Phillips Edison & Company, Inc. (PECO) Earnings Call Transcript & Summary

Good afternoon, and welcome to the Phillips Edison & Company's webinar presentation for its financial advisers and retail investors. My name is Rocco, and I will be your conference operator -- conference call operator today. Before we begin, I would like to remind our listeners that today's presentation is being recorded and simultaneously webcast. A replay of today's presentation will be available later this afternoon on the Investors section of the Phillips Edison & Company website at phillipsedison.com. A copy of today's slide deck is available for download on the same website. I will now turn the call over to Stephanie Hout with Phillips Edison & Company. Please go ahead.

Thank you, operator. Good afternoon, everyone, and thank you for joining us. My name is Stephanie Hout, and I'm the Director of Investor Relations with Phillips Edison & Company. Joining me on today's call are Chairman and Chief Executive Officer, Jeff Edison; our President, Devin Murphy; and our Chief Financial Officer, John Caulfield. Following today's prepared remarks, we will answer your questions submitted via e-mail or through the webinar's chat function. Before we begin, I would like to remind our audience that statements made during today's call may be considered forward-looking, which are subject to various risks and uncertainties as described in our SEC filings. In addition, we may also refer to certain non-GAAP financial measures. Information regarding our use of and reconciliations of these measures to our GAAP results is available for download on our website. Please turn to Slide 3, where we will begin our prepared remarks. With that, it's my pleasure to turn the call over to Jeff Edison, our Chief Executive Officer. Jeff?

Thank you, Stephanie. Good afternoon, everyone, and thank you for joining us. Today, we want to share with you the results of an exceptional year of Phillips Edison & Company. We will share some of the financial and operational highlights for the year, review our growth initiatives for 2022 and discuss our strategy of PECO GROW. Afterwards, you will have an opportunity to ask questions. If we can all turn to Slide 4. These are a few of the PECO accomplishments achieved by the team in 2021. We had an outstanding operating year, one of the best operating environments I've seen in my 30 years in the business. Our occupancy as of December 31 was a PECO record high of 96.3% driven by retailer demand for space in grocery-anchored neighborhood shopping centers. Our pricing power can also be seen in the average rent growth of our comparable new leases of 15.7%. This will create higher cash flow and higher value for our properties. Additionally, the IPO allows us to resume our external growth. Since the IPO and through the first quarter of 2022, we acquired over $367 million of assets and disposed of $104 million, for net acquisitions completed of over $260 million. We were also able to execute on our long-term goal and deliver on commitment to provide a full liquidity event for our pre-IPO shareholders. Because of our preparations, strategy and performance, we were ready to initiate our underwritten IPO in July 2021, followed by a full liquidity event for all of our pre-IPO shareholders in January of 2022. Because of your support and the support of new institutional world-class investors, our price has grown since the IPO and through the lockup expiration. Since the IPO, our share price has increased 23.6%. I believe it has more room to grow. Lastly, our financial results exceeded expectations as we saw an increase in our core funds from operation, or FFO, up 15.7%. We also had same-center net operating income growth of 8.2%. Our results are exceeding pre-pandemic levels, and we're on track for future growth. Now let's turn to Slide 5. Previously, we described how our strong balance sheet positioned us to achieve our goal of selectively acquiring $1 billion of grocery-anchored centers that meet our investment criteria. As you can see, we are well on our way to achieving this goal. In the second half of 2021, we purchased $267 million of assets. We also disposed of $92 million of assets. In the first quarter of 2022, we acquired over $100 million worth of assets. Each of these have strong grocery stores as part of the center, consistent with our grocery-anchored strategy, and will generate strong returns for PECO. We are targeting unlevered returns of 8% or better on these assets and future acquisitions. Even in this market, where values for grocery-anchored centers continue to rise, we believe our operating platform can create growth and opportunities at assets where others cannot. We are very disciplined in our acquisition process. On Slide 6, we are showing the growth in PECO's stock price since the IPO. Our newly issued common stock began trading on NASDAQ on July 15, 2021. As of April 8, 2022, our share price has increased nearly 24% since the IPO. This makes us the best-performing real estate IPO of 2021. In the first quarter of 2022 alone, our share price increased 4.9%. In addition to the increased value of your investment, we increased the dividend to $1.08 per share on an annualized basis. We continue to pay our dividends monthly as we know consistent income is important to our investors. We are currently covered by 10 sell-side research analysts. These firms include Bank of Montreal, Bank of America, Green Street Advisors, Goldman Sachs, JPMorgan, KeyBanc, Mizuho, Morgan Stanley, Wells Fargo and Wolfe Research. Our largest stockholders include many high-quality institutional investors. Together, these funds manage trillions of dollars, believe in the PECO story and are invested right alongside you. And of course, we have shareholders like you who have been invested with PECO from the very beginning. We have a very active investor pursuit strategy and continue to believe there's untapped demand for PECO stock in both the retail and institutional markets. Now moving to Slide 7. I will remind you that on our fourth quarter earnings call, we provided guidance as of February 10, which we are not updating at this time. The guidance was net income per share of between $0.29 and $0.35, same-center net operating income growth between 3% and 4%, core FFO per share in the range of $2.16 to $2.24 as well as net acquisitions of $300 million to $400 million. These reflect the growth we hope to achieve through a combination of internal and external strategies. We believe our internal growth will come from leasing vacant space, driving rent increases at lease renewal, executing leases with built-in rent escalators and completing outparcel development and redevelopment projects. We expect to make meaningful progress towards our $1 billion acquisition goal this year. Looking forward, we're excited about the future growth opportunities of PECO. We hope you share this excitement and will continue to remain invested alongside us for many years to come. Let's turn to Slide 8. Since PECO's founding, our strategy has been consistent. We own and operate grocery-anchored neighborhood shopping centers. Our differentiated strategy and strong operating results allow us to provide regular income and strong total returns to our investors. We are an omnichannel landlord. Our brick-and-mortar grocery-anchored centers provide an attractive alternative for last-mile delivery and buy online and pick up at the store, or BOPIS, commerce for our retailers. Our centers are complementary to e-commerce and have thrived in this emerging omnichannel environment. We are also well aligned and experienced. Management is PECO's largest stockholder, owning 8% of the company. This represents over $330 million of value. It's hard to find better alignment than having meaningful skin in the game, and we clearly have meaningful skin in the game. Let's turn to Slide 9. We own and operate a $6 billion portfolio comprised of 291 grocery-anchored shopping centers in 31 states. Being grocery-anchored has been our strategy for over 30 years. We focus on owning rightsized centers with the #1 or 2 grocer in each area. You might ask why. It's because we know the average American family visits the grocery store 1.6x per week. Our groceries draw consistent daily traffic to our properties. We track foot traffic at our centers monthly. Foot traffic is now higher than it was before the onset of COVID. This regular foot traffic benefits the small shops in our centers. We focus on building community at each center we own. This is why we refer to our tenants as neighbors. We are creating centers that have the right mix of neighbors for the communities they're in. Most of our in-line neighbors sell necessity-based goods and services. 72% of our rents come from neighbors that are necessity-based as of December 31, 2021. As we saw during COVID, we believe that makes our centers recession-resistant. As you can see on this map, our nationwide portfolio is geographically diverse. Rather than focusing exclusively on coastal markets, we focus on well-located suburban markets with strong demographics. We compete on the corner of Main and Main. Our top neighbors are strong grocers. Kroger and Publix are PECO's #1 and 2 neighbors, respectively. We are Kroger's largest landlord and Publix' second-largest landlord. All of these factors combine to create regular monthly income and strong returns for our investors as illustrated on Slide 10. PECO's properties and its team have delivered strong performance in all market cycles. We have a consistent track record of growing stockholder value. Our goal remains constant. We are focused on increasing the principal amount of your investment and providing income in the form of regular monthly distributions that can grow over time. Since the IPO, our stock price has increased 23.6% and increased 4.9% in the first quarter of '22 alone. Our original offering price was $10 per share for our initial shareholders. Adjusted for the 1:3 reverse stock split, this is equivalent to $30 per share today. The price of our NASDAQ-listed common stock as of market close on April 8, 2022 was $34.61 per share. This is 15% higher than what those investors paid for the stock. When combined with distributions, this has produced an equity multiple for our investors between 1.2x and 2.2x. We currently pay a dividend of $0.09 per share or $1.08 when annualized. This is a distribution yield of 3.1% on our April 8 stock price. As we look forward, we expect our cash flows to grow as they have historically. We believe this will allow us to increase our dividend over time. We have a conservative payout ratio, which gives us confidence in the stability of our distribution rate while allowing us to invest meaningfully in our portfolio and to drive cash flow growth. We're proud of our track record of positive results. We believe our future is bright. We are well positioned to increase investor returns going forward. Now turning to Slide 11. The future of retail real estate combines traditional brick-and-mortar and e-commerce into omnichannel retail environment. Today, we primarily see omnichannel strategy through BOPIS. Customers order their products online and then pick them up at our centers. Grocers have embraced BOPIS as delivering groceries continues to be logistically and economically challenging. Our brick-and-mortar assets are conveniently located in the communities they serve. This makes them ideal for BOPIS customers. Our centers help solve the last-mile delivery dilemma faced by retailers. Because they are located close to the end consumer, our centers can also act as local distribution points serving the surrounding neighborhoods. During 2020, we launched our Front Row To Go program, which provides designated parking spaces close to the retailer's front door. This allows our retailers to offer BOPIS to their customers. Our property management team has installed over 1,200 dedicated Front Row To Go spaces at our centers. 91% of our centers offer BOPIS. Over the past 2 years, our team also upgraded our centers to further enable omnichannel strategies, with 79 projects to add walk-up windows, drive-thrus and outdoor dining options for our neighbors. Our centers continue to be essential to their communities. As the needs of consumers and neighbors change, we are successfully evolving with them. As an omnichannel landlord, we are helping our neighbors grow their business. Turning to Slide 12. PECO manages its portfolio as owners, and we make decisions that align with stockholders' interest because we are stockholders just like you. Every associate at PECO receives equity after being with PECO for 1 year. This creates ownership and alignment and encourages our associates to think like owners. PECO's experienced and aligned management team owns 8% of the company, representing over $330 million of equity value. We have serious skin in the game. For 30 years, being a responsible corporate citizen has been integral to our strategy. Our approach has a particular emphasis on environmental stewardship, social responsibility and corporate governance and compliance. We believe that our corporate responsibility initiatives are critical to our success, and we are focused on actions designed to have a long-term positive impact on all our stakeholders. We are well aligned with our investors' interest, and our 30-year track record of success demonstrates this. Now please turn to Slide 13. PECO GROW is the story of why you and thousands of others have invested with us. Our unique and differentiated strategy is focused on owning and operating small-format neighborhood shopping centers anchored by the #1 or 2 grocer in the market. Our locally smart operating platform is scalable and vertically integrated. When applied to our national portfolio, exclusively focused on grocery, we have produced regular monthly income and strong returns for our investors. Our strategy has proven to be recession-resistant and successful through multiple business cycles. Looking forward, our commitment to be the preeminent omnichannel landlord positions us to capitalize on unique growth opportunities. We are well aligned with our stakeholders, have an experienced team and a strong track record. We firmly believe PECO is a great long-term investment opportunity. As the largest shareholder of the company, I've never sold a share, and I don't plan to sell any shares soon. Looking forward to 2022 and beyond, we see meaningful growth opportunities ahead, and we hope that you will continue to grow with PECO. We will now answer your questions. I will turn it over to Stephanie for our Q&A session. Stephanie?

Thanks, Jeff. This concludes our prepared remarks. Our webcast listeners are able to submit a question via the webcast portal. [Operator Instructions] And we've already had multiple questions submitted. Our first question is, is the dividend yield of 3.1% going to remain? If there's a downturn in dividend, how and when will we be informed?

Why don't I take that, guys? So thank you for the question. Dividends are an important part of PECO's strategy, and we know they're an important part of the investment that our shareholders have in the company. We paid over $1.4 billion in dividends that the company adds to our investors, and we don't anticipate that changing. We think we have a very stable and growth-focused strategy for our dividend. Our dividend growth will be tied directly to what we see as the growth potential of the company and the ability to grow our cash flow. So we pay about 60% of our cash flow out in the form of dividends, and we anticipate that to continue. So we don't ever -- we don't anticipate informing people of our dividend being cut because we don't anticipate that happening. We're excited about sort of our ability continue to grow the business, as we talked about, and with that, to grow our dividend, which we know is important to our investors.

Thanks, Jeff. You have a lot of debt outstanding. How much will higher interest rates affect you?

John, why don't you take that?

Sure. Thanks, Jeff. So we built a very strong balance sheet, and part of our strategy has been to weather times such as this. So right now, approximately 99% of our debt is fixed rate, and we have one of the strongest balance sheets in the sector. One of the things that we do is utilize different sources of debt capital to help manage that cost, whether it be the investment-grade bond market, which we did last year. We've done bank debt. We've also done secured debt at different times. And when you look at our maturity ladder, we make sure that we have a regular amount maturing every year. And currently, we have no material maturities until 2024 so that we never have a lot to mature in any one given year that we think will help us manage through this time and still allow us to execute our growth plans.

And our next question. What kind of impact is higher inflation going to have on the company?

Devin, do you want to take that?

Sure, Jeff. Good afternoon, everyone. Thanks for being with us. So if inflation is the result of strong economic growth, it historically has been favorable for real estate. And our expectation in this cycle is that it will be favorable for certain types of real estate, particularly our portfolio of grocery-anchored necessity-based shopping centers. The operating model that we employ is structured in the way that allows us to run our business successfully through inflationary periods, where we're able to pass through a lot of the increase in cost to our neighbors. There are basically 4 components of our business model where higher inflation could impact us. One would be interest costs. The second would be construction costs. The third would be operating costs. And then the last would be the impact of inflation on consumer demand. In terms of interest costs, as John just outlined, we have successfully restructured our balance sheet so that virtually all of our debt is fixed rate debt today, and we have no material maturities until 2024. So between now and the next meaningful maturity we have, the impact to us in this regard is not meaningful. In terms of construction costs, we do have a component of our business where we are redeveloping and adding GLA to our centers. As we've indicated over time, it's approximately $50 million a year in costs. Given the short duration of these projects, we're able to monitor and plan for these increase in costs. And we have continued to be able to get the kind of returns on these projects of 9% to 11% that we've indicated previously, despite the fact that our costs are increasing. So we've been able to pass the increase in costs through to the new tenant who's agreeing to rents that are giving that stat level of return. In terms of operating costs, as I had mentioned earlier, we're largely able to pass a meaningful component of the increase in our operating costs through to our tenants. We recover approximately 85% of these costs from our tenants today. And then lastly, consumer demand. As you know, over 70% of our rents come from retailers that are necessity-based. Necessity goods are less susceptible to higher prices than discretionary goods are. And in addition, the American consumer is in a strong position right now with exceptionally strong balance sheet, and we have not seen any falloff in demand to date. The one potential positive of higher interest rates could mean that we face less competition for acquisitions, and therefore, if there's less competition for acquisitions, that could translate into higher returns for us since we will stay in the market. And that could be one of the potential upsides to a higher inflation environment.

Thanks, Devin. Our next question, how are the grocers at your shopping centers performing now? Are grocery deliveries hurting their business?

Well, that's a great question and one that we obviously stay on top of. As you know, we are the grocery-anchored shopping center player in the public markets with the rightsized centers, and having the #1 or 2 grocer is critical to our strategy. So this is a topic that is very top of mind for us. If you look at it, we went into the pandemic in a time where the grocers were doing okay but not great. They came out of the pandemic or wherever we are right now in a very strong position. They had almost 20% sales growth in the first year of the pandemic. There was a lot of stories that this was going to reverse and go back to normal. It doesn't appear that that's happening. We've seen still solid growth this year on the grocer, much less than the amount that we had during the first years of the pandemic, but it has continued to stay strong. And what's happening is that the grocers are becoming the center of the communities that we're in. And the bricks-and-mortar stores are what are the center of their omnichannel experience. And they're all moving forward with an omnichannel approach to the grocery business. And if you look at their sales, it seems to be a strategy that's working. And we're optimistic that that's going to continue. We believe that the type of delivery that's going to become the norm is going to be BOPIS because that seems to be the most economic way for the grocers to give an omnichannel approach to their shoppers and be able to have a successful execution without the cost of delivery. And we're seeing -- we're already starting to see a change in the way delivery is done, which is basically the people are charging for it. And if you can pay for delivery, you're going to be able to get delivery, but it's not going to be a free service anymore. And when Amazon made the change with Whole Foods, you knew that, that was -- that many were soon to follow and we're seeing that. So it's -- there's going to be a cost to having delivery. The main omnichannel, we believe, is going to be BOPIS, and the store is still going to be the center of the grocery business.

Our next question. On the last call, you mentioned you expected PECO to be added to REIT index funds. Has that happened?

John, you want to answer that, or Devin? Anyone...

Sure. Sure, I'll take it. So we saw the first addition in March. We track our stock performance pretty closely. In March, our volume meaningfully increased. And we believe that's based on the addition to the CRSP index -- or actually the rebalancing, not the addition. The CRSP Index, we've been advised, that those are the indexes used by Vanguard for their funds. So unfortunately, because reporting only comes out 45 days after a quarter end, we won't know the full index participation likely for about another month, in the middle of May. But we do believe there is additional index demand coming in the future as additional indexes rebalance. So that would be the Russells, the MSCI REIT Index. And as we said previously, we believe that will happen over the 3 to 6 -- the next 3 to 6 months, but we won't know for certain, but we do think there's more coming.

Great. Another question. We've been happy with the stock performance since the IPO. How are you going to be able to continue that growth?

Devin, do you want to...

Sure. I'll take this, Jeff. Yes, we've been pleased with the stock performance since the IPO as well, with the stock being up over 20% since the IPO. That's both strong, absolute and relative performance. And as Jeff has mentioned in his remarks earlier, we are very focused on growth, and we believe that we can achieve growth from both internal and external sources. In terms of the internal sources of growth, there are primarily 3. One is the continued lease-up of vacant space. As you'll see, we continue to increase the occupancy levels at our centers, and our centers are currently leased at an all-time high level. Secondly, we're increasing our expiring rents, and our leasing spreads continue to be strong. And again, we're seeing leasing spreads in this current environment that are as strong as we've ever seen. And then lastly, as I mentioned earlier, outparcel development. We continue to identify attractive development opportunities in our portfolio, and we're also acquiring attractive development opportunities in assets that we're buying. And we believe that we can generate returns on this outparcel development in the high single-digit to low double-digit levels. In terms of our external growth, we have indicated to the Street that we will acquire $1 billion net of assets through the 3-year period through July of 2024, which is the 3-year period from our IPO. And we are ahead of the pace that we outlined at the time of the IPO. And the critical element of our acquisition strategy is that we're looking to acquire assets that will deliver an 8% unlevered IRR to us. And despite a more competitive acquisition environment that we currently find ourselves in, we are and have been able to acquire centers that are meeting or exceeding that 8% unlevered objective. There are a number of macro factors that we are currently being the beneficiaries of. And we believe that these will allow us to continue to achieve strong growth. Number one, the growth in the Sunbelt, over 50% of the PECO portfolio is located in the Sunbelt, and the Sunbelt continues to enjoy stronger growth than other parts of the country. The second is suburbanization. 100% of our portfolio is located in the suburbs, and the suburbs are benefiting from the work-from-home phenomenon. And we've seen the work-from-home phenomenon increase the demand in our suburban portfolio. You're also seeing certain retailers migrate from malls to open-air centers. And these are tenants that have historically been mall-based and they're now leasing space in open-air centers. So that's an incremental source of demand for our portfolio. But we're really seeing an increased level of demand from certain retailers that have been primarily urban-focused but are now more suburban-focused. And we think a good example of that is Chipotle, where they have announced that they're going to increase the number of stores that they have, from 3,000 to 7,000, and that more of these stores are going to be located in the suburbs. And the primary reason for that is because they are getting better margins on their suburbans than they're getting on their urban stores because the suburban stores are seeing a comparable level of sales that they're seeing in their urban stores, but their costs are lower, and therefore, their margins are higher. So the combination of all these factors, in addition to, we believe, having the best operating team in the business that allows us to drive performance, is why we're confident that we'll be able to continue to grow the company at very attractive levels.

Yes. Thanks, Devin. And I just wanted to add one other thing in there, and that is if you look at our FFO multiple relative to our 2 closest peers, ROIC and Regency, we're about 200 basis points below them in terms of our FFO multiple. And when you look at that, there's a timing that we're going to have to earn our way into that, but I do believe that, that creates even additional upside in the pricing where we could get recognized with them. And if you look at our strong growth and strong dividend, I think that's going to continue to prove itself out over time, and we're going to close that gap. And as we close that gap, obviously, that would be a great benefit to our shareholders.

This now concludes our question-and-answer session. I would like to turn the call back over to Jeff for some closing remarks.

Well, I just want to thank everybody for being on the call today. As I hope you can see from our call, we're very optimistic about where we are today and the environment ahead of us. And we really appreciate the support we've gotten from our investors. And we continue -- we will continue to work hard to deserve that loyalty, and we're going to, I think, be in an environment where we feel really positive about the growth potential of the company. So thanks, everybody, for being on the call today, and have a great day.

Thank you for joining us. You may now disconnect.