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

I think out of respect for everyone's time, we'll try to get started on time here. But again, Rich Hightower with the Barclays REIT team. So thank you for being here, everyone in the room and everyone online. I'll do a quick round of intro, and then we'll get going on the questioning. But immediately to my right is Michael Bilerman, EVP, CFO and CIO of Tanger. To his right, then we have Ross Cooper, President and CIO of Kimco -- and then finally, at the far end, John Caulfield, EVP and CFO of Phillips Edison & Company. So I appreciate you gentlemen being here. Of course, -- but I think maybe just for the benefit of the folks in the room and listening in, if they're not quite familiar with your companies, just give us 60 seconds on who you are, what sort of differentiates you within the retail REIT sector at large, and we'll go from there. So Michael, also with you.

Great. We're Tanger Inc., ticker SKT. We're obviously a retail REIT about $6.5 billion, $7 billion of EV, $4.5 billion of equity market cap. We are opening a REIT that's focused on the outlet channel as well as open-air lifestyle centers outlets, who's been to an outlet. I've been to one. All right. Good. So you know what outlet centers are an open-air lifestyle centers. We've been in business for over 40 years. We've been traded on the NYSE for over 30 -- and just from a financial structure perspective, our current dividend of $1.25 represents about 60% of our cash flow -- the industry is about 75%. So we're keeping more of our free cash flow to invest. And then from a leverage perspective, we're currently at 4.7x debt to EBITDA relative to a 5 to 7x target -- so we not only have additional free cash flow to drive our growth, but we have a balance sheet positioned for growth.

Ross Cooper, President and Chief Investment Officer at Kimco I've been at the company now over 20 years. We own currently about 564 shopping centers at 100 million square feet gross diversified geographically throughout the country, but primarily in the top 20 or so major MSAs. We own all types of format of open-air retail, but primarily grocery-anchored and mixed-use shopping centers. We've been in existence since the late 1950s, public since 1991 and current enterprise value is plus or minus $24 billion. So we continue to look for opportunities to grow the portfolio, grow the earnings stream. We've seen a tremendous amount of success operationally, which we'll get into in the panel. And I won't steal too much of the thunder of the conversation, but excited to be here.

I'm the Chief Financial Officer for Phillips Edison & Company. I've been Pico for about 12 years. I think we are sort of the new kid on the block relative to this. We've been publicly traded for 5, but we have been around for 35 years. We focus exclusively on grocery-anchored shopping centers. So for us, it's -- we own about 330 of them in 31 states. We focus on the 3-mile trade ring in the neighborhood where that grocery, we have the #1 or #2 grocer and then we have in-line neighbors, which is what we call our tenants. And we are ultimately that place in the community that people go to 2 and 3x we -- in terms of overall growth profile, we also have a very low leverage right around 5x on a debt-to-EBITDA basis with a low to mid 5x target. We look to grow our internal cash flow 3% to 4% a year. We also call that same-center NOI growth. But ultimately, we're looking to grow our earnings per share at a mid- to high single-digit per share annually, combined with a 3% to 3.5% dividend, which we think will deliver 9% to 10% annual return on it to our investors. And I think it's a great representation of different styles of opener retail routes.

Yes. I think I'll jump off from there and we'll get to the earnings and total return algorithms. We'll dive more into that later as well. But Broadly speaking, I mean, I think as I look around the different REIT sectors, retail, both within the grocery anchored more sort of necessity-based and even within the more discretionary categories, -- it's got 1 of the best supply versus demand fundamental setups. I think out of -- I mean senior housing is probably the other 1 that immediately comes to mind and I'm sure we can name others, but retails very favorably -- position. So John, I'll start with you and we'll kind of come back this way. Talk about what that fundamental backdrop looks like for PECO and explain how that flows through into leasing and occupancy and kind of what's the opportunity from here is being driven by that fundamental backdrop.

Yes. So occupancy of retail is very high in this environment. And part of it is because new construction is very expensive. It does have the opportunity to happen. There are places we spend our development dollars on building out parcels in our parking lots, trying to buy adjacent land. But ultimately, overall retail is high. But that allows us to have pricing power. Ultimately, we're seeing -- this is, I believe, the third or fourth year in a row where our renewal spreads are over 20%. And -- so as rents are coming up and on renewal, it's so important because we put in very little capital dollars for that. So retail real estate, particularly those owned by the REIT is the best in the market. I mean, I don't -- I haven't seen the stat you might know this or Ross, it's some fraction that the REITs actually own and generally the REITs on the best. And so for us, we're focused on that 3-mile trade ring -- and we have 83% of our centers have the #1 or #2 grocer in the market. And ultimately, that brings the foot traffic that allows the retailers to be successful. And high occupancy gives us the ability to further push rents, which improves chanting risk, ultimately improves their sales, allows us to push rents more and it kind of goes from there. So I think that it is a very positive environment. And I think that sometimes there's a concern of, well, maybe the -- all the growth is gone. And I would say absolutely not. We continue to generate -- and that's why I think about the percentage of the REITs on -- we have a lot of transaction volume. We buy a lot of we're going to buy between $500 million and $600 million of assets this year, but we're also selling $100 million to $200 million of assets this year, and that gives us opportunity to refresh what our teams are working on. We do all of our own leasing and all of our own property management, our own portfolio management, and we're able to drive rents because we're in the market, and that's what we specialize in.

Yes. Ross, keep us going on the fundamental side.

Yes, just adding on to that, I think you articulated, but I completely agree. I mean it's very difficult to see that the supply-demand dynamics, which are very much in our favor as landlords is going to change anytime soon. We ran some studies and some others research have reported that we would need to see anywhere from 50 upwards of 65% in terms of market rent increases on retail rents in order for a developer to justify any substantial amount of new development. When you think about construction costs, borrowing costs and all the challenges of difficulty of building new retail owning high-quality infill real estate where the consumer lives is a very good value proposition, and that's really what we've leaned into in terms of density markets and where we're focusing our efforts. In terms of the growth trajectory, particularly for Kimco, we see tremendous opportunity, both in terms of internal growth as well as external growth in the sense of recycling capital. So from an internal standpoint and an organic standpoint, we're seeing occupancy levels that are approaching all-time highs, but we still have about 110 basis points to achieve our all-time anchor occupancy. And so we still see some room to grow. And while we've reached a small shop all-time highs from an occupancy standpoint, just around 92.9% given the quality of the portfolio and the lack of new supply, we believe that there still continues to be room to run. And to John's point, in terms of growth, -- from a market rent standpoint, there is significant spread between where our leases are currently paying rent and where the market is. The challenge and our job is to get to that. And how do we get to there quicker to create that upside because when you think about it currently today, the retention rates for retailers are also at all-time highs. So tenants that are coming due on their lease are staying in place over 90% of the time. Historically, that was somewhere in the mid- to upper 70s. So you're seeing fewer limited churn, less CapEx going into replacing these tenants and therefore, your ability to really enhance the bottom line. And then you couple that with some capital recycling. And what I mean by that is within our portfolio at Kimco, we have upwards of 10% of our annual base rents that are coming from long-term flat leases. Think about a Costco or a Home Depot or a Walmart, really the best credit tenants in our business. But the challenge with those leases is that they have control for an extended period of time and the growth in those contractual rents is fairly limited. So we've taken the opportunity in a market where there's been dislocation between the private market pricing and the public market pricing, selling and disposing of those assets and reinvesting them in multi-tenant shopping centers that have a higher growth profile in addition to a higher going-in yield. So that really enhances the trajectory of the growth profile for the company. The other initiative that we've taken at Kimco as we've evaluated our real estate over the last decade or so it became very clear to us that we have a significant amount of property that's underutilized, single-story shopping centers with a massive parking field that's nonincome producing as it relates to that parking field. And we've, in certain select cases, been able to densify with multifamily and other uses. And so we're starting to really crystallize the value and monetize some of those entitlements and multifamily projects that we've built. We sold two large multifamily projects just this year, 1 at a 4.9% cap and the other a 5.1 cap. And then again, we can reinvest those at a higher going-in yield, but more importantly, at a 300-plus basis point spread on the growth profile. So that also is enhancing our growth profile. And we think there's a long runway to continue to execute on that strategy.

Keep going. So I think building off of what John and Ross were talking about, the whole demand supply environment for retail real estate irrespective of the type. I mean you had a whole big article today about the enclosed mall business right, and that coming back really is driven by the fact that we haven't had supply for almost 20 years. And we go back to -- we're at the financial services conference. So if I say GFC, everyone knows what I'm talking about. But you go back to that point, retail supply was 1.5% of stock which meant every year the market was adding 1.5. You went in the GFC, it plummeted to 20, 30 basis points. And it has remained at those levels for almost 20 years. We had that COVID thing, we had coming out of all these elements. And so we just didn't building off of it. And so I think, Ralph, to your point, rents would have to rise so dramatically to make development work that makes the existing amount of real estate that much more valuable, whether it's in grocery anchored 3- to 5-mile range or in the large format neighborhood community centers that time on, but also for outlets and open-air lifestyle centers that we own. And what we're finding today is bricks-and-mortar retail is such a key component of a retailer and brand's omnichannel strategy. They need to have that bricks-and-mortar retail. How many people have ordered stuff online and returned 30% of it. Okay. I got right exactly. So all of that has to go somewhere. And increasingly, what you're finding is the cost to return is now you have a cost that's no longer free -- and so where are you going to bring it? You're going to bring it to your store. If you don't have that store in your local market, that brand does not have value. And so in the outlet world, we are a utility for the brands and retailer, right? And those -- you called it discretionary, but yes, they're discretionary items. But our brands and retailers need somewhere to clear all of their excess inventory they need somewhere to make the made-for-outlet product, which they earn a significant amount on that branding, and they need to bring that newness into that customer and all being operated in an open-air environment, which, from a cost perspective, benefits us all because it's cheaper when you think about being in close structure like this, lot of air condition, a lot of roof, all these things that you got to maintain. We are in an open-air format, we benefit from having these single-story buildings that sit on large plots of land that provide each of us the opportunity to densify, whether that's building out lots or building other things. The demand, I would say, right now for retail is very strong, because there's not a lot of supply and the retailers need their places to grow. And so all this tying back to our growth algorithm, we really focus on the internal growth -- our rents today are at 9.7% of tenant sales, and I think a little bit different than the centers that Ross and John own and operate. We get tenant sales for the vast majority of our tenants. We don't give them options. And so we feel today our rents relative to their sales are below. But the big part is we continue to focus on remerchandising our centers reducing the amount of lower productive tenants to bring in higher productive ones that can pay us additional rent. And our portfolio at 16 million square feet, 3,000 stores, -- our average size is only 5,000 square feet, which is pretty small from a tendency perspective. We're not dealing with big boxes to retenant and household names from all the brands and retailers that you and your others like to shop.

There's a lot of potential follow-ons in what each of you just said. But 1 thing I think, really for myself, but also I think the benefit of the people in the room the news flow around different retailers in many cases, headline can be negative. We can name who those are. But at REIT, when we compare it to your leasing stats that you put up every quarter, record occupancy, as you said, double-digit leasing spreads on a blended basis, as you said, explain the delta there between perception and reality -- and the fact -- I mean, we brought this up in a meeting, sporting goods had a terrible quarter. It's an isolated reason, but they're leasing tons of space, and they're doing it very aggressively. So help us understand what that's -- whether it's Michael's base at 1 end of the spectrum or John is at the other end, Rob somewhere in between. Help us understand that.

Yes. Don't believe everything that you read. But the reality is that we've seen a really strong demand within retail for quite some time. And even in the depth of the -- going back to the financial crisis, the pandemic, I mean, we have not seen occupancy go below 90 -- some of that has to do with the fact that we have long-term credit leases. You think about our business, everyday goods and services and necessities. People need a place to go eat, shop, be around other people as we saw on pandemic, how critical it was to be essential. People are social creatures by nature. And so I think that when you think about the most profitable transaction for a retailer, as Michael was articulating, it's in the store with returns now much more difficult in terms of timing and cost. The retailer wants to get you to that store to shop. And if you're buying in the store, chances are you're going to return less. You have a much better margin on that product when you're acquiring -- and most likely, you're going to buy something maybe impulsively or otherwise, you see something that you may not have realized that you needed and you're going to go and you're going to spend and you're going to buy. We, at Kimco, have upwards of 87% of our assets that have that grocery component. So when you think about traffic, foot traffic at the shopping center. It's up over 3% year-over-year. So you continue to see a very healthy consumer in our demographic and our shopping center. There's no doubt that there are certain segments of the population that are having a more difficult time in this economy. The Kimco everyday goods and services in the upper middle income demographic is still seeing a tremendous amount of success from a traffic standpoint, from a tenancy standpoint, from an occupancy and a leasing demand and velocity standpoint. You mentioned DICK'S. And I think the example there is that they had a very challenging situation a couple of weeks ago where they came out with earnings and due to the Foot Locker acquisition and some other supply challenges, -- they had a very tough day in the market from a trading standpoint. But when you're talking to them about their portfolio, their desire to expand, nothing has slowed down. There's a tremendous desire to continue to grow, house of sports, their field concept other prototypes that they have. And that's just 1 example of many. So we have seen no slowdown in the velocity of our retailers looking to continue to grow their store network, and we'll continue to lean into that pretty aggressively.

Our focus about 74% of our rent comes from necessity-based goods and services, people coming every day. So what Ross was saying, just under 30 -- a little under 30% of our rent comes from the grocery stores and Kroger had a weaker print as well as some of the other retailers. The sophistication and the adaptability of these retailers cannot be understated and ultimately talking about health ratio, I will say we're actually very similar. If you look at our in line, we're right around 10% on a health ratio, which is really their ability to pay. So sales, so their occupancy cost to their sales. The grocers though are 2.4%, because ultimately, they have much thinner margin. But when you think about what these grocery stores have done, Walmart was not in the business of -- then you had online and the expansion and now you have Whole Foods came around. This is before [indiscernible]. Now you have simple truth. That was the Kroger brand is having incredible growth. The adaptation of these retailers is not to be interested. I think it's interesting we talked a few years ago, everyone was going, "Oh my gosh, there's so much going on. Why are these retailers continuing to expand -- it's because there is no other place for them to go. Talking about foot traffic. They know the locations in the market where they want to be. And if there is a rare occupancy available, they need to act then because their opportunity to get to that space is a decade plus, if not more than that away. So they're going to move and they're looking at it going, we can be in a small portion of the cycle or a bigger, they're going to go. I think that it's interesting quick service revenue -- or quick service restaurants. I continue to say, Americans are going to eat out. We've looked at it. And since 2000, QSR has always grown. In the GFC income, it will go down some, it's always positive. And so when you think about the coffee concepts and all the variety of things the new bakeries that are coming, ultimately, the consumer is resilient. The consumer is going to continue to spend, and we all have to eat, and that's where we play.

I think delineating because you talked about perception versus reality. And where I think that breaks down is the fact that look, retailers, branded merchandise gets a lot more airplay than its size of the stock market, right? Because we all understand it. I'd like to say a lot of REITs have household names, but unfortunately, Tanger does, I think we do. But a lot don't, right? You had Equity Residential in Avalon Bay, the 2 largest multifamily landlords that got together to become Viva now knows what those names. Public Storage, the largest self-storage landlord. All you know is orange, okay? So these retailers have brand names and their companies just like every other -- so they're going to have hits, misses, whether it's in their capital allocation, whether it's in their fashion and they tend to get blown out of proportion, right? In retail, because all of us service to customers, -- it is the most unique asset class. If you think about real estate. We're here at a hotel. There's only -- it's a one-to-one relationship. In retail, you have 2 customers. The retailers that pay us rent, and we're 96% fixed rent, right? We're not volatile like a retailer. We don't get to miss a season. We actually don't sell anything. We sell our loyalty program, but put that aside -- we don't sell a product. And so that whole ability to the retailers that pay us rent, but then the customers who show up and shop with us every day and the environment that they want to shop in. And our job is to bring as much of that newness to what is in our centers, whether they're drawing from a 3- to 5-mile ring in John's portfolio coming 2 to 3 times a week or coming to our assets, which draw from a 30, 40, 50-mile ring. I don't know everyone's going to go to Dollywood, I hope, to celebrate Dolyparton and you'll go to our asset in severe Hill. And 1 of the top outlets that we have, and I couldn't pronounce the Bearville when I first got to Tanger 4 years ago. But the Smoky Mountains are great. And so those retailers I think that's part of the reason why you see that disconnect I think the other aspect really comes down to quality, right? And John, you mentioned this, the REITs generally own the better quality centers and the better quality markets. So if you're a retailer on the other side, we're all transparent. We all talked about our balance sheet strength and reinvesting capital to our assets. Our retailers doing their business in our centers, right? You guys can be in any office building that you want. But the retailer cares about those 4 walls, who their co-tenants are, what are we doing? And I think that's why the retail REITs are seeing a disproportionate amount of that. And then the last thing I'll end on is credit. To your point, there have been some hits and misses in retail. But at the end of the day, where we have to be concerned is at what point does it break that bankruptcy or balance sheet becomes a risk. And thankfully, I would say our watch list, we mentioned on our 2Q call is at the lowest level that has been in years. Now part of that is we've seen some bankruptcies take space, take hold. But there's not this newness where from a credit perspective, we're worried about the tenant not paying their rent.

Again, more we could dive into -- I'll pause for any questions from the audience. second-relapse hands. .

Don't be shy.