EastGroup Properties, Inc. (EGP) Q2 2013 Earnings Report, Transcript and Summary

Good morning and welcome to the EastGroup Properties second quarter 2013 earnings conference call. At this time all participant are in a listen-only mode. Later you will have the opportunity to ask questions during the question-and-answer session. (Operator Instructions). Please note today's call is being recorded. Now, it's my pleasure to introduce David Hoster, President and CEO. Please go ahead.

Good morning and thanks for calling in for our second quarter 2013 conference call. We appreciate your interest in EastGroup. As usual Keith McKey, our CFO will be participating in the call. Since we will be making forward-looking statements today, we ask that you listen to the following disclaimer covering these statements.

The discussion today involves forward-looking statements. Please refer to the Safe Harbor language included in the company's news release announcing results for this quarter that described certain risk factors and uncertainties that may impact the company's future results and may cause the actual results to differ materially from those projected. Also, the content of this conference call contains time-sensitive information that is subject to the Safe Harbor statement included in the News Release is accurate only as of the date of this call.

Thank you. The past quarter was productive for EastGroup. Funds from operations of $0.80 per share exceeded the upper end of our guidance range and represented an increase of 3.9%, as compared to the same period last year. We have achieved FFO per share growth as compared to the previous year's quarter in eight of the last nine quarters. Strong leasing and a 95% renewal rate increased occupancy to 94.2%. Same property cash net operating results were positive for the ninth consecutive quarter. We continue to expand our development program and we acquired eight building complex in Dallas. As of June 30, we were 94.2% occupied and 95.5% leased. Both figures represented increases over the end of the first quarter and we were well ahead of our internal projections. These results reflect both the improving industrial leasing fundamentals in every one of our markets and the quality of our assets. Activity continues to be good but still lack significant depth. Prospects were becoming even more decisive and moving to lease more quickly. We have moved past the stage of just a flight to quality and are now experiencing a real increase in both expansions and new users to the marketplace. As might be expected, our Texas markets were the best at 98.4% leased, followed by our California markets and 97.3% leased. Houston, our largest market was 5.4 million square feet, was 99.2% leased and 98.4% occupied. Jacksonville, which experienced several large move-outs, was our only larger core market below 90% leased, but it is expected to be above that level by the end of the third quarter. In all of our major markets, rents for the higher quality assets are increasing and should continue to improve as market vacancies continue to decline. It is too early to say that we…

Good morning. FFO per share for the quarter was $0.80 per share compared to $0.77 per share for the same quarter last year, an increase of 3.9%. Operations had benefited from lower interest rates on refinancing mortgage debt and an increase in property and net operating income related to developments, acquisitions and higher occupancy. Acquisition costs reduced FFO by $138,000 for the quarter. Bad debt expense, net of lease termination fee income was $49,000 for the quarter compared to $74,000 for the second quarter of 2012. FFO per share for the six months was $1.56 per share as compared to $1.53 per share last year, an increase of 2%. Lease termination fee income exceeded bad debt expense by $331,000 for the six months in 2013 and bad debt expenses exceeded lease termination fee income by $127,000 in the same period last year. Debt to total market capitalization was 34.6% at June 30, 2013. For the quarter, the interest and fixed charge coverage ratio was 3.75 times and debt-to-EBITDA was 6.85 times. We have included a new schedule in the supplemental information, adjusted debt-to-adjusted EBITDA. The debt-to-EBITDA ratio sometimes does not match. The net operating income associated with debt that is borrowed. In our case, we made two adjustments. One is for acquisitions during the period where you may have only a partial period of income recorded but the full amount of debt is barred and the other developments with a little or no income recorded because properties are under construction or at [lease] but the debt is included in the ratio. The adjusted debt-to-adjusted EBITDA ratio was 6.39 for the quarter. Our floating rate bank debt amounted to 6.8% of total market capitalization at quarter end. Our bank debt was $177 million at June 30 and with bank lines of…

We had a strong second quarter, good leasing ahead of expectations, continued momentum in our development program and an attractive acquisition in a core market where we want to grow. Our balance sheet is the strongest as ever been and we believe it's well structured to take advantage of future opportunities. Keith and I will now take your questions.

(Operator Instructions) We'll go first to the side of Craig Mailman with KeyBanc. Go ahead your line is open.

Just curious, Florida looks like you guys saw some good improvement there and I was just wondering outside of Black & Decker move out in August. Is the move there is sustainable or you guys think that demand [really] come back?

Yes. We had projected much lower leasing in both Jacksonville and Tampa and we've been prudently surprised with the activity in both markets, Jacksonville I mentioned previously. In Tampa, we have the Black & Decker move out in a month or so but we've already released over 50% of that space and prospect, the user will be moving in the third quarter. So we are pleased with the activity.

Is it pretty broad based demand, I know in your earlier comments you were saying the activity lacked depth is that projected towards any one market or?

No, to me the definition of debt is when you have either a prospect for every vacancy that you have and then the next step is two prospects competing, either three prospects competing in each vacancy and that's where you really start to develop your pricing power with rents other than general move up in the market. So we are not at the stage yet where we can say we have a good prospect for every vacancy in the portfolio, but from the standpoint of users, I would say it's a bit more broad based over the last three months, four months than it has been in the past and housing certainly has been contributor to some of that and that range is everywhere from construction equipment to accustomed towards windows, flooring and HVAC and one that's somewhat new that we haven't talked about before is furniture. So I guess when we think characterize it under housing, 3PLs who have been increasing their space usage electronics companies, medicals especially in Florida, in Florida we're seeing increased interest from convention center and entertainment and in Texas it's a variety of all those but Houston obviously, energy seems to be leading the way. So it just seems to be a broader number of prospects and maybe we had a lot earlier in the year.

That's helpful. And then just lastly on the acquisition front, how does the pipeline look there, could there be any bigger deals similar to Dallas in '13?

We'd love that to happen but that's, we're such a disciplined, picky buyer that you just never know. We don't have any additional acquisitions in our guidance but hopefully we will find some attractive properties between now and the end of the year. But as I mentioned before we don't have anything under contract and don't have anything with offers outstanding, it's just but that changes every week. Hopefully we will find something more.

We will go next to the site of Michael Bilerman with Citi. Go ahead your line is open.

This is Kevin Varin with Michael. You mentioned in your opening comments that there's an additional $40 million upstart expected for the remainder of the year. Could you walk us through what markets do you expect us to use as new projects coming on line and then also what are the expected yields on the incremental projects versus the existing pipeline?

We see additional construction starts in, a building in Denver, but I think we've mentioned previously that we are not starting quite as quickly as we would have liked but it's now, it'd probably be a third or early fourth quarter start. San Antonio and some more in Houston because the demand we're experiencing there. Our yields, which we defined as 100% occupancy was fully loaded, nearly cost in the investment are still running from a low to mid eight. We have been able to maintain that so far.

Okay. Thanks and then just one more general question. Just with the ramp in development activity in the industrial markets across the U.S., are there any markets for the new suppliers a concern or maybe it could be a concern over the next 12 months?

The only market we're seeing a significant and some as any new supply that compete with us in Houston. Other industrial REITs are building there and some private developers now have institutional money backing them as partners and are building. Some of that will be competitive with us but a lot of it is in different sub-markets and in many cases, larger buildings where we're not going to compete for the same users. So in our portfolio in Houston is one that we're watching most closely from that standpoint.

We will go next to the side of Vance Edelson with Morgan Stanley.

Could you provide an update on the percentage of the higher rate leases from the last cycle that you burned through? When we will be able to say that's all behind us and I guess related to that, could you just provide some color on the cadence of rents spread improvement over the next six to 12 months, when you think will be in a positive territory?

I wish I can give you the exact answer on when we're going to be 100% positive and really have some pricing power, but that's still a little bit of gray area. When we look at leases that were signed before 2008, we've got about 10% of our square footage that still fits that category and that is going to be a terminating and maturing over the next four or five years so it's not happening at all at one point. So from that standpoint, we're going to see improvements and I think, I've said many times in the past, we really want to look at the renewal rates in the renewal results, because that's much more apples-to-apples because I'd like to remind people if we've had a space vacant for the two or three years and then tenant moves in today we compare today's rent with what the quite the previous tenant, no matter how long ago was it was paid so I think we sometimes over shake it, roll down in rents, because when we rented spaces went vacant for over a year, that rent plus the [CAM] charge augured at the bottom line and were obviously a big plus to FFO.

Okay that's helpful. And then related to that the rents that you're commanding versus the competition based on the location, quality of your space, do you feel like you're getting a significant premium now and would you expect that premium to typically grow more pronounced as the cycle improves in vacancy is declined further.

Well, it sometimes is really hard to compare rents, because it's different submarkets, or the size of the spaces and the office build outs in the spaces. So, we think we are generally outperforming on a leasing standpoint, simply because of the great locations of most of our properties and the quality to begin with and one of the things we are experiencing rather than say a direct comparison to competitors is a overall higher quality spaces are experiencing better rent growth than B minus or C spaces, there still is somewhat of a [fight] to quality when the opportunity is there as companies get more confident in their own futures.

Okay. And then just final quick question you talked about housing becoming more of a driver, how about the interactions with FedEx and UPS, I think you've indicated from time to time that there's been an uptick in negotiations. How do you feel about those types of relationships right now?

We feel good about them and we signed in a number of markets, new leases and expansions with FedEx and continue to enjoy being a provider for services our space for them in many markets that's still positive.

Okay, that's great. Thanks.

Thank you.

We'll go next to the side of Alex Goldfarb with Sandler O'Neill. Go ahead your line is open.

Hello, thank you, good morning.

Good morning.

Just quickly, just a few questions here. First the NOI and re-leasing seemed to be much better this quarter than prior quarters. But just given that can be influenced, quarter-to-quarter depending on what's rolling, what should we expect for the balance of the year, should we expect third and fourth quarter to be similar to the second quarter or was this just unusually tough, strong just because of the leases is happened to be rolling in this period?

I think in some markets it will be the same and I think some of our rents in Florida were better from as you said leases that were rolling. So I've always been a believer that one quarter isn't a trend, so we'll talk to you again in October to see how we did. From the same property operating standpoint, we're going to have lower growth in the third and fourth quarters, we have in our guidance and we did in the second quarter with the main reason being and last year we had occupancies of over 94% in both third and fourth quarter. So the comparisons are more difficult from that standpoint and but we still believe they'll be positive.

Okay, and then you guys have ramped up your -- you outlined before you ramped up your development starts and assuming that this trend continues of just improving fundamentals, it will seem reasonable that you guys would continue to ramp up development team and more as the year progresses, wouldn't it, or is there some sort of capital restructuring maybe a Keith has locked the money box that you can't start anything new, I mean how should we think about the balance for the year as things continue as they are?

I would say, you'd go with our guidance which shows a good many additional starts and those are all projects that we are working on today's in terms of either pre-leasing or permits or confirming that we think that the market will accept those assets with open arms, so that you know I think the issue is how can we continue that pace next year? And the answer to that is all based on the leasing of what we are doing now.

Okay. And just finally and specific in Orlando on Horizon, maybe you said it earlier, is that project pre-leased or you are doing spec?

That will be a spec development.

Okay.

And one of the reasons that we are comfortable doing that is the last building in Southridge that we started I think in January we pre-leased all of that building to a single user before it was done. So we believe that shows the demand for high quality first generation space and then an attractive part.

We will go next to the site of Brendan Maiorana with Wells Fargo.

I'm not sure if it's Keith or David, but looking at your guidance for Q3 and then for Q4, the mid-point of your guidance for Q3 is $0.81, which suggests $0.83 in Q4. Is that ramp between Q3 and Q4 because you've got some financing tailwinds in the fourth quarter from the path of those high interest mortgages or is it more that you think the overall NOI level and fundamental performance gets better as we move sequentially throughout the year?

In the fourth quarter we are projecting more NOI, so it's mainly geared to more property NOI.

Okay. It's helpful. And then, Keith, so if I think about the balance sheet, I guess with the payoff of those mortgages, any other, the other capital sources that you got, you got little ATM issuance and asset sales, but you also have some developments pending. Your line balance, your credit facility balance was still be probably, 65 million, 70 million sort of towards the end of the year. Is that kind of a rough target level that you think is about right for the size of the company in the balance sheet?

We usually try to keep it around 100 million. We will drop it when we do financing and go below and then we run it up about 175 million mark. We own now is about as high as we want to go. We got 100 million that we intentionally put off until August start yet to write our bank line a little longer to close on and get benefit from that, but as we go above 100 million, we start trying to line up financing and then take it back down.

Sure. And then last one foe me. So if I look at the term loan, I think the 60 million that you've got, assumed in the back half of the year at 4.5%, is that an apples-to-apples rate today versus the 3.8% that you locked in early in the year. So, is it up 70 basis points or is that not a fair comparison?

I think it's up 70 basis points and the 60 million is not a done deal, that's just a projection. And what we did was take, told a few people and see what today's rate were and looked at other debt market and it was around 4.5%. So, that's just a guess. We don't have anything lot to answer that.

Yeah, okay. But 70 basis points is your projection of the change, okay. That's helpful thanks.

We will go next to the site of John Guinee with Stifel. John Guinee - Stifel, Nicolaus & Co.: John Guinee here, guys very impressive quarter. Just couple of more curiosity questions and anything. If you look at your development over the last couple of years which evolve fairly nicely, how much of the tenants are existing tenants were moving and how many of the tenants just on a percentage basis are new tenants who aren't exiting your existing space and moving into new product? There is one question. And then the second question is, you've done a good job of keeping your tenant improvement costs low, how much of your tenant improvement costs or what how we call basic costs versus special purpose and way I define special purposes is tenant specific, what you should want to be paid them simply to build out for them?

Let me answer the first, probably do the first part first, we have not calculated a number, that's as a good question, we will have to go back and look at it, but I would say that probably six, two-thirds of our tenants (inaudible) 50-50 that 50%, each city is different, but 50% to two-thirds are new users for development and the other third, 40% are existing customers, but we're not going to do a new building for an existing customer, unless of course it's an expansion. So everyone, I can think of is a really good size expansion, for example the Southridge building is just being finished now, that user I think is going up about three times in size their existing customers at Southridge. The side like they provide services for users to convention center. So in Houston, we've done, Houston three build-to-suits or pre-leases for freight forwarders, two of those we had no relationship with the fourth and third. We've done one build-to-suit and they had bought some other companies and came to us and said they wanted to do a second build-to-suit. So it wasn't an expansion of an existing facility, but an expansion for them. So we did the build-to-suit. Pre-leased building in Charlotte is little over doubling of freight forwarders space and in most of those cases, if we haven't been able to provide that additional space, we would have lost them as a customer. To answer to your question on tenant improvements, one of the things that it's harder to breakout is once, many times when our figure is higher than average it's because we're taking a larger space and splitting it for two customers or three customers and so you put in the demising wall, add new office pods and those really…

We will go next to the side of John Stewart with Green Street Advisors. Go ahead your line is open.

David, you are going to call for a seasonal summer slowdown this year?

So far we have not been told that from the field other than possibly in Phoenix. The first quarter, first four months of the year in Phoenix were very strong especially for the big boxes and maybe just used up a lot of pent-up demand and a bunch of new big boxes where we started is under construction and that seems to, it's still positive I think in the second quarter but its little way down and maybe because Phoenix gets the hottest summers but that's the only one where we've been told by our people who feel that they have seen a slowdown.

How about the small acquisition you did in Charlotte in July? What was the cap rate on that deal?

That's a high seven and to say it's next door to our Interchange One which has been a very successful building because major two interstates coming together in Charlotte. It's a longer term lease with the user and there is the potential to add I think about 16,000 square feet to the building. So that combination of factors gave it some extra appeal for a building of that size.

Sure. And then what cap rate or yield do you expect on the $10 million that you've got [keyed] up to sell in the second half and then maybe if you could speak more broadly to the investment market given the 70 basis point back up that Keith mentioned?

We are assuming about 7% cap rate on the sales and that's we have a mix of assets that we are talking about selling or about to put on the market or where in one case a tenant has an option to buy and say they want to and that's just an average for all those together so they will probably end up a little different than that. I don't think enough time has passed for there to be any significant statistical change in cap rates but in talking to brokers and it's my own opinion is there if there's going to be effect on cap rates, it will be B minus and C assets where they're less well capitalize buyers or local buyers who are going to, who're always looking to finance the acquisition as high leverage is possible and that the institutional type buyers REITs, pension fund advisors, private REITs already have their capital and doing little or no debt on it. So not heard any of the quality assets so far suffering any cap rate deterioration but this could take another three, four, five months I think to get some real feedback on that.

Sure and then lastly, one for Keith. On the $60 million unsecured target for the fourth quarter, what format is that going to take? Is that going to be another private placement or will it be a term loan?

Right now, it looks like a private placement. We are (inaudible) to a number of people directly and so we hope to add something lined up pretty soon.

We will go next to the side of Erin Aslakson with Stifel. Go ahead, your line is open.

You mentioned that you think concessions are actually in decline now in many Asian markets. The free rents actually coming in but when you look at the CapEx actually spent this quarter versus last quarter and the previous quarter continues to go up, when do you think that trend actually changes?

We look at TIs, I think that's I guess which you're referring to.

Yeah.

Two different ways. If you look at it on just the TIs per lease they're up significant this quarter and I think that's a combination and looking that the individual leases a combination of they splitting some spaces, we're doing some over spaces like building in Jacksonville, and some service center spaces that are closer to had higher office finishes. If you divide the average link leases into the little over $2 per square foot is more in line where we've been over the last four quarters. Now do we expect that to come down over the next year and year and a half? Yes, but not significantly, but it will come down because there's still, I think I would say Phoenix and some of the Florida markets, when there is skills although improving, still soft enough where we do a little more in TIs than we'd like to do but are still pleased with the economics of the overall lease. It generally if we're doing higher TIs, we're getting a little higher rent.

Right, right, right. And then just going back to the I guess the cap rate question and adjustments for increasing or expected to or increasing interest rates, have you made any adjustments in your underwriting in terms of exit cap rates for the assets you're looking to acquire?

We don't have a specific hurdle rate for each market, what we look at is our gets a call rightful approach, cost of capital today. What's our cost to equity, what's our cost to ten year money blend that on a 35, 65 basis, and so that, pretty much where our minimum would be. And then have a sense of what properties should sell for different qualities and different markets. And so each one is different with interest tenure rate up a bit, our cost to capital is up some but not somewhat should it's effected our approach on any acquisitions or development.

Okay, well. Thank you very much.

Thank you.

And we'll go next to the line of James Feldman with Bank of America. Go ahead your line is open.

Great. Thank you. I was hoping you guys could just speak your macro [hat] on for a little and just talk a little bit more about what tenants are saying, I think we're seeing rents driving, people are trying to figure out as the economy is really holding up here. What kind of your thoughts about the markets going forward, the property markets going forward and maybe talking about some of your weaker markets, what your sense is that the recovery there as the recovery spreads?

Yeah. We think that the demand has become more broad based than it was 6 months, 12 months ago. And each one is a little different like Houston is certainly, the energy. The Houston now is starting because of the strong employment population growth, we're starting to see more housing related users, Orlando which commonly is based on a lot of tourism was, as I mentioned, receiving convention center. We are seeing like cruise ship tenant in Tampa. We are seeing the growth in medical across Florida and actually the growth in Charlotte also there. So it's becoming, I guess the fundamentals continue to improve say both in terms of demand and the type of demand. So that builds confidence for us. Also as I mentioned in my remarks, users prospects, they are moving little bit faster, they don't feel real urgency yet, but a whole lot more than they did 6 to 12 months ago. So that is positive. You don't put have to proposal and wait three months to get a response, it comes back pretty quickly and they are making their decisions more quickly. And I think that impact reflects the confidence in those users businesses, so they are willing to make longer term commitments and start to pay for expansion in space. So, I mean, it's positive, we look at the population and all of the job goes statistics in our individual markets and they were positive you know that. Some of you heard me mention statistic in Texas. So if you go at the trailing 12 months, you combine Dallas and Houston, it's 700 residents a day and something like 545 new jobs a day. Another example I have used it offers but it's certainly going to affect Houston. Chevron announced a brand new tower downtown Houston, that's going to be 1.7 million square feet and 50 stories and they are going to move some employees from California, but they are talking about and they didn't give the time horizon, but they are talking about adding almost 1,800 new employees. So all of those people need a place to live and shop and consumer goods, so that's very positive for cities like that both shorter and longer term.

And then as you think about, what's in your guidance for leasing spreads in the back half of the year?

About where we are today, we try not to be too specific, they bounce all over the place, but you know the real effect on our same property operating results tend to be more occupancy than leasing spreads right now.

So if you are year-to-date, you are at minus 5.1% on cash leasing spread, do you think that's about right for the back half of the year?

You know I could get pinned down that.

Right.

Yeah, probably on average.

Okay. And then I know it's a little early, but just thinking about your largest expirations next year, it looks like you are weighted in Tampa, Houston and I guess those are the big ones. Do you have a sense of whether market, I mean those tend to be some of your better markets, I guess some of your better markets on leasing spreads and fundamentals, do you have a sense of where you are versus market in those leases?

I have somewhat of a gut feel on it, but I have not -- that can't really give you specific number on it at this point. And I think you have to look at the broader results.

Okay. And then just thinking about rising rates, do you get a sense -- since you do focus on some of the smaller tenants, do you get a sense that some of those tenants might be impacted by rising rates, you know as their cost of borrowing rises and what impact that might have or drag that might have on their business conditions?

We have a feedback from people in the field is that is a reason for somebody now expanding or renewing or shrinking or anything like that. And so far, the rising rates are ten years, the short-term rates still haven't moved much or somebody's borrowing based on a LIBOR or prime metal I don't think it's really affected them yet. So we've not heard anything negative from users related to that really of any size.

Yeah, I guess, I was thinking more about as they are thinking about the next couple of years, what kind of drive?

I guess I don't think out that far right now in terms of our planning. So it's more. Look what we think our prospects and our current customers are going to do over the next 12, 18 months and so far everybody we're talking to seems pretty positive and I think some of that is related just to the markets we're in.

Great, thank you.

And we have no additional questions.

Well, thank you for your continued interest in EastGroup and as always keep an eye, we will be available to give any additional information or question answering that you like. So please don't hesitate to give us a call. Thank you.

This does conclude today's conference. You may disconnect at any time.