Cedar Shopping Centers' (CDR) CEO Bruce Schanzer on Q2 2014 Results - Earnings Call Transcript

Aug. 6.14 | About: Cedar Realty (CDR)

Cedar Shopping Centers (NYSE:CDR)

Q2 2014 Earnings Conference Call

August 6, 2015 5:00 p.m. ET

Executives

Bruce Schanzer - President and CEO

Nancy Mozzachio - Head, Leasing

Philip Mays – CFO

Mike Winters - Head of Acquisitions

Jennifer Bitterman – IR

Analysts

Todd Thomas - KeyBanc Capital Markets

Rj Milligan - Raymond James

Craig Schmidt – Bank of America/Merrill Lynch

Operator

Welcome to the Second Quarter 2014 Cedar Realty Trust Earnings Conference Call. At this time, all audience lines have been placed on mute. We will conduct a question-and-answer session following the formal presentation.

I’ll now turn the call over to Mr. Jennifer Bitterman, Director of Investor Relations and Corporate Analytics. Please proceed.

Jennifer Bitterman

Good evening and thank you for joining us for the second quarter 2014 Cedar Realty Trust earnings conference call. Participating in today’s call will be Bruce Schanzer, Chief Executive Officer; Philip Mays, Chief Financial Officer; and Nancy Mozzachio, Head of Leasing.

Before we begin, please be aware that statements made during this call, that are not historical may be deemed forward-looking statements and actual results may differ materially from those indicated by such forward-looking statements due to a variety of risks and uncertainties including those disclosed in the Company’s most recent Form 10-K and other periodic filings with the SEC. Forward-looking statements speak only as the date of this call, August 6, 2014 and the Company undertakes no duty to update them.

During this call, management may refer to certain non-GAAP financial measures including funds from operations and net operating income. Please see Cedar’s earnings press release posted on its website for reconciliations of these non-GAAP financial measures with the most directly comparable GAAP financial measures.

With that, I now turn the call over to Bruce Schanzer.

Bruce Schanzer

Thank you, Jennifer and welcome to the second quarter earnings call of Cedar Realty Trust. On this afternoon's call, I will briefly review our progress for the quarter and year to date, before having Nancy discuss our leasing results in more detail and having Phil do the same for our financial results.

In addition to Phil and Nancy, I am also joined by Brenda Walker, our COO, Mike Winters, our Head of Acquisitions; Charles Burkert, our Head of Construction and Development as well as Adina Storch, our General Counsel. As always the balance of team Cedar is dialled into the call. The accomplishments I will be discussing are very much a credit to their efforts and ongoing commitment to every day excellence.

I'm pleased with our result as the continued evidence of our steady approach to growing value with Cedar as well as our ability to deliver on our announced goals and initiatives. We reported $0.14 of operating – funds from operations this quarter versus $0.12 a year ago. The strong second-quarter results allowed us to raise the low end of our 2014 guidance of a penny to a revised range of $0.50 to $0.54 per share.

Our leasing results for the quarter were solid with roughly 380,000 square feet of new and renewal leasing of which 355,000 was done at an average 8.9% comparable cash lease spread. Year-to-date we've completed over 700,000 square feet of new and renewal leasing at roughly a 9% cash lease spread.

Additionally our same-store net operating income or NOI growth was 2% for the quarter and 2.4% year to date. Lastly, our leverage at 7.7 times and trending downward is consistent with our overall balance sheet strategy of gradually reducing leverage in the ordinary course.

As we have described previously, in addition to continuous balance sheet improvement, our long-term strategic plan includes a focus on leasing and operations, a commitment to reinvesting into certain of our high potential assets as well as intensifying our footprint and upgrading our portfolio through capital recycling.

What I would like to highlight in particular on this call is the complete portfolio transformation that is continuing to occur through this capital recycling strategy. We’re doing this by selling our lower density assets and acquiring higher density assets while continuing to focus, as always, on grocery anchored centers between Washington DC and Boston.

On our last quarter call, I drew back the curtain a little into how we think of our portfolio by walking you through the quartiles in which we rank all our assets. This was done in in the context of discussing our $92.3 million Quartermaster Shopping Center acquisition, a 450,000 square foot center located in the heart of the South Philadelphia retail submarket with approximately 325,000 people within a 3-mile radius.

To fund this acquisition and certain other pipeline opportunities, we have sold and continue to sell assets in the bottom two quartiles of our portfolio. It is important to note that although these bottom two quartiles constitute half of our assets by number, they collectively generate roughly a quarter of our NOI and represent only about 20% of our aggregate portfolio value. More importantly, our top two quartiles which have the other half of our assets by number generate about 75% of our NOI and represent about 80% of our value.

Notably, the centers in these top two quartiles have on average 120,000 people within a 3-mile radius and 1,777 households per square mile. This population density ranks the top 80% of our portfolio, third highest of all shopping center reads. Keep in mind, we’re planning on selling the bottom 20% to fund further acquisitions like those now at the top.

Year-to-date, we have sold four bottom quartile assets for aggregate sales proceeds of $65.3 million. The weighted average cap rate of the four assets sold was approximately 7.8%. An average population density for these four centers is only 22,000 people. Ironically, at our current share price, the implied cap rate of our entire portfolio is only 35 to 40 basis points below the cap rate at which these bottom quartile assets just traded notwithstanding that they were among our weaker assets. In addition to these four assets, we are exploring the divestiture of another 10 or so bottom half assets with similar average densities some of which are already listed as out for sale.

We will use these proceeds to continue funding the Quartermaster acquisition and for other investment opportunities now in the works. Although with both acquisitions and dispositions one never knows whether a deal was done until it closes, I would characterise what we had done thus far in 2014 as being very consistent with our capital recycling strategy. Specifically, we are targeting high density, more infill assets for acquisition and targeting our lowest density, more rural assets for divestiture. Because of our relatively small size we can pick our spots and because of our local footprint we can identify opportunities before they come to market.

Another benefit of our relatively small size is that if we are successful in executing this strategy, the resulting portfolio will leapfrog past most other REITs when it comes to population density as a measure of portfolio quality, though to be fair roughly 80% of our portfolio by value already has made that jump. We will of course continue to keep up apprised of our progress as we execute on what I expect will be a portfolio transformation that is completed in two or three years.

With that, I give you Nancy to discuss our leasing results.

Nancy Mozzachio

Thanks so much, Bruce. The leasing results this quarter reflects a steady performance in our asset base. We are continuing to execute on our long-term plan to maximize asset value through lease up and purposeful retenanting of space in our centers. Our portfolio lease rate is now 93.3%.

We signed 61 leases during the quarter totalling 380,000 square feet with average base rents or ABR of $13.41 cents per square foot, 6% above our core portfolio ABR. We executed 17 new leases during the quarter totalling 87,000 square feet. This new lease pool was almost entirely comprised of service tenants including restaurants and health-related concepts in a concerted effort on our part to commit to tenants complimentary to the tenant mix of our grocery-anchored centers incapable of producing sustainable sales growth.

In terms of renewal activity in the quarter, we renewed 293,000 square feet at 9% positive cash spreads with no capital expenditures. Small shop positive cash renewal spreads were just over an 11.1% increase for the second quarter of 2014 as compared with an increase of 10.7% in the first quarter and 9.1% in the second quarter of 2013. Overall positive renewal spreads for the quarter were consistent with guidance and it’s worth noting the second quarter of 2014 marked our 34th consecutive quarter of positive renewal spread.

While 87,000 square feet represents a significant amount of new leasing activity, second quarter occupancy numbers declined slightly 40 basis points quarter over quarter. This decline is a combination of a few events. One, the continuation of our capital recycling strategy in which we moved some additional highly occupied non-core assets into our held for sale portfolio; two, the expected return of certain spaces and three, allowing for strategic lease expirations in favor of retractive retenancing opportunities. A perfect example of this strategic retenancing is reflected in the business plan for Colonial Commons.

As discussed on our prior calls, we are repurposing a former freestanding autostore with Noodles, a fast casual restaurant. While the leasing team could have solely focused on finding a replacement auto concept, we were willing to take some additional downtime to creatively retenant the space. Noodles complements our tenant mix at the center and represents a significant gain over prior rents. We are prepared to and are willing, if needed, to accept temporary short-term physical occupancy decline at certain centers in exchange for long-term value-add opportunities.

I would also like to provide a few update on our Kempsville Crossing redeveloping asset in Virginia Beach. The new Wal-Mart neighborhood market construction is on schedule and on track to open in the fourth quarter of this year. As a result of the much anticipated opening of Wal-Mart within the local market, we’ve seen an uptick in our leasing activity at the center. We signed two new leases during the second quarter at substantial increases to expiring rents. Both tenants are expected to be open and operating by the end of the third quarter.

We also chose to renew one small shop tenant at Kempsville during the quarter at a 20% cash spread. We are confident in our ability to continue this pace and lease the balance of the space in the center at significant cash spread, which will drive our double-digit return on this redevelopment.

In closing, as we entered the second half of 2014, the cadence of positive leasing and renewal momentum from the first and second quarters set the stage for continued growth in our portfolio, specifically with new small shop tenants and junior anchors.

Looking ahead, continued commitments from well-capitalized restaurant franchisee, mom and pop service tenants, discount-oriented junior anchors and new grocery concepts will likely provide the basis for steady, predictable leasing and operating results for many quarters and years to come.

And with that, I give you, Phil.

Philip Mays

Thanks, Nancy and good afternoon everyone. In addition to our portfolio improvement and leasing progress, our balance sheet has also been strengthening. As Bruce and I started about three years ago this quarter, I will briefly highlight some of the balance sheet improvements that have taken place.

Since we arrived, our debt to EBITDA has decreased from an excess of 9 times to 7.7 times today and 7.5 times pro forma for the disposition of assets currently held for sale. Interest coverage has increased from 2.1 times to 3.1 times. Fixed charge coverage has also increased from 1.2 times to 1.8 times. And our encumbered NOI has increased from practically 0 to almost 60%.

Now these balance sheet metrics may drip up and down a little as we continue our capital recycling strategy aimed at upgrading our portfolio. However, we are committed to further strengthening our balance sheet as one of our core long-term objectives. In fact over the next few years we’ll have the opportunity to improve our balance sheet just with the ordinary course of business.

Let me walk you through a couple of ways this will happen. First, as discussed on this previous call, approximately one-third of our GLA is rolling between 2014 and 2016. We anticipate renewing or releasing this GLA with high single-digit cash lease spread and little capital investment. Second, we currently generate about $20 million annually of free cash flow. This free cash flow permits us to fund redevelopment opportunities or to simply repay debt. Although these may not appear to be immediate and exciting, when combined they will consistently drive incremental balance sheet improvement and organic earnings growth.

Moving to operating results. Operating FFO was $11.2 million or $0.14 per diluted share for the quarter compared to $9 million or $0.12 for the same period last year. Same-property NOI increased 2% for the quarter. This growth also included a favorable impact from re-leasing the dark anchor at Oakland Commons. Excluding this favorable impact, same-property NOI would have increased 1%. Notably, the new anchor has now been paying rent for a full year and this is the last quarter same-property NOI will be impacted by this specific lease.

And lastly guidance. With half of the year completed, we are raising the low-end of our full-year 2014 operating FFO guidance to an updated range of $0.52 to $0.54 per diluted share. This full-year guidance includes approximately $40 million of additional dispositions during the second half of the year and no additional acquisitions. This does not mean that we will not acquire any additional assets prior to the end of the year, but at this time no additional acquisitions are included in our guidance.

And with that, I’ll open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question is from Todd Thomas with KeyBanc. Please go ahead.

Todd Thomas - KeyBanc Capital Markets

Hi thanks. Good afternoon. Just a couple of questions I guess on your capital recycling efforts. First, Phil, I think you just mentioned what the disposition target would be for the back half of the year. I believe I missed it. So if you could just mention what that was again. But then more broadly, Bruce, I guess that the 10 properties that you mentioned you’re teeing up for sale, can you provide a range of expected gross proceeds for that entire bucket of properties and what should we expect from a timing perspective to shed all 10 of those properties essentially?

Bruce Schanzer

Go ahead.

Philip Mays

Yeah. Hi Todd. This is Phil. So year-to-date we’ve done about $85 million of dispositions, $25 million of that sure mall [ph] which really we kind of thought about it as under the old disposition program and delevering program. So we’ve done a little over 60 year-to-date as part of recycling and what I state is we do about another 40 on the back half, which will get us to about close to $100 million for the year in recycling disposition proceeds.

Bruce Schanzer

Todd, this is Bruce just to address your other question. So dividing up the pool of 10 into two buckets, those that are actively being marketed in those, that we characterize as being on deck. So the assets that are being actively marketed totalled about $35 million that Phil touched on, it gets us to the $100 million in total proceeds and then you have about an equivalent value in assets that are being teed up to be divested. In terms of the assets that we’re actively marketing, I would anticipate closing if we’re successful on what we’re doing right now, closing on all of those by the end of the year and/or certainly closed to that period of time and the on-deck assets ideally we get them closed again in that same timeframe, but there is a high likelihood considering the way these transactions worked that at least one or two of them slipped into next year.

Todd Thomas - KeyBanc Capital Markets

Okay. And in terms of pricing, you mentioned what the average cap rate on the four properties sold during the quarter and subsequently another quarter of 7.8%. Is that what we should be thinking about for these additional asset sales?

Bruce Schanzer

It really varies by asset. Some of the assets that we’re going to be selling are very low quality assets. So you’ll talk about flirting with potentially a 10 cap, but those are on assets that have very relatively little NOI. So I would say that, broadly speaking, if you look at the warranted cap rate for sort of the bottom half of our portfolio that is ultimately the part of the portfolio that we’re going to be selling, I would say that that’s probably the right zip code in terms of cap rate. So if you think back to how we described the spread between what we’re selling and what we’re buying from a capital recycling perspective, we’ve talked about it as being call it 150 basis points and that’s roughly what we’re seeing in terms what we’re selling versus what we’re buying and that’s how I would characterize it. The step for selling these particular 10 assets. Some of them are weaker assets, some of them are stronger assets but across the whole capital recycling effort, I would say that kind of mid-to-high 7% cap rate flirting with 8% is probably the right way to think about it.

Todd Thomas - KeyBanc Capital Markets

Okay. And then in terms of investments I know Quartermaster, it sounds like -- that basically gets you to 100 million target that you set out for the year and there's nothing else in guidance. But what's the pipeline look like today? I know you’re being selective and looking to conduct business off market, are you seeing anything of interest that that could hit this year?

Bruce Schanzer

Sure, we’re seeing a whole slew of interesting assets but again I will go back to the point you made in your introductory comment, which is that we’re being very selective. The reason why we are comfortable putting $100 million of acquisitions into our guidance is that we knew that the Quartermaster deal was likely to occur. And so we felt comfortable including that in our guidance.

With respect to prospective acquisitions, again I think that you characterized it very well. We’re focusing on off market opportunities and we have a healthy list of opportunities that we’re pursuing but we’re going to be very selective in terms of which ones we actually end up taking down. I think I've quipped before that we look at two or three deals a year – I mean, I am sorry, we look at two or three deals a week and we aspire to do two or three deals a year. So I think that, that's probably going to be consistent with -- certainly looking at two or three deals a week is certainly consistent with what Mike and his team and I have been doing. But I would say it's in the similar vein, we’ll probably end up doing two or three deals this year, including Quartermaster.

Todd Thomas - KeyBanc Capital Markets

Just one or two quick ones for Phil. I am looking at Page 12 in the supplement of that schedule, can you just give us an update on the mortgage for Fieldstone marketplace that came due last month of 6%, and also what we should expect with regard to the remaining 2014 maturities? And then also is there opportunity to pull forward any of the other debt maturing in sort of the out-years there?

Philip Mays

Yeah, sure, Todd. So if you recall we did two term loans early in the year, that totaled $150 million and that was basically what our maturities are mortgage maturities for all of ’14. So we’ve already pulled down the whole 150, we paid off, call it 120 or so in mortgages already and we took the extra 30 and reduced our line. So now we have that 30 availability on our line, so that this remainder of 30 million or so comes due over the rest of the year, that will just roll the line. So if you remember we just went ahead and refinanced all of the ‘14 maturities early this year.

As far as ’15, there is not an opportunity to move many of those, forward at all maybe a month or two. But most of them do not allow for prepayment and early payment.

Todd Thomas - KeyBanc Capital Markets

And then just lastly -- just a clarification on Page 23m why are certain properties held for sale or conveyance? Why are some included in results from continuing ops while Huntington Plaza and Maxatawny are in disc ops?

Philip Mays

Totally just for GAAP reasons, right? So they changed the rule, and something negative had been pushing for, for a while, as they look, when you sell a property that’s not a whole line of business, REITs are continually buying and selling and we shouldn’t have to do all this brain damage around discontinued ops. They were successful in our lobbying effort, accounting standard related to disc ops got amended such that selling individual property is no longer qualified as a disc ops. Most REITs – otherwise you could adopt that standard was January 1 of this year, so we did and most other REITs adopted it also. So generally you will not see a lot in disc ops anymore and this was just to help you clarify how much NOI is maybe running through disc ops versus how much NOI is in the face of the financial, the detail that you see when you’re doing your analysis, we thought it might be helpful to split the two out for you.

Todd Thomas - KeyBanc Capital Markets

Right, so the NOI from Huntington and Maxatawny which have not sold yet – that’s still -- that's running through disc ops at this point so – on a go forward basis.

Philip Mays

Right, and the NOI for the other assets that are above are in continuing ops. So we’re just trying to give you a little guidance since that came out and changed the classification of that. And we want to provide some assistance for you – when you run your model.

Operator

Thank you. The next question is from Rj Milligan of Raymond James.

Rj Milligan - Raymond James

Curious, following up on Todd’s questions about dispositions, just what the appetite is out there, if there's a particular asset size or type that there's a lot of demand out there for, and who is out there looking at those assets to buy?

Bruce Schanzer

So the way I would characterize the universe of buyers that Mike might amplify my comments is that the assets with very thin demographics and we have some assets that have again like our average density, 22,000 people. We have assets within that average that are less than 20,000, some of these very rural assets are susceptible to competition. Frankly, that’s why we are looking to sell them and some of those assets again have a hard time attracting super aggressive bids. As you start trending up into the kind of 30, 40, 50,000 people, 3 mile densities which again are – they’re not urban but yet they are not rural, they’re sort of secondary market type assets, where they have healthy grocers, those actually do attract very aggressive bidding and we’ve seen a fairly a healthy appetite. And so just to give you a feel for the types of buyers, yet the buyers of the very thin density assets are typically non-institutional smaller scale buyers. The buyers of some of our – again bottom quartile -- bottom half assets that we’re selling that are in slightly more dense call it 30,000 to 50,000 people population densities are other REIT – other REITs or other – some non-traded REITs, some smaller public REITs that are finding – feel that these assets are more than adequate for their portfolio, it’s obviously where we've concluded that they are not appropriate for our aspirational portfolio which we hope will be again among the best of all shopping center REIT. So that’s how I would characterize it, a lot of the breakpoints really have to do with just how rural these centers are, and then obviously how – high quality the gross rent – I don’t know Mike if you want to amplify that or --

Mike Winters

Yes, I think Bruce has hit it right on the bull’s eye, characterizing the different types of buyers. But we do see – and you did ask what is I guess the most interesting product out there with the most demand, and that’s certainly the core assets in urban areas. We’ve continued to see compression of cap rates on those properties and I do not see it lessening in the near future.

Rj Milligan - Raymond James

And I know it’s early guys but how is Quartermaster shaping up relative to underwriting or is it too early to comment?

Mike Winters

So far we’re very careful in our underwriting of that asset, it’s performed probably a little bit better than we had hoped it would but the real upside in this center is how we leverage the 100,000 square feet of expansion potential and how we also use it to enhance the potential redevelopment of this asset [ph] and that’s all yet to come. So the real benefit of Quartermaster, we’re certainly benefiting from it now in the sense that it’s doing a little bit better than we had thought but the real benefit is going to be borne out by how -- have the ability and successfully execute on investing into that center and using it as a way to invest into South Phil.

Operator

And the next question is from Craig Schmidt of Bank of America.

Craig Schmidt – Bank of America/Merrill Lynch

With the total portfolio leased at 93.3%, what would be the physical occupancy relative to that number?

Nancy Mozzachio

Craig, it’s Nancy. Physical occupancy is roughly 110 basis points, less than that, and it’s an interesting number because if you look back historically for us from a physical occupancy standpoint, where we stand today is roughly where we were in 2008 and on the lease side, for overall occupancy, we’re basically at number where we were in 2007.

Craig Schmidt – Bank of America/Merrill Lynch

And then how long do you think that vacancy will get occupied, or how long will it take for that?

Nancy Mozzachio

In terms of the spread between lease rate, I would say quite a bit of it has been done already and we expect, I would say, a high percentage of it to be reflected in balance of 2014. We lease, for example, Michaels at Brickyard Shopping Center that will likely translate to revenue in 2015 but much of what we have, including the Walmart deal in Kempsville in Virginia will be reflected in the latter part of 2014.

Craig Schmidt – Bank of America/Merrill Lynch

And then just, we've been hearing from some of your peers that they're able to put in some stronger contractual annual bumps into leases. Are you having any success in that area?

Nancy Mozzachio

Interesting you say that, as we have mentioned previously we have a significant amount of square footage rolling over the next three years. And one of the methods that we’ve implemented quite successfully is importing annual escalators into many of those leases particularly with the small shop. Quite frankly our numbers are strong at 9% cash spread but if we were to cut flat rent deals, for example, we would likely be in the double digit but we’ve intentionally focused on gaining those kinds of escalators. So I would say that, that’s absolutely true for us.

Operator

Thank you. We have no further questions in queue at this time. I would like to turn the floor back over to Mr. Schanzer for any closing remarks.

Bruce Schanzer

Thank you for participating in today's call. We continue to process of causing Cedar to be a leading shopping center REIT as reflected by our consistently improving operating results and value per share. We appreciate your investing the time to follow our progress and hope to maintain our positive trajectory. Have a good evening.

Operator

Thank you ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.

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