STAG Industrial's (STAG) CEO Ben Butcher on Q1 2018 Results - Earnings Call Transcript

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About: STAG Industrial, Inc. (STAG)
by: SA Transcripts

STAG Industrial (NYSE:STAG) Q1 2018 Earnings Conference Call May 2, 2018 10:00 AM ET

Executives

Matts Pinard - IR

Ben Butcher - CEO

Bill Crooker - CFO

Dave King - Director of Real Estate Operations

Analysts

Sheila McGrath - Evercore

Jamie Feldman - Bank of America Merrill Lynch

Blaine Heck - Wells Fargo

Michael Carroll - RBC

Mitch Germain - JMP Securities

John Massocca - Ladenburg Thalmann

Chris Lucas - Capital One

Dave Rodgers - Robert W. Baird

Operator

Greetings, and welcome to the STAG Industrial First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Matts Pinard, Vice President of Investor Relations. Thank you, sir. You may begin.

Matts Pinard

Thank you. Welcome to STAG Industrial's conference call covering the first quarter 2018 results. In addition to the press release distributed yesterday, we posted an unaudited quarterly supplemental information presentation on the company's website at stagindustrial.com under the Investor Relations section.

On today's call, the company's prepared remarks and answers to your questions will contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. Examples of forward-looking statements include statements relating to earnings trends, G&A amounts, acquisition and disposition volumes, retention rates, debt capacity, dividend rates, industry and economic trends, and other matters.

We encourage all of our listeners to review the more detailed discussions related to these forward-looking statements contained in the company's filings with the SEC and the definitions and reconciliations of non-GAAP measures contained in the supplemental informational package available on the company's website. As a reminder, forward-looking statements represent management's estimates as of today. STAG Industrial assumes no obligation to update any forward-looking statements.

On today's call, you will hear from Ben Butcher, our Chief Executive Officer and Bill Crooker, our Chief Financial Officer.

I will now turn the call over to Ben.

Ben Butcher

Thank you, Matts. Good morning, everybody and welcome to the first quarter earnings call for STAG Industrial. We're pleased to having you joining us and look forward to tell you about our first quarter results. Presenting today in addition to myself will be Bill Crooker, our Chief Financial Officer, who will discuss the bulk of the financial and operational data. Also with me today are Steve Mecke, our Chief Operating Officer, and Dave King, our Director of Real Estate Operations. They'll be available to answer questions specific to their areas of focus.

The first quarter was a great way to start 2018. The team was very busy on all fronts. For the quarter, the platform produced 4.9% core FFO per share accretion, while maintaining leverage at the low end of our target range. We continued to identify accretive opportunities, closing 79 million of acquisitions at a 6.7% stabilized cash cap rate. The team also closed on $50 million of opportunistic dispositions, resulting in a gain of 23 million and an unlevered IRR of 13.5%.

Particularly notable was a disposition that generated 32 million of proceeds and was sold at a 6.2% cap rate after we accomplished various building improvements and extended the lease. We acquired this building in 2010 at a 9.2% cap rate. The leasing team was just as busy during the quarter that featured our largest lease expirations schedule today. The team signed leases for 3.3 million square feet, resulting in 9% positive leasing spreads.

Notably, we achieved an 83% retention rate for the quarter. Tenant confidence continues to be very high. Tenants are signing longer term leases with higher contractual rate bumps generally between 2.5% and 3%. This quarter, we were able to achieve greater than five years of term on our renewal leases and over seven years of term on our new leases, both longer than our historical average.

Our operating platform delivered results that clearly demonstrate the strength of the industrial sector. The industrial sector's health is both general and specific to the markets in which we operate. We are seeing strong tenant demand for our buildings, declining vacancy and rising rents across the majority of these markets. By most accounts, the supply demand imbalance is at or near equilibrium for the US as a whole. However, there is excess supply being delivered in five or so large primary markets.

This would suggest that the remainder of the primary markets, which are 200 million square feet or greater and secondary markets 25 million to 200 million square feet must have relevant better supply demand characteristics from those few oversupplied primary markets. The demand for our buildings is generally tied to consumer demand and population and GDP growth, but we continue to see the incremental demand from the growth of e-commerce.

Our exposure to e-commerce in our portfolio has risen greatly over the past two years, with now approximately 35% of our buildings having an e-commerce activity within the building. We believe this incremental demand driver will persist for the foreseeable future. We are very optimistic for 2018. We've had a great start to the year and we plan to take advantage of the persisting opportunity to acquire accretive acquisitions. We plan to do this while simultaneously recycling assets at attractive prices.

In March, we announced the appointment of Michelle Dilley to our Board of Directors. She brings a strong background of supply chain management and logistics expertise as well as valuable perspective into the evolving needs of distribution and warehouse tenants.

With that, I'll turn it over to Bill to provide more detail on our first quarter results.

Bill Crooker

Thank you, Ben and good morning, everyone. Before I begin, I would like to remind everyone that beginning this quarter, STAG's disclosure of certain non-GAAP operating metrics such as same store, retention and releasing spreads are consistent with our industrial operating peers as discussed in our joint release from January. These changes did not have a material impact to our disclosures. Additionally, effective January 1, we have adopted the GICS classification for our industry disclosure in our supplementary reporting package.

The first quarter puts the company in position to achieve and potentially exceed the 2018 business plan communicated in February. Core FFO was $0.43 for the quarter, an increase of 4.9% as compared to the first quarter of 2017. Retention was 83% on the 5.6 million square feet expiring in the quarter. For context, the 4.6 million square feet renewed in the first quarter of 2018 was greater than the amount of space renewed for any given calendar year during the company history.

Same store cash NOI decreased by 80 basis points, which was better than previously forecasted due to the higher than expected retention of releasing spreads for the quarter. Given this outperformance, we are raising our annual same store guidance to positive 25 to 75 basis points from our previous guidance of flat to positive 50 basis points. We are also increasing our expected retention guidance for the year to between 75% and 80%.

The 2018 annual same store pool represents approximately 80% of our total portfolio as of the first quarter. The 20% of the portfolio that is not included in 2018 same store pool has annual fixed rental bumps of approximately 2%. While excluded from this same store metric, these assets contribute to core FFO. Our balance sheet continues to be very strong as evidenced by a BBB rating, which was affirmed by Fitch in March.

We have not issued common equity this year and leverage was 5.1 times on a net debt to run rate EBITDA basis at quarter end. Including subsequent acquisitions and dispositions, our leverage remains at 5.1 times today. Our fixed charge coverage ratio was 4.2 times and our liquidity is $312 million.

In March, we drew $75 million of the previously undrawn $150 million term loan. This term loan is fully swapped with an all-in interest rate of 3.15%. In April, we closed a $175 million private placement transaction with a weighted average interest rate of 4.2%. The transaction consists of two tranches, 75 million of 7-year notes with a coupon of 4.1% and 100 million of ten-year notes with a coupon of 4.27%. Funding is expected to occur in June.

For comparison purposes, the ten-year treasury had risen 50 basis points in the three and a half years since our last 10-year private placement transaction. Despite that increase and because of the contraction in credit spreads, the all-in rate for this transaction reflects a 5 basis point decrease when compared to this previous transaction. Also, the 7-year treasury had risen 100 basis points in the 2.5 years since our last seven-year private placement transaction and the increase in the cost of debt for this tenure was only 12 basis points when compared to the previous transaction.

Although long term rates have increased over the past few years, spreads have compressed almost on a one for one basis, resulting in little to no increase in the overall cost of long term private placement debt.

With that, I will now turn it back over to Ben.

Ben Butcher

Thank you, Bill. Our focus remains on delivering bottom line performance for our investors, while maintaining a defensive balance sheet. As previously noted, our core FFO per share grew by 4.9% and leverage remains conservative. We intend to maintain balance sheet flexibility and keep our leverage comfortably below the upper end of our target range of five to six times. We'll continue to look to deploy our available capital to its highest return. Currently, this is further accretive acquisitions. As demonstrated this quarter and in the past, we have and will execute on asset and portfolio sales as a source of capital.

We thank you for your time this morning and for your continued support of our company.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Sheila McGrath with Evercore.

Sheila McGrath

Dispositions were larger than we had expected in first quarter. I was just wondering if you could give us any more color on pricing, IRR or why those assets were chosen for sale and any guidance for dispositions for the year.

Ben Butcher

Those were opportunistic dispositions. So they're tied in to when the buyers were interested in buying these assets. We gave a little bit of color on the IRR and the cap rates in the body of our remarks today. We're going to continue to expect to sell between -

Bill Crooker

Yeah. Hi, Sheila. I think we continue to expect sell between 100 million and 200 million for the year. And as Ben mentioned in the prepared remarks, it was 13.5% unlevered IRR on the two dispositions in Q1, both were opportunistic.

Sheila McGrath

Okay. Sorry, I missed that. And then then just curious Ben on your big picture thoughts on the DCT news. Are there premiums paid for aggregated industrial portfolios, just your thoughts on the transaction market and that -

Ben Butcher

I think - well I will start off by saying, I was a little surprised on a public transaction occurring in these days of such aggregated private capital. But having said that, when in the past, our experience has been aggregating portfolios of smaller variety, five to ten assets. We've seen, in our history of doing that and some of them, 100 to 150 basis points of cap rate compression between the individual asset pricing and the portfolio pricing. We have suggested in the past that there's another leg in that transaction, as you move from that small portfolio to an enterprise, i.e., assets that are being operated by an operating entity, there should be another 100 or more basis points of cap rate compression.

We would look at the DCT transaction, we're not surprised that the DCT was the target of acquisition attempts. It's a well-run company with nice assets, a very clean story, but the 4.1 or 4.2 cap rate to us represents that next leg up in terms of, it's an enterprise with operating characteristics and there is since development expertise.

It's worth noting however that PLD already had that evolved expertise. So presumably, that wasn't much of the equation, perhaps, the development opportunity, but not the expertise. We're very confident of our ability to produce growth going forward through our execution of relevant value purchase, but as similar to what we think some of our peers like DCT can produce by developing assets. So we're very encouraged by the mark that occurred with the DCT purchase and we think it's consistent with the opportunities that exist within the industrial market.

Operator

Our next question comes from the line of Jamie Feldman with Bank of America Merrill Lynch.

Jamie Feldman

I guess can you just talk about the leasing market and maybe just across your different, whether it's asset quality or locations, where you are seeing the most demand across the portfolio.

Ben Butcher

I think we're seeing general tenant confidence. I think, the industrial tenants probably have been, by our observation, is encouraged by the tax law changes, any group out there. We're seeing capital expenditures in the assets, longer lease terms, shorter down time, all the things you might expect from more confident tenants. I don't think that there is particularly any particular - class or sector of asset that there is more - relatively more than others. Dave?

Dave King

It was pretty broad based, Jamie. The major point of sensitivity for tenants is, that means labor. So provided we have a big labor pool surrounding our buildings, they're in compete well. But the demand seems to be broad based.

Ben Butcher

Jamie, on that point, you've heard I'm sure from some of the other CEOs and other market commentators the evolution of the Amazon effect which was - it used to be, everyone has got excited when Amazon announced they were going into the neighborhood where they had a building and now there's some level competition because they might suck up all the available labor. So the Amazon effect has reversed over the last few years where they now are considered a very tough competitor for labor.

Jamie Feldman

I'm sorry. I missed it. I just want to make sure I heard it. Did you say 100 million to 200 million of dispositions this year?

Ben Butcher

Yes. That's right. And that three days are - in the body of our remarks today, I think we're a little stronger in our statements about the consideration of portfolio sales. The 100 million to 200 million was based on opportunistic and non-core dispositions, if you will, granular dispositions. We are now saying that we will contemplate a portfolio sale within the year.

If indeed, but it could add to that number, we're not committing to add that number at this point, but it could be - it's really something we will actively consider.

Jamie Feldman

Okay. And then I guess just thinking more broadly, so you said 2.5% to 3% rent bumps, can you help us through like the growth that this company can produce? It's kind of a normalized date. So if you aren't getting 2.5% to 3% rent bumps, so what does like a normalized internal growth rate look like?

Ben Butcher

Yeah. The normalized internal growth rate, Jamie, would be after we had a stabilized portfolio. As we've discussed in the past, as we acquire primarily 100% occupied buildings, there is an occupancy normalization weight that goes against that. In a normalized portfolio, with no rent growth, I think you're looking at that 2.5% is probably - 2% to 2.5% is probably a reasonable number.

Obviously, there's a better rent - as long as the markets continue to have rent growth that exceeds, so the contractual rent bumps, then you'll see - you might see growth is larger than that, to the extent, we move into a point of the cycle where rent growth falls off to the lower than contractual rent bumps that weigh on same store numbers going forward. We think that our portfolio will produce through the course of the cycle at or about the same internal growth as a portfolio that was more concentrated in primary markets or more concentrated in coastal markets or whatever. That has been the history and that's what the data shows. Could the world have changed around us? Possibly. But again that's what the history has shown.

Jamie Feldman

Okay. And then I guess I was also going to ask about the external growth piece of it. So you didn't hit the ATM this quarter. You've done some asset sales, like how do we think about your ability to recycle capital and generate growth through that based on the type of capital?

Ben Butcher

Yeah. I think what we've suggested earlier in our responses was our experience has been on small portfolio sales on the level of 100 to 150 basis points of cap rate compression, contemporaneous cap rate compression between where we can buy those individual assets and where we can sell the portfolios. And having said that, obviously, it's a very accretive transaction for us to buy assets, say at 8 and sell them at 6.5. If that was the type of accretion that occurred. So we can do that. We have - it has been better for us to raise new equity and buy assets as long as equity pricing is sufficiently attractive. We have not raised equity as you've noted in the first quarter.

We've taken advantage of the fact that we were at the lower - indeed below the lower end of our leverage range going into the year. So we've used asset sales combined with leverage to execute on our acquisitions to date and we can continue to do that throughout the year without having to raise equity and stay within our promulgated balance. We are not likely to do that because we are we know - our goal is to maintain a defensive balance sheet. So we will look to continue to do dispositions hopefully with some recovery in equity pricing to issue equity, but we have the flexibility through asset disposition, through the use of leverage to operate for a considerable period of time without having to raise equity.

Jamie Feldman

I guess what I would also ask is, what's the spread between where you can sell and where you can buy? I know you can buy and shrink cap rates, compress cap rates before you sell, but in terms of like on a same year basis, what's the spreads?

Ben Butcher

Contemporaneous. It's 100 to 150 basis points. That portfolio sale we did in some of that areas, those assets we were buying exactly at the same time, roughly exactly the same time as we're selling the portfolio to 6.9 cap. We're buying equivalent assets that are in 8.4 cap.

Operator

Our next question comes from the line of Blaine Heck with Wells Fargo.

Blaine Heck

Ben, you hit on this briefly, but in looking at the portfolio characteristics, you guys are roughly 41% in primary markets, 51% in secondary and 7% in tertiary. At this point last year, those figures were 25% primary, 65% in secondary and 10% in tertiary, seems like a big shift. Is any of that shift reclassification of the markets or is it all through asset recycling? And then where do you guys see those figures this time next year or maybe the year after it?

Ben Butcher

It's a combination. So we have been buying probably in more primary markets, but we also went through in the classification we use for primary remarks is 200 million square feet or greater. We have been using a market list that was derived at around the time of our IPO and there are now five more markets that have risen to be in the primary market. So there's a total of 34 markets that are 200 million square feet here, for instance, Charlotte has gone from sub 200 million to over 200 million. So, a market that we're particularly active in. So a fair amount of that is because of reclassification. However, we also have been buying more assets in the primary market. So it is to some degree mix as well.

Bill Crooker

And we have not been acquiring really in the tertiary markets at all, Blaine.

Ben Butcher

And as to your question on where we're going, I think you would expect the primary market concentration to continue to increase.

Blaine Heck

Bill, we've talked about this before, but it looks like again expenses were up pretty substantially 12% on a same store basis. Is that still just higher taxes that are fully recoverable as we've discussed before. Is there anything else going on that we should be aware of?

Bill Crooker

This one's really just driven by occupancy change, the same store pool. So you're getting some recovery of that, but the occupancy change increase the occupancy decreases in the same store pool and increases the expenses.

Blaine Heck

And then on the retention, just wondering if there's any reason for the higher retention that's expected this quarter. You guys typically I think point to tenant expansions as the reason for most of your moveouts. So was this may be a tenant that was going to expand that decided to stay put or is something else going on there?

Bill Crooker

I put it to mix. Our long term expectations for retention probably haven't changed very much. We're hitting a bunch and so it's not a small group of tenants. We have the largest role ever in the first quarter. It's just tenants are happy what the buildings that we're not seeing a reasonable.

Dave King

Yeah. The guidance really is just a budgetary exercise, so we had made some calls and some stays and goals and we were able to exceed that this quarter and that's therefore up - increased our guidance for the year.

Operator

Our next question comes from the line of Michael Carroll with RBC.

Michael Carroll

Hey, Ben and Bill, I wanted to touch on more on the leasing activity that you saw during this quarter and how it compared to your expectation. So I just want to get the street, the increase in guidance, was that mainly due to the strong activity you saw in the first quarter or do you expect to see better activity throughout the year.

Bill Crooker

I think primarily, the increase in guidance for the year was due to the higher than expected retention. The new leasing contribute to it a little bit, but is really the retention that drove the increase in the same store guidance for the year.

Michael Carroll

And that's retention that you already realized this quarter, not what you expect to realize going forward.

Bill Crooker

That's right.

Michael Carroll

Okay. And then can you talk a little bit about your leasing spreads? I know you guys had some pretty good leasing spreads you recognized during the quarter. What really drove those - that bump in cash rent?

Ben Butcher

On the new lease side, there was a handful of tenants that rolled - that we signed within that 900,000 square feet, one of which was a below market lease, which we rolled up almost 50% to market and the other four rolled up on average mid-single digits. So, it was fairly widespread but driven primarily by the one large rollover rent.

Michael Carroll

And those are just typical industrial buildings.

Ben Butcher

Standard industrial buildings, warehouse distribution and the large role was in the Greenville, Spartanburg area where we were able to successfully acquire two additional buildings this quarter in that same market.

Michael Carroll

Okay. And then what would the spread be on the leasing statistics if you exclude some of those positive rollups.

Ben Butcher

Well, if we exclude that one, as I mentioned, it would be mid-single digits on the new leases. So call it mid-single digits on the total weighted averages. That's where the renewals were. But it's a blend.

Operator

[Operator Instructions] Our next question comes from the line of Mitch Germain with JMP Securities.

Mitch Germain

Has anything changed with regards to your underwriting in terms of maybe markets, the type of tenants, the industry is your specific focus. I know you mentioned e-commerce previously. Is there any sort of shift that you're making?

Ben Butcher

Mitch, our focus is on delivering the most cash flow we can to our shareholders. Not only today, but tomorrow and going forward through time and we find by looking seamlessly across 65 or so markets for the best individual transactions on a relative value basis that we can find. Our mission is to identify and underwrite the risk, so we're not only getting returns, we're getting good risk adjusted return for the expenditures that we make in acquiring these assets. So we're conscious of introducing risk into the portfolio by undue correlation. So for instance, our auto exposure and some other things are things that we pay attention to, but we're confident that our - we have not introduced a lot of the risk into the portfolio, because we haven't paid attention to those particular metrics.

Operator

Our next question comes from the line of John Massocca with Ladenburg Thalmann.

John Massocca

So going back and be touching on the potential for portfolio transactions, are those maybe more attractive today versus say a year ago, given price compression where you bought the assets that would be in a portfolio versus where you could dump today as opposed to kind of where you could redeploy the capital versus where you could sell the portfolio?

Ben Butcher

I think that there's no question that whatever cap rate compression that occurred last year might be reflected in the portfolio evaluation, but it is also reflected in the individual assets. So I don't think that the - at least, we have not yet identified an increasing spread between individual asset cap rates and the portfolio cap rates. Should we market a portfolio, we'd be happy to discover as it has gotten bigger, but our expectations are that that kind of spread has not changed. So again, contemporaneous individual assets versus portfolio, we're continuing to expect that 100 to 150 basis points.

John Massocca

Understood. And then G&A came in pretty well below guidance, but your full year guidance remained unchanged. Is there something in that that maybe you're kind of expecting that - you were expecting in 1Q that's going to maybe get shifted out to later quarters in terms of the G&A hit?

Ben Butcher

Fair value. And if you will, we're trying to add some with our compensation will be, especially in the non-cash compensation which varies with total shareholder return performance and frankly, our performance this year has not been at a level that would get us to the midpoint of the range that's reflected in our budgeting.

Bill Crooker

Right. And given that it's so early in the year, we didn't change our guidance, but if performance continued throughout the year, it would probably be at the low end of our G&A guidance for the year.

John Massocca

Understood. And then in terms of the balance sheet, as you look at the remainder of that term loan, is that something you would be thinking of pulling down for July, especially with the private placement expected to close in June?

Ben Butcher

Yes. We'll pull that down. We left some dollars on the revolver at quarter end, just to maintain some flexibility, the costs of term loans. The term loan has already swapped, so putting it on the revolver or draw the term loan really doesn't matter. So we'll draw that down before July and then we'll fund the private placements in June.

Operator

Our next question comes from the line of Chris Lucas with Capital One.

Chris Lucas

Just a quick question on the portfolio opportunity. I guess, just in terms of the characteristics that you would be looking for in terms of the kinds of assets or markets or tenants that would potentially go into this and then secondarily if you could maybe provide some sense of size and whether size is potentially dictated by sort of where the stock price is.

Ben Butcher

I think what we're going to do is work with some of our friends in the brokerage community to assess where the sweet spots are in terms of portfolio size and market response, in addition to which we would look at - to work with the brokers to identify a makeup of a portfolio that the investors receive by the market. When we sold that last portfolio, there was a very strong message from the brokerage community that geographic proximity study could drive in a day, it was very important to the potential buyer pool. I think there has been, in the market, recently a lot of appreciation for term. So maybe we'll look at a portfolio that has longer term leases in it, but again, that will be the determination we'll make in concert with our friends in the brokerage community about what the appetite is from buyers out there.

Operator

Our next question comes from the line of Dave Rodgers with Robert W. Baird.

Dave Rodgers

Ben, maybe for you or Dave. Wanted to talk a little bit about just any signs of bad debt that you're seeing and I did jump on late, so I apologize if you addressed this, I'll go back and read it, but any signs of bad debt, any thoughts in your own heads about recycling assets faster either in retail or some sort of other sector that you may be worried about or seeing some stress in.

Ben Butcher

Well, I will let Dave get into specifics, but I would say on a - within the concept that we've got an overlays, so if our perception of credit risk on a tenant is higher than the markets, that's an asset probably we could do well selling. If our perception of credit risk is lower than the markets, we understand for instance the situation we had in - with a few years ago where we were pretty sure they were going to affirm the lease, even if they went for bankruptcy. That's a place where probably that makes sense for us to hold on the assets, because we're going to get relatively more cash flow out of all the net assets in the market ascribes, the opposite obviously could occur too where we were - held an asset that we're pretty sure that we're going to project a lease in the bankruptcy and the market thought that that was not the case and was willing to ascribe more cash flow in the future for that asset. So that's a situation where it probably will make sense for us to sell.

Dave?

Dave King

Dave, the one specific challenge we have right now is, you probably read upon Bon-Ton stores liquidating their tenant in a lot of our assets from the date of the market. We're eager to get the building back. It's just well located, so great characteristics. So we view that as an opportunity rather than a stress.

Dave Rodgers

And from a financial standpoint, that kind of does not contribute a material amount of ABR to our portfolio?

Dave King

So I think the overarching answer is, there's not a lot - we don't see a lot of risk in the portfolio, we have a pretty de minimus exposure to the brick and mortar retail. And the exposure we have we feel pretty good about.

Operator

Thank you. Mr. Butcher, we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Ben Butcher

Right. Well, thank you, everybody for joining us. We're very encouraged about the fundamental strength of the industrial market, the continuing opportunities to identify accretive acquisitions and the strength of tenant demand and tenant confidence. We look forward to delivering good results for the rest of 2018 and thank you for your participation today.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.