Kennedy-Wilson Holdings Inc (KW) 2017 Q2 法說會逐字稿

Good morning, and welcome to the Kennedy Wilson Second Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Daven Bhavsar, Director of Investor Relations. Please go ahead.

Good morning, and welcome to Kennedy Wilson's Second Quarter 2017 Earnings Conference Call. This is Daven Bhavsar, and joining us today are Bill McMorrow, Chairman and CEO of Kennedy Wilson; Mary Ricks, President and CEO of Kennedy Wilson Europe; Matt Windisch, Executive Vice President of Kennedy Wilson; and Justin Enbody, Chief Financial Officer of Kennedy Wilson.

Today's call is being webcast live and will be archived for replay. The replay will be available by phone for 1 week and by webcast for 3 months. Please see the Investor Relations section of Kennedy Wilson's website for more information.

On this call, we will refer to certain non-GAAP financial measures, including adjusted EBITDA and adjusted net income. You can find a description of these items, along with the reconciliation of the most directly comparable GAAP financial measure on our second quarter 2017 earnings release, which is posted on the Investor Relations section of our website.

Statements made during this call may be of -- may include forward-looking statements. Actual results may materially differ from the forward-looking information discussed on this call due to a number of risks, uncertainties and other factors indicated in the reports and filings with the Securities and Exchange Commission.

I would now like to turn the call over to our Chairman and CEO, Bill McMorrow.

Thanks, Daven. Good morning, everybody, and thank you for joining our call today. We're pleased to have reported another solid quarter of results. In the second quarter, we continued our trend of delivering market-leading same-property results, while continuing to enhance our portfolio through our capital recycling program, which is focused on harvesting nonincome-producing investments, completing value-added initiatives within our existing portfolio and, at the same time, upgrading the overall quality of our assets.

This morning, I'll discuss our financial highlights for the quarter, the operating performance of our properties and our investment activity before commenting on the proposed combination transaction between Kennedy Wilson and Kennedy Wilson Europe.

So starting off with the financial highlights for the second quarter. Kennedy Wilson reported GAAP earnings of $0.08 per diluted share compared to a loss of $0.02 per diluted share in Q2 of 2016. Adjusted EBITDA was up 39% to $102 million for the quarter compared to $73 million during Q2 of 2016. Adjusted net income was up 18% or $8 million in the period to $51 million compared to $43 million for Q2 of last year. For the quarter, our share of property level NOI grew by $5 million to $65 million, an increase of 8% from Q2 2016. This metric is now up almost 50% since the beginning of 2015. This growth has been driven by strong operational results in our properties, growing our ownership stake and our investments over time, and the continuous improvement of our portfolio through selective capital recycling.

At the end of the second quarter, we had an ownership interest in over 400 real estate investments globally. The largest component is our multifamily portfolio, which stands at over 25,000 units, of which 1,500 are under construction. This portfolio, which produces a $152 million of NOI on an annual basis, is concentrated in the coastal markets of the Western U.S., with the Pacific Northwest, Northern California and Southern California accounting for 83% of the portfolio on an NOI basis. Our largest market remains the state of Washington, focused in and around the Seattle area, where we have 10,000 units, which produce almost $55 million in annual NOI to KW.

For the quarter, our share of total multifamily revenues and NOI increased by 6% on a same-property basis. Once again, this outperformed many of our peers. Looking at the top public multifamily REITs, NOI growth averaged 4% on a same-property basis during Q2 versus 6.1% for us. So we are outperforming by over 50%. Our outperformance can be attributed in part to our weighting in the state of Washington, which led all our of markets with same-property NOI growth of 9.3% in the quarter. The state of Washington, along with its largest city Seattle, continues to thrive. Amazon has nearly 8,000 job openings in Seattle, and they continue to expand as seen through their most recent announcement regarding the acquisition of Whole Foods. Seattle also experienced the highest growth rate in meeting home prices in the country, according to the latest Case-Shiller index. Seattle and its surrounding areas continue to benefit from strong population growth, a large diversified employer base and relative affordability compared to any -- many other large coastal cities. Additionally, the combination of high incomes and high home price growth creates an attractive rental market and bodes well for our apartment portfolio.

Our multifamily portfolio in the U.S. is mostly comprised of low-density, garden-style communities, where we have added high-quality tenant amenities. Our properties are typically located in the suburban areas of major cities with rents that come at a substantial discount to Class A CBD apartments. Our rents average around $1,700 per month compared to the rents of our peers, which are 40% to 50% higher.

Also, we now have $103 million of estimated annual NOI coming from 8,400 wholly owned apartment units, which is up $16 million and 600 units from a year ago, meaning that almost 70% of our annual multifamily NOI is coming from wholly owned units.

Looking at our commercial portfolio for the quarter, our stabilized portfolio is concentrated in the Western U.S. and the U.K., which together account for 81% of our total commercial portfolio on an NOI basis. For the quarter, occupancy revenue and NOI were flat on a same-property basis from Q2 of last year. The same-property pool currently excludes many commercial assets that we have either recently stabilized or acquired and thus, the overall pool become more meaningful as these high-quality assets enter the same-property analysis.

Turning to Europe. Our portfolio there is concentrated in the U.K. and Ireland and includes assets acquired prior to the formation of KWE, along with our ownership stake in KWE itself, which stands at approximately 24% at the end of the quarter.

Earlier this morning, KWE released its first half results. During the second quarter, KWE completed 40 commercial lease transactions at 5% above in-place rents, bringing its total year-to-date to 76 commercial leases across 1.1 million square feet at 13% above in-place rents. For the first half of 2017, KWE reported NOI of approximately $100 million. As of June 30, KWE's portfolio includes 207 assets with occupancy of 94% and a weighted average lease term of 7 years. The portfolio produces an estimated NOI of $208 million annually.

Turning to the KW balance sheet. We ended the quarter with $569 million of corporate cash and $125 million available on our revolver, for a total of almost $700 million of liquidity at the KW corporate level. During the quarter, we drew $350 million on our revolver to satisfy the majority of our cash obligation in relationship to the KW-KWE merger in accordance with the funds, certain requirement of the UK Takeover Code. We intend to reduce this amount substantially over the next few quarters, including through identified asset sales. Besides our line of credit, we have no corporate debt maturities until 2024. In total, our debt has a weighted average interest rate of 4.2% per annum and a weighted average maturity of approximately 6 years with 63% of the debt fixed and 17% hedged against long-term interest rate increases.

On the investment side, investment activity picked up in the second quarter during which we and our partners completed over $1.3 billion of investment transactions, consisting of $434 million of acquisitions in which we had an average 45% ownership interest and $828 million of dispositions in which we had a 31% ownership interest.

Through these transactions, we were able to capture 300 basis points of positive yield spread when comparing the cap rates of our buys at 8% and the cap rates of our sells at 5%, which at the same -- while at the same time, improving the quality of our assets.

For the year, we have now completed almost $1.7 billion of investment transactions with approximately $700 million of acquisitions, of which our share was 41% and almost a 1 -- almost $1 billion of dispositions, of which our share was 33%.

One of the key differentiators for Kennedy Wilson has been having local investment teams and local relationships, which often lead to off-market investment opportunities. During the second quarter, our teams continued to find opportunities that would allow us to strategically recycle capital to improve the recurring NOI of the company. In Q2, we sold Rock Creek Landing, a wholly owned 576-unit multifamily property located in Kent, Washington for $109 million. We originally acquired the property in 2014 for $58 million, after which we executed our value-add asset management program, resulting in NOI growth of 56%. We took the cash proceeds of almost $75 million from this sale and recycled them into the $153 million off-market acquisition of 90 East, the 573,000 square-foot office campus in an affluent suburban of Seattle, Washington. This 3-building campus is fully leased to Microsoft and Costco with over an 8% going-in cap rate. The impact of these 2 transactions are expected to result in a plus $7 million increase in NOI.

We continued to sell our nonincome-producing assets during the quarter, which represented roughly 25% of our quarterly sales on a pro rata basis. Nonincome-producing and unstabilized assets have now shrunk from 27% of our investment account a year ago to 18% at the end of the second quarter, which is a trend we expect to continue as we strategically sell or convert these assets into income-producing assets.

Turning to our development activities. Many of the projects that we are currently developing, including Capital Dock and Clancy Quay are built on excess land, which we originally acquired with little or no cost basis. This land, in most cases, sits within or adjacent to income-producing assets that we already own. In our supplemental financial information that we released yesterday, we detailed our largest developments in which we expect to spend $175 million to $200 million of KW cash on over the next 2 to 3 years. We are targeting annual 10% to 15% returns on our equity once these assets are stabilized.

To go into 2 of the bigger assets at Capital Dock, which is one of the largest single-phase developments to ever be carried out in Ireland, we continue to make great progress. Once completed, this project will deliver approximately 690,000 total gross square feet, including 345,000 square feet of office, 25,000 square feet of retail and 190 multifamily units, housed in a 23-story high-rise, which will be doubling this tallest building once finished. During the quarter, we sold one of the 3 office buildings under the development known as 200 Capital Dock to J.P. Morgan through a forward-funding sale agreement. The building totals 130,000 square feet of Class A office with the ability to accommodate over 1,000 employees. We will continue to develop this property, along with the entire Capital Dock site until its completion, which we expect will be by the end of the third quarter of 2018. Additionally, the cash to be received from this sale together with the construction loan of EUR 125 million that we secured in the second quarter will fund the majority of all remaining cost for the entire project.

Also, in Dublin, we completed Phase 2 of Clancy Quay during the quarter. This is an apartment community that we acquired back in 2013, which came with 423 new existing multifamily units and 8 acres of predominantly undeveloped land, which we plan to develop over 2 phases. The original 423 units we acquired are currently 97% leased, and we are now just completing the Phase 2 of 163 units, and we've already leased 55% of those units. Phase 3, which is still in design and stands 3 acres, is expected to deliver another 250 units by 2020. When completed, Clancy Quay will total approximately 845 units and will be one of the largest multifamily properties in all of Ireland.

In the U.S., we continued to build multifamily units through our Vintage Housing platform, which we acquired 2 years ago, and is majority owned by Kennedy Wilson. This partnership is engaged in the development and management of affordable housing on the West Coast with a focus on independent senior living. We originally started with 5,500 units and today, Vintage has over 1,000 units either in planning or under construction in Seattle and Northern California, all of which we expect to complete in the next 12 months.

Finally, during the quarter, we announced the proposed combination between Kennedy Wilson and Kennedy Wilson Europe, including a revised offer that was announced on June 13. We expect that this combination will significantly improve our recurring cash flow and enhance our ability to generate attractive, risk-adjusted returns. We remain on track to close this transaction in the fourth quarter, subject to customary closing conditions, including the receipt of approval from both sets of shareholders.

So in conclusion, while it's always difficult to predict what volatility it may arise in the short term, we now have many sources of growth, which will help Kennedy Wilson over the long term. We produced another great quarter of operational results and have consistently grown both our recurring cash flow and dividend over time. We also have many value-add and development initiatives underway that will add additional recurring NOI over the next 2 years. Our portfolio remains well diversified in select markets that we think will perform well. And we are in the midst of a merger that will enhance our cash flow streams and further our flexibility to allocate capital globally. All of this positions us well for sustained growth and to continue our track record of creating long-term value for our shareholders.

So with that background, I would like to open it up to any questions.

(Operator Instructions) The first question comes from Craig Bibb of CJS Securities.

You made a great progress in reducing the investment and nonincome-producing assets during the quarter. Excluding development activity in the nonstabilized properties, I think it's still $200 million of lands and other nonincome-producings. You guys have a target for where that might be at the end of the year or the end of next year?

Matt, do you...?

Sure. Craig, so as you noted, we have substantially reduced the amount of nonincome-producing assets and unstabilized assets over the past year. We've gone in fact from 27% of our overall investment portfolio down to 18%. And we continue to see that number come down over time. There is no specific number we'd give you on that. But certainly, it's trending down and that's our plan. In particular, as some of these development assets, such as Capital Dock, come online that will further reduce that number and move into the income-producing bucket.

Yes. I was really focused on the land portion of it. So the 6% of NAV that's land or residential?

Yes, on those assets, in many cases, we're building on those and selling out. And so we do see that coming down over time as well.

Okay. And so you traded a -- you sold a big piece of property in Orange County to [be provided] on Dillingham Ranch or other pieces of land that would move that number down?

Well, specifically as it relates to Dillingham Ranch, we're in a -- we're still in an entitlement mode with that property. But I would say that generally speaking, every other piece of land that we own is entitled with some form of a business plan currently being executed. And with the exception of really 2 properties, most of the construction activity that's going on the land is going to be completed by the end of 2019.

Okay. Kennedy Wilson is spectacular at seizing opportunity. You guys -- by far, your best risk-adjusted returns in the Vintage Housing projects realized -- a 1,000 units is not particularly timid, but given the returns, why not expand into more markets and ramp that up even more?

Well, I think you are making a good point. I mean, I think, that's clearly our plan over time. But you got to make sure too as you're doing those things that you got the right infrastructure in place. And just, as we've done here, in Europe, and Mary can comment on that, I mean when we started here, our first real investing that we did in hard assets, really started it towards the tail end of 2011 and ended 2012. And what Mary did with her team here, of course, over that period of time since then was put in place a management team that was capable of executing on the construction management. And any time you're doing construction management, it's all hands on deck kind of exercise, especially on these larger scale properties. And what has been great about here in Europe is that we've been able to -- I'd call it, really test the capabilities of our team and so you've seen really 3 major projects in Europe come to completion; Baggot Plaza, what we call Block K at the Vantage apartment units and now, Clancy Quay. And so when you add all that up, that -- I'm doing it in my head, Mary, but that's roughly about -- in totality about $215 million of construction, including the base buildings or the land that we have. And so we have a very, very, very good team here in Europe that can execute on all of these types of things. And so all of them, to this point, have really coming in on time and on budget.

So switching gears to the Vintage, as you know, we own 62% of that company and the management team owns 38%. But that management team started that company. Now 16, 17 years ago until all of the product that they had, up to the time that we bought, they built up. And so now we're clearly going to expand that business over the next 3 to 5 years. It's a very sweet spot in the market. When you see market rates on apartments going to the levels that they have over the last -- particularly, the last 5 years, it creates a gap in the market for what I call or what they call affordable housing. Yet, when you think about affordable housing in the context of what we're doing, it's actually very high-quality product. It just happens to qualify for -- as affordable housing or for seniors above 55. So the 1,000 units that you see is really just the beginning of what we plan to do in Vintage. And I think, over time, you'll see us pretty consistently with 1,500 to 2,000 units of building in the pipeline in Vintage. And over time, the goal, of course, is to get that portfolio up well above the 10,000 units.

(Operator Instructions) The next question is a follow-up from Craig Bibb of CJS Securities.

So Mary, since you're there and Bill, you're currently in Europe, but the Brexit vote now is a year ago, public real estate assets in the U.K. continue to trade at a discount of the private transactions. Can you talk about what you're seeing in terms of activity in the market and give us your thoughts on how the Brexit discount plays out from here?

Yes, I mean, I don't know if you saw Kennedy's results at all this morning, but we continue on an operational basis to really hit the ball out of park. We've obviously been continuing the momentum on the leasing side. So we're seeing our occupiers continue to make decisions in terms of where they want to lease their space and make sure that their people are in the right location for their businesses. And I think the portfolio that we have is not only defensive in that we have long [loans], we have very high occupancy and very diversed. There's also big opportunities to really grow the portfolio, whether that's in Dublin, whether that's in Spain, and Madrid as our retail office. So I think, as it relates to Brexit, we haven't really seen the impact hit our portfolio. And we also see there is a lot of liquidity in the market looking for, I would say, the assets and our noncore disposal program continues to -- we've been disposing of assets at 30%-plus returns. So there's still a lot of liquidity in the market. You also have a lot of foreign buyers in London because London is such a diverse and unique city, regardless of what happens with the financial jobs, leaving the city where we haven't really seen that happen in big amounts. You've seen the takeout from other industries and many of them have been announced in the last couple of months, especially the technology industry be Advanced. So London continues to put up very big numbers in terms of the occupancy, and we think it's a vibrant city and it's going to be for the long term. So we feel really good about everything that we're doing on the asset management side in the portfolio.

Yes. I think Mary, there was a study that was published last week that was interesting to me. In the financial services industry here in United Kingdom, in London particularly, there's 560,000 jobs according to the study. And the entity doing this study is now saying that in their estimate there's 17,000 jobs at the high end that would leave London. So you're obviously talking about 3%. And I think what we've said all along and believe is that London in the United Kingdom is always going to be a market that is viewed very positively from an investment perspective, particularly foreign investors. And you saw a transaction now about a 1.5 week ago, the sale of what they call the Walkie-Talkie building here to a Hong Kong-based company, but the size of the transaction was $1.7 billion. And so the property market here is sound. And I think the other part, there's so many -- I spent a good part of last week in Dublin. And there's so many interesting other unintended consequences of what's going on with Brexit and so the application -- In Ireland, the university systems are very, very good, then there is big universities, Trinity University of Dublin, their applications are up 40% -- between 25% and 40% over the prior year because people that are applying to these universities that are coming from other parts of Europe don't necessarily know what the outcome of passporting and all of that is going to be.

And so if you see what's going on in Dublin today, now it is producing all of these younger people. And just like happened here in London, really starting 15 years ago, all of those services now are starting to fill in behind that, the restaurant themes. All of the technology companies are expanding their businesses in Dublin. Yes, it's still a market that has limited land. And so rents have obviously, been growing up -- going up, and we have a really some of the highest-quality assets in Dublin.

And takeout, Bill, is up to 40% year over-year in Dublin, and which is really driven by TMT and financial services. Some of it -- to the point that you're making, Dublin is a huge beneficiary of Brexit.

And I think, without getting into politics here, clearly, this last vote, I think slowed some people down, so to speak. And I think it's just -- it's going to take some time, but I think you have to -- instead of thinking this in terms of headlines, really look at what's going on at the underlying property level. And as Mary said, we continue to do great lease transactions here in the United Kingdom.

And then as Lockwood have it, there are some unintended benefits that are coming out of this for us in Dublin. And not the J.P. Morgan's purchase of building 200, really, I'm not trying to say tha, that was a direct result of Brexit, but the kinds of businesses that some of the banks are in, particularly the U.S. banks here, they have to be able to trade in the EU market. So there's -- just benefits that are coming out of this for us in terms of Ireland itself. DMS announced expansions into Ireland. Barclays, I think, yesterday announced the same. So the markets who are in here are principal markets, are really healthy and doing well. And I think to Mary, just -- although it's not -- it's only 5% of our business here, I think Spain, in Madrid particularly.

Yes, now Madrid, it really feels lot of energy. It's a growing economy, consumer confidence is very, very high, spending is up. So -- yes, all is growing in the right direction.

Okay. So actually -- I was trying to get out with -- all of that is extremely helpful. But what I was trying to get out with Brexit is, I believe transaction activities slowed after the vote. And it's more or less normal as they could be wrong. And then the Kennedy Wilson U.S. shareholders are wondering if they're going to be buying a Brexit discount along with KWE. I assume that it'll just go away at some point, but I don't really have a scenario for -- when that normalizes.

I'm not -- are you asking when does the Brexit discount that's being applied to property companies go away, is that your question?

In a fact, right, it's already been a year and you're not going to always have private transactions at higher values than the public company's trade, because it will get arb away and it just -- Mary might have an idea on how that eventually settles out.

Well, I mean, that's a market-driven dynamic. I mean I can't comment. I think that there, clearly, I'm talking about the Landsec, I mean when they sold that building, I mean, they felt that they've gotten a very attractive price for that. And I think what tends to happen in our businesses is as you go through these periods of time, there tends to be a disconnect between what the public market is perceiving is going on and what's actually happening down at the property level. And I think too -- Craig, too, people, they tend to talk about Europe in its totality, and we're not in Europe in its totality. It would be no different than saying, as I've said many times, how is the housing market in Southern California. And I have to say to you, "Well, which of the 50 submarkets do you want me to talk about. If you want to talk about get Beverly Hills, that's fantastic. Riverside County is not so great." And so you've got to get very granular when you talk about any of the markets that we're in, and not paint it with this big brush of Europe, 90% of our portfolio was really in 2 places. And then when you think about London itself, we only have 2 assets of any consequence in London. So...

And I think, Craig, we're going to continue to sell noncore assets in the U.K. With the window being open, and -- because selling things above book, that will continue to -- we'll opportunistically take advantage of the liquidity in the market.

Yes, I mean, Mary, when we bought a number of these portfolios, they came with some smaller assets plus good high-quality bigger assets. And so in the last 2 years, and numerically you've sold how many smaller assets? Over a 100?

Smaller assets, a little over 100.

Over 100 assets. And so we're continuing to -- that trend will continue as we wind down some of these noncore smaller assets, and there is an extremely liquid market for those assets, and we're taking advantage of it.

Okay. Could we gear to maybe Capital Dock. So when your Capital Dock sold in a forward-funding sale agreement, does that mean your -- are your booking percentage of completion profit now? Or is it kind of lump sum at the end? How does that work?

Matt?

Craig, so yes, that's being -- it's being booked over time. So it will be recognized over the next 12 months or so. It's not being -- it's not going to be all back-ended. So we had a small amount this quarter, and it will continue for the next several quarters.

And what is the expected cash profit on the project when you're all done?

Do you mean on the whole Capital Dock project?

No. On just 200 Capital Dock.

Yes, I'm not sure that we're putting that number out there right now, Craig. But I will tell you that once -- forgetting 200, that's gone, that's going to J.P. Morgan. But once the remainder of the project is finished and stabilized: with leasing, we got 2 more office buildings to lease and then the roughly 200 apartment units.

And which, by the way, on the office buildings we've seriously seen demand, so that's going extremely well.

We expect that the NOI on that project's going to be somewhere around the $20 million range, which will equate to a stabilized cap rate of around 10%. And that's the interesting -- I went through -- We have many, many assets in Ireland and here that are stabilizing at 9% and 10% cap rates. And unlike -- and I don't mean to belittle the garden-style apartment buildings that we have in the U.S., these are very, very high-quality buildings. And so when you think about Clancy Quay, that would be analogous. The 423 units throughout the front of that property, those would be New York quality, L.A. quality, 12, 15-story buildings, first-class construction.

And when you think about those 423 units, we -- to the original loan amount that was on that property, we paid 25 cents on the dollar for that, very, very high-quality 423-unit portfolio. And so then when you're averaging it in with the other 400-plus units that you're building on the back of the property, you get a very high cap rates stabilized, much, much higher than you would have if you had just gone out and bought a stabilized building.

Yes, with really low cost land basis as well in Phase 2 and 3.

Yes, and I think too, just to your point about construction, see the Clancy project, the front 423 units were new, but the ones that we're building, some of them were refurbishments of actually what they called the Clancy Barracks, which were 200-year-old buildings that the British Army occupied during some of the wars they were involved in, and are in public. And so these stable buildings, as they call them, where they halt their horses, we've had a historical overseer onsite, while we've been restoring those buildings on the back. They're all finished right now. And -- but it's very tedious construction. So but -- anyway, my point is that we have many assets throughout this portfolio that is they continue to get another year or another 2 years behind them. You're going to see them stabilize in these higher cap rate ranges.

Okay. And last one for Justin and Matt. You guys added the property level NOI reconciliation on the supplemental, which is helpful. Have you guys -- after the transaction closes, you're just going to be heavily 100% on property company. Would you consider a switch to the FFO, AFFO type of boarding or ADAT?

Yes, Craig, I mean, we're going to be looking at all that in conjunction with the transaction. And certainly, we want to continue to improve the disclosure over time as we have been doing.

And that concludes today's question-and-answer session. I would now like to turn the conference back over to Bill McMorrow for any closing remarks.

All right. Well, thank you everybody for listening in today, and as I always say, we're also available for any questions that you think of once we get off the call. So thanks, again, for your support and for listening in today.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day.