W. P. Carey's (WPC) CEO Jason Fox on Q1 2018 Results - Earnings Call Transcript
W. P. Carey & Co. LLC (NYSE:WPC) Q1 2018 Earnings Conference Call May 4, 2018 10:00 AM ET
Executives
Peter Sands - Director, Institutional Investor Relations
Jason Fox - Chief Executive Officer
Toni Sanzone - Chief Financial Officer
John Park - President
Brooks Gordon - Head of Asset Management
Analysts
R.J. Milligan - Robert W. Baird
Nicolas Joseph - Citi
Todd Stender - Wells Fargo
John Massocca - Ladenburg Thalmann
Operator
Hello and welcome to W. P. Carey's First Quarter 2018 Earnings Conference Call. My name is Diego, and I will be your operator today. All lines have been placed on mute to prevent any background noise. Please note that today’s event is being recorded. After today’s prepared remarks, we will be taking questions via the phone line. Instructions on how to do so will be given at the appropriate time.
I will now turn the program over to Peter Sands, Director of Institutional Investor Relations. Mr. Sands, please go ahead.
Peter Sands
Good morning, everyone, and thank you for joining us today for our 2018 first quarter earnings call. I would like to remind everyone that some of the statements made on this call are not historic facts and may be deemed forward-looking statements. Factors that could cause actual results to differ materially from W. P. Carey’s expectations are provided in our SEC filings. An online replay of this conference call will be made available in the Investor Relations section of our website at wpcarey.com, where it will be archived for approximately 1 year.
And with that, I will hand the call over to Jason Fox, Chief Executive Officer.
Jason Fox
Thank you, Peter, and good morning, everyone. I will start by briefly reviewing the market backdrops in some of our recent investments, and after that our CFO, Toni Sanzone, will take you through the key elements of our first quarter results, balance sheet and guidance. We're joined this morning by our President, John Park; and our Head of Asset Management, Brooks Gordon, who are also available to answer your questions.
Despite volatility in the capital markets, the first quarter was relatively routine for W. P. Carey, and one in which we continue to examine a significant number of investment opportunities, closing on a handful of the accretive deals that enhance the quality of our portfolio. Given our scale and long history investing in net lease, we believe we see virtually every opportunity out there, giving us unparalleled insight on market conditions. Generally, we continue to see evidence of late-cycle sentiment with motivated sellers displaying a willingness to transact, enabling buyers to regain some leverage. Market volume, especially for sale leasebacks, remained healthy, despite continued pressure on cap rates. And we are yet to see any direct evidence of cap rates reacting to the backup in 10-years treasury yields. However, if interest rates remain at current levels or move higher, we would expect to see cap rates increase later this year.
In the U.S., retail generally remains unattractive on a risk-adjusted basis, although we are finding pockets of opportunity given the negative sentiment towards receptor due to the disruptions from e-commerce. In warehouse and logistics, while we view the overall business fundamentals for this sector as strong over the medium term, pricing remains very tight, given the level of demand. In fact, we question whether current market yields provide enough return over the long term as we think it's likely that new supply will eventually overshoot demand.
Amid this market backdrop, we completed two acquisitions during the first quarter: the first with a $79 million sale leaseback with a large regional furniture retailer in the Midwest for a portfolio of three properties, including a warehouse facility; and two standalone retail stores. The portfolio represent highly critical real estate and a master lease with a good corporate credit, conservative management and a long operating history. The lease term is long at 25 years and has built in fixed rent increases. This transaction is a good example of the pockets of opportunity being traded by the broader disruption in retail. We view the furniture segment at retail as largely resistant to the threats in e-commerce. And in this deal, we were able to acquire high-quality retail assets that rank among the tenant’s highest grossing with very strong state-level coverage. Furthermore, the warehouse facility offers future expansion opportunities and was acquired at a significant cap rate premium to where general logistics assets are currently trading.
The other transaction we completed during the first quarter was the $600 million acquisitions of a warehouse facility in Indiana, within the Louisville MSA. The lease is guaranteed by the parent company, LKQ Corporation, which is the largest provider of recycled auto parts in the U.S. with an equity market cap of around $10 billion. It has more than 14 years remaining under lease and fixed rent escalations.
Moving on to the environment gear-up, where we generate about one-third of our annualized base rent, or ABR, and have had on-the-ground presence for over 20 years through our offices in London and Amsterdam. The economy in Europe generally remained strong, despite a recent slowdown, and geopolitical concerns seem to have eased. As a result, we expect capital to continue to flow into Europe, maintaining pressure on cap rates. Risk tolerance appear to be increasing with foreign capital moving into regions beyond the core northern and western countries, although we’re maintaining our focus on to our markets.
Similar to the U.S., logistics continues to be among the most sought-after asset classes and yields have compressed rapidly, although in the long term we expect it to be most resilient. While retail has been impacted by e-commerce, there is substantial activity across Europe, particularly for convenience retail and big box stores in good urban locations. Although we didn’t complete any transactions in Europe during the first quarter, we have significant near-term pipeline in the region and feel good about the progress we are making on a number of potential transactions.
From an asset management perspective, we continued to enhance our portfolio in terms of credit quality, lease term and asset criticality. The Astellas transaction we reviewed last quarter is a good example of this. We are creating significant value by converting a suburban office building into a state-of-the-art life sciences facility.
We also continued to refine our focus. Since the end of the quarter, we sold one of our two remaining operating hotels, leaving just one operating asset in our portfolio of close to 900 properties. In a geographic perspective, we continue to target North America and Northern and Western Europe as our core markets and plan to exit our two remaining investments in the Asia-Pacific region.
Turning briefly to our sources of capital. Over the last four years, we become regular issuers in the public debt market, and in February, successfully completed our sixth public bond offering, accessing the euro debt market for the third time. Demand was strong and we continue to build out the base of participating investors as well as reducing our issuance debt.
In addition to providing debt funding at an attractive rate of 2.125%, fix for nine years, the offering also maintain the natural hedge we have on our euro-denominated income and investments, reduced our exposure to floating rate debt and advanced our unsecured strategy by paying down mortgage debt.
Equity market volatility was high during the first quarter and looks likely to continue, given the uncertainty over the general economic outlook, impacted tax return -- reform, trajectory of interest rates and potential action of the Fed. By focusing on more structured off-market deals often at above market cap rates, we continue find attractive deals relative to our cost of capital. But we have also had a sizable disposition pipeline as part of our proactive approach to asset management to provide us with the flexibility to make new investments without an immediate need to issue equity.
In closing, we continue to execute on our long-term strategy to create shareholder value by maximizing recurring revenue streams, simplifying our business and enhancing the quality of our portfolio. In the near term, given the current strength of our pipeline and the breadth of opportunities available to us, we have confidence in our ability to increase lease revenues through same-store rent growth, accretive sale-leaseback and build-to-suit transactions as well discretionary capital project sourced from our existing portfolio.
And with that, I’ll hand the call over to Toni.
Toni Sanzone
Thank you, Jason, and good morning, everyone. This morning, we announced AFFO per diluted share of $1.28 for the 2018 first quarter, representing a 2.4% increase over the year-ago quarter. AFFO from our real estate portfolio was $1.06 per diluted share for the first quarter, representing 83% of total AFFO. These results reflect same-store rent growth, lower interest expense and stronger euro relative to the U.S. dollar. In aggregate, those factors more than offset low restructuring revenues from our investment management business, resulting from the fully invested status of the managed funds and strategic decision we made last year to cease raising new funds.
As announced this morning, we’ve affirmed our 2018 guidance and continue to expect to generate AFFO per diluted share of between $5.30 and $5.50 for the full year, with about 80% of that coming from our core real estate portfolio. Given the expected timing of deal closings and the strength of our pipeline as well as the expected timing of structuring revenues and certain expenses that were weighted to the first quarter, our first quarter results do not reflect a run rate for the rest of the year. I will cover that in more detail shortly.
Turning to our portfolio. At quarter end, our real estate portfolio was comprised of 886 properties, covering over 85 million square feet, net lease to 208 tenants. ABR for all leases in place at the end of the quarter totaled $689 million. The weighted average lease term in the portfolio increased to 9.7 years, while the portfolio maintained closed to full occupancy at 99.7%. Overall, same-store rent was 1.5% higher year-over-year on a constant currency basis and contributed to AFFO growth. With 68% of our ABR coming from leases with rent escalators tied to inflation, our portfolio is well positioned for continued internal growth. This is coupled with the stability of 27% of ABR coming from leases with fixed rent bound that have a weighted average increase of about 2% per year.
Investment volume for the first quarter totaled $106 million comprised of the two acquisitions that Jason discussed and the completion of a $21 million built-to-suit project.
In aggregate, these investments had a weighted average cap rate of approximately 7% and a weighted average lease term of 24 years.
In addition to deals we sourced externally, we continue to source attractive investment opportunities from within our existing portfolio in the form of expansions, renovations and redevelopments. During the first quarter, we committed to fund three new capital investment projects, and we completed one. Including the $21 million built-to-suit investment completed during the first quarter, we expect to complete five built-to-suit investments and four four discretionary capital investment project during 2018 for a total investment of $110 million. As a reminder, investment projects expected to be completed in 2018 are included in our guidance assumption for total on-balance sheet investment volume, which remains unchanged at $500 million to $1 billion for the full year.
In addition to attractive investment returns, capital investments on existing properties are a key element of our proactive asset management strategy, as they typically enable us to extend the overall lease term on the original asset, creating substantial additional asset value. The two lease extensions we completed during the first quarter were both tied to relatively small discretionary capital investments that nonetheless allowed us to attain 8 years of incremental lease term on $18 million of ABR, while generating average incremental yield of almost 9% on the new investment.
We are continuing to make progress on our disposition plans for the year, disposing of five properties during the first quarter for $35 million. As Jason mentioned, in April, we also sold one of our two remaining hotel assets for $39 million, in line with our strategy to focus on our core net lease portfolio.
We continued to expect total dispositions of between and $300 million and $500 million for the full year. As a reminder, our investment and disposition guidance assumptions are not targets but are current view of what is achievable based on the visibility we have into our pipeline and expected market conditions as well as our current asset management plan.
Turning briefly to our investment management segment. Revenues from investment management, excluding reimbursable costs, were $19 million for the first quarter. Within this segment and for the company overall, revenue composition has improved dramatically over the last 12 months, reflecting our strategic decision to exit retail fund raising and the fully invested status of the remaining managed fund.
We expect [structuring fees] to come down significantly in 2018 to around $10 million for the full year, and therefore, be a minor contributor in this segment with about 90% of investment management AFFO coming from more valuable recurring fee stream.
Moving on to expenses. During the first quarter, we continued to see the benefits of the sustainable reduction we have made to our cost structure over the last two years. It is important to note, however, that G&A may fluctuate from quarter to quarter and tends to run higher during the first quarter due to payroll taxes, given the timing of annual compensation. Therefore, we do not view the first quarter as a run rate for this year. We continue to expect G&A expense for the full year to be between $65 million and $70 million, which is embedded in our AFFO guidance.
Interest expense decline by $3.9 million or 9% year-over-year, impart reflecting a decline in our weighted average cost to debt through replacement of higher-rate mortgage debt with lower-rate unsecured debt over last year. As a result of the work we have done over the last few years executing on our unsecured strategy and extending our debt maturity profile, we currently have $78 million of mortgage debt coming due through the end of 2019, a very manageable amount.
Turning to our capitalization and balance sheet. In March, we successfully accessed the euro debt market issuing 500 million euro-denominated unsecured bonds with a nine-year term at a coupon rate of [indiscernible]. Net proceeds from the offering, we used to repay floating rate debt, comprised primarily of mortgage debt comprised primarily of mortgage debt and the outstanding balance on our euro-denominated term loans as well as reduced balance on our euro-denominated credit revolver. This latest euro bond offering also continued to advance our unsecured debt strategy, taking secured debt to growth assets down to 11% at the end of the first quarter compared to 19% at the end of 2016. It also extended our weighted average debt maturity to 6 years at the end of the first quarter compared to 4.7 years at the end of 2016.
We have ample liquidity totaling $1.4 billion at quarter end through cash and the available capacity on our revolver, 93% of total debt outstanding with fixed rate, primarily in the form of unsecured bonds with well-laddered series of maturities between 2023 and 2027. A combination of limited near-term debt maturities and very moderate use of floating rate debt, therefore, continues to limit our exposure to interest rate volatility.
To wrap up, we increased our AFFO this quarter, while continuing to improve the overall quality of our revenues and real estate portfolio. We continued to grow our quarterly dividend, while maintaining a conservative payout ratio of 79%. Our portfolio remains well positioned for growth both through inflation-linked and fixed rate increases as well as through expansion and redevelopment opportunities. And our balance sheet is well positioned, both to minimize interest rate risk and provide flexibility and funding a healthy pipeline of investment opportunities.
And with that, I will hand the call back to the operator to take questions.
Question-and-Answer Session
Operator
Thank you. At this time, we will take questions. [Operator Instructions] Our first question comes from R.J. Milligan with Robert W. Baird. Please state your question.
R.J. Milligan
Hey, good morning, everyone. Jason, you mentioned that retail in general still wasn't very favorable in terms of the acquisition environment, but you were finding some pockets of opportunity. Any specific sectors where you’re seeing that opportunity?
Jason Fox
Yeah. I mean, with this disruption, we think pricing is getting in some cases back to a level that may make some sense. I mean, we've always viewed that segment in the past as the commodity segment just given the efficiency in pricing. I think that’s starting to change, though, if there's a little less capital flow coming in. Now I would say, where we're seeing our opportunities, and this is both on the recent deal we did in the U.S. as well as what our pipeline looks like in Europe, these are going to be connected the sale-leasebacks, where we have - there’s a small universe of buyers who can structure those deals and that gives us some extra pricing power we’re able to generate some excess yield to really get us comfortable with the risk-return profile to make sense.
R.J. Milligan
Got you. But in general, no real movement in cap rates given the movement in the 10-year?
Jason Fox
You know what, I think there's still the lag effect happening. I think, again, in retail, there's a little less capital flows into that area. So I would think that in certain pockets you are seeing cap rate tick up a little bit, but generally across the board for net lease. We’re optimistic that it will happen, but there's still bit of a lag. So I don't think that the - where the 10-year treasury is right now, it’s still - is yet to really impact cap rates a lot. There’s still a lot of money targeting net lease generally.
R.J. Milligan
Got you. And then obviously CPA:17 had filed that they were looking at some sort of strategic alternatives. Do you guys have an internal view as to what you think the timeline is there on CPA:17 for them to have some sort of liquidity event?
Jason Fox
John, do you want to cover that?
John Park
Sure. We can add to public disclosures CPA:17, but what I’ll say is that we continue to believe that we are the most natural and debt buyer for CPA:17, and we have number of advantages over the buyers.
R.J. Milligan
Okay, yeah. That was case. Thanks, guys.
Operator
Our next question comes from Nicolas Joseph, with Citi. Please state your question.
Nicolas Joseph
Thanks. Just give me the comments around the impact of interest rates on cap rates may be moving together going forward. Does it change the way the pace of your dispositions of acquisitions for the year?
Jason Fox
On the disposition side, we do have a plan of assets that we think strategically make sense to sell. In some cases, it’s a bit opportunistic given how strong the disposition market is. But I don’t think it’s going to impact the pace and we have we have the business plan in place that we’re going to follow.
On the acquisition side, you are - I think that it is going to be helpful. We still feel good about the guidance that we’ve provided, as Toni mentioned, and our near-term pipeline is probably strong as it’s been over the past 2, 2.5 years. And I think some of that is a reflection in little bit more pricing power from the buyers.
Nicolas Joseph
And so just on the balance sheet, how do you view the current mix between U.S. and euro-denominated debt. And then if you were to do another debt deal, where would you lean today?
Toni Sanzone
Look, we have the ability certainly to continue issuing in both markets. Given our current waiting of European debt in the capital structure: a) future issuance would probably depend largely on the acquisition and disposition activity and market conditions really. In the short term, we have sufficient room on our credit facility to give us the flexibility, but I think that will depend largely on the net acquisitions and where those happened.
Nicolas Joseph
But from a current portfolio standpoint, do you think you’re hedged from an asset-level perspective on the euro debt?
Toni Sanzone
Yeah, I think that we are comfortable. It’s almost fully hedged at this point. There is probably a little bit room, but I think that’s a fair statement.
Nicolas Joseph
Thanks.
Operator
Thank you, our next question comes from Todd Stender with Wells Fargo. Please state your question.
Todd Stender
Thanks. For the build-to-suit projects, you completed one in the Nord Anglia properties in the quarter. Can you remind us what the has been initial yield and then, if that two more coming for the remainder of the year, any additional or color around those or change in yields versus this one?
Brooks Gordon
So, this is Brooks. Just to remind you on the Nord Anglia portfolio, the initial yield was 7.2%, and we have two projects ongoing. And as a reminder, there is a another tranche that we agreed to in the transaction that we think will follow in one to two years’ time, and that’s based off a spread to ten-year treasuries, plus 500 basis points plus 10-year treasuries.
Jason Fox
I think the other thing to keep in mind, Todd, is as we complete these build-to-suits, we reset the leases factor there original 25 years. So there is some upside embedded in those lease expansions as well.
Todd Stender
So despite being in different locations, they are all under the same yield?
Jason Fox
That’s correct.
Todd Stender
Okay, thanks. And then for the three retail locations you acquired in the quarter, I know you are not disclosing who the tenant is, but you can give any color on the credit rating, or maybe if its private equity owned, any color around that?
Jason Fox
Yeah. Through confidentiality agreement in the lease, we're not allowed to disclose the name. But they mentioned earlier, it’s a larger regional furniture retailer. They're good size for their markets. I think what equally important is the assets that we purchased are some of their highest-performing retail sites with over four times coverage. So we feel pretty good about what we have there. And that’s all under a 25 year lease. So again, sale-leasebacks allow us to put a good structure in place that includes a longer-than-typical lease term.
Todd Stender
Okay, thanks. And then on dispositions, you’ve got five listed here. Any of these were handed back to the lenders or vacancies, any color around that?
Jason Fox
Sure. None of those were handed back to lenders. With one small asset [Indiscernible] asset sold for about $1.6 million, it had one small tenant. It's a multi-tenant office building that was primarily vacant. But the balance was all occupied.
Todd Stender
Thank you.
Operator
Thank you. [Operator Instructions] And next question comes from John Massocca with Ladenburg Thalmann. Please state your question.
John Massocca
How should we think about the composition of the pipeline between many granular transactions and bigger portfolios? I mean, would you expect kind of the acquisition activity to be kind of bulkier quarter-to-quarter or a different size quarter-to-quarter going forward?
Jason Fox
Yeah. Yes, I think it's more the latter. I mean, we tend to especially sale-leasebacks, we tend to do larger transactions than a typical net least investor. So these tend to be a little bit on the lucky side, and I think that's what we're seeing in our pipeline right now. It can be a little bit more skewed to Europe for the near-term pipeline, but we also have some interesting opportunities we're looking at in the U.S too.
John Massocca
And in terms of the European skewed, you mentioned there is more capital kind of moving to riskier markets. Is there some reason why that’s not, maybe attractive to you given the health of Europe over the last couple of quarters and the potential to get maybe outsized yield if you were to move maybe out of some of your traditional markets in Europe, obviously not outside of the Europe?
Jason Fox
Yeah, I mean our pipeline, we’re seeing some good deals that have yields that makes sense for us and the risk of that particular deal in more of our core markets, Northern and Western Europe. But we are open to opportunities as long as we think that we’re getting paid for the risk and we can understand the risk. And we’ve been in Europe for 20 years now. So we’ve transacted in most of the markets. So we have a good feel for how to structure and optimize the transactions there. So yeah, I think we are open to it, but I think you’ll see the bulk of our focus being on Northern and Western Europe.
John Massocca
Yeah. Understood. And that’s it from me. Thank you guys very much.
Jason Fox
Great. Thanks.
Operator
At this time, I'm not showing any further questions. I’ll now hand the call back to Mr. Sands.
Peter Sands
All right, thank you. Thank you for your interest in W. P. Carey. If you have further questions, please feel free to call Investor Relations directly on 212-492-1110. That concludes today’s call. You may now disconnect.
Operator
Thank you. All parties may disconnect.
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