WP Carey Inc (WPC) 2017 Q1 法說會逐字稿

Hello, and welcome to W. P. Carey's First Quarter 2017 Earnings Conference Call. My name is Diego, and I will be your operator today. (Operator Instructions) Please note that today's event is being recorded. (Operator Instructions)

I will now turn over today's program to Mr. Peter Sands, Director of Institutional Investor Relations. Mr. Sands, please go ahead.

Good morning, and thank you all for joining us for our 2017 first quarter earnings call. I would like to remind everyone that some of the statements made on this call are not historic facts and may be deemed forward-looking statements. Factors that could cause actual results to differ materially from W. P. Carey's expectations are provided in our SEC filings.

Also, an online replay of this conference call will be made available in the Investor Relations section of our website at wpcarey.com, where it will be archived for approximately one year.

And with that, I will hand the call over to Mark.

Thank you, Peter, and good morning, everyone. I am joined this morning by Jason Fox, our President, who will review the investment climate in our portfolio; and Toni Sanzone, our CFO, who will take you through our first quarter results and guidance. In addition, I'm joined by John Park, Head of Strategy and Capital Markets; Brooks Gordon, Head of our Asset Management team; and Mark Goldberg, Head of Carey Financial, who will all be available to take questions.

From an operational and reporting standpoint, it was a very straightforward quarter. Toni will take you through the key drivers. But at a high level, the $1.25 of AFFO per diluted share that we reported reflects several of the proactive steps we have taken over the last year, including planned real estate dispositions, financing activities that lowered our overall cost of debt and our focus on operational efficiency.

Last quarter, Jason spoke about our focus on highly structured sale-leaseback transactions outside of the commodity segment in net lease. This approach, which differentiates us from many of our net lease competitors, plays across all property types, including retail where we have avoided the commodity segment of retail characterized by small deal size and very efficient pricing.

Our investments and asset management teams have also done a tremendous job over the past decade identifying and staying ahead of the competitive threat to traditional retailers from e-commerce. As a result, we believe that an extremely low level of retail tenants in our portfolio faced significant competition from e-commerce.

While we saw fewer interesting investment opportunities for our portfolio during the first quarter, we have seen a pickup in the number of attractive opportunities more recently. We are, however, maintaining our investment discipline as we navigate the uncertainty of the current business environment. We have a strong and flexible balance sheet, with approximately $1.6 billion in total liquidity at quarter end and continue to build dry powder, so we remain well positioned to execute on opportunities that meet our core investment criteria.

With that, I'll turn the call over to Jason.

Thank you, Mark, and good morning, everyone. Starting with the acquisition environment. In the U.S., cap rates had remained tight, mainly due to the supply-demand imbalance that exists for net lease assets. The supply side has been impacted by continued uncertainty about the current administration's ability to pass tax reform and infrastructure spending bills, particularly given the circumstances surrounding health care reform.

Also contributing to the lack of deal supply has been a slowdown in M&A activity and corporate spending, both of which have particular impact on the sale-leaseback market. Meanwhile, demand for net lease assets has remained very strong as both domestic and international capital continues to seek income-producing assets and the relative safety of the U.S. dollar.

In Europe, activity has picked up modestly from the levels we saw in 2016. Accretive investments with adequate spreads do exist, especially given the low cost of borrowing. However, absolute yields remain low, resulting in high prices per square foot, which tend to be meaningfully above replacement costs. Against this backdrop, we are maintaining a disciplined underwriting approach. And while we have reviewed a substantial number of opportunities so far in 2017, our investments year-to-date have all been build-to-suit expansions.

This includes the completion of one small construction project during the first quarter; and since quarter end, the substantial completion of two build-to-suit expansion projects for existing tenants, bringing the year-to-date total to approximately $37 million at a weighted average cap rate of around 8%. We currently have one additional expansion project underway with an existing tenant, which we expect to complete by the end of the year, bringing the total for 2017 to about $60 million.

Since quarter end, deal flow both in the U.S. and Europe has picked up, so we are cautiously optimistic that it will translate into a more robust pipeline as the year progresses.

Moving to dispositions. During the first quarter, we disposed of a two building office property in Finland, an industrial property in Germany and a small parcel of land in the U.K. for total gross proceeds of $53 million.

Before I review some of the portfolio metrics, considering the rapidly shifting retail landscape, we thought it would be helpful to provide some additional color on the retail segment of our portfolio. First, retail represents a small portion of our overall portfolio, with only 16% of total annualized base rent, or ABR, coming from retail properties.

We've been clear about our strategy towards retail, which is different from that of many other net lease REITs. As we've said many times, we don't operate in what we refer to as the commodity segment of net lease, which is how we view much of the retail sector, as we don't like the risk-return trade-off it offers. When we do acquire retail assets, it is typically as large portfolios in noncommodity property types or where there is excellent physical real estate for very low basis.

Second, our retail portfolio is heavily weighted to Europe with only about 1/4 of our retail ABR located in the U.S., equivalent to just 4% of our total portfolio ABR. This is a theme that we have emphasized ever since we began investing in Europe in 1998. We believe that the U.S. has fundamentally too much retail square footage per capita, a reality that is exacerbated by the fact that the U.S. e-commerce market is the most developed. As a result, we expect the pace of U.S. store closures and retail bankruptcies to continue.

Third, the retail real estate that we do own is largely insulated from e-commerce disruption, with do-it-yourself retailers and car dealerships representing over 3/4 of our retail properties based on ABR. Other concepts, including AutoZone, Dick's Sporting Goods, C-stores, drug stores and grocery retailers, make up the remainder of our retail assets, all of which are performing well in the face of e-commerce.

The retail concepts we view as being particularly exposed to e-commerce competition such as department stores, apparel retailers, electronic stores and bookstores represent less than 1% of our total portfolio ABR, and over half of that comes from retailers in excellent locations such as our sole-remaining Best Buy asset, which is very well located on the Pacific Coast Highway in Torrance, California.

Lastly, we have always complemented our retail investment thesis with proactive asset management. For example, we exited close to one million square feet of big-box retail properties with excellent execution around 2011, which would have been a material risk exposure for us today had we continued to own those assets. We will maintain this approach going forward as we opportunistically manage exposures by tenant, geography, store format and retail concept.

Moving to leasing activity. First of all, in the context of our overall portfolio, it's important to remember that leasing activity relates to only a very small portion of it, roughly 1% of ABR during the 2017 first quarter. We entered into eight lease extensions with existing tenants during the first quarter, recapturing about 90% of the existing rent and adding 6.6 years of incremental weighted average lease term. Separately, during the first quarter, we entered into one new lease with a term of close to 11 years.

Turning to lease expirations. At March 31, we had seven leases expiring in 2017, representing just 1.1% of total ABR, all of which has now been addressed, primarily through new leases and lease extensions. We have 10 leases expiring in 2018, representing just 1.6% of total ABR, 2/3 of which has either been addressed or is in active negotiations. And we are already in active discussions on over half of the leases expiring in 2019.

Turning to our same-store metrics. Year-over-year, our same-store rents were 1.4% higher on a constant currency basis, which represents a meaningful increase compared to 1.1% for the 2016 fourth quarter, driven primarily by the level of ABR generated from leases with rent escalations tied to CPI.

At quarter end, 99% of our portfolio ABR came from leases with some form of built-in contractual rent escalations, including 68% tied to CPI. Accordingly, our portfolio remains well positioned for higher levels of inflation, which we are currently starting to see. To illustrate this point, the most recently published global inflation data weighted by the proportion of our ABR in our portfolio tied to each specific index averages 2.1%.

In conclusion, at quarter end, our portfolio was comprised of 900 properties covering roughly 87 million square feet, net leased to 214 tenants with a weighted average lease term of 9.6 years and occupancy remained high at 99.1%. Our top 10 tenants represented 32% of ABR with a weighted average lease term of 11.5 years, with less than 1% of ABR expiring within the next five years. 69% of our ABR came from properties in North America and 28% from properties in Europe, predominantly located in the developed economies of Northern and Western Europe.

And with that, I'll hand the call over to Toni.

Thank you, Jason, and good morning, everyone. This morning, I will review our 2017 first quarter results, touching on the key drivers of AFFO compared to the year ago quarter, our current guidance expectations and our key capitalization and leverage metrics.

For the 2017 first quarter, we generated AFFO per diluted share of $1.25 and raised our quarterly cash dividend to $0.995 per share, maintaining a conservative payout ratio of 79.6% for the first quarter. Our first quarter dividend is equivalent to an annualized dividend rate of $3.98 per share, and based on yesterday's closing share price, that represents an annualized dividend yield of 6.4%.

On a segment basis, Owned Real Estate generated about 94% of our total AFFO for the quarter, with the remaining 6% coming from our Investment Management business. Total AFFO per diluted share was $0.06 lower compared to the 2016 first quarter due primarily to lower revenue from both our Owned Real Estate and Investment Management segment, partially offset by lower interest and G&A expenses.

Owned Real Estate revenue decreased due primarily to lower lease termination income, which can fluctuate significantly from period to period. The remaining decline was driven by lower lease revenues resulting from planned property dispositions during 2016.

Revenue from Investment Management declined as a result of lower structuring revenue, partly offset by higher asset management revenue. In the first quarter of 2017, structuring revenues declined by $8.9 million compared to the 2016 first quarter, resulting from lower investment volume on behalf of the managed funds. While we continue to expect structuring revenue decline on a year-over-year basis, the specific timing and amounts will fluctuate from quarter-to-quarter.

Asset management fees and distributions from our partnership interest in the managed funds both increased as a result of higher assets under management. At quarter end, total assets under management for the managed funds stood at $13 billion, up 12% from $11.6 billion at the end of the 2016 first quarter. Partly offsetting the decline in revenues were both lower interest expense and lower G&A expenses.

On a year-over-year basis, interest expense for the first quarter of 2017 decreased by $6.4 million or 13%, driven primarily by a lower overall cost of debt as a result of replacing higher-cost mortgage debt with unsecured debt at lower interest rate. Our weighted average interest rate during the first quarter of 2017 was 3.8%, down from 4.1% for the year ago quarter. And we expect to continue to benefit from that decline on a year-over-year basis.

G&A expenses for the first quarter totaled $18.4 million, down $3 million or 14% compared to the year ago quarter, primarily reflecting lower compensation and professional fees resulting from the cost reduction initiatives we implemented last year. While the timing of expenses may vary from quarter-to-quarter, we continue to expect the G&A expenses for the 2017 full year will be consistent with or slightly down from 2016 at around $80 million.

Turning now to our guidance. We announced this morning that we have affirmed our previous AFFO guidance range of $5.10 to $5.30 per diluted share. For our Owned Real Estate portfolio, our 2017 guidance assumptions for acquisitions and dispositions remain unchanged from last quarter, with expected acquisitions for W. P. Carey's balance sheet of between $450 million and $650 million and dispositions of between $350 million and $550 million.

While we have not closed any acquisitions other than our completed build-to-suit transactions, we have factored that into -- that timing into our guidance range as we assume acquisitions primarily occur in the second half of the year. We also anticipate that our disposition volume will be weighted towards the second half of the year, which may partly offset the impact of the timing of acquisitions on our lease revenue.

For our Investment Management business, we continue to assume that we will complete between $300 million and $500 million of acquisitions on behalf of the CPA funds and between $400 million and $700 million on behalf of our other managed funds.

Turning briefly to our capitalization and balance sheet. As we discussed on our last earnings call, during the 2017 first quarter, we completed an underwritten public offering of EUR 500 million denominated senior notes in January, amended and restated our senior unsecured credit facility in February, extending the vast majority of our debt maturities out to 2021 and beyond.

As a result of this, at quarter end, on a pro rata basis, our overall weighted average interest rate was 3.7% with a weighted average debt maturity of 5.9 years versus 4.7 years at the end of the 2016 fourth quarter. Our unsecured debt had a weighted average interest rate of 3% compared to 5.1% for our outstanding mortgage debt. And we continue to believe that over time, as this mortgage debt comes due, we will be able to replace it with lower-cost bond financing.

Turning to our key leverage metrics. At the end of the 2017 first quarter, net debt to enterprise value was 38%, total consolidated debt to gross assets was 47.9% and net debt to adjusted EBITDA was 5.7x. As we continue to grow our balance sheet through accretive acquisitions, we expect our leverage metrics to remain around similar levels while further enhancing our overall credit profile through the use of unsecured debt under our unencumbered strategy.

And with that, I will hand the call back to the operator for questions.

(Operator Instructions) Our first question comes from Sheila McGrath with Evercore.

Mark, first quarter was pretty quiet on the acquisition front for both the balance sheet and the fund business. I'm wondering if you could just discuss in more detail the drivers of that. Were you adjusting your underwriting? And how is the pipeline looking? And how's the mix, Europe versus U.S.?

Yes. I think -- and I'll let Jason -- I'll start and then I'll let Jason chime in a little bit on that. It was a light -- extremely light quarter from an opportunity standpoint. We've seen a recent pickup of that, primarily in -- starting to come through in April. But we're focusing on the basics. We're fixing our balance sheet. We're maintaining dry powder. We're well positioned when we do see opportunities come through to take advantage of it. But as you know, we focus on our underwriting criteria. And that criteria is more than just whether a transaction is accretive or not for our financial statement. It comes into play, criticality of the assets, the basis we're buying into those properties, the structure of the lease, we look at all those things. And unless an investment meets that criteria, we're just not going to chase it. So we're maintaining that discipline. We'll continue to maintain that discipline through this climate. For the U.S. versus Europe, Jason, I'd turn it over to you to talk about that a little bit.

Yes. I mean, Mark's right. I mean, the market is competitive. There certainly has been less supply of net lease assets and sale-leasebacks out in the marketplace. I think a lot of that, as I mentioned earlier, has to do with the ongoing debates about tax reform, trade policy, infrastructure spending, corporate regulation. All of that has created uncertainty and a bit more of a cautious tone out in the market. So that said, as Mark mentioned, we're maintaining our underwriting discipline. We're staying patient, and we'll wait until we find the right deal, set the right pricing and the right structure. But we're not going to stretch to -- just to do deals. So in terms of Europe and the U.S., I think a lot of those themes probably more apply to the U.S., but there have been some elections in Europe that has caused some uncertainty. Yields have compressed more in Europe as well. We start getting concerned about basis and where that is relative to replacement costs, where total returns are. So we're factoring all that in, we're staying disciplined. But as Mark said, our pipeline is picking up, and we do expect to be more active as the year progresses.

Okay. And as a quick follow-up, you did raise more money in the nontraded REITs than in a while. Just wondering if there's any factors driving that, and if you could update us on the regulatory environment and expectations for the DOL changes.

Yes. Well, let me address the last part of your question first, and then I'll turn it over to Mark to talk about some of the fundraising that occurred in the first quarter. There has not been any more clarity in that space. I think that's reflective -- I saw a report this morning where I think capital raise in that space for the month of April was less than $300 million. I think that's reflective of both the uncertainty in the broker-dealer market on what type of structures and what business model they want to come out with as well as uncertainty dealing with the regulation around what the current administration will do with the DOL rule. There's been no clarity since our last call on that. As far as capital raising, Mark, I would turn it to you and talk about...

Sheila, we did have a very strong first quarter. I attribute that to two factors. Obviously, the brand and the historic recognition of W. P. Carey is always present. But we did have two fund closings, which generally garner greater capital flows towards a close. So CCIF 2016 T, which is our credit fund, closed April 28. So we did see a surge in the first quarter in the capital raise there. And our lodging fund, Carey Watermark Investors 2, closed as well at the end of March, and that garnered the amount of capital. I think it was approximately $265 million for the first quarter. But again, that is not a run rate, but rather the result of closings of those two funds temporarily. Carey Watermark 2 is open again. We closed that fund temporarily to appropriately appraise the value of the assets and reprice the shares.

Our next question comes from Nick Joseph with Citigroup.

Appreciate the additional color on guidance. I just wonder if you could walk through kind of the ramp assumed in guidance as we get into the full year. You did $1.25 of AFFO in the first quarter. It sounds like most of the acquisitions and dispositions will be tied in the back half of the year. So maybe what should we expect from a quarterly basis to achieve the midpoint?

Yes. I think we're still assuming we'd be at or around the midpoint of the guidance at this point in time. I mean, the range is there really to account for the fluctuation in the acquisition and disposition volume. But I think, generally speaking, with the assumptions we have, we are looking at the midpoint.

Okay. So would you expect second quarter similar to first quarter and then more of a ramp in the back half of the year? Or are there other -- either onetime items or structuring revenues that would create volatility even into the second quarter?

I think the first quarter was affected by, number one, overall, of a lack of opportunity. We saw both in the Investment Management business, we still have dry powder to put to work in our funds. I think in the CPA funds, we have roughly half the dry powder allocated to two follow-on deals with existing tenants in those funds that we expect to close at some point. But I think each quarter, it'll depend on the timing of when those acquisitions are done, whether it's on our balance sheet or in the funds itself. As I said to you and I've said this before, from an investment standpoint, it comes down to our underwriting criteria. We don't -- we're not going to close deals just to hit a number. It's got to meet our underwriting criteria, and a lot of that has to do with the structure of the lease, which takes time to negotiate. So that, to some extent, impacts the quarterly results. That's why we give guidance on an annual basis based on that overall volume. If we see a change in our expectation on any portion of that guidance, either acquisitions, dispositions or in the number overall, we'll announce it at that point in time. But I think we're still comfortable at this point that we'll meet the annual guidance given.

And just maybe on that last point. You got two net lease deals in the managed funds in the quarter. Could you just talk about the decision to put those into managed funds and not on balance sheet?

Yes. As I've said before, we have a responsibility to use up the capital in those funds and invest those funds. These particular net lease deals that I spoke about are with existing tenants in those funds are follow-on deals at that point. That utilizes half of the dry powder left on there. I would not -- as I've previously announced, the likelihood is that we'll put all net lease deals on our balance sheet going forward once that capital is utilized. But we do have a responsibility to put that capital to work, and I think that's what we're doing now.

Our next question comes from Joshua Dennerlein with Bank of America Merrill Lynch.

The 1Q dispositions, what kind of drove those sales? Was it opportunistic or something else?

There's three of them, totaled about $53 million. One of them was a two building vacant office in Finland. That was around $28 million. The other two -- one was kind of a high residual risk asset, industrial property in Germany, $24 million; and then the third was just a small piece of excess land in the U.K. So all European dispositions, relatively small relative to what we expect on the full year, which should be more back half of the year weighted as Toni mentioned.

Okay. So it sounds like you were just taking some risk off the table?

That's right.

And the CESH fund, that's the European student housing fund, correct?

Yes.

How are flows into that business and how's the interest in it?

That fund, since it's a private placement, is subject to safe harbor provisions. We're most comfortable to directing you to the supplemental, where you'll see on page 36 our acquisition volume. What I can say is that we're taking in capital into the third quarter. We saw sufficient capital for those opportunities, and we're now taking in new capital. But more than that, we really can't say.

Okay. And then I know on the re-leasing spread, you said that it was just a small percentage of your ABR. But should we kind of take the negative re-leasing spread as a sign that in-place rents are -- in your portfolio are well above market?

I'm sorry, I didn't entirely hear your question. Can you repeat it, please?

Yes. Just like your re-leasing spreads this quarter were pretty negative. I don't think that's the first time it's happened. Trying to just get a sense, is that a sign that the in-place rents in your portfolio are pretty high above the market rent?

This is Brooks. To answer your question, first of all, keep in mind, any particular quarter of leasing activity represents a very small sample size relative to the overall portfolio. So I think it's very difficult to extrapolate across the portfolio from any quarter's activity. So I think that's the real important answer here. I know on some of these leases where we've owned a property for a very long time subject to annual CPI bumps, we've reaped the benefit of those bumps over decades, in some cases. And so in some of those cases, our rent can accelerate faster than the market rent, but we've reaped the benefit of that over all those years. So again, I would hesitate to extrapolate. Every deal is different. We have rents that are above market, below market and at market across our portfolio. So I think it's difficult to extrapolate that from this particular quarter.

Okay. So do you think you, on average, benefit more from the above-market rent bumps than like kind of bumping them at rent and then not having like the rest of -- the risk at the end where you're lower -- selling something that's going to roll down?

Yes. I think we benefit more from the rent bumps because we also cross-reference that with the criticality of the asset. So even if we have rent that has increased faster than market for a particular building, if we're diligent in our understanding of the criticality, we can actually renew that tenant at above-market rent and keep that rent stream continuing. And then we see that happening all the time. So as long as we are diligent and proactive with the criticality assessment, we are benefiting more from the bumps over time than not.

Our next question comes from Todd Stender with Wells Fargo.

Just to get back to the Finland assets, looks like you handed back the keys to the lender. Can you just speak about who the tenant was, maybe if there was any lease duration left and maybe just what was your purchase price there?

Yes. Sure. It was Tieto. I don't have the purchase price in front of me. It was a building we bought maybe ten years ago. It's a Finnish company. They had vacated the property several years ago. The lease ended in 2016. And really the property itself is in need of redevelopment. It'll likely be repositioned as a multifamily investment. And under that scenario, the intrinsic value of the real estate itself was less than the debt balance, so we chose to work with the lender and proceed on a sale on that basis.

Okay. And just switching back here to the U.S., with changes in the accounting standards, you now have tenants that have to treat their leases as debt. How do you -- so I guess, in your conversations with tenants who will do a sale-leaseback, how are they thinking about doing long-term leases or maybe potentially shortening their lease duration just because that would mean maybe a larger liability on their books?

Right. I mean, you got to think of the types of deals that we do, which are predominantly sale-leasebacks and, really, the purpose for those types of transactions that tenants do. And a lot of it comes down to use of proceeds, they're doing deals -- and really occupancy costs as well. They're looking at their options to raise capital, equity markets, debt markets and their assets as well. And so when they choose to do sale-leasebacks with us, I think they're, first and foremost, looking at the economics. And in many cases, not in all, but in many cases, depending on the real estate fundamentals, a longer lease term will translate into a lower occupancy cost, mainly in terms of cap rate or going in yield. So I still think that's going to be the primary driver of how sale-leasebacks are structured. Now, on the margin, I think you will see lease terms trend shorter. But again, the primary driver is going to be economics, and a longer lease term will probably result in better economics for the particular companies.

(Operator Instructions) At this time, I am not showing any further questions. I'll now hand the call back to Mr. Sands.

All right. Thank you for your interest in W. P. Carey. If you have any follow-up questions, please call Investor Relations on (212) 492-1110. That concludes today's call. You may now disconnect. Thank you.