STAG Industrial, Inc. (STAG) Earnings Call Transcript & Summary

Greetings, and welcome to the STAG Industrial Second Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Steve Xiarhos, Associate Investor Relations. Thank you, sir. You may begin.

Thank you. Welcome to STAG Industrial's conference call covering the second quarter 2023 results. In addition to the press release distributed yesterday, we have posted an unaudited quarterly supplemental information presentation on the company's website at www.stagindustrial.com, under the Investor Relations section. On today's call, the company's prepared remarks and answers to your questions will contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. Examples of forward-looking statements include forecast of core FFO, same-store NOI, G&A, acquisition and disposition volumes, retention rates and other guidance, leasing prospects, rent collections, industry and economic trends and other matters. We encourage all listeners to review the more detailed discussion related to these forward-looking statements contained in the company's filings with the SEC and the definitions and reconciliations of non-GAAP measures contained in the supplemental information package available on the company's website. As a reminder, forward-looking statements represent management's estimates as of today. STAG Industrial assumes no obligation to update any forward-looking statements. On today's call, you will hear from Bill Crooker, our Chief Executive Officer; and Matts Pinard, our Chief Financial Officer. Also with us here today is Mike Chase, our Chief Investment Officer; and Steve Kimball, EVP of Real Estate Operations are available to answer questions specific to the area of focus. I will now turn the call over to Bill.

Thank you, Steve. Good morning, everybody, and welcome to the second quarter earnings call for STAG Industrial. We're happy to have you with us today as we discuss our results for the quarter. Our portfolio continues to produce exceptional results as seen by our record leasing spreads this quarter. The industrial sector is benefiting from the secular tailwinds unique to our industry, including the near and onshoring and the continued penetration of e-commerce as a method of consumption. Vacancy rates have crept up to approximately 3.7% nationally. While demand for industrial real estate remains historically strong, it has come off pandemic highs as we enter the new normal. Tenants are taking more time to evaluate their space needs. There are more examples of tenants weighing their supply chain footprint against the associated corporate finance cost of outfitting space. These are large cash outlays, which include items such as material handling equipment and automation systems. 9 to 12 months ago, there was strong demand for recently constructed buildings with large footprints, generally buildings north of 500,000 square feet. In today's environment, the $50 million to $100 million investments by tenants to outfit large new spaces is being avoided by contracting with third-party logistics firms to manage supply chains. On the supply side, deliveries are expected to be approximately 3% of the overall industrial stock this year, with nearly half of those deliveries classified as big box buildings with sizes at or above 500,000 square feet. These deliveries are expected to result in a national vacancy rate of 4.2% by year-end. This level of vacancy is still indicative of strong conditions. We continue to expect market rent growth in our portfolio to be in the mid- to high single digits this year. Development STAG's, however, are down approximately 30% since the end of 2022. This lower level of development STAG's coupled with continued strong demand, should push vacancy rates lower in the back half of 2024. Moving to our portfolio, we are proud to report cash and GAAP leasing spreads at high watermarks for STAG. As of July 25, we have achieved 94.2% of the leasing we expect to accomplish in 2023 at cash spreads of 30.6%. After the slow start to the year, we recently have seen an uptick in development and acquisition opportunities as the capital markets slowly normalize. One area where this has been evident is on the development side. There's been a growing number of opportunities as developers look to derisk their positions. Financing, supply and leasing risks are pushing some developers to lock in profits today thereby foregoing a portion of potential upside in exchange for certainty. We see opportunities ranging from the purchase of full entitled land sites with approval and negotiated construction contracts to completed vacant spec buildings. These projects present very limited construction risk with favorable upside in exchange for capital funding and leasing exposure. Also, STAG can be selective focusing on developments that demise to smaller spaces that align with leasing demand. On the acquisition side, deal activity has restarted, the bid-ask spread between sellers and buyers has begun to narrow towards levels where transactions can begin to clear. Buyers have greater clarity into their cost of capital. Sellers now understand that prices previously achievable in 2021 are not available to them in the current interest rate and macro environment. The ongoing attractiveness of industrial real estate, given the strength in the underlying fundamentals further supports the case for capital to be placed in our sector. This has resulted in an uptick in deal flow during Q2 and an expectation of increased transaction activity in the back half of 2023, although unlikely to reach level seen prepandemic this calendar year. This sparring in the acquisition market can be seen by recent marketing and closing of several large portfolios of industrial real estate, something that was absent during the recent period of volatile capital markets. Our acquisition volume for the second quarter totaled $40.7 million, this consisted of 2 buildings with stabilized cash and straight-line cap rates of 6.2% and 6.3%, respectively. In April, STAG acquired a 100,000 square foot warehouse distribution facility located in the I-287 Exit 10 submarket of Central New Jersey for $26.7 million. This acquisition represented an opportunity to acquire low coverage, functional asset in one of the nation's top markets. In May, STAG acquired a fully occupied 134,000 square foot facility in the airport submarket of Greensville, North Carolina, $14 million. As of closing, this building is leased for 1.8 years to a tenant who is moving to a larger facility at the end of their term. STAG will have the opportunity to realize a 50% or greater roll-up upon the release of the building. With the recent openings in the market of the Toyota EV battery plant and an aerospace manufacturing plant, the building's modern specs and airport adjacent location leave it well suited to capture the growing tenant base supporting these plants. Subsequent to quarter end, we acquired 6 buildings for $70.7 million. On the disposition side, we sold 5 buildings for aggregate proceeds of $33.8 million. Three of these buildings were noncore assets. The other 2 buildings were located in Louisville, Kentucky, as a portfolio, resulting in proceeds of $26.8 million and reflecting a 6.2% cash cap rate. Year-to-date, the aggregate cash cap rate on the company's opportunistic dispositions was 5.5%. Finally, I'm excited to announce that STAG Industrial was added to the S&P MidCap 400 in May of this year. This is a testament to how the markets have begun to recognize the growth of the company and the evolution of the platform. With that, I will turn it over to Matts, who will cover our remaining results and updates to guidance.

Thank you, Bill, and good morning, everyone. Core FFO per share was $0.56 for the quarter, equal to the second quarter of last year. Cash available for distribution for the second quarter totaled $87.2 million. We have retained $42.5 million of cash flow after dividends paid this year through June 30. Leverage is near the low end of our guidance range with net debt to annualized run rate adjusted EBITDA to go to 4.9x. Liquidity stands at $794 million. During the quarter, we commenced 29 leases totaling 3.6 million square feet, which generated record cash and straight-line leasing spreads of 28% and 42.6%, respectively. We expect cash leasing spreads of approximately 30% for the year. Retention was 79.6% for the quarter and 97.4% when adjusted for immediate backfills. We achieved same-store cash NOI growth of 4.5% for the quarter and 5.3% year-to-date. Year-to-date, we have experienced 2 basis points of credit loss with not incurred during the second quarter. Moving to capital market activity. We issued approximately 2 million shares under our ATM program at a gross average share price of $35.86 resulting in gross proceeds of $70.5 million. As of today, we have $61.1 million of forward equity proceeds available to fund at our discretion. The equity will be used to match fund our acquisitions and development pipeline. In terms of guidance, we made the following updates. We increased our cash same-store guidance to a range of 5% and 5.25% for the year or 12.5 basis points at the midpoint. This change was driven by improved retention and a modest reduction in expected credit loss from 40 basis points to 20 basis points. We increased our disposition guidance to a range of $100 million and $200 million, driven by our progress through today, an increase of the midpoint of $25 million. We updated our retention to range of 70% to 75% based on leases signed to date. We still expect net debt to annualized run rate adjusted EBITDA to be between 5 and 5.5x. I will now turn it back over to Bill.

Thank you, Matts. I'm excited about where the company sits today and the road ahead. I must express my gratitude to our team for their effort and dedication in achieving our goals this quarter. We continue to have extremely strong operational results and forecast for 2023. We are also benefiting from a conservative balance sheet with ample liquidity. These factors will allow us to take advantage of the opportunities that present themselves through the remainder of 2023 and beyond. We will now turn it back over to the operator for questions.

[Operator Instructions] Our first question comes from Craig Mailman.

Just kind of curious, you guys have a kind of a broader portfolio than maybe some of your peers and more recently, rent growth and sequential rent growth have been sort of top of mind for investors, especially in L.A. and some of the other coastal markets. But I'm just kind of curious, as you guys look at your portfolio, your footprint, what are you seeing on that front from a sequential market rent growth, fundamental kind of stable kind of conditions that kind of maybe differentiate your portfolio, your growth rate from people that are a little bit more exposed to some of the markets that maybe really benefit during COVID and are now kind of coming back a little bit to reality.

Yes. Craig, thanks for the question. Our market rent growth forecast at the beginning of this year, were mid- to high single digits for the portfolio. We affirmed that last quarter and affirmed it again this quarter. So market rent growth has been pretty stable in our portfolio. Last quarter, we mentioned benefiting from some of the near-shoring in El Paso markets. We're seeing those mega site investments start to go up in pockets in the U.S., the Southeast Texas, some Midwest markets. So we think that will be a demand driver for some of our markets as well. We're seeing also some demand coming from logistics tenants continuing to build up the supply chain in our market. So for all those reasons, we've seen pretty stable and strong market rent growth in our markets.

Do you feel like you kind of mentioned the hesitancy of tenants to make big cap outlays and so maybe they're using 3PLs in the near term. I mean do you feel like there's a substantial amount of pent-up demand in your markets that if maybe the Fed pivots or something else gives people more assurances on the economy that you could see almost a reacceleration in the absorption in potentially kind of an upward pressure on rents in your market? Or is it just -- just it would be incremental on the margin?

Yes. I mean, certainly, that's a scenario that could play out. I mean there's a lot of factors that would contribute to that, and we need to figure that out, but certainly could be an outcome. Right now, as I mentioned in the prepared remarks, big box demand is still very slow. We're seeing a lot of demand from 3PLs as -- which is consistent with last quarter. So overall, I mean, we're really happy where the supply-demand dynamic is for our portfolio in our markets and our box size. As a reminder, our average lease size is 140,000 square feet and the demand -- the supply that's coming online today about half of that supply is big box supply, 500,000 square feet or above.

And then if I could slip one more in. You guys talked about your -- the acquisitions that you made in the quarter, kind of the $70 million due to post quarter end versus the dispose and kind of your equity availability. I mean if you guys hit your guidance, what does the accretion on a net basis looked like from all the capital recycling activity within earnings maybe for '23 and what that kind of translates to on an annualized basis for a run rate?

Yes. I mean for earnings this year, our acquisition guidance is back-end weighted. So we're not factoring in a large contribution to core FFO from acquisitions. Dispositions are happening a little quicker in the year. We increased our disposition guidance. But for this year, not a major contributor to core FFO. The acquisition this year should benefit significantly 2024 core FFO, and we'll obviously speak about that on our later call.

Our next question comes from Eric Borden with BMO Capital Markets.

I appreciate the color on the potential development acquisition opportunities and just hoping that you could kind of expand on that, maybe quantify what you're seeing today in the pipeline and what you expect to close in the back half of the year? And then just a clarifier is, are those opportunities included in acquisition guidance? Or are they separate too?

Yes. Good question, Eric. Thank you. The development opportunities we're seeing, we're really excited about. We've had really great success on our past developments. The developments are not in our acquisition guidance, any incremental developments would be incremental to that. But they do take time anywhere from 12 to 15, sometimes 18 months to develop. So the deployment of capital for those will be over a period of time. We're seeing opportunities, as I said, from newly constructed buildings that are vacant to entitled land sites that will run the development to partnering with a developer and providing capital to that developer in return for taking the risk for upside and downside in the transaction. So we're seeing a lot of opportunities now as we close on those opportunities, we'll be sure to let everyone know. At this point, there's not enough certainty in the pipeline for us to give guidance on that. But as that happens, we will be sure to give guidance and lay out a schedule, [ noting ] the deployment of capital when those developments will be completed, the yields, profit margins, et cetera.

Okay. That's helpful. And then maybe on the funding side, just how are you thinking about the funding for the remainder of the year, just given your share price today, you have $60 million of forward left versus cost of debt and mix of dispositions. What's the most attractive source of capital today? And how should we think about the mix kind of through the remainder of the year?

Eric, this is Matts. You're right. So we have unfunded proceeds on the forward roughly $61 million. We're going to use those to fund acquisitions in the future ongoing developments that Bill just mentioned. The capital market has materially improved since April. And as we've talked about, our initial guidance ranges were set at the beginning of the year to allow us to operate our target leverage in, if we hit the midpoint of our net acquisition volume issued no equity would likely be at the high end of that leverage range. With this modest amount of equity funding, it's more likely we're going to operate closer to the middle part of our range. But the concept of being able to operate without any additional equity is still in place. As Bill mentioned, we slightly increased the bottom end range of our disposition guidance. So we expect from a funding source, you're going to see, I'd say, incrementally more disposition proceeds.

Our next question comes from Vince Tibone with Green Street.

I just wanted to clarify the cash cap rates on the acquisitions in the quarter. Just given the shorter WAULT deals, does that 6.2% cap rate reflect run rate current NOI? Or does this incorporate this kind of big mark-to-market you highlighted, especially in the Carolina property?

Yes. It depends on if it's a known vacate, Vince. One of the deals is a known vacate, so that would be stabilized. And the other one is not a known vacate, so that would be the in place.

Got it. So basically, the year 1 yield on these is going to be a little lower than the $62 million, just to clarify.

Yes, slightly lower.

Yes. Got it. And then just a kind of question on the development opportunities and kind of just really how leasing risk is being priced today. So if you were going to buy the completed development that's vacant, how much additional yield do you think you could achieve by leasing that building versus just buying a stabilized core property today?

It depends on the market. It depends on suite size, demand, the supply, but anywhere, call it, circa 75 basis points depending -- again, depending on the suite sizes. But we're -- the opportunities we're looking at on the development side is, call it, smaller boxes generally, medium-sized boxes. And a lot of times, we're building those. We're planning to build those to demise them into 2 to 3 suites, so really meets the teeth of the demand.

Our next question comes from Samir Khanal with Evercore ISI.

Matts, I mean there's a lot of positivity around the comments here, but you kept the guidance unchanged. So I'm just trying to figure out as you kind of still a pretty wide gap considering you're in August here. So wondering what's sort of holding you back here? Maybe talk about the factors, maybe to get you to the low end of guidance here?

Yes. So just to talk about the no change in core FFO. To your point, we did have a modest increase in our same-store guidance. Look, there's still macro uncertainty as we sit here in July, that definitely influences our view on guidance. We did increase our disposition volume expectation for the year. Look, there can be a timing mismatch between selling an asset and redeploying those proceeds. As Bill mentioned, external growth is really not a material driver to earnings this year. The acquisitions are expected to be back-end weighted. In terms of the low end of guidance, to the extent something on the macro front, really kind of tipped the capital market picture and that flowed into the share price. But we're very confident with the midpoint. And to the extent credit loss comes in lower, et cetera, we would dip towards the higher end.

Yes. Just to add on to that, I mean I think you'd have to have some a real material macro event to push us to the low end of guidance, some significant credit issues in the portfolio, which we're not anticipating, but we certainly don't want to put a guidance range out there that doesn't factor some of that uncertainty into it.