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

Welcome to the Phillips Edison roundtable. Happy to have Jeff Edison, CEO of the company, with us here today and maybe introduce your team and then opening remarks, please.

John, our CFO; and Kim, our Head of IR. And in terms of opening remarks, it's [ great to ] live in interesting times. You don't need things to be this interesting because it's really trying to figure out what's going on. I mean we're in one of the best operating environments we've been in. We saw a little run-up over the last 45 days ago. And then all of a sudden, it starts going back. And the operating market is as good as it's ever been in terms of leasing, leasing margins, leasing occupancy, all just very, very strong, like record kind of strong. And not just like good, but really as good as they've been. The acquisition market, our volume is going to be as high as it's been, quite a bit higher actually than it's been any time since we've been public. And at numbers that we think are very consistent with what we've been targeting. We have 9% unlevered IRRs on what we're buying. We're buying in at about a 6.7% initial yield. So very strong dynamic there. So you got great operating environment. You've got a great acquisition market where we're seeing -- we're selling stuff at basically a 5.9% yield. So we're buying at a 6.7%, we're selling at a 5.9%. We have a really strong ask and buy on that side. Again, we've increased our disposition numbers as well at those kind of rates. So like, yes, if you -- if I woke up and I said this is as good of an environment as you can get, but the market is not trading. And there are obviously a lot of explanations for that. What we're focused on is continuing to do the things that we influence, which is put great numbers on the board, which I think we have and will continue to do throughout the year. And then the market will do what the market does. Over time, we -- what we're committed to is growing our FFO per share mid- to high single digits, paying a 3.5% plus dividend and getting a 10% return for investors year in, year out in a hard asset, low leverage business, we think that's a good return. And our management team owns more of PECO than any other of our peers in terms of percentage of it that's owned by the teams. So we're not talking -- I mean, we are skin in the game, and we're going to keep skin in the game because we believe in this business, and we think that it is particularly in an environment where there's uncertainty, we have a lot less beta in what we do, but we're convinced that we've got a really good alpha, and we're putting scores on the board that would say we've got good alpha. So that's our opening remarks, what we're feeling. But as we said, we're going to keep taking advantage of what is a very strong market and growing the business.

Maybe on the flip side of that, I mean, you look at recent news, grocer earnings, right, you talked about softer consumer spending, some pressure there on kind of the lower end, lower income consumer. I guess what are you seeing across your portfolio today?

So the consumer is actually doing really well. And it was 2 months ago, we were talking about the K and like everything is going to be lift up or the lower end of the market is not going to do well. Well, that's sort of gone because the lower end is growing faster. Our market is the top of the game anyway because we're -- if you look at our median household income of our centers, it's whatever 17%, 18% higher than the median. So like we're -- that's what we service. And that's what we're in density and incomes that are above what Kroger is and Publix are, which are our 2 largest tenants. So we're doing well in that. So this concept that the consumer is having trouble is one that like I mean you guys -- I mean, the credit card debt and all that, like those are actually pretty healthy right now. They're not -- you're hearing news, you're hearing stories like all the consumers like in trouble and having but you're not seeing it. We're not seeing it. And one of the things that we look at really closely is our local neighbors. Those are the -- what would be called mom-and-pops, but they're really the true entrepreneurs, the people who are like counting on that business as their -- what they're going to pay their rent with and what they're going to pay for the house and like that's what they live on. They make -- every time when they renew a lease, they come back to us and they have to make a decision like what are they going to do? And they can walk from the deal if it's not profitable. or if they see the future is not profitable, they can extend for a year or 2 and just kind of see what happens or they can extend their leases for long term. And they come at us negotiating and we keep a very close look at that. Today, that retailer is looking for longer term. And they're renewing at 90% of their spaces. So you think about that, that means the person who knows the consumer the best, which you can have all the talking heads, you can have all the research you want. There's nobody who knows the consumer better than the entrepreneurial local retailer because they actually know when somebody's husband or wife got laid off. They know like they know why they're buying something and what's too expensive, what's not. That is their job. They're making the bet on a long-term basis. They want to be there. They're trying to tie up the space for as long as they can. That to me is probably -- I mean, it's certainly one of the things we watch really closely and encourages us that we have -- we're in a much better position than what you're kind of hearing about from their perception of consumer.

Maybe taking that -- expanding that a little bit as you think about the shopping center space overall, what are the biggest risks facing the industry or the sector over the next 12 to 24 months, do you think?

So we're -- our stuff is grocery-anchored shopping centers, rightsized grocery-anchored shopping centers with small stores that provide necessity-based goods to. So my answer to you is based on that. So there are a lot of people in the open-air space who are doing more discretionary spending and that stuff. That's not where we spend our time. In that particular market, the necessity-based side, it's like very strong, like it is -- the consumer is not -- we're not seeing the consumer react in any sort of dramatic way. As a matter of fact, they're actually spending more. And so that would be, we think, a positive.

I think that when we look at -- that's a negative side of question why we want to try to be positive. But I think if you look at it from a risk perspective, that is kind of how we conservatively approach the business. When you're focused on necessity-based goods and services, you're focused on the best retailers of the grocer. Ultimately, that's why we often talk about we have less beta. And so when you look at the different things going on and your first question was talking about kind of retailer earnings, I mean, there is an adjustment, but they -- the large nationals, Jeff highlighted the locals, but less, they're incredibly adaptable. So Kroger's same-store sales were a little softer, but they reaffirmed their profit guide. And so ultimately, as you look at that, they're continuing to grow. They're going to continue to operate. We actually think that -- I think some of the things from the headlines that we're hearing is perhaps it's interest rates or inflation? Well, actually, these retailers, they actually like some inflation that allows them to pass along price increases more easily. And when we look at interest rates, we actually think that's an advantage to us because when we talk about the acquisition market, that has just made it that much more expensive for the levered buyer. And so in our space, maintaining the balance sheet that we have and being lowly levered like we are, then those moves give us an opportunity to play a bit more offense in that market. But ultimately, I mean, I think when we've back tested and we look at the GFC and we look at the pandemic and things, our real estate has performed exceptionally well because of the resilience of the local retailer of that grocer and the consumer spending for necessity-based goods and services.

Maybe just on the grocer specifically, any concerns about grocer health or M&A potentially leading to closures? I mean we had Kroger and Giant Eagle announced earlier this year. Any updates on divestitures there or closures?

So you're going to see any M&A activity is not going to be -- include closures. They can't get it through the government if there is a -- if that is part of the plan. Now long term, could that happen? Yes. It's not going to happen in any kind of short-term merger conversations. That being said, I don't know as many people know as there is, like Kroger is built on mergers. They have -- I think they have close to 19 different brands that they keep. They're going to keep the Giant Eagle brand when that transaction closes because they actually use the brand and the brands are really important to the local customer that they don't change it. They bring in their product, they bring in a lot of things to change the way the business is run, but they don't change the name. And that's so like I think the Giant Eagle thing is a good example. And I think you will continue to see particularly the family-owned, the Snips of the world, maybe some -- maybe the Cub Foods, you'll see potentially some of the Albertsons brands potentially getting sold. Like you will see some of that -- there'll be some M&A transactions. But that's actually more normal for the grocery business than not having it, which really has been blocked by the government with the Albertsons thing, just basically put a stop on any kind of M&A activity until that was resolved. That took 2.5 years, 3 years to get resolved and not happening. I think that will -- is probably a pretty good overall.

I think the other piece is that when we look at the PECO portfolio specifically, this really goes to the importance of having the #1 or #2 grocer in the market, which over 80% of our shopping centers have the #1 or #2 grocer in the market because when these pieces come up and there are those questions, we look at it and we're able to say, this is a great grocery-anchored location and ultimately gives us confidence in that someone will be there. And you go kind of go and say, okay, Albertsons didn't have the sale. Well, maybe they'll separate certain brands. We know the markets that they're actually very successful in and then in other places. And that sort of grocery knowledge allows us to curate our portfolio to be quite strong.

And it's a critical part of understanding like where you -- like it's not whether you have Albertsons or Kroger, it's what market you have Kroger. If you have Kroger in Denver, you have the dominant player in Denver. Like they just -- King Soopers just kills it compared to everyone else. And -- but if you have the Albertsons there, let's say these are okay, but they're not great. You're going to pay, there'll be 50 to 100 basis points difference in cap rate between a Kroger center in Denver and a Safeway own center. So that -- but -- and it's that way in literally every market across the country, which is why you need to -- it's not whether you have Kroger or Albertsons or -- but what markets you have them.

I just want to stop there to see if there's any questions from the audience. Okay.

Doing really good, John.

On nonmonetary clauses, right, as we think about on renewals, the renegotiation of that, whether it's restrictions, can you quantify the incremental NOI that can be there to get unlocked?

It's very complicated to give you a hard number on that because it is things like being able to develop an outlot that you couldn't get the approval before. There's also the -- and the controls are almost all at the grocer level. Our small stores have very little control of what we do and we don't give them control. We never have given them control of how we operate the shopping center. Some of the anchors will have visibility things. So the negotiations with them are more about sight lines and the ability to put outlots into spaces. And then probably the most important, and this is particularly important when you're buying a property is what restrictions they have on what merchandising mix you can put in the center. That is -- because that can definitely constrain what you can do in terms of turning around the shopping center and getting the right merchandising mix for that shopping center. And that's really changed a lot in the last 3 to 5 years as they still ask for stuff. I mean the grocer always ask for stuff and any of the anchors who have some of the exclusives, they ask for stuff in exchange for that. But it used to be no. I mean the answer was no for a long time. Now you're getting some -- you're getting the ability to kind of trade certain pieces for that. And it does unlock outlots, it unlocks leasing opportunities. Importantly, it allows you to merchandise your center to the right kind of retailers, which allow you to grow rents more. Those are the pieces that we're seeing in...

More about today.

Today than we have in for a long, long time.

Got it. And then maybe switching to external growth acquisitions, which is a big part of your strategy. Maybe talk about kind of what you're seeing in the transaction market out there. Clearly, you're seeing from all the meetings we've been in, cap rates continue to compress. Like talk about kind of the competition that you're facing today in the market.

Yes. So we started the year targeting $400 million to $500 million of acquisitions this year. We increased that at midyear to $500 million to $600 million. Currently, what we bought and have under control is at the very high end of that range. So we've had a very strong acquisition activity so far in the year. And it's been in a wide variety of markets, but nothing that we would -- that wasn't sort of where you would think Florida and Texas being the biggest, California being large, Washington. We bought some stuff in South Carolina. We bought some stuff in Minnesota. So it is, as you'd expect, the PECO it's spread across the country, which is what our platform is. There are more buyers in the market. Grocery-anchored shopping centers are in favor. They're in favor among institutional buyers. They're in favor in family offices. So there are more buyers in the market, and each segment probably has a little bit more demand than it has historically. Most people were underweight grocery-anchored shopping centers. And I'm going to keep focused on grocery-anchored shopping centers, not on power centers and malls and other parts of retail because that's the market we know, and I don't really -- we're not in those other markets. But the institutional demand has been high. When there is strong institutional demand, pricing usually gets way beyond something we're willing to get involved in. We've looked at a lot of portfolios this year and the private equity buyers have been the buyers of that. These are multibillion-dollar portfolios, so they're sizable and -- but private equity has had the biggest bid on -- the highest bid on all literally every single major real estate or retail real estate portfolio with that is predominantly grocery-anchored. So that has -- we've been participants. We have not been winners of any of that because the pricing has gotten to levels that we're not going to go to.