Equity Lifestyle Properties, Inc. (ELS) Management Discusses Q2 2013 Results - Earnings Call Transcript

| About: Equity Lifestyle (ELS)

Equity LifeStyle Properties (NYSE:ELS)

Q2 2013 Earnings Call

July 23, 2013 11:00 am ET

Executives

Marguerite M. Nader - Chief Executive Officer, President and Director

Paul Seavey - Chief Financial Officer, Senior Vice President and Treasurer

Analysts

Gaurav Mehta - Cantor Fitzgerald & Co., Research Division

Nicholas Joseph - Citigroup Inc, Research Division

Jana Galan - BofA Merrill Lynch, Research Division

David Harris - Imperial Capital, LLC, Research Division

Todd Stender - Wells Fargo Securities, LLC, Research Division

Michael Bilerman - Citigroup Inc, Research Division

Operator

Good day, everyone, and thank you all for joining us to discuss Equity LifeStyle Properties Second Quarter 2013 Results. Our featured speakers today are Marguerite Nader, our CEO; and Paul Seavey, our CFO. In advance of today's call, management released earnings.

Today's call will consist of opening remarks and a question-and-answer session with management relating to the company's earnings release. As a reminder, this call is being recorded.

Certain matters discussed during this conference call may contain forward-looking statements in the meanings of the federal securities laws. Our forward-looking statements are subject to certain economic risks and uncertainty. The company assumes no obligation to update or supplement any statements that become untrue because of subsequent events.

At this time, I would like to talk turn the call over to Marguerite Nader, our CEO.

Marguerite M. Nader

Good morning, and thank you for joining us today.

Our normalized FFO for the second quarter was $0.57 per share, which was approximately $700,000 ahead of guidance and represents a 9-plus percent growth rate from 2012.

Our results for the quarter showed the strength of our business, which is supported by our quality real estate locations, stability of our cash flow and flexibility of our product offerings.

Today, I'd like to comment on our operating business, our recent financing and then discuss transaction activity.

On the MH side of our business, we continue to focus on increasing the number of ownership transactions in our portfolio. We see the impact of this focus as our used home sales volume within our MH footprint increased 22% this quarter. Our operating teams are using available tools, including additional marketing channels, to attract buyers.

The RV industry has had some positive trends in 2013, including growth in sales of 13%. While the industry has seen strength in all categories of RV sales, there has been a significant increase in higher-end sales, with a 30% increase in sale of motor home. While these sales do not translate directly into our RV revenue, it is helpful to see sales following an upward trend.

ELS continues to be focused on marketing to the 8 to 9 million installed base of RVers. We did see strength in our RV revenue this quarter, with an overall growth rate of 5.5% versus our projection of 2.5%. The majority of this growth was the result of increased seasonal and transient revenue. While our transient revenue represents less than 4% of the total revenue, it has the highest exposure to new customers.

We have directed our marketing campaigns to gain exposure to a new customer base and, as always, we continue to rely on referral business.

We have increased marketing programs and designed new online campaigns focused on specific properties, which resulted in an increase in reservations online and at our call centers.

With respect to our recent financing, we are pleased with the execution. Paul will provide more details on timing and execution, but for ELS to be able to take advantage of the low interest rate environment and execute for a blended term of 18 years, it makes us feel very confident about our balance sheet management and our assets.

I would like to update you on our transaction activity. As disclosed in the press release, we are under contract to sell 11 Michigan properties -- 11 properties in Michigan. These are 11 of our 13 Michigan-manufactured home communities that we purchased with the Hometown transaction.

When ELS closed on the Hometown transaction in 2011, we discussed at the time that the Michigan portfolio was not in our core market and we would consider divesting the properties under the right circumstances.

We purchased these 11 properties for approximately $125 million in July 2011 and are under contract to sell these assets for $165 million. In concert with this transaction, as we contemplated redeploying our capital, we looked for assets that we could reinvest our capital in that would reflect our core business model, stable cash flow with low working capital demand. Our acquisition pipeline currently contains $100 million of assets that meet this criteria and that we are currently in due diligence on. While there can be no assurances that any of these transactions will close, I thought it was important to highlight these potential transactions. To the extent that the transactions close, we will update guidance.

I will now turn it over to Paul to walk through the numbers in detail.

Paul Seavey

Thank you, Marguerite, and good morning, everyone.

I will discuss our second quarter results, provide an update on our refinancing activity and update guidance for the remainder of 2013.

Keep in mind, we completed a stock split on July 15, so per-share results reflect our new share count.

For the second quarter, we reported $0.57 of normalized FFO per share, approximately $700,000 ahead of guidance and consistent with the midpoint of our split-adjusted per-share guidance range.

As stated in our press release, 11 of our Michigan assets are held-for-sale. Therefore, they are excluded from our core results. They are, however, reported as discontinued operations for the quarter, as well as in our historical comparisons and in third quarter and full year 2013 guidance.

Overall, for the second quarter, core income from property operations performed better than expected, primarily as a result of strong performance in our RV portfolio. Core MH rents came in better than we had projected and was 3.2% higher than last year. The base rental income increase includes 2.4% rate growth and 80 basis points related to occupancy gains. We had core occupancy gains of 30 MH sites in the quarter.

Our Core RV resort-based rental income growth was 5.5%. Our annual growth rate was 4.3%, consistent with our expectations. We had strong growth of 12.2% in seasonal income and 6.6% in transient income.

Membership dues came in at $12 million for the quarter. During the quarter, we sold and activated approximately 5,100 new memberships. Year-to-date, we've generated approximately 7,700 new memberships through our various distribution channels.

For the quarter, the net contribution from right-to-use contracts or membership upgrades was roughly breakeven, resulting from approximately $3.4 million in revenues and $3.3 million in expenses. We sold 782 upgrades at an average price of approximately $4,500.

Core property operating expenses were approximately $200,000 lower than expected in the quarter. The better-than-expected performance is attributed to management of our controllable expense categories, including payroll and rental home maintenance expenses.

In summary, second quarter core property operating revenues were 2.7% and core property operating expenses were up 2.5%, resulting in an increase in core NOI before property management of 2.8%.

Property management and corporate G&A came in at $17 million, excluding transaction costs. Other income and expenses included an expense accrual of $1.4 million related to an award of legal fees to the plaintiff as a result of the Ninth Circuit's recent decision in our San Rafael rent control litigation. The net contribution from these line items was $3.6 million, excluding the income related to our contingent asset.

Year-to-date Core property operating revenues increased 2.9% and Core NOI increased 2.7%, driven by our Core community base rent increase of 3% and our resort-based rental income increase of 3.8%.

Now to update you on our refinancing. During the quarter, we closed on a $110 million 10-year CMBS loan at 4.87% as part of our previously announced refinancing plan. The interest rate on this loan increased prior to closing as a result of changes in market conditions. Based on the CMBS loan rate and the rate locks associated with the anticipated loan closings I'll describe in a minute, we expect to complete our refinancing with a weighted average rate of 4.47% for 18 years.

The CMBS loan is secured by a portfolio of RV assets. We used $110 million in loan proceeds and available cash to defease approximately $136.8 million of debt maturing in 2014 and 2015, with a weighted average rate of 5.64%. Note that approximately $120 million of this defeasance occurred July 1. Therefore, our June 30 balance sheet does not reflect this use of cash or the debt reduction.

To date, we have paid approximately $17.8 million in defeasance costs associated with early debt payments. The remainder of our refinancing plan is expected to close as follows: on August 1, $242.4 million, with a weighted average rate of 4.28% and a weighted average maturity of 20.3 years; loan proceeds and available cash will be used to defease $175.4 million maturing in 2015, with a weighted average rate of 5.65%; and we paid $60.7 million maturing in 2013, with a weighted average rate of 6.02%. This represents the remainder of our 2013 scheduled maturities. Our current estimate of defeasance costs is $21.9 million.

On December 1, we expect to close on $23.1 million at 4.35% for 25 years. Proceeds will be used to repay debt maturing in early 2014, with a weighted average rate of 5.81%. And on April 1, 2014, we expect to close on $54 million, with a weighted average rate of 4.5% and a weighted average maturity of almost 22 years. Loan proceeds will be used to repay debt maturing in 2014, with a weighted average rate of 5.63%. Upon completion of our refinance activity, we will have remaining maturities of $30 million in 2014 and $286.5 million in 2015.

The press release and supplemental package provides third quarter and full year guidance in detail. Please note, the following remarks are intended to provide our current estimate of future results. All growth rates and revenue and expense projections represent midpoints in our guidance range.

Consistent with our historical practice, we have not adjusted guidance to reflect the impact of the previously mentioned transactions because we have not yet closed. If we close, we plan to provide a guidance update.

For the remainder of 2013, we assume no change in our Core MH occupancy from the end of the second quarter and expect community base rent revenues of $204 million, a growth rate of 3% for the remainder of the year.

In our RV business, we anticipate Core RV revenues of $69 million for the rest of the year, which is a growth rate of 4.4%. We expect annual to continue showing strong performance, with 4% growth projected. Our seasonal and transient businesses are expected to continue their recent trend and deliver 6.1% and 4.9% growth, respectively. We expect about 45% of the full year transient income will come in the third quarter.

Total core revenue from dues and membership sales for the second half of the year are expected to be $31.4 million. The associated sales and marketing expenses are anticipated to be approximately $6.8 million, for a net contribution of $24.6 million compared to $25.4 million in 2012.

Core operating expense growth is projected to be 3.6% for the remainder of the year and 3.4% for the full year. Full year growth is down from prior guidance of 3.6%, primarily as a result of savings achieved in the second quarter.

Consistent with our prior guidance, utilities, insurance and real estate taxes, which represent almost half of our total expenses, are projected to increase approximately 7%.

Real estate taxes are a significant component of the projected growth. Given the timing of increased notifications in various states, we don't yet have much information available to project real estate tax increases for 2013. We will have greater visibility over the next 90 days as we receive notices in Florida and Arizona.

For the rest of the year, core property operating revenues are anticipated to be up 3.3%, with core expenses growing at 3.6%, resulting in a net increase in core property NOI of 3%.

We expect the 2012 acquisition properties will contribute about $700,000 in income from property operations for the remainder of the year for a total of $2.3 million for the full year. Property management and corporate G&A is expected to be $33.5 million for the remainder of the year and $67.9 million for the full year. Other income and expense items are expected to be approximately $8.3 million for the rest of the year and approximately $18.9 million for the full year.

Financing cost and other are expected to be $58.6 million, savings of approximately $900,000 from prior guidance. Given the timing of our refinancing activity, we will not see the full effect of interest expense savings until 2014.

Our current full year 2013 normalized FFO per share guidance range is $2.51 to $2.61. At the midpoint, we are $0.04 per share ahead of prior guidance, primarily as a result of better-than-expected Core operations and the impact of our refinancing in the second half of the year.

Now some comments on our balance sheet. As evidenced by our recent refinancing effort, we continue to focus on our balance sheet. As we have stated in the past, we intend to execute on opportunities to capitalize on the strength of our balance sheet while maintaining flexibility to position ELS for growth opportunities as they may develop. Our interest coverage ratio was 2.9x.

Current secured financing terms available for MH and RV assets range from 60% to 75% LTV, with rates between 4.9% and 5.95% for 10-year money. Long-term 30-year debt is in the mid-5% range. High-quality, age-qualified MH assets will command preferred terms from life companies, Fannie Mae and the CMBS market. Generally, CMBS and certain life companies are currently offering debt to finance RV assets.

We have a $380 million undrawn line of credit with more than 3 years remaining and a 1-year extension option.

Now we would like to open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Gaurav Mehta from Cantor Fitzgerald.

Gaurav Mehta - Cantor Fitzgerald & Co., Research Division

In your opening remarks, you talked about the used home sales outlook. Can you also talk about what you're seeing on the new home sales side? And have you seen any impact on the home sales as a result of the financing venture with Cavco that you announced in 1Q?

Marguerite M. Nader

Sure. Let me just give you a little flavor for both the new and the used. In the quarter, we sold 23 homes at an average price of about $55,000. Those homes were mainly sold in Northern California, the Northeast and Florida. So while it's an increase from 2012, I think 2012 we had 3 or 4 homes -- new home sales, it's certainly not at the rate where we would want to be. We had -- we're struggling with new home sales, but we have had an increase in the used home sale portfolio, but these are lower-price point sales than in -- and they're typically a cash buyer.

From a perspective of the deal that we've been working on with Cavco, we purchased 50 homes across 11 communities. Half of those homes were set in the second quarter and the remaining will be set in the third quarter. The homes took a little bit longer than anticipated to arrive at our communities, but we have sold 7 of those homes and have initiated around the same number of used loans, so the financing is available both on the used side and the new side. But obviously, we still need to find the right buyers, and we have that additional tool to improve that sale process.

Gaurav Mehta - Cantor Fitzgerald & Co., Research Division

Okay. And I think in your supplement, you also mentioned that there were 2 third-party home sales in the second quarter. Can you just elaborate on that?

Marguerite M. Nader

And those are the Cavco deals. And actually, when I was talking about 7, the 7 that are sold are not necessarily closed. But the 2 that were sold that are part of those -- the 23 are part of the Cavco deal.

Gaurav Mehta - Cantor Fitzgerald & Co., Research Division

Okay, that's helpful. Second question I have is on the guidance. It seems like within your 2013 guidance, you lowered rental home income guidance. Is that because of the Michigan assets that you're selling?

Paul Seavey

Inside the Core, yes. We have about 1,000 rentals in the Michigan portfolio, and those are no longer in our rental home portfolio.

Gaurav Mehta - Cantor Fitzgerald & Co., Research Division

Okay. And then lastly, can you provide details on rent control initiative? It seems like it's higher than what we have seen in the past, at $1.6 million for the second quarter. So what's included in that line item?

Paul Seavey

As I mentioned, we have an accrual in there for $1.4 million in legal fees associated with the Ninth Circuit's overturn of the prior decision in that case. And that includes the legal fees as well as a small amount of interest that's payable to the plaintiff.

Operator

Your next question comes from the line of Nicholas Joseph from Citigroup.

Nicholas Joseph - Citigroup Inc, Research Division

Can you talk about the marketing process for the asset sales? How long have you been marketing the assets, and how was the demand?

Marguerite M. Nader

We've been marketing them, a few of them, I would say, over the last several months, and we were able to work with a buyer who wanted to have a larger portfolio transaction. He knew we had 11 properties -- we actually have 13 manufactured home communities in Michigan, and was interested in taking the 11 properties. And the 2 properties that they -- they're not under contract to buy is because they are tied up in CMBS financing. It would be difficult to transfer those assets.

Nicholas Joseph - Citigroup Inc, Research Division

Okay. And then did you disclose the cap rate on the transaction for the 11?

Marguerite M. Nader

Yes. We bought those Michigan properties, I think it was 24 months ago, at an approximate cap rate of between 11% and 12%. And we have it under contract at a 9-plus percent cap rate right now. And I think -- when you think about our -- our interest in selling Michigan was twofold. It was -- first of all, it's not in our core market and it's not in an area we're looking to increase exposure. So I think the analysis becomes more than just a cap rate analysis.

Nicholas Joseph - Citigroup Inc, Research Division

All right. And then could you just give us an update on the program partnering with the RV dealerships? It's been about a year since that program started. So do you have any statistics on renewals?

Marguerite M. Nader

Sure. We have -- I think we have about 4,500 memberships that are in the sale -- that are embedded in the sale of the RVs to date. The program -- we like the program because 40% of the sales come from first-time home buyer -- or first-time RV buyers. And really, I think in this past -- in the second quarter, there was a de minimis number of transactions or memberships that were sold last year. So it's really in the third and fourth quarter when those memberships are going to come up for renewal.

Operator

And your next question comes from the line of Jana Galan from Bank of America Merrill Lynch.

Jana Galan - BofA Merrill Lynch, Research Division

I was wondering if you could comment on the transaction market, if you're seeing more RV or MH in the market than you saw at this time last quarter, and just if you're seeing any movement in cap rates?

Marguerite M. Nader

Sure. We're seeing -- I think it's consistent with what we've seen in the past, that it's a relatively choppy pattern. I think just as a -- in terms of a data point, you may have seen Dave Knapp and Colleen Edwards of Carefree RV. They've recently announced the sale of the majority of their portfolio. It's an RV portfolio of 61 RV properties. We bought the encore portfolio from Dave and Colleen, I think in 2004. It was the start of our RV platform. This was good real estate mainly located in Central Florida, and they had an -- they were interested in staying in as owners. So I think they got a good execution on that, where they're continuing to maintain a piece of the business and operate the business. So that shifts in terms of the data point, what's out there in terms of transactions that have closed.

Jana Galan - BofA Merrill Lynch, Research Division

And I know this is tiny, but you listed about $200,000 transaction costs. I was curious if that was related to the disposition, or is that potentially some due diligence on some deals that you didn't pursue?

Marguerite M. Nader

I think it's a little bit of both.

Operator

Your next question comes from the line of David Harris with Imperial capital.

David Harris - Imperial Capital, LLC, Research Division

Great timing on the mortgage. Can you just run through with me why you didn't choose to do a more major recap refinancing along the lines of -- that the company undertook several years ago?

Paul Seavey

Yes. When we looked at it, we considered our options and went through them with the board. And the primary challenge associated with a larger recapitalization was, in part, the cost of the transaction in terms of the total defeasance costs we would incur, as well as potential limitation on flexibility and the availability of the long-term capital. We believe that there was an appetite for life companies to put out long-term capital along the lines that they have. But at the same time, there were not a lot of transactions that we could look to that really demonstrate that life companies were executing on those types of deals. So I think that we took advantage of an opportunity and have managed our future maturities to a level that $300 million on an annual basis is a manageable number for us to handle, as far as refinancing.

David Harris - Imperial Capital, LLC, Research Division

So if we think about the move in long-term rates, I mean, I'm in the camp that believes we've turned a 30-year cycle here and rates are going up. Is there any more to do whilst we remain fairly -- still fairly close to the bottom?

Paul Seavey

We're looking to get through the transaction that we've announced. I think that -- as I said, the appetite on the part of the life companies is they're interested as well in getting through this transaction. And to the extent that we see that appetite continue to be strong and rates continue to be low, we may execute on that in the future.

David Harris - Imperial Capital, LLC, Research Division

Okay, but -- I think your last slug of mortgage takedown is, what, December? So what I'm hearing is you're not likely to move on a new initiative until the new year?

Marguerite M. Nader

Right. That's -- the last portion of it actually comes in April of 2014.

Operator

[Operator Instructions] And your next question comes from the line of Todd Stender with Wells Fargo.

Todd Stender - Wells Fargo Securities, LLC, Research Division

Just in looking at the price you paid for the Hometown properties that are queued up for sale, I believe you said $125 million and you signed for $165 million?

Marguerite M. Nader

That's correct.

Todd Stender - Wells Fargo Securities, LLC, Research Division

If you go through some of the metrics, there's obviously some value creation there. Can you talk about where the occupancies were in July of '11 and where they are now?

Marguerite M. Nader

It's really just -- the occupancy is essentially flat to where we were in 2011. I think in my -- in the earlier discussion, we talked about just the cap rate. There was some cap rate compression. So it went from an 11%, 12% cap to a 9%-plus cap. So that was really the valuation creation.

Todd Stender - Wells Fargo Securities, LLC, Research Division

But then the rates -- it seems the rates are essentially flat?

Marguerite M. Nader

Right.

Todd Stender - Wells Fargo Securities, LLC, Research Division

Okay. Are the properties encumbered? Are there mortgages on them?

Paul Seavey

There is. There's a loan on one that's -- there's a loan on one of the mortgages -- one of the properties. It's about $8 million.

Todd Stender - Wells Fargo Securities, LLC, Research Division

And it's a single buyer, you indicated?

Marguerite M. Nader

It is a single buyer, yes. A private operator.

Todd Stender - Wells Fargo Securities, LLC, Research Division

Okay. And what's behind these? Are there other properties acquired in the Hometown transaction that you expect to tee up as well?

Marguerite M. Nader

No. I mean, this is -- I think this is consistent with what we've said through the last couple of years and when we bought the properties, that these are assets that we would be interested in disposing of, if given the right opportunity. But there aren't other assets within that portfolio that we would look to be selling.

Todd Stender - Wells Fargo Securities, LLC, Research Division

And they're all considered in the all-age category?

Marguerite M. Nader

Yes.

Operator

[Operator Instructions] Your next question comes from the line of Nicholas Joseph from Citigroup.

Michael Bilerman - Citigroup Inc, Research Division

It's actually Michael Bilerman speaking. Marguerite, I was wondering if we can sort of go back to balance sheet strategy and dividend policy. And a number of times over the last couple of years when we've talked about the dividend and the extraordinarily low payout, but obviously great growth in that dividend over time, one of the hesitations that you've had and prior management has had about raising that dividend was looking at the near-term maturities, which -- that you've now solved. And so I wonder, we're sitting here today with still a well below 50% payout, which will grow even further as we head into next year. You're generating excess proceeds from the dispositions relative to the acquisitions you have targeted. You're still generating and it's a growing number, free cash flow per year. How are you and how is the board thinking about that dividend?

Marguerite M. Nader

We talk about, with the board, the dividend, at every board meeting. And certainly, it's always been discussed relative to the 2014 and '15 maturities and solving for those. I think our last board meeting in May, we had discussions which resulted in what we decided to do in terms of the restructuring of the debt. So I would see us consistent with what we've done in the past, Michael. I would say that we would be making an announcement in our October press release regarding the dividend for 2014.

Michael Bilerman - Citigroup Inc, Research Division

But I guess the removal of the debt risk and one of the reasons why you wanted to maintain this much free cash flow, should we expect a more -- a payout ratio or a suggestion to the board by management, a payout ratio more along the lines of where the REIT industry is, which is, call it, 70% to 75%?

Marguerite M. Nader

Yes.

Paul Seavey

I think that it's not -- for us, as we've said in the past, it's not going to be so much what is the payout ratio as it is how do we maintain financial flexibility. And I think, as Marguerite said and as you just suggested, we'll go through our budget process and then we'll evaluate the factors that we evaluate on a regular basis, principal amortization, CapEx, working capital requirements, and then make the recommendation. But obviously, the 2015 maturities, we've taken that off the table as far as a risk factor.

Michael Bilerman - Citigroup Inc, Research Division

And how does the amortization compare on the new loans that you have relative to the amortization that you had on the prior in terms of the cash usage?

Paul Seavey

There's an uptick. We'll be at -- just under $40 million annually, as compared to about $30 million today.

Michael Bilerman - Citigroup Inc, Research Division

But a significant reduction in cost, so you probably -- from an interest perspective?

Paul Seavey

Correct, correct.

Michael Bilerman - Citigroup Inc, Research Division

And then just on the acquisitions, the $100 million that you have teed up, what sort of yields are those coming in at?

Marguerite M. Nader

We're still in due diligence on those assets, but I would anticipate that the yield would be around 6%.

Michael Bilerman - Citigroup Inc, Research Division

Okay. And just on Michigan properties. If you go back to the Hometown proxy, the Michigan assets, the 13 that were listed there, the 6,900 sites had a stated purchase price of $119 million. The Clinton asset you didn't acquire, which I believe was $30 million. And so I guess that would be $90 million for 13 assets. And you're saying the 11 have a book value of $125 million. I'm just trying to reconcile those 2 numbers.

Marguerite M. Nader

It also includes -- the home notes are part of the transaction. And they were not -- and what you're -- I think what you're referring to was just the real estate.

Michael Bilerman - Citigroup Inc, Research Division

Okay, so how much -- so the $90 million is effectively for the 13 assets you have bought. The 11 assets probably have a value somewhere around $75 million, and then there's $50 million of the notes. Is that the way to think about it?

Marguerite M. Nader

I have to -- Michael, I don't have the breakdown between the $165 million. I can get that for you offline.

Operator

Ladies and gentlemen, this will conclude today's question-and-answer portion of today's conference. I would now like to turn the call back over to Marguerite Nader for closing remarks.

Marguerite M. Nader

Okay. Thank you very much. Paul Seavey is available for questions following the call.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation, and you may now disconnect. Have a wonderful day.

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