Modiv Industrial Inc (MDV) 2022 Q3 法說會逐字稿

Good day and welcome to Modiv's third-quarter 2022 earnings conference call and webcast. (Operator Instructions) On today's call, management will provide prepared remarks, and then we will open up the call for your questions. (Operator Instructions) Participants may also ask a question by emailing ir@modiv.com. And please note that this event is being recorded.

I would now like to turn the conference over to Margaret Boyce, Investor Relations for Modiv. Thank you. Please go ahead, ma'am.

Thank you, operator, and thank you all for joining us today to discuss Modiv third-quarter 2022 financial results. We issued our earnings release and investor supplement before the market opened this morning. These documents are available in the Investor Relations' section of our website at modiv.com.

I'm here today with Aaron Halfacre, Chief Executive Officer of Modiv; and Ray Pacini, Chief Financial Officer. On today's call, management will provide prepared remarks, and then we'll open up the call to your questions. Participants may also ask questions by emailing ir@modiv.com.

Before we begin, I would like to remind you that today's comments will include forward-looking statements under the federal securities laws. Forward-looking statements are identified by words such as will, be, intend, believe, expect, anticipate, or other comparable words and phrases. Statements that are not historical facts, such as statements about our expected acquisitions or dispositions are also forward-looking statements. Our actual financial condition and results of operations may vary materially from those contemplated by such forward-looking statements. Discussion of the factors that could cause our results to differ materially from those forward-looking statements are contained in our SEC filings, including our reports on Form 10-Q.

With that, I'd now like to turn the call over to Aaron. Aaron, please go ahead.

Thank you, Margaret. Hello, everyone, and thank you for joining our third-quarter earnings call. Joining me today is Ray Pacini, our CFO, who will cover our financial results in detail following my opening remarks. I will then close with a few more thoughts on the market before we open the line for Q&A.

The major theme for the third quarter was steady, disciplined execution. We completed two core acquisitions and two noncore asset dispositions as part of our continued long-term growth plan and strategic portfolio repositioning. We have been intently focused on price discovery as we evaluate both potential portfolio acquisitions and select industrial manufacturing investments.

As part of our focus on identifying investment opportunities that could offer Modiv greater enterprise scale, we successfully expanded the capacity of our credit facility by $150 million. As most of you know, the markets remained volatile during the quarter with large swings in interest rates, creating disruption in the real estate market. An environment like this requires patience and an experienced management team to navigate the uncertainty, and we have been in no hurry to sign deals unless they can create long-term value for our shareholders.

That said, third-quarter revenue increased 17% year over year, excluding the one-time early termination revenue reported in the prior-year quarter, reflecting strong portfolio performance. Due to market conditions, we exercised the patience this quarter, and our reported transaction activity was lighter than the second quarter. That said, our pipeline is robust and we see significant opportunities on the horizon. We are especially focused on the emerging trend of US industrials reshoring their manufacturing operations.

Based on our experience in providing the vital infrastructure needed for critical manufacturing facilities, Modiv is well-qualified to partner with key manufacturers making this transition. As I'm sure you are aware, reshoring is gaining momentum primarily due to both global supply chain and geopolitical issues. We think that industrial manufacturing real estate will prove to be a bright spot for investors looking to capitalize on this long-term economic trend.

As we continue to scale our portfolio in conjunction with this reshoring resurgence, we believe this can create strong, sustainable, and differentiated value for our shareholders. We are already making good headway in transitioning our portfolio into industrial manufacturing properties.

In the past 12 months, our team has completed over $100 million in industrial manufacturing acquisitions at greater than an 8.5% blended weighted average cap rate while also completing multiple noncore dispositions for total proceeds of over $83 million.

And now, some observations on the overall market. Over the quarter, we witnessed accelerated upward cap rate momentum as buyers began to sit on the sideline searching for a modicum of price stability. Even so, we continue to find highly compelling opportunities in the industrial manufacturing sector. Specifically, we are actively identifying properties where demand is consistent and relatively defensive in nature, such as those that can be equipped to produce manufactured goods like infrastructure and component products. The Valtir and Producto acquisitions we completed in the beginning of the third quarter reflect this strategy.

While market volatility remains high, we are very optimistic about the opportunities in front of us. Modiv provides much-needed liquidity to companies that want to monetize their industrial real estate assets and invest in the growth of their manufacturing businesses, ranging anywhere from highway guard rails to indoor farming. Even in a rising interest rate environment, the need for capital does not go away, and the commercial real estate market will eventually find pricing equilibrium with some sectors adjusting more quickly than others. Right now, we are seeing volatility in cap rates along with the volatility in treasuries. That said, we believe most of the bad news is out and is increasingly being priced into the market as transactions get printed.

To state the obvious, the broader market volatility has not only impacted property transactions, but also public company stock prices. On September 30, the last day of the quarter that insiders were eligible to acquire more shares, I purchased additional Modiv shares at $14.86, at a price that was comfortably below the $17 share price range seen in mid-September. Since then, throughout October and into November, our share price has traded at an even lower level that quite candidly defies rational investment behavior.

Considering that our last reported NAV per share was greater than $28. The research analyst consensus target price is $20, and even our depreciated GAAP book value is greater than $18 per share. No matter which number you choose to focus on, we are trading at a steep and valuable discount.

At present, it appears our stock is suffering the vagaries of small-scale day traders able to induce daily price volatility with minuscule share transactions. Meanwhile, these short-term profit seekers fail to realize that investors can collect a double-digit dividend yield with full knowledge that the company is currently trading for less than the sum of its parts. We see no logical long-term reason for this price dislocation to continue and as such, remain adroitly focused on our long-term growth plans and strategic portfolio repositioning.

I'll now turn the call over to Ray.

Thank you, Aaron. And good morning, everyone. I will now discuss our operating results for the third quarter and first nine months of 2022, provide an update on our portfolio, and cover our balance sheet and liquidity. Third quarter AFFO was $3.1 million or $0.31 per diluted share compared with AFFO of $3.8 million or $0.44 per diluted share in the third quarter of 2021. The primary drivers of the decrease in AFFO per share relate to one, an increase in dividends on our preferred stock as the third quarter of last year only had 14 days of dividends payable on the preferred stock, which we issued on September 17, 2021. And secondly, an increase in the fully diluted share count, primarily due to the addition issuance of $1.3 million Class C units in January 2022, in connection with our acquisition of the Kia auto dealership property.

AFFO for the first nine months of 2022 increased 8% to $9.7 million or $0.95 per diluted share from AFFO of $9.1 million or $1.04 per diluted share in the first nine months of 2021. AFFO per share benefited from our acquisition activity and rent bumps. offset by the increase in preferred stock dividends and the higher share count that I just mentioned.

After excluding early termination fee revenue of $1.5 million in the prior-year quarter, third-quarter revenue of $10.2 million increased by $1.5 million or 17.2%, reflecting rental income contributions from our acquisition of 16 properties during the first seven months of 2022. The increased rental income from these recent acquisitions was partially offset by decreases in rental income from the sale of eight noncore properties over the last 12 months.

The early termination fee related to a Texas property, which was leased to Dana Incorporated and sold during July 2021. Total revenue for the first nine months of the year increased to $30.2 million from $28.3 million for the first nine months of 2021. Excluding the early termination fee revenue of $1.5 million in the prior-year period, but I just described, revenue increased 12.9%, primarily reflecting rental income from our 18 acquisitions over the last 15 months partially offset by the decrease in rental income from the sale of 12 noncore properties over the last 21 months.

On the expense side, G&A costs were $1.8 million in the third quarter, down from $2.9 million in the third quarter of last year, reflecting our focus on maximizing efficiency in our operations and undertaking process improvements. G&A costs were $5.6 million for the first nine months of the year, down from $7.5 million in the prior-year period, reflecting reductions in personnel and technology costs following our exit from the crowdfunding business in the first quarter of 2022.

Property expenses were $2.1 million in the third quarter, an increase from $1.7 million in the prior-year period and were $6.8 million for the first nine months, up from $5.3 million in the prior-year quarter period, reflecting the previously announced one-time write-off associated with our decision not to pursue large Walgreens portfolio acquisition prior to our NYSE listing, along with higher property taxes and property management fees due to growth in our portfolio.

Property expenses for the first nine months of both 2022 and 2021 were 1.6% and 1.5% of average real estate assets during their respective periods. After excluding the one-time write-off I just mentioned, most of these property expenses are reimbursed by tenants with at least 82% reimbursed each year. Adjusted EBITDA for the third quarter of $6.7 million increased $655,000 over the prior-year quarter, primarily reflecting the decrease in G&A expense, partially offset by an increase in our interest expense. On the other hand, adjusted EBITDA declined by $503,000 compared with the second quarter of 2022 due to write-offs of straight-line rent receivable related to the sale of Williams-Sonoma during the third quarter and higher G&A expenses due to the timing of our annual meeting and tax compliance. We expect adjusted EBITDA to increase in the fourth quarter, primarily reflecting increases in revenue from our acquisitions, along with lower G&A expense.

Now turning to our portfolio. As Aaron stated in his remarks, we continue to focus on acquisitions primarily in the industrial manufacturing sector as we expect the trend of onshoring manufacturing to remain strong, and we continue to execute on our long-term strategic plan to reduce our office exposure.

During the third quarter, we completed two industrial manufacturing acquisitions in sale and leaseback transactions with Producto Holdings, LLC and Valtir, LLC, which was formerly known as Trinity Highway Products, for a total purchase price of $28.7 million and a blended weighted average cap rate of 7.61%. The Producto acquisition comprised two properties in Upstate New York, and the Valtir acquisition included four properties located in South Carolina, Texas, Utah, and Ohio. The Producto acquisition is a 20-year lease term and annual lease escalations of 2%. The Valtir acquisition includes a 25-year lease term for the South Carolina and Ohio properties with 15-year lease terms for the Texas and Utah properties and annual rent escalations of 2.25%. Including these transactions, our year-to-date acquisition activity totals $162 million at a weighted average cap rate of 8.2%. We have a strong pipeline of potential acquisitions under review, and we will continue to patiently pursue accretive opportunities that make sense for our portfolio and our shareholders.

Now, I'll provide some color on our portfolio management activities, which are also key component of our ability to generate long-term returns for our shareholders. During the third quarter, we sold two office properties for $22.2 million at an exit cap rate of 7.4%. On a year-to-date basis, we have sold six office properties and one flex property, which generated total gains on sale of $13.1 million. As we execute on our plan to reduce noncore assets in our portfolio.

Over the last 21 months, as part of our portfolio transition strategy, we have sold 12 noncore assets, primarily office properties. Over the same period and partially funded by these dispositions, we have acquired 18 properties with a primary focus on industrial manufacturing. As of today's date, our portfolio consists of 47 properties located in 17 states. The portfolio is comprised of 26 industrial properties, which represent approximately 54% of the portfolio based on annual base rent, 13 retail properties representing approximately 19% of the portfolio, and eight office properties representing approximately 27% of the portfolio. We expect to continue to opportunistically sell office properties from the portfolio, but we'll remain patient and disciplined in this process.

Now turning to our balance sheet and capital markets activities. As of September 30, 2022, we had total cash and cash equivalents of $5.7 million. And as of both September 30 and October 31, we had $201.4 million of outstanding indebtedness, consisting of $44.6 million of mortgages and $156.8 million outstanding under our credit facility, including $6.8 million on the revolver. On October 21, we announced that we exercised the accordion feature of our credit facility, increasing it to $400 million. It is now comprised of $150-million revolving credit facility and a $250-million term loan for which only $150 million is currently drawn on the term loan. The credit facility includes an updated accordion option. The law allows us to request additional revolver and term loan commitments up to a total of $750 million. The maturities for our revolver and term loan remain unchanged. With the revolver's maturity in January 2026, with options to extend for a total of 12 months and the term loans maturity in January 2027.

I would like to acknowledge and thank our banking partners who participated in the expansion of our credit facility, KeyBank, Truist, the Huntington National Bank, and First Financial Bank for their support and efficient execution in what has been a challenging financing market.

On October 26, 2022, we purchased a five-year swap to fix SOFR at 3.44% on an additional $100 million of our term loan that was resolved at a fixed interest rate of 5.04% on additional draws under the expanded term loan when our leverage ratio is less than or equal to 40%. As part of the swap transaction, we sold a one-time option to terminate the swap on December 31, 2024, which reduced the swap rate.

Under the credit facility, the interest rate will continue to vary based on our leverage ratio. The credit facilities priced on a leverage-based grid that fluctuates based on the company's actual leverage ratio at the end of the prior quarter. In accordance with the terms of our credit with KeyBank credit facility, we define leverage ratio as debt as a percentage of the aggregate fair value of our real estate properties, plus our cash and cash equivalents.

Based on our leverage ratio of 38% as of the quarter ended September 30, 2022. The interest rate for the revolver is SOFR plus 155 basis points plus a 10 basis points SOFR index adjustment, and the interest rate on that overall revolver was 4.7125% on October 31, 2022. Based on the current balance sheet, approximately 90% of the company's indebtedness holds a fixed interest rate. The weighted average interest rate and the company's total debt outstanding of $201.4 million as of October 31, 2022, is 4.08% based on the company's leverage ratio of 38% as of September 30, 2022.

As previously announced, our Board of Directors declared dividends for common shares of approximately $0.096 for the month of October, November, and December, representing an annualized dividend rate of $1.15 per share of common stock. Based on the recent closing price of our stock, this dividend equates to an 11% annual dividend yield. As Aaron mentioned, we affirmed our 2022 annual AFFO guidance in the range of $1.26 to $1.36 per diluted share.

I will now turn the call back over to Aaron.

Thank you, Ray. Before we turn to Q&A, I'd like to share some final thoughts. Volatile times in the marketplace can be true tests for our company's strategy, management team, and Board of Directors. And I'm proud to say that for Modiv, our strategy is balance sheet strong, and our management and Board remain not only confident but optimistic. We are more convinced than ever in our long-term value-creation strategy and believe that our story is unique and compelling. Our commitment to providing our investors with an attractive, stable monthly dividend is unwavering, and the quality, resilience, and long-term earnings power of our portfolio continues to improve.

With that, I'd like to thank everyone for joining us today as well as wishing you and yours a happy holiday season. Now, I'll turn the call over to the operator for questions.

(Operator Instructions) Gaurav Mehta, EF Hutton.

Thanks. Good morning. You guys talked about having a strong pipeline of acquisitions. I was hoping if you could maybe provide some more color on what you have in the pipeline between portfolio-level acquisitions and individual properties?

Hey, Gaurav. Yeah, sure. We were busy in the third quarter. Even though we were disciplined, we didn't -- we haven't announced anything yet. But in terms of pipeline activity and due diligence activity, we've looked at four portfolios -- four portfolios out there; three of them were pure play, industrial manufacturing, one was diversified, but majority industrial. We've also -- I've been on the road. I toured 30 properties physically myself, along with Bill Broms, our Chief Investment Officer. We've been doing a lot of homework trying to be very thoughtful, right? Every decision we make here, this size of a company, has to be well thought out.

So I'd say, we -- over the course of that period of time from early third quarter to later third quarter, we just saw a lot of shuffling of deals and cap rates. And obviously, we had market selloffs and treasury impacts. And so we just wanted to be very cautious, right? I've been looking at the prints of the other REITs that have come out, and a lot of them have third quarter results have been anywhere from sort of, in the industrial space, at least sort of a -- and maybe some of the other retail ones, too. Some are between like a 6.5 to 7.1, 7.2% cap rate in that range is what they've executed on.

We've gotten indications that cap rates have gapped much wider now in terms of [ask], but we're not sure where they're all necessarily closing. And so we've been patient. We see a lot of things. There was a -- we could have pulled the trigger multiple times or just trying to be thoughtful about it right now. But we're not worried about the ability to put capital out; we're just trying to make sure we're seeing the key leases as best we can, as opaque as the crystal ball maybe, but just trying to think of around the corner what the first quarter might look like in terms of opportunities as well.

Okay. Maybe one on your guidance. Can you maybe talk about the 10% variance between lower end and upper end? What are you underwriting to get to the upper end of the guidance versus lower end?

Yeah. So I mean, the -- Ray, will give you some more specifics -- but the variance, the guidance really is driven by two factors. One is asset dispositions and the other one is acquisitions. And as a general course of matter, I don't like to tell about any of those activities until we have certainty that they're going to transact. So if you're, for an instance, if you're in a deal and you're still not hard or the buyer is not hard, if you're selling an asset, we don't broadcast those. But to get the high end of the range, we would have to not sell and buy more if I am not mistaken.

Our original guidance was $50 million of acquisitions at a 6.25% cap rate. Trust me, I'm not seeing any [six and a quarters]. And the low end of the thing was that we sold assets but didn't buy.

Correct.

Yeah.

Okay. Maybe last one on your -- downside.

[The acquisition is $28 million, I think?] -- Sorry. Go ahead, Gaurav.

Maybe last one on your portfolio allocation. You obviously talked about your focus on growing industrial manufacturing and then lowering exposure to office. I was curious to maybe learn more about how you are viewing retail as a part of your portfolio?

Yeah. Look, I would love nothing more to be a pure play, or not today. Our focus on asset dispositions has naturally been on the office. That's been our primary focus that will continue to be. Our retail that we have is fairly vanilla, nothing overly. It doesn't have hair on it. It's very liquid. We could sell it tomorrow if we wanted to. But we're just thoughtful about sequencing. I would tell you that long term, our intent would be not to have it.

Okay. Thanks for taking my questions. Till then.

Rob Stevenson, Janney.

Good morning, guys. Aaron, so just how are you thinking about dispositions in the current market environment? Do you wait for things to settle down? Is the spread attractive enough between where you could sell and where you could buy that you still go forward? How should we be thinking about dispositions for you guys over the next couple of quarters?

Yeah. There's some assets where we've -- we're putting out to market to just get sold. Those are office assets we had. I think the volatility in the early part of the quarter or mid part of the quarter was we had several transactions where we got, in one instance, an unsolicited -- two instances, actually -- unsolicited bid for assets that we thought were decent cap rates. We went under contract, but then the Fed did what it did, and I think they cooled their jets. And so they came back -- one of them came back in for re-trade, and we just -- we just weren't interested in it as though the new levels that they had suggested. So I think we've been patient. I think right now, it's a somewhat quiet period for transaction activity, certainly compared to other environments. I think, candidly, when you're selling office assets, those people have to have secured financing, got lined up in advance, and it's been a little bit harder for them to get that pegged. I think it's getting a little bit -- falling a little bit now.

And so we don't want to throw the baby out with the bathwater. We're throwing off AFFO from these properties. They've got term. We're actively still on many of them, doing lease renewal negotiations right now. And so I think our view is -- look, we know we're going to sell them. We don't have a specific time to sell them. We have to be mindful if we sell too much, too fast and we haven't bought something, then that will be a drop in AFFO. If we buy too much and not sell fast enough, then we're going to have more leverage. So we're just being really thoughtful about that. And I think ultimately, though, I mean, some of these are going to clear at the prices they need to clear. But we think that patience isn't hurting us and we're getting paid for that.

Okay. And then how are your conversations going with tenants on annual bumps? I mean, a lot of -- you did [2.3%] with Valtir, but majority of the stuff that you've done recently has been 2% bumps. Is there acknowledgment in the marketplace? The 2% is still the right number or leases as we look at them going forward from here going to start being more in the 2.5% pushing towards 3%, given how strong inflation has been? Or is it just not going to change that fast in the marketplace?

I think 2% is the floor. I think brokers have now recognized that 2% was not sweet anymore. We've seen a lot of 2.5%. And we're under LOI, which means it's nonbinding. It could not happen until it's done in our guidance and was runner LOI for our property, a very big one. But it's -- I think it's an 8.25% cap and it's got 4% bumps. And so we are seeing movement. I've talked to some, I guess peers or competitors, if you will, because it's a fairly small space what we're acquiring, and they're seeing and they're forcing a little bit differently, but they're getting sort of uncapped CPI. I'm not seeing that at all. I'm seeing -- I've seen some cap CPI deals, I've seen some sort of range, collared ranges tied to CPI. But by and large, most of the ones that we've been seeing at 5% and 2.5% right now.

Okay. And then last one for me. Ray, how penal is the rate adjustment if you were to go above 40% leverage, if you guys were to acquire more than you sell in the near term? What does -- how does that change? How much does that impose for you guys?

So for every 5% up to 50, it goes up 10 bps. And then north of 55, or north of 50, it goes up 15 bps. So it would top out at 210 bps on the term loan and 215 bps on the revolver.

Okay. Thanks, guys. Appreciate the time.

Sure.

James Allen Villard, Ladenburg Thalmann.

Good morning, guys.

Hey, James.

Okay. So did you repurchase any stock post-2Q earnings call? And if so -- I mean -- kind of how are you thinking about that utilization of that program going forward?

Post Q2, we bought -- I mean, year to date and then we bought 211,000 shares at an average of just under 17. Between -- during Q3, I don't remember the exact number of shares, but we bought at an average of just around 15 or so. It's disclosed in our 10-Q. I just don't have the number ready. (multiple speakers)

Yeah. So look, we still have it available. We turned it -- we only do sort of a 10b-5. So we set and forget anything. We're not trying to micromanage that process. We still have capacity available. I would tell you, it's a balanced reaction to these things. But at these prices, I would probably participate in the buyback. We're just trying to manage that process a little bit. But yes, it's a tool we have it's not a panacea. We don't expect it to move the needle for us. So I'd say it's a tool we have right now. Looking at where we're at today, it's a tool that I could potentially use.

I just picked up the number from the 10-Q, which is going to get filed a little bit. In July and August, we bought a total of 45,715 shares for a total of about $704,000 for an average cost of $15.40 a share.

That's helpful. And then a follow-up question is can you provide us any more color on what's under PSA, what's under LOI?

No.

Yes.

I kind of let you know something, but my general rule is I like to -- I'd like to know that it's baked because it's been a really -- it's been a little -- the market's been very volatile. And so I don't like to chase my tail. I don't want you guys to do that either.

I appreciate that. I fully understand. That's it for me.

Great.

Thank you. This concludes the question-and-answer session, and I would like to turn the floor back over to Aaron for any closing remarks.

Thanks, operator. Thanks everyone for making the call. Look, the quarter was steady, disciplined, not exciting. We're not going to deliver exciting every quarter. We're going to be very thoughtful. This -- when you are -- while we were small in our microcap name. When you're this thin and you've got to make decisions about leverage and about growth and about share price and about execution, you just really want to be thoughtful. You don't want to be knee-jerk. You don't want to be impulsive. Too many times in the past, we've seen that small cap names destroy themselves because of that, right? Each decision we make is one that's going to have a second- and third-order effect.

So what you're seeing is us being thoughtful, not being rote, not having blinders on trying to pay attention to the environment. If you recall, I've created this team to be sort of like a hedge fund team or private equity team where you have a lot of subject matter experts leverage. It's a small team of 12 people in total, and we're really just really gathering data, thinking about things, making sure that we are reiterating our process, challenging our paradigms. And I think that's important in these types of markets because if we're just a hammer and we're hammering every nail, it could be great or could be bad depending on the market outcomes. And so right now, I think there's a lot of ambiguity in terms of the market, it's risk-on risk-off, risk-on risk-off. It seems like that every day. And so we're just being very thoughtful.

We are executing. We're not worried about executing. The timing of that execution is crucial, though. And so we're being thoughtful about that. Ray and I are getting on a plane right after this, shortly after this head into Nareit in San Francisco where we'll be talking to investors. We'll keep plugging along. Looking forward to more transparency, more stability in the broader markets. And I think that's going to be something that would avoid all net lease REITs as a sector. It's been a little bit of a laggard. And so I think we're well placed to keep executing and get out there in the marketplace. Thank you all for your time and hope you have a great holiday season.

Thank you, everyone. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a great day.