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Alexander & Baldwin Inc. (NYSE:ALEX)

Q3 2007 Earnings Call

October 26, 2007 9:00 am ET

Executives

Kevin L. Halloran – Vice President of Corporate Development and Investor Relations

Allen Doane - Chairman and Chief Executive Officer

Christopher J. Benjamin – Senior Vice President, Chief Financial Officer and Treasurer

James Andrasick – President and Chief Executive Officer, Matson Navigation Co. Inc.

Stanley Kuriyama – Chief Executive Officer, A&B Properties Inc.

Analysts

Jonathan Habermann - Goldman Sachs & Co.

Jonathan Chappell - JP Morgan Equity Research

Christopher Haley – Wachovia Securities

Operator

Welcome to the third quarter 2007 Alexander & Baldwin earnings conference call. I’d now like to turn the call over to Mr. Kevin Halloran, Vice President of Corporate Development and Investor Relations.

Kevin L. Halloran

Before we commence, I will note that statements in this call and presentation that set forth expectations or predictions are based on facts and situations that are known to us as of today, October 26, 2007. Actual results may differ materially due to risks and uncertainties such as those described on pages 16-22 of the Form 10-K in our 2006 Annual Report and our other subsequent filings with the SEC. Statements in this call and presentation are not guarantees of future performance.

I would also note that slides from this presentation are available for download at our website, www.alexanderbaldwin.com. You will see an icon in the upper left and right hand corners of the home page that will direct you to the slides.

Now to the call. Joining me today from Shanghai are Allen Doane, Chairman and Chief Executive Officer, and Chris Benjamin, Senior Vice President, Chief Financial Officer, and Treasurer; also participating in the call, also from Shanghai and joining us for the question-and-answer portion, are Jim Andrasick, Chief Executive Officer of Matson Navigation and Stan Kuriyama, Chief Executive Officer of A&B Properties.

Slide 3 provides an agenda for our presentation after which we’ll take your questions. We’ll start our presentation with Allen, who will provide insight into the performance for the quarter and will also provide a high-level outlook for the balance of 2007.

With that, I’ll turn it over to Allen.

Allen Doane

Thank you, Kevin. Good morning everyone. Before talking about the financial results for the quarter, let me point out some noteworthy performance and trends for the quarter. I’m very pleased to note that we posted a very strong third quarter, with net income exceeding $49 million. It’s an impressive figure, particularly given some of the macro-headwinds that we’ve experienced recently; our strong outcome for this quarter was propelled by continued strength in shipping and a series of property sales in the quarter - more on this later on when we go through the individual segment reports.

I’ll also note that the credit and financial markets have been volatile over the last three months, and amid this turmoil, we made repurchases of our stock at an average price of just under $49 per share. We feel good about these repurchases.

On the operational front, our Matson China service continues to fire on all cylinders. We are running full as to be expected during the peak season and we are seeking the benefit and seeing the benefit of rate increases that we enacted earlier in the year. At MIL, we are being challenged by the current volume environment in the industry.

We spoke last quarter about anticipated sales of several of our income properties and I will note that we closed three of these properties during the quarter, demonstrating the strength of the commercial market in Hawaii. Our lease portfolio is performing at a very high level.

With that, let me provide a summary of the quarterly results. We posted operating profit of $91.5 million. Matson Navigation once again led the way, a reflection of its innovative China service and stability in the Hawaii trade. MIL posted a good gain, while our leased income portfolio posted essentially flat year-over-year results. You will note the exceptional results from our property sales, which includes not only the sale of three income properties but also our earnings from joint ventures.

And finally, our Agribusiness segment posted a loss of $3 million, which is directly attributable to a reduction in our sugar production forecast for the year.

On a year-to-date basis, our earnings per share are up 13% at $2.46 versus $2.18 for an equivalent period in 2006. Year-to-date performance puts us on a trajectory to close the year well ahead of 2006.

Turning to Slide 7, I will now make a few brief comments on our full-year outlook. You will note that we expect double-digit earnings growth in our two core businesses, well above our long-term targets. As we look out to year-end, we are pleased by the expected results. This year has had its challenges and we expect that macro-headwinds that we face today are likely to continue as we enter 2008. We will have more on 2008 on a webcast that we are planning for late November.

With those summary comments complete, I will describe the quarterly operating performance of each of the units. Let me start with Matson Navigation, which posted another excellent quarter amid a challenging volume environment in Hawaii. Matson’s favorable performance reflects the strength of our China service. We are sailing nearly full from China and are seeing the benefits of rate increases that emerged from our recent contracting season, along with improvements in our cargo mix.

In Hawaii, while our container volume was down 4%, favorable yields provided support and we were able to respond to volume softness by continuing to press hard on our operating efficiencies to stabilize margins.

We did see a surge in auto volume, which reflects rental fleet replacements. And finally, our mix and yield were favorable in Guam. The coming military presence there is still ahead of us, but we did see an increase in volume of 9% even in this early stage.

For the balance of the year, we will continue to focus on implementation of cost containment initiatives to offset the flat volume forecast for the Hawaii markets, and we will seek to extend the China peak season into December. As we mentioned before, contractual wage increases in our shoreside and sea marine operations, coupled with more limited fleet deployment flexibility, should return margins to a more historic 10% range in the fourth quarter. We will also see less lift from our China service for the year-over-year comparison in the fourth quarter because we were sailing full for the last quarter of 2006.

The logistics segment produced another favorable quarter amid an increasingly challenging volume environment in the intermodal sectors. MIL boosted its gross margins, the positive year-over-year variance resulting principally from a reduction of certain accruals, such as a lower provision for bad debts, and from an expansion of gross margin in key highway segments. We are now forecasting modest year-over-year growth for MIL based on our near-term outlook. We do expect challenges in the fourth quarter, which we expect will result in an unfavorable comparison to 2006.

The real estate leasing segment produced another solid quarter of earnings based on high portfolio occupancies; 97% and 98% respectively for our US Mainland and Hawaii properties. The $12.2 million in operating profit was off slightly from the same period in 2006, principally because in the third of quarter 2006, we had a favorable business interruption insurance gain that positively impacted those results.

Looking out, we expect continued market strength; however, given our recent portfolio sales, modest near-term revenue and margin compression is likely. Further, we’ve had positive non-recurring items that occurred in the fourth quarter of 2006; as such, a fourth quarter of 2007 comparison is likely to be unfavorable.

As we had mentioned, property sales were driven by three income portfolio dispositions in the quarter, which drove most of the variance from the year-earlier period. We also had additional sales from our joint venture projects. These results demonstrate the continuing strength of Hawaii’s commercial markets. We continue to benefit from binding contracts in place at some of our key residential projects. Additionally, we’ve had no material subprime exposure at these projects.

We have referenced our income portfolio sales a few times in the call. . Slide 16 provides detail for the two transactions involving the three properties. Two of the three property sales closed late in the third quarter and both offered compelling deal metrics. These sales are a good example of two core strategies: first, we solidly believe we have optimized value creation; and second, as you will see on Slide 17, we reinvested proceeds through tax advantage 1031 exchanges to grow our commercial portfolio.

Yesterday, we entered into a binding agreement to purchase an institutional grade seven building business park in Dallas, Texas for $102 million. The park encompasses 1.3 million square feet and includes an additional 28 acres of developable land. We expect to close this transaction in short order. The project is ideally located next to the Dallas Fort Worth Airport, and we’ve got a tenant roster of blue-chip companies, many in the logistics area. We own or have previously owned institutional property in Dallas, including an industrial retail and office building, for a number of years. We like the market; we like the location; and particularly, we like the property because we believe it’s very logistics-friendly. If you may recall in our recent strategic plan webcast presentation, we emphasized both logistics at MIL and logistics-friendly real estate.

And while we were pleased by the third quarter results, sales are inherently episodic. We feel good about the prospects of more property sales and are encouraged by the considerable construction and sales progress we are making at some of our key development projects. At Keola La’i, we topped off at the 43rd floor early in the quarter and are preparing for delivery of units of the binding contract in the first and the second quarter of 2008. We are now at the 90% binding level. At Wailea on Maui, we are well underway in the construction of new pipeline projects as we look to close out our delivery on the very successful Kai Malu joint venture over the course of the next six months.

On Kauai, sales at Kukui’ula are slowing, but we expect that as we build out the amenities over the next 18 to 24 months, sales velocity will increase. And finally, at Port Allen on Kauai, we have closed and delivered the first of our primary housing index there.

We were frankly disappointed by the results from our Agribusiness segment. We lowered our production forecast for the year which resulted in an over $3 million loss for the quarter. In addition, the dry weather that plagued our production efforts early in the quarter also meant a decline in power sales.

Despite the production challenges, we believe we will finish the year in the black given the strength of our first-half performance. While regrettable, these production adjustments are part and parcel of the cyclical nature of large-scale farm production. That said, our Agribusiness unit provides support for our operations through Hawaii, including those at both Matson Navigation and our real estate business.

I will now turn the call over to Chris Benjamin who will speak about our financial condition and other pertinent matters.

Christopher J. Benjamin

Thanks Allen. I have just a few slides, and I’ll focus first on cash flows, then on capital expenditures, and finally, our recent share repurchases. On the cash flow statement, our operating cash flows were strong and approximated last year’s, with higher earnings modestly offset by the fact that our Keola La’i project is treated as real estate held for sale and therefore, CapEx on that project reduces operating cash flows. The largest year-over-year changes on the cash flow statement relate to the fact that last year, we completed a four-year vessel replacement initiative in the third quarter. You will see the much higher CapEx and much lower proceeds from the capital construction fund in 2006 as compared to 2007.

For those of you who are new to A&B, we make pre-tax contributions to the capital construction fund and then purchase vessels with these funds, effectively taking immediate tax depreciation for the assets and greatly enhancing our returns. These vessels also have improved our operating performance and facilitated mass inventories of the China trade.

Other cash flow items of note included a reduction in proceeds from disposal of property and sale of investments, which includes the 2006 return of our Hokua joint venture capital. Also, while we’ve undertaken share repurchases in each of the past two years, our 2006 year-to-date total repurchases were higher than our 2007 year-to-date repurchases at the end of September.

Moving now to the CapEx slide, through the first three quarters of 2007, we’ve made only about one-half of our intended full year capital expenditures; however, with the pending purchase of the Heritage Business Park and other planned capital spending for the fourth quarter, we expect to end the year in line with our original estimate.

I’ll also point out the line item for buyers’ deposits at Keola La’i. One of the several benefits of our disciplined approach to real estate investments is the strength of our underwriting, and in particular, our practice of securing a majority of the binding contracts and deposits before commencing construction. These buyer deposits are an important source of construction financing. Now, on the cash flow statement, buyers’ deposits partially offset the capital expenditures required for our real estate development held-for-sale, and in turn improved our investment returns.

Moving now to my last and favorite slide, I’d like to elaborate on our recent share repurchase activity. Market volatility, as Allen indicated, can create opportunities. We have spoken at length in the past about our desire and willingness to execute share repurchases. During the quarter, we purchased over $12 million worth of our company shares, at an average price of less than $49.

We have a track record of well-timed repurchase activity. You’ll see that we’ve entered the marketplace when we believed that the time and the price were right, always treating repurchases as an investment decision that requires the same rigorous discipline we apply to all of our capital allocation decisions. We have an ongoing appetite for repurchases, and a current authorization for an additional 1.7 million shares, should opportunities present themselves again in the future.

On a final note, I should mention that I’ll be representing the company at the upcoming Stephens Fall Investment Conference in New York City. We are scheduled to present on November 15th, and you should see a notice with the details of that event soon. We will be webcasting that event.

With that, I’d like to turn the call over to Kevin, who will take us through an economic and market outlook.

Kevin L. Halloran

Thank you, Chris. As you will note on Slide 26, the Hawaii economy is stable, despite a modest adverse impact of a reduction in visitor arrival counts. We’ve posted the three most recent annual forecasts for key metrics in the health of the Hawaii economy to demonstrate this stability and also to describe the excellent underlying fundamentals of this economy. Unemployment is at an exceptionally low rate and there has been a measurable uptick in real personal income growth in the most recent forecast.

When we look at the commercial real estate environment, we are very healthy. Honolulu has the highest industrial rent rates in the nation, and the annual rent of over $14 described in this slide is almost three times the national average. For a little bit of perspective, the next highest annual rate is in San Francisco at just over $10 per square foot. Many of you may have seen the recent New York Times coverage about the exploding retail presence here in Hawaii. According to that article, beside the market-leading low vacancy rate for retail space, retail property owners have been able to ratchet rents by 41% over the past four years. The office market is also robust; we are encouraged about our prospects here in both the short and long-term.

And while the commercial sectors are experiencing record growth, the residential markets have very clearly reached a point of stasis. We are pleased to see no price erosion in single-family home re-sales. Although sales velocity has slowed, we believe that the limited supply of primary housing in Hawaii provides strong pricing support.

While Hawaii has seen an increase in foreclosures in the most recent reporting period, we still have one of the lowest rates in the nation and do not believe that significant subprime exposure exists. The story is essentially the same for condominium re-sales - a mixed market depending on individual properties throughout the islands. That said, slide 29 clearly shows the stability of this asset class over the past 30 months on Oahu, where the majority of these sales occur. This stability underscores the supply constraint that characterizes most real estate activity in Hawaii.

With those remarks in hand, I would like to turn the call back to Allen for his closing commentary and remarks.

Allen Doane

This will be brief. Just wrapping up the formal portion of our presentation, let me note once again that we will be scheduling another webcast, probably in late November, to review the company’s business outlook for 2008.

We do welcome your questions at this time.

Question-and-Answer Session

Operator

Your first question comes from the line of Jonathan Habermann - Goldman Sachs.

Jonathan Habermann - Goldman Sachs & Co.

First question concerning the real estate sales, could you just talk a bit about the reasons for selling? Is this simply there is no more value or you fully realized the value there? And secondly, why Dallas? I know it looks like an interesting opportunity, but can you talk about the yields you are forecasting and how much incremental dollars you might invest for potential future development there?

Allen Doane

Stan, why did we sell and why did we buy?

Stanley Kuriyama

This is just a continuation really of our core strategy. So, in the cases of these three properties, they really were unsolicited offers. But the properties, in the case of the two shopping centers, were fully mature. We had maximized value. Prices that came in for these properties were at full value, so it was a good time to sell.

And as far as Dallas is concerned, we’ve been in the market for a number of months looking for replacement properties. We really liked this Dallas property. It’s in a great location - it’s immediately adjacent to the Dallas Fort Worth Airport. We like the logistics angle of this purchase. I think certainly on a long-term basis, this can complement our logistics business at Matson. We bought this property at a low-6 cap rate and the properties we sold were a sub-6 cap rate. We got a spread there and of course, we are using the 1031 benefit to enhance our returns from that Dallas investment.

Jonathan Habermann - Goldman Sachs

What sort of growth do you anticipate from that property?

Stanley Kuriyama

Market rates of growth; it’s fully occupied. Rents are at or slightly below market, but we don’t anticipate any unusual growth there, but we do expect that it will grow consistent with the market.

Jonathan Habermann - Goldman Sachs

In terms of just anticipated property sales heading into next year, do you anticipate having a few more of these types of sales?

Stanley Kuriyama

Yes, we do. We are evaluating various sales prospects now and we will continue to have these sales throughout the year.

Allen Doane

I will just emphasize that this is a pretty big whopper of a quarter here, both in terms of a sale and some reinvestments, but it is a long-term strategy for the company that we’ve replicated year-after-year. We think we are going to do the same thing in ‘08.

Jonathan Habermann - Goldman Sachs

I have just one quick question for Jim, switching over to Matson. For the cargo mix going into Hawaii, have you seen that change materially over the last six months to a year, and given your outlook for the Hawaiian economy, just where do you see volumes going in the future?

James Andrasick

Yes, we have seen a change, and predictably, it’s been in the building products segment. We’ve also had a rundown in auto volumes. I think the third quarter of this year, as you can see from the stats, is a little unusual because we had a surge, but year-to-date, we are down in autos. I think those two areas are the principal changes. As far as the outlook for the near-term and perhaps the next 12 months, it goes in line with a fairly stable Hawaii economy. And consistent with Kevin’s review of that economy, I do not foresee nor do we project any significant mix shifts from what we’ve seen during the last six months.

Operator

Your next question comes from Jonathan Chappell - JP Morgan.

Jonathan Chappell - JP Morgan Equity Research

Follow-up to a comment that Allen made in response to the last question about a whopper of a third quarter, you obviously gave us some insight on the last conference call, some forewarning that there would be some income-producing sales in the second-half of the year. I noticed that most of these sales were done late third quarter. I know you don’t give guidance, but as you look at the fourth quarter, were these three that were done at the end of the third quarter supposed to be the second-half allotment? Or do you think there is still the potential to get some sales done before year-end?

Allen Doane

Yes, the one I’m talking about, the whopper, was the single sale that we did in Honolulu. That is a pretty extraordinary one for us. The other two that we did on Maui that Stan referenced were sort of more in the normal course. And by the way, one of those was not a fee-owned property, it was leasehold. You can get a sense of where we are going based on slide 7 in terms of our full-year outlook, and those metrics would suggest that we do have some sales planned for the fourth quarter.

Jonathan Chappell - JP Morgan Equity Research

But not a whopper?

Allen Doane

It’s not going to be a whopper. We are not at the stage yet where we’re earning $50 million a quarter.

Jonathan Chappell - JP Morgan Equity Research

Just a second question regarding the logistics business: clearly it has been a focused growth, but some of the comments in the press release and in your call offered tempered expectations, at least for the near-term. Is this making you reassess the strategy in the near-term, or does the potential near-term weakness in logistics provide more opportunities in your opinion to accelerate the growth in that market?

Allen Doane

We’ve got some plateauing here after a period of steep growth in the business. That’s not totally unexpected and it’s partially a result of economic conditions and just partially a result of having performed very well and gotten ourselves to a pretty high level of performance at MIL. But the answer to the question is, we are more enthusiastic than we’ve ever been, and I think we were trying to convey that when we gave the strategic overview of how we saw the future. You can expect that we are going to do our best to begin to demonstrate a plan in place to continue to grow the business in logistics. Times like this in some ways are better for investment; they may not help the P&L that much, but they are certainly great for making investments. They are going to help you in the longer run.

Operator

Your next question comes from Christopher Haley – Wachovia Securities.

Christopher Haley - Wachovia Securities

Just following up on Jonathan’s question in terms of MIL, is it solely the slowing economic conditions that are causing the lower outlook for the fourth quarter? It just seems that if you are expecting modest growth that would probably be one of the weaker quarters that you’ve had over the past couple of years. While our economic conditions are slowing, it seems like it’s a moderate pace of slowing rather than something drastic?

James Andrasick

Volumes definitely have slowed throughout the industry, again, kind of an uneven mix of products and services, and we’re victims of that slowdown. But it certainly hasn’t dropped off the cliff; we did not intend to suggest that it was. This moderation is what we are looking to in the near-term that will affect the earnings performance of that particular unit, absent an acquisition or other corporate development activity.

Christopher Haley - Wachovia Securities

In terms of the Matson and ocean transportation, I think last quarter, it was stated that in the second-half of the year, there would be some dry-docking that would impact margins a little bit. The margins were pretty high in the third quarter. Is that all expected to hit now within the fourth quarter, given the margin outlook of 10% that Allen talked about?

James Andrasick

That’s certainly one element of it. We’ve had the heaviest vessel dry-dock schedule in probably the last ten or more years this calendar year, and it did have a certain impact during the first nine months. And I would say, yes, the fourth quarter may see a negative impact before we get every ship back into its normal deployment. I would also add that we do run a seasonal business here and we’ve added to that seasonality with the China service, because there is a peak period, of course, and it starts to fall off in late November-December. A combination of factors will likely moderate the margin performance going into the fourth quarter.

Christopher Haley - Wachovia Securities

Stan, Kevin talked a little bit about the upside for rents on Hawaii. I am just wondering what the rental rate growth profile should look like for the commercial portfolio over the next one-to-two years, both for the Hawaiian portfolio and Mainland?

Stanley Kuriyama

I would say that the Hawaii portfolio is probably going to have a greater growth than on the Mainland. I think retail rents are moving up nicely. Office rents probably will stabilize. We’ve had a nice uptick in office rents. Office rents will probably stabilize a bit in Hawaii. Industrial rents will continue to go up. In Hawaii, you could easily look at a 3% to 6% type of rental rate growth. Mainland, our properties there are fully leased, they are at-market rents. I wouldn’t anticipate anything above normal market growth rates on the Mainland.

Christopher Haley - Wachovia Securities

Do you have an estimate of - if you marked all your rents up to market - how much of a lift that would be? It sounds like on the Mainland, you are roughly in line with spot market rates; on Hawaii, is that the case as well? Is the growth going to be driven by continued growth in rental rates or is there a markup that you could get for new leases, just marking them up to spot?

Stanley Kuriyama

No, we don’t do that. We don’t engage in that type of exercise.

Christopher Haley - Wachovia Securities

Lastly, I appreciate the sales of the commercial properties and the big income recognition that you get, do you calculate what the economic return on that is, if the properties aren’t fully depreciated at their original cost basis, so we can get a sense of kind of what the IRR return is for some of those properties?

Stanley Kuriyama

Yeah, actually we do an IRR return on every property, both before we acquire it, when we sell it, and when we consider selling it.

Christopher Haley - Wachovia Securities

And can you offer some details on what some of the returns were for transactions in the most recent quarter?

Allen Doane

No, but they were impressive.

Stanley Kuriyama

One of the two Maui properties that we sold was leasehold, but in the aggregate, the sales cap rate there was a sub-6 cap rate. That was really an excellent price for us.

Christopher Haley - Wachovia Securities

You guys talked about the strengths in the commercial market in Hawaii. I know Allen, you’ve said that in terms of allocating additional investments, you would prefer to do investments in Hawaii first and then probably some industrial properties on the Mainland. Are you seeing any let-up in terms of buyers for commercial property in Hawaii or is it still a pretty tough environment there?

Allen Doane

I’d say , on the commercial side, it’s still a pretty tough environment. The residential market is no big surprise because it’s starting to be a little bit better priced. I think risk is starting to get priced into the residential side; in many cases, that’s been done. There is nothing atypical on the commercial side in Hawaii other than the fact that it’s just higher. Office values are not higher in Hawaii than they are in many large cities, but retail and industrial land values to the aggregate value of the investment, the land value is so high, that’s where you see the huge disparity because of land values in Hawaii. But there is really nothing that atypical. No, we don’t see real cracks on the commercial side or in any area frankly.

Operator

We have no more questions in queue. I would now like to turn the call over to Mr. Allen for closing remarks.

Allen Doane

We were in Shanghai two years ago at this time, and I won’t say we were quivering in our boots, but we were slightly anxious about this huge strategy of moving into China. Two years later, who would be thinking that our China business would be as strong as it is and that it’s been such a great growth story. Our China business has enhanced the brand name and the reputation of Matson at the same time that it has been a good investment. We’re really pleased to be in China and we hope that there will be other great growth stories that we’ll able to tell you about Matson, our real estate business in many places including China, in the future.

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