Phillips Edison & Company, Inc. (NASDAQ:PECO) Q4 2022 Earnings Call Transcript February 10, 2023
Operator: Good day, ladies and gentlemen, and welcome to Phillips Edison & Company's Fourth Quarter and Full Year 2022 Earnings Conference Call. Please note that this call is being recorded. I would now like to turn the call over to Ms. Kimberly Green, Head of Investor Relations. Please go ahead, ma'am.
Kimberly Green: Thank you, operator. I'm joined on this call by our Chairman and Chief Executive Officer, Jeff Edison; our President, Devin Murphy; and our Chief Financial Officer, John Caulfield. Once we conclude our prepared remarks, we will open the call to Q&A. After today's call, an archived version will be published on our Investor Relations website. As a reminder, today's discussion may contain forward-looking statements about the company's views of future business and financial performance, including forward earnings guidance and future market conditions. These are based on management's current beliefs and expectations and are subject to various risks and uncertainties as described in our SEC filings, specifically in our most recent Form 10-K and 10-Q.
In our discussion today, we will reference certain non-GAAP financial measures. Information regarding our use of these measures and reconciliations of these measures to our GAAP results are available in our earnings press release and supplemental information packet, which have been posted to our website. Please note that we have also posted a presentation with additional information. Our caution on forward-looking statements also applies to these materials. Now I'd like to turn the call over to Jeff Edison, our Chief Executive Officer. Jeff?
Jeffrey Edison: Thank you, Kim, and thank you, everyone, for joining us today. The PECO team in 2022 delivered another year of strong growth with same-center NOI increasing by 4.5%. We continue to benefit from a number of positive macroeconomic trends that drive neighbor demand and support our growth, including hybrid work, migration to the Sunbelt and population shifts that favor suburban markets. These demand factors are further amplified because limited new supply is being delivered to the market. We accomplished a great deal in 2022 and have a lot to be proud of. At the macroeconomic level, the year presented many challenges with record inflation, rising interest rates and global conflict. However, the sustainability and consistency of our growth is a testament to our differentiated and focused strategy of exclusively owning grocery-anchored neighborhood shopping centers and the strength of our integrated and experienced operating platform.
As we assess our business today, we're optimistic about the health of our neighbors and the strength and diversity of our neighbor mix. Our team in 2022 delivered record highs in occupancy of 97.4% and combined leasing spreads of 18.1%, our development activity provides attractive risk-adjusted returns on investment and sustainable and meaningful contributions to our same-center NOI growth. Our acquisitions are performing very well, and our pipeline continues to grow. We closed on an asset in January with more under contract and in negotiation. We observed the market power shifting to the buyer and with our platform, experience and capital, this should position us well to capture additional opportunities. Our centers are located in markets that are growing and have a strong competitive advantage with our grocery anchors.
We have grown our cash flows and dividend distributions. We have a great balance sheet, low leverage and flexibility to be both patient and opportunistic. We could not have accomplished these results without the hard work of our PECO associates. I'd like to thank the PECO team for all of their efforts. As we look ahead to 2023, we remain focused on delivering long-term growth. Our gross-anchored neighborhood centers continue to benefit from structural and macroeconomic trends that create strong tailwinds and drive strong labor demand. These trends include population shifts from the urban to suburban markets, the increase in hybrid work the renewed importance of physical locations in last mile delivery, wage growth and low unemployment and low supply and lack of new construction.
The resiliency of our neighbors, combined with the aforementioned tailwinds and position PECO well for all economic environments due to the following, our necessity-based neighbor mix, our rightsized format, our well-positioned locations in growing markets our record high occupancy and continued strong labor demand. Our strong credit neighbors and diversified mix, the lack of exposure to distressed retailers. Our balance sheet and our talented and cycle-tested team. When we consider our pricing power created from continued retailer demand at high occupancy, combined with these aforementioned tailwinds and the resilient necessity-based focus of our neighbors. We believe our growth strategy generates more alpha with less beta. While John will provide details of 2023 guidance later, I'd like to spend a few minutes walking you through the components of our long-term growth.
We believe our portfolio can deliver organic same-store NOI growth of 3% to 4% on a long-term basis. The components of this growth include continued increases in occupancy, which will contribute 50 to 100 basis points. Rental growth, which will contribute 100 to 125 basis points through new and renewal leasing spreads and contractual rent increases, which will add 75 to 100 basis points and redevelopment and development activity, which will add 75 to 125 basis points. This gets us to our 3% to 4% long-term growth. Beyond the strong internal growth, we remain focused on accretively growing our shopping center portfolio. These investments are core to PECO's long-term external growth strategy, and we continue to be well positioned to capitalize on opportunities as they arise.
We are conservatively guiding to $200 million to $300 million in net acquisition this year with the capability and the leverage capacity to acquire more if attractive opportunities materialize. We previously increased our targeted return for new acquisitions to an unlevered IRR of 9% or above. We plan to participate in the market when we can achieve this return objective while exercising the same diligence we've always exercised. We are finding those opportunities today. Therefore, with our combined internal and external growth drivers, we believe PECO can deliver mid-to high single-digit FFO per share growth on a long-term basis. I'd now like to provide a quick update on the proposed Kroger and Albertsons merger from PECO's perspective. We continue to believe that the merger is positive for PECO and for our centers and for the communities that we -- that our centers serve.
We have 33 stores with an overlapping brand within 3 miles that could potentially be impacted. These stores have average store sales of $35 million or $620 per square foot. This compares to PECO's average of $6.42 per square foot. These are all productive grocery locations with strong sales and health ratios. These centers are also vital parts of their communities. We believe all 33 locations will remain productive grocery locations regardless of the ultimate outcome of the merger. This merger process will take time to unfold, but we remain positive on the impact it will have on the assets that we own. I'll now turn the call over to Devin to provide more color on the operating environment. Devin?
Shopping, shopping center, People
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Devin Murphy: Thank you, Jeff. Good afternoon, everyone, and thank you for joining us. As Jeff mentioned, the PECO team is encouraged by the continued positive trends that we are seeing in our grocery-anchored portfolio and in the overall operating environment. We realized strong internal growth in 2022, which is reflected in our financial results. Lease portfolio occupancy increased by 30 basis points sequentially from the third quarter and by 110 basis points year-over-year, reaching an all-time high of 97.4%. We still see some occupancy upside in our portfolio. And when that driver of growth is no longer available, we believe that it will be replaced by incremental rent growth. We are seeing that transition today as our rent spreads have increased above historical levels.
Throughout 2022, our neighbors demonstrated resiliency and successfully managed many challenges, including inflation, supply chain issues and labor shortages. Despite these challenges, our neighbors continue to invest in their stores, their technology platforms and the overall customer experience. Comparable new and renewal rent spreads for 2022 were strong at 32. 2% and 14.6%, respectively. Excluding anchors, renewal spreads were 17.7% in the fourth quarter. Our leasing pipeline remains strong and shows no signs of slowing. The most active neighbor categories include medical, quick-serve restaurants and health and beauty. We are seeing consistently strong neighbor demand across all geographic regions. We continue to have excellent success retaining our neighbors, while growing rent at attractive rates.
Our fourth quarter retention rate was 92%, ahead of the historical average of 87% over the last five years. As Jeff mentioned, this factor is a large contributor to our rent growth over time. Our retention means no downtime and less tenant improvement costs. Our TI spend on renewals over the last five years averaged less than $2 per square foot. We also have been successful at driving higher contractual rent increases. On average, our new and renewal in-line leases executed in the fourth quarter had annual contractual rent bumps of 2.4%, another contributor to our long-term growth. In addition to our strong rental growth trends, we continue to focus on and expand our pipeline of ground-up outparcel development and repositioning projects. In 2022, we stabilized the highest number of these projects that the PECO team has ever delivered in a single year.
These projects delivered over 300,000 square feet of space and add incremental NOI of approximately $5 million annually. These projects provide superior risk-adjusted returns and have a meaningful impact on our long-term NOI growth. In 2023, we will invest $50 million to $60 million in ground-up outparcel development and repositioning opportunities with average estimated underwritten cash-on-cash yields between 9% and 11%. We continue to see the many benefits of PECO's grocery anchor portfolio with our healthy mix of national, regional and local retailers. More than 70% of our rents come from neighbors offering necessity-based goods and services, and our top grocers continue to drive strong recurring foot traffic to our centers. We are currently seeing a resilient consumer despite the tougher macroeconomic backdrop.
We believe our incentives are less impacted by an economic downturn because more than 70% of our rents come from necessity-based goods and services. Our trade areas offer favorable demographics with median household incomes of $77,000, which is approximately 9% higher than the U.S. media. The demographic strength of our trade areas is reinforced by the continued demand from retailers for space at our centers. In a recession, consumers will continue to frequent the grocery store, the barber, the local quick-serve restaurant and other necessity retailers. Our single non-grocery neighbor is T.J. Mac at 1.4% of ABR. And all other non-grocery neighbors are less than 1% of ABR. PECO had no exposure to luxury retailers, office or theaters and very limited exposure to distressed retailers.
The top 10 neighbors currently on our watch list represent just 2% of our ABR. As a reminder, our combined exposure to Bed Bath & Beyond and Party City is minimal. These two retailers represent 10 and 20 basis points of ABR, respectively. 26% of our ABR is derived from local neighbors. 64% of our local neighbors rents come from retailers offering necessity-based goods and services. Our local neighbors are successful businesses run by hard-working entrepreneurs. The acute credit and are less susceptible to corporate bankruptcy caused by weaker performing locations. A local neighbor typically receives less capital at the beginning of their lease, accepts more Peco-friendly lease terms, high retention rates and achieved renewal spreads similar to national neighbors.
Importantly, they differentiate the merchandise mix that our centers offer our customers. Our local neighbors are resilient and have been in our centers for 8.8 years on average. According to CoStar's recent global Predictions report, grocery stores and essential retail are among the most resilient retailers during recessions. During the pandemic, grocery stores and the foot traffic to these centers recovered at a faster rate than that of other retail locations. Since the pandemic, the vacancy spread between grocery-anchored and non-grocery-anchored centers has widened. Grocery-anchored centers are well positioned to maintain these lower vacancies, which we are experiencing in our portfolio. We expect these favorable trends to continue to benefit PECO's well-located, grocery-anchored neighborhood centers in 2023 and beyond.
We have added slides to our investor presentation on these recent CoStar insights. In summary, the PECO team remains optimistic about the current strong operating environment and the continued positive momentum we are experiencing across leasing, redevelopment and development. In addition, our healthy neighbor mix and grocery-anchored strategy positions PECO well for continued steady growth. I'd now like to turn the call over to John.
John Caulfield: Thank you, Devin, and good morning, and good afternoon, everyone. I'll start by addressing fourth quarter results, provide an update on the balance sheet and then walk through some highlights of our initial 2023 guidance. Fourth quarter 2022 NAREIT FFO increased 43% to $71 million or $0.54 per diluted share. This result benefited from an increase in rental income and reduced general and administrative expenses. Fourth quarter core FFO increased 22% to $74 million or $0.56 per diluted share driven by increased revenue at our properties from higher occupancy levels and strong leasing spreads as well as lower property operating costs and general and administrative expenses. Our fourth quarter 2022 same-center NOI increased to $91 million, up 2.8% from a year ago.
This improvement was primarily driven by higher occupancy and an increase in average base rent per square foot, driven by our strong renewal and new leasing spreads, which was partially offset by lower collectibility reserve reversals in the current period when compared to 2021. During the quarter, we acquired two grocery-anchored shopping centers and 1 outparcel for $52 million, and we sold 1 shopping center in 1 outparcel for $25 million. Our net acquisitions for the year was $226.5 million. Subsequent to quarter end, we acquired one additional grocery-anchored shopping center for $27 million. From a balance sheet perspective, we ended the year with over $700 million of borrowing capacity available on our $800 million credit facility, and we have no significant debt maturity until the second quarter of 2024.
Between the free cash flow generated by our portfolio and the significant capacity available on our revolver, we are confident in our ability to fund our growth plans, which is an important place to be given the current capital market environment. Our leverage ratio continues to be strong as a result of our strong earnings growth as well as our prudent balance sheet management with our net debt to adjusted EBITDAR of 5.3 times as of December 31, 2022, compared to 5.6 times at December 31, 2021. At year-end 2022, our debt had a weighted average interest rate of 3.6% and a weighted average maturity of 4.4 years. Approximately 85% of our debt was fixed rate. We continue to monitor the debt capital markets for the right opportunity to extend our maturity profile.
Our variable rate debt allows us to maintain flexibility such that we can access the bond market or bank market without prepayment penalty and our low leverage reduces the impact of rate volatility to our earnings. We anticipate addressing our 2024 maturities along with long-term funding for our expected 2023 acquisition volume later this year. We believe patience is prudent as we continue to gauge the attractiveness of the market. Turning to guidance. Please be sure to review the incremental detail added to our press release, which we have also added to our supplemental. Starting with our same-center NOI growth, we are guiding to a range of 3% to 4% growth from our portfolio in 2023. This growth is aided by our leasing activity in 2022 with increased occupancy and favorable rent spreads in our development and redevelopment activity.
Included in this range is the negative impact of normalizing our anticipated uncollectible reserves to historical levels of 60 to 80 basis points of revenue. Our initial core FFO per share guidance range is $2.28 to $2.34. Our internal growth is aided by an incremental lift from our 2022 and anticipated 2023 acquisitions, partially offset by incremental interest costs. As we look to 2023, we anticipate approximately $86 million of interest expense at the midpoint. Our acquisition pipeline is healthy, for 2023, we are guiding to acquire between $200 million and $300 million of assets net of disposition activity to further optimize our internal growth. We plan to continue to selectively recycle assets with proceeds being deployed into high-quality, higher-growth assets.
As Jeff mentioned, we believe we are well positioned for long-term growth and we are delivering strong internal and external growth. Importantly, we have the flexibility to be patient and pursue accretive opportunities as they arise that will provide meaningful NOI contribution in 2023, 2024 and beyond. And maybe most importantly, as we consider the economic uncertainties, we continue to have one of the strongest balance sheets in the sector allowing us the ability to remain on offense and pivot quickly in response to changing market conditions. We believe our strategy has historically and will continue to prospectively generate excellent risk-adjusted returns. Our results in 2022 are no exception. With that, we look forward to taking your questions.
