Kimco Realty Corporation (KIM) — Q3 2017 Earnings Call Transcript

Good morning and thank you for joining Kimco’s Third Quarter 2017 Earnings Call. Joining me on the call are Conor Flynn, Chief Executive Officer; Ross Cooper, President and Chief Investment Officer; Glenn Cohen, CFO; and Dave Jamieson, our Chief Operating Officer, as well as other members of our executive team, including Milton Cooper and Ray Edwards. As a reminder, statements made during the course of this call may be deemed forward-looking. It is important to note that the Company’s actual results could differ materially from those projected in such forward-looking statements due to a variety of risks, uncertainties and other factors. Please refer to the Company’s SEC filings that address such factors. During this presentation, management may make reference to certain non-GAAP financial measures that we believe help investors better understand Kimco’s operating results. Examples include, but are not limited to, funds from operations and net operating income. Reconciliations of these non-GAAP financial measures are also available on our website. Before transitioning the call to Conor, I want to make you aware of an important upcoming change regarding the timing of our future earnings reporting. Beginning with our fourth quarter earnings, which will take place in February of next year, we plan to announce our results in the morning, a few hours ahead of the conference call. We believe that having the benefit of management’s comments taken together with the reported results will provide a more meaningful and comprehensive understanding of the Company’s performance and enables us to mitigate any potential Reg FD risk. With that, I’ll turn the call over to Conor.

Thanks, Dave, and good morning, everyone. Today, I will provide an overview of our strong third quarter performance, update you on our progress for achieving our 2020 Vision strategy, and give additional color on our portfolio including an update on our assets in Puerto Rico. Ross will review our quarterly transaction activity and the general market environment. Finally, Glenn will provide details on key metrics and updates to our 2017 guidance. In terms of key highlights. We signed 343 new leases, renewals and options this quarter, totaling 1.8 million square feet. Occupancy increased 30 basis points sequentially and the blended spread on new leases and renewals was a positive 16%. These results validate our ongoing thesis that open-air centers that focus on grocers, off-price, fitness, everyday goods and services continue to be solid investments and remain the backbone of our strategy to create the optimal portfolio and drive shareholder value. But the retail landscape is changing, which should not be a surprise to anyone. The history of retail from small vendors to specialty stores to department stores to big boxes is a history of winners and losers and the fight to win the consumer’s dollar. What is surprising today, however, is the speed in which these changes are occurring. Today, it’s about millennials and their taste for experiential retail, services, and convenience. They research with their smartphone, which has become the retailer’s front door. Today, it’s also about an omnichannel environment which requires retailers and landlords to work together to combine e-commerce and brick and mortar to attract shoppers and to keep up with their changing tastes. And that is why in this ever-evolving retail landscape our core principles of quality, growth, and a strong balance sheet are more important now than ever. Quality locations are where the retailers will always want to be, and the quality of our portfolio continues to improve. Since 2010, we have sold over $6 billion of real estate, recycling the proceeds into higher quality assets and reducing the size of our portfolio from over 900 to 508 assets. The result is a higher quality portfolio concentrated in the best markets in the United States. By focusing on high barrier-to-entry markets and executing on our unique customer strategy, we have become more efficient and are able to drive greater value creation. Quality drives growth, which is our second core principle. Creating multiple drivers of NOI growth from leasing, redevelopment, and development has been at the heart of our operating strategy. The leasing results this quarter once again demonstrated that when all is said and done, the key to our business is leasing. Our pro rata occupancy now stands at 95.8%, making it one of the highest levels in our sector, and we continue to see opportunities to grow this metric. Leasing is the most direct and important creator of value, whether it comes from filling vacancies, renewing existing tenants, preleasing our redevelopment and development projects, or realizing our mark-to-market opportunities. One example of this is our ability to transform and reposition specific assets. Specifically, we signed new leases at strong leasing spreads that included the recapture of three former Kmart boxes just this quarter alone. Redevelopment and development continue to be a part of our long-term growth strategy. And this quarter, we achieved several critical milestones that will pave the way for our future success. On the redevelopment side, we have secured all approvals and cleared all contingencies for our Signature Series, Staten Island project, renamed The Boulevard. A 460,000 square foot center fostering a Towne Square environment, which we believe is emblematic of the future of retail real estate. Construction started recently at the Boulevard, which is already 71% preleased, anchored by a shop rent grocery, Marshalls, and many other great national and regional and local retailers. The tenant lineup not only demonstrates the vibrancy of the market but also significantly reduces the risk associated with major construction. And keep in mind, redevelopments like The Boulevard necessitate the demolition of existing stores and cause short-term impacts to same-site NOI. Ultimately, however, the revitalization of irreplaceable assets like The Boulevard will create significant net asset value. Separately, phase 1 of Grand Parkway in Houston is just about complete and the final anchor box in Phase 2 is now leased. The Boulevard and Grand Parkway represent just two examples of our robust pipeline of development and redevelopment opportunities. Our third core principle is to maintain a well-positioned balance sheet that enables us to support our growth initiatives and let our shareholders sleep comfortably at night. Glenn and his team continuously seek opportunities to improve our already solid capital structure and healthy liquidity position. Specifically, they have successfully extended our debt maturity profile, judiciously tapped the preferred equity market, and refinanced existing mortgage debt at favorable terms. Furthermore, as our NOI growth accelerates, we expect our debt metrics will continue to improve. Finally, let me take a moment to update you on our Puerto Rico portfolio. First and foremost, our employees on the island are safe and have performed tremendous efforts in helping other team members, some of whom have lost homes and spearheading our cleanup and restoration efforts. In particular, I would like to thank Victor Aguilar for leading our team in the face of enormous logistical, physical, and emotional challenges. Conditions on the island are now improving. Fuel shortages are easing and grid power is gradually being restored. Fortunately, none of our seven assets sustained major structural damage. Comprehensive restoration plans are being implemented at each of our sites. Tenants continue to reopen, and many of our anchor tenants are now open for business. In closing, our leasing volume continues at a record pace. Our occupancy is pushing toward all-time high and continues to validate the quality of our portfolio. Our pipeline of development and redevelopment projects is now starting to deliver. And our balance sheet remains the source of strength. Our team is determined to make our 2020 Vision a reality. I firmly believe that for Kimco, the best is yet to come. And now, I will turn the call over to Ross.

Thank you, Conor. While the acquisition environment remains highly competitive for infill shopping centers with upside and value creation potential, we continue to pick our spots, recycling the disposition proceeds from non-core properties into irreplaceable Signature Series assets with long-term redevelopment opportunities. The third quarter was quite active as we enhanced the quality of our portfolio and strengthened the concentration of assets in our primary markets. During last quarter’s call we announced the Jantzen Beach acquisition in Portland, Oregon, a dominant 67-acre center with substantially below market leases and both near and long-term prospects for value creation and redevelopment. We continue to mine our assets for growth and expansion opportunities and added adjacent parcels to several assets in the third quarter. We accretively acquired an unowned parcel at Jantzen Beach in addition to boxes that are Webster Square asset in Nashua, New Hampshire, and Gateway Station in Burleson, Texas. Subsequent to the end of Q3, we purchased Whittwood Town Center, a dominant West Coast asset. Whittwood is a 787,000 square foot grocery-anchored property located on 54 acres in Whittier, California, a densely populated suburb of Los Angeles. It is anchored by Target, Vons Supermarket, Sears, J.C. Penney, Kohl’s, 24 Hour Fitness, and others. Our attraction to the site includes irreplaceable real estate and impressive demographics. The substantial upside is what we envision for the future. Collectively, the below market leases of Kohl’s, J.C. Penney, and Sears have an aggregate mark-to-market spread of 560%. The anchor leases, including Target, average $3.01 per square foot versus a market rent in excess of $10 per square foot. The $123 million purchase price was funded with 1031 exchange proceeds and $43 million loan assumption of in-place debt. With the addition of Whittwood, Kimco now owns 25 assets in Los Angeles, adding to the significant scale we have in this market and further leveraging our Southern California regional offices. In terms of disposition activity, we remain on track, selling five non-core assets for $62 million at a mid-7% cap rate. This brings our sales total for the first nine months of 2017 to 21 shopping centers and three land parcels for a gross price of $331 million. We have another 19 assets, either under contract or with price agreement for a total of approximately $185 million, much of which we expect to close by year-end. The market remains strong for our products, especially those properties with value-add components. This quarter, we sold an asset in Joplin, Missouri, with a strong junior anchor lineup and one box vacancy to a local buyer. We had seven offers for that center. We also now have a price agreement for a power center in the secondary market of North Carolina with 14 offers for that asset. Bidders in the secondary markets have generally consisted of local buyers with private equity backing, private REITs, and opportunity funds. Debt is still readily available for reputable sponsors at extremely attractive rates. We remain confident in our ability to execute on our strategy of pruning the non-core asset from the portfolio. And given the current cost of capital, our expectation is that we will sell substantially more than we will acquire in 2018. Glenn will now walk you through the financial results.

Thanks, Ross, and good morning. We are happy to report positive third quarter results from our open-air shopping center portfolio as we continue to execute on all operating fronts. Leasing was strong, leading to increased occupancy; development and redevelopment projects continue to progress, and our balance sheet and liquidity position improved as a result of our capital markets activity. For the third quarter, we reported NAREIT-defined FFO per diluted share of $0.39, which includes $0.03 per share of foreign currency gain on the substantial liquidation of our Canadian investments. Also included is a $0.02 per share charge attributable to the preferred stock redemption, prepayment of bonds, and some land impairments. NAREIT-defined FFO per share for the third quarter last year was $0.18 per diluted share and included transactional expenses totaling $0.20 per share from the early repayment of debt and the deferred tax valuation resulting from the merger of our taxable REIT subsidiary into the REIT. FFO as adjusted, which excludes transactional increment expense and non-operating impairments, was $161.3 million, with $0.38, the same per share level as last year’s third quarter. Our NOI increased $7.4 million compared to the same quarter last year and was offset primarily by lower tax benefit from our TRS merger last year. During the quarter, we moved Phase 1 of our Grand Parkway development project into the operating real estate line as occupancy is approaching 90%. Grand Parkway provided $1.6 million of NOI during the third quarter. It’s important to keep in mind that we have over $360 million invested in development projects that are not earning today, thus impacting our FFO growth in the short term. These development projects will begin slowing in stages in the latter half of 2018 and into 2019. Our operating portfolio continues to deliver positive results. Same-site NOI growth was 3.1% for the third quarter and includes negative 20 basis points impact from redevelopments. For the nine months, same-site NOI growth was 1.7%. With no incremental contribution from redevelopments as we have started a similar number of new redevelopment projects to those that have been completed. The Boulevard redevelopment project, Conor mentioned, is an example of this. Taking into account our year-to-date same-site NOI performance, we are revising our full year same-site NOI growth assumption to 1.5% to 2%, from the previous 2% to 3% range. This is primarily due to the timing of contributions from redevelopment projects, the 320 basis-point spread between leases executed versus rent commencement, and the expected business interruption in the fourth quarter at our seven Puerto Rico assets due to Hurricane Maria. Although our insurance will cover a substantial portion of lost rent and physical damage, the timing of payment covering business interruption is not expected to be received in the fourth quarter. It was a very active quarter on the balance sheet front. We issued $850 million in unsecured bonds, $500 million at 3.3% and $350 million at 4.45% with a weighted average life of 16.7 years. We completed the $206 million refinancing of the mortgage at our Tustin property with a new 13-year mortgage at a reduced rate of 4.15% versus 6.9% previously and issued $225 million of perpetual preferred stock at a coupon of 5.8%. Proceeds from the bond and preferred offerings we used to redeem $225 million of 6% preferred, $211 million of our 4.3% bonds due in 2018, and to repay the outstanding balance on our revolving credit facility. As a result of these transactions, our weighted average debt maturity now stands at 10.8 years, one of the longest in the REIT industry. We have over $2 billion of immediate liquidity with less than $100 million of debt maturing in 2018. Our balance sheet and liquidity position are in excellent shape. Let me spend a moment on 2017 guidance. Based on our nine-month results of NAREIT-defined FFO per diluted share of $1.17 and our FFO as adjusted per diluted share of $1.13, we are narrowing our guidance range for NAREIT-defined FFO to $1.55 to $1.56 per diluted share from the previous range of $1.53 to $1.57 per share. Similarly, we are narrowing our FFO as adjusted per diluted share guidance range to $1.51 to $1.52 from the previous range of $1.50 to $1.54. We are pleased to announce that based on our 2017 performance and expectations for 2018, our Board of Directors has approved an increase in the common stock quarterly cash dividend to $0.28 per share from $0.27, an increase of 3.7%. The increased dividend level represents a conservative and safe dividend payout ratio in the low 70s area, and based on the current share price, the dividend yield is 6%. We will provide 2018 guidance on our next earnings call. As a reminder, our initial 2018 NAREIT-defined guidance will not include any transactional income or expenses. Our NAREIT-defined FFO per share range and our FFO as adjusted per share range will be the same at the start of the year and will only differ upon completion of specifically identified transactional events. And with that, we’d be happy to answer your questions.

We are ready to move to the Q&A portion of the call. To make the Q&A more efficient, you may ask a question with one additional follow-up. If you have additional questions, you are welcome to rejoin the queue. Francesca, you can take our first caller.

I was curious, when I examine the total size of the GLA for both Whittwood and Jantzen Beach, if there is an alternative approach to underwriting these large centers. Do you see different opportunities here and what risks do you consider when making these acquisitions?

Yes. Absolutely. We’re underwriting several opportunities at both properties. And we really believe that the size of these assets gives us the ability to create substantial value. When you look at Jantzen, you have several undeveloped outparcels that are immediate near-term upside opportunities, and then you have the below market leases there that give you the opportunity longer term. Both assets we think have very similar attributes, and that long-term, we think that there is additional density that can be added. At the Whittwood shopping center, we’ve already started the process with the municipality of master planning the entire asset, and we began that process while we were going through the loan assumption process. So, given the size of the 54 acres in Los Angeles, the surrounding density and the initial positive reception that we’ve had from the city, we think that that’s a very viable strategy. When you look at the anchors that we have at Whittwood, while we do have several large tenants there that will have to be moved around or replaced in time once we have that liquidity and the site, we think that it’s prudent in advance to really start that process, the master planning. And when you look at specifically Sears and J.C. Penney, those are opportunities that we think at the appropriate time that we can move forward with a negotiation and recapture of those spaces. So, we think that the size, the below-market leases, and the tenants that we’re dealing with give a lot of upside opportunity.

Just in Puerto Rico, what percentage of your rents and recoveries are you not actually collecting today, and when would you expect business interruption proceeds to start to kick in? And then, just bigger picture, what’s your view of the longer term impact of this event on sort of the retailing business in Puerto Rico and thinking about kind of the longer-term viability of these centers as well as on the value of commercial property on the island?

So, in terms of the rents, around 3% of rents from Puerto Rico makes up about $32 million a year, $8 million for the fourth quarter. Our guess is, you might have 25% of that that might be at risk for collection as we still evaluate what’s happening on the island. As Conor mentioned, tenants are opening, but again, small shop tenants are still evaluating, and we’ll have to see how and when that rent starts flowing again. So, we think there is a risk of a couple of million dollars there. That represents roughly a 100 basis points of same-site NOI for the fourth quarter, which would equate to about 25 basis points of same-site impact for the full year. We are still evaluating what’s going to happen. In terms of the proceeds, you have to first put your claim in. Claims would probably start getting paid 60 days after those claims are in. But, we haven’t filed any business interruption claims yet because we are still evaluating it. You need to get the full picture before you start putting the claims in. So, as I mentioned in my opening remarks, I don’t expect that we will have claims paid to us really in the fourth quarter; we will start recouping the business interruption part of it in 2018.

I think Puerto Rico, longer term, they have a very manageable retail per capita when you look at the island. So, when you look at the rebound of hopefully the island’s recovery, it really will tie back to how quickly they can get the grid back up and running, how quickly they can get services and really power to the entire island. Clearly, everybody has been seeing in the news and we have been working hard in getting our grocery stores and our home improvement anchors open as quickly as possible. But longer term, you are going to have to wait and see in terms of really what kind of impact it has on the population and really how many people move back after the island gets stabilized.

Again, keep in mind who the tenants are in our centers, which is important. It’s really everyday goods and services, it’s discounters, some Home Depots, and some Kmarts. It’s really everyday goods and services, which is what really drives the island.

Hey, guys. This is Ronald Kamdem on for Richard Hill. I just had two quick questions. The first is just going back. Can you just walk us through what drives the variability in lease compressions? Presumably, our understanding is that the contracts have a fixed start date. So, if you can just maybe just help us understand what instances can drive that variability, that would be pretty helpful.

Sure. Yes. This is Dave Jamieson. With anchored tenants and junior anchor boxes as they are going through the permitting process, there are tender dates where we complete our work and we tender it over to this tenant. There is a permitting window that the tenants go through as well for their right to complete their box. Sometimes, depending on the use and depending on what you are doing specifically to that box may add some additional time to that permitting process, which may delay their ability to open and impact the RCD. That said, it doesn’t necessarily increase the cost on our side of the equation. But, those are some of the variables that can set in. Sometimes, for example, you may have to go for a parking variance in which this city then you have work through that entitlement. So, those are a couple of the components that can drive and impact the open date itself.

In terms of the reduced same-store NOI guidance, lease economic occupancy gap is one of the items that seems to miss expectations here in terms of being wider than you had anticipated. I am just wondering what your timing expectations are now as we hear today for this narrowing? And as we look at the 3Q number, obviously you seem to get a benefit on the expense side, I assume this is maybe a tax reversal. Was this anticipated when you held the range last quarter?

Yes, we received some tax refunds that contributed to this improvement. Additionally, we experienced a revenue increase. Looking ahead to 2018, we anticipate that the difference between economic and lease occupancy will begin to decrease, which is a contributing factor. While we've been actively leasing, those numbers have been consistent. In fact, the gap has widened from 200 basis points at this time last year to 320 basis points now.

The other piece to it, just to keep in mind, is obviously the hurricane had a pretty big impact on our Puerto Rico portfolio, which had a negative impact on our same-site NOI. So that’s something that unforeseen and we continue to try and manage that.

I just want to go back to Puerto Rico here on the $32 million of NOI annually that’s at risk. Does that include all income including ancillary income and any percentage rents you might be getting, and are those two categories also covered by business interruption?

Yes. So, it does include ancillary income; it does not include percentage rent. Percentage rent is just an additive component of that. As it relates to business interruption insurance, it would include that. If you have historic performance that identifies the type of income you would have received otherwise prior to an event, then you have a case in which you can claim business interruption insurance.

So, on Puerto Rico, the 25% of rent at risk, given that your properties are mostly up and running, at least that’s what it sounds like. What was the cause of that? Is that tenants just decided to stop paying rent, is it damage, or is it the fact that maybe these smaller tenants, they don’t have their own insurance, which is causing some of this?

Well, you have a few things. The larger anchored tenants have generators that are up and running, so that’s how they are able to run their stores. The smaller shops, which is about half the rent that comes from all the tenants at the seven properties, a lot of them don’t have generators, a lot of them are smaller store businesses where, quite candidly, some of them lost their homes. So, we are still evaluating just how much of that is missing. So, we are trying to be realistic about what we have. We know half of our rents are coming from small shops base. So, we are making an estimate that some portion of that, as much as 50% of that could be potentially at risk during the fourth quarter. Now, again, most of it will be covered by business interruption insurance. But more importantly, we’d like to get the tenants back open and running so that they can provide their goods and services to the communities.

Yes. Just to add some detail to that, regarding the anchor boxes, all our largest boxes are open and operating. We have two fully functioning Kmarts, two Sam's Clubs, two Home Depots, and two Costcos among our seven properties. The major retailers are opening and providing essential services during this restoration process. As for the small shops, the situation varies by location. Three of our centers, which house a significant majority of those small shops, are already open and operating. However, as Glenn mentioned, power availability is inconsistent since it relies on generators or some reconstruction of the power grid, and conditions in Puerto Rico remain quite challenging. We anticipate improvements, but for now, we are taking a cautious approach.

Okay. And maybe just one last one if I might, just on the Whittwood. Just looking at some disclosures from DDR there, it seems like this is sort of a low four cap going in. Is that more or less correct?

It’s in the low 5s.

Good morning. Two questions. First, obviously we’ve been in a period of time for depressed cost capital, depressed stock prices. I understand that Whittier was a 1031 exchange, don’t know if your dynamics would have changed, if you were to undertake that underwriting today versus when you originally did. But, as you guys talk about mixed-use projects and different external investments, even if you are sourcing it from dispositions, where your stock is trading, or now your decline in the stock prices? Does that at all affect how you guys think about the external side or is it independent because as long as you can fund it from dispositions, you’re agnostic?

Yeah. The short answer is yes. The cost of capital definitely has an impact on our evaluation of future investment opportunities. When we look at Whittwood and Jantzen, those were deals that were both put under contract early in the year, March and April. So, obviously, we had hoped that by this point of the year, cost of capital would be different than where it is today. So that being said, we are very excited about those two assets and we did utilize the dispositions to fund those. But on a go forward basis, the expectation is that without a substantial change in that cost of capital, our external investment will be significantly lower.

Hi, this is Michael Bilerman with Christy. I want to discuss capital allocation in terms of match funding and whether your approach will change moving forward. You've mentioned entering into contracts on Jantzen and Whittwood earlier this year. Considering your deposits and seller relationships, it seems there wasn’t a reason to withdraw from those deals. However, it appears this is impacting your balance sheet, even though you've effectively extended terms and reduced costs. Your debt to EBITDA ratio has improved by half a turn over the past year. Are you considering, independent of your stock price, whether it might be better to finance potential acquisitions sooner to avoid situations where you feel pressured to close transactions despite the current cost of capital? Would you contemplate using joint venture capital for these deals? Can you explain how this experience might influence your future approach to external growth in relation to match funding at the time of entering and pursuing deals?

Yes, Michael, you raise a valid point that Ross has examined thoroughly in his comments. With our current cost of capital, it’s clear that we plan to be a net seller next year, which is our expectation. Regarding the loan assumption process on Whittwood, we recognized that the situation has changed since we put the project under contract. Moving forward, we intend to prioritize our balance sheet and our net debt to EBITDA. Consequently, we anticipate selling more and focusing on adjacent parcels in the coming year that could lead to future redevelopment projects. Overall, we envision being a net seller next year given our current cost of capital.

Glenn, a quick one for you. You took out more than half of the 6% preferred and there is still remaining. What’s your plans for the remainder of that and why didn’t you fully redeem out that $400 million preferred?

At the right time, we’ll redeem the balance of those 6% preferred. Again, we are trying to balance the total look through of consolidated net-debt-to-EBITDA including it with preferreds. And when we went to the market, we went with a very aggressive rate, 5.8% rate was a pretty aggressive. So, we took out what we could get done at that point. I mean, we clearly got to the debt market and replaced it at a lower rate, but that’s just going to put more pressure on consolidated net-debt-to-EBITDA. So, we will take it out at an opportunistic point.

Hi. Now that a little time has passed, have you had any new discussions with Whole Foods and has Amazon’s involvement changed their appetite for new stores or the redevelopment of existing stores?

Yes. We have been actively engaged in Whole Foods, obviously prior to the acquisition, we had all noticed I think it stalled a little bit, but they are very much on the expansion, looking for new opportunities to expand. In terms of how they utilize, Amazon will utilize the Whole Foods locations, they still keep things very close with us. So, it’s yet to be seen. I think we all have opinions and there are a number of opportunities in which they could do it in the four walls. But to our benefit, they are absolutely actively looking to expand in the market.

Thank you very much and thank you to everybody that joined our call today. Have a good day.