very well. So yes, I think it is fair to say that where we were in 2004 as we looked at the landscape is very different to how we look at the landscape in 2016.

So I think that it doesn't mean that we wouldn't do ground up development in the right scenario, but not to the scale and not to the exposure to our balance sheet that we once had. I think the exposure that we have to non-income producing assets right now is the exposure that is the maximum exposure as we look today.

Okay.

It could change, Alex, based on the macro. We're not going to dig our head in the sand. We're going to pivot based on what's happening, and my personal view is that a little bit of caution right now is probably a good thing.

Okay. And then as far as -- I realize that you won't discuss the deal, but certainly in speaking about what was reported, it was the mix of assets, so some of the assets people liked and others didn't seem to be appropriate for a combination.

In your view, do you think retail is as neatly as a company has a sector and that's only where it is, or do you think that retail is more fluid and as you are seeing demand from tenants that their ideas are more fluid in such that maybe traditional views of how retail properties lay up may not be the way it lays up going forward?

Look, I think in my view this a supply and demand business, and supply remains extremely low. However, demand is what I would call moderate. So I think retailers are looking at the landscape and are certainly willing to look across spectrums as it relates to where they want to be, but they are always going be focused on the dirt, the real estate.

So when you go back and talk about our Company over time, we have been very good at understanding dirt, understanding real estate. We will continue to focus on that. We want to own assets that are in locations that we will be able to transition.

So that is our view of the market is that it is very low supply. So that makes retailers -- that puts retailers in a position they will look at various products. But look, when you look at our portfolio we own 121 properties. I think 119 of those are open air shopping centers.

That's the business we like. We like being in a business where we have good tenant relationships. We will continue to focus on having great tenant relationships and great real estate, and I think everything else will go from there.

Awesome. Listen, thank you, John.

Thank you very much.

I am showing no further questions at this time. I would now like to turn the call back over to Mr. John Kite, CEO for closing remark.

Thank you, everyone. We appreciate your time and look forward to talking to you next quarter.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone have a great day.