U.S. Markets close in 4 hrs 35 mins

Edited Transcript of ILPT.OQ earnings conference call or presentation 30-Jul-19 2:00pm GMT

Q2 2019 Industrial Logistics Properties Trust Earnings Call

Aug 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Industrial Logistics Properties Trust earnings conference call or presentation Tuesday, July 30, 2019 at 2:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* John G. Murray

Industrial Logistics Properties Trust - President, CEO & Managing Trustee

* Olivia Snyder

Industrial Logistics Properties Trust - Manager, IR

* Richard W. Siedel

Industrial Logistics Properties Trust - CFO & Treasurer

* Yael Duffy

Industrial Logistics Properties Trust - VP

================================================================================

Conference Call Participants

================================================================================

* Alexander Mark Pernokas

BofA Merrill Lynch, Research Division - Analyst

* Bryan Anthony Maher

B. Riley FBR, Inc., Research Division - Analyst

* Michael Albert Carroll

RBC Capital Markets, LLC, Research Division - Analyst

* Mitchell Bradley Germain

JMP Securities LLC, Research Division - MD and Senior Research Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good morning, and welcome to the Industrial Logistics Properties Trust Second Quarter 2019 Financial Results Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Olivia Snyder, Manager of Investor Relations. Please go ahead.

--------------------------------------------------------------------------------

Olivia Snyder, Industrial Logistics Properties Trust - Manager, IR [2]

--------------------------------------------------------------------------------

Thank you, and good morning, everyone. Thanks for joining us today.

With me on the call are ILPT's President, John Murray; Chief Financial Officer, Rick Siedel; and Vice President, Yael Duffy. In just a moment, they'll provide details about our business and our performance for the second quarter of 2019 followed by a question-and-answer session with analysts. First, I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company.

Also note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on ILPT's beliefs and expectations as of today, Tuesday, July 30, 2019, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission, or SEC, which can be accessed from our website ilptreit.com or the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statement.

In addition, we will be discussing non-GAAP numbers during this call, including normalized funds from operations, or normalized FFO, and cash-based net operating income, or cash basis NOI. A reconciliation of these non-GAAP figures to net income and the components to calculate cash available for distribution, or CAD, are available in our supplemental operating and financial data package, which also can be found on our website.

And now I will turn the call over to John.

--------------------------------------------------------------------------------

John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [3]

--------------------------------------------------------------------------------

Thank you, Olivia. Good morning, everyone, and welcome to ILPT's second quarter earnings call. This morning, we reported second quarter normalized FFO of $29.8 million or $0.46 per share. As of the end of the second quarter, ILPT's portfolio consisted of 298, primarily warehouse and distribution properties, with 42.4 million square feet located in 30 states that were 99.3% occupied.

Approximately, 41% of ILPT's annualized rental revenues come from 16.8 million square feet of industrial properties located on the island of Oahu in Hawaii. Our Mainland portfolio consists of 72 properties with 25.6 million square feet located in 29 states that are 100% leased.

During the quarter, we focused on integrating our 2019 acquisitions into our existing portfolio operations and maintaining our strong leasing activity. As discussed on prior calls, during the first half of the year, we acquired 2 portfolios for approximately $905 million. The 28 properties containing 12.9 million square feet have been integrated into our portfolio with the expertise and support of the RMR Group's national platform of real estate professionals in more than 30 offices across the country.

Our top 3 tenants are Amazon, FedEx and Procter & Gamble, representing 14.6%, 4% and 3.8% of total annualized rental revenues, respectively. Investment-grade-rated tenants or subsidiaries of investment-grade-rated parent entities make up 62% of our Mainland revenues.

Looking at the entire portfolio, nearly 3/4 of revenues come from those investment-grade tenants or subsidiaries or from our secure Hawaii land leases. Our top 3 markets after Hawaii, at 41%, are Indiana, Ohio and Virginia, representing 10%, 8.2% and 5.2% of our total annualized rental revenues, respectively.

A quarterly dividend of $0.33 per share continued to be well covered with a payout ratio of 71.7%. On prior calls, we discussed the possibility of raising our dividend following the closing of the 2 portfolio acquisitions.

ILPT's Board considers many factors when setting dividend rates, including peer evaluation and investor feedback. Our current dividend yield is nearly twice the industrial peer group average. Our share price suggests that we are not getting credit for our high and well-covered yield and the Board questioned whether bringing yield higher would draw more investors to the stock or spook them.

We also know there is investor concern about our leverage level and a possible equity issuance. Considering these and other factors, our Board decided to maintain the current dividend level rather than raising our dividend this quarter and to use increased cash flow from our acquisitions to reduce leverage. As we have said previously, we will not issue common equity at current share price levels.

Before I turn the call over to Yael to discuss our leasing activity, I'll quickly mention that earlier this month, the governor of Hawaii vetoed legislation that would have disallowed the dividend pay deduction on income taxes for REITs. This is an important win for Hawaii, ILPT and other REITs doing business in the state as it will continue to provide stable growth through job creation and economic development.

--------------------------------------------------------------------------------

Yael Duffy, Industrial Logistics Properties Trust - VP [4]

--------------------------------------------------------------------------------

Thanks, John. During the second quarter, leasing activity was focused within our Hawaii portfolio. We entered new and renewal leases for approximately 359,000 square feet at rents that were 27.5% higher than prior rents for an average lease term of 11 years. Leasing capital and concessions for new and renewal leases were approximately $0.12 per square foot per lease year. There were no rent resets in the second quarter.

Now to highlight a few positive leasing transactions. In Q2, we negotiated an early termination of a lease with a local beverage company ahead of its contractual lease expiration. At the same time, we were able to sign a 15-year lease with FedEx at a nearly 25% blow up in rent. We are pleased with the upgrade in tenant credit and our ability to re-lease the property with no downtime.

Turning to the slight decrease in the same-store occupancy. In April, we negotiated a lease termination with a tenant in default. While at quarter end, we show a temporary decrease in occupancy, the property was re-leased to a new tenant in July with rents that are 13.5% higher than the prior tenant's contractual rent. These transactions illustrate that while small businesses in Hawaii may occasionally fail, the strong demand for our Hawaii product has historically allowed us to re-lease the parcels within a short period of time and at increased rental rates.

Also, in Q2, we signed a new space lease for a property that had been previously ground leased. While this resulted in our reported total lease square footage decreasing by approximately 80,000 square feet, the rent we will receive is nearly 90% higher than previous rent for this parcel. On the Mainland, we have no significant near-term lease expirations, with only 10 basis points of total annualized rents expiring over the remainder of 2019 and 1% expiring by the end of 2020. In Hawaii, one lease for approximately 1.2 million square feet for $1.9 million of annualized rent is scheduled to reset in 2019. Our leasing team has begun discussions with the tenant and we expect to have further clarity in the coming months.

The industrial market continues to display strong fundamentals nationally, as industrial sector jobs maintain their steady upward trend and industrial zone land continues to increase in value. On the Mainland, market vacancy rates remain near historical lows of 5% while Hawaii is even stronger with a vacancy rate of just 2%. Specifically in Hawaii, with high construction cost and a scarcity of developable land, we expect demand for our product to remain high.

I'll now turn the call over to Rick to provide details on this quarter's financial results.

--------------------------------------------------------------------------------

Richard W. Siedel, Industrial Logistics Properties Trust - CFO & Treasurer [5]

--------------------------------------------------------------------------------

Thanks, Yael, and good morning, everyone.

Normalized FFO for the second quarter of 2019 was $29.8 million or $0.46 per share, up from $0.39 per share for the second quarter of 2018. Adjusted EBITDA for the quarter was $44.2 million, up 30% from last quarter and 50% year-over-year. Total rental income for the second quarter of 2019 increased by $21 million to $60 million, representing a 52% increase over prior year results. This increase primarily reflects our acquisition activity as well as increases from leasing, rent resets and real estate tax expense reimbursement. This quarter also included a $0.5 million of rental income related to the elimination of a below-market lease obligation following the termination of a lease that was in place when we acquired the property back in 2003.

Total portfolio same property cash basis NOI increased by 2.6% over the prior year. Hawaii same property cash basis NOI increased by 3.2% over the prior year, reflecting increases in rents from new leasings and resets. Mainland same property cash basis NOI increased by 1.8% over the prior year, primarily reflecting contractual rent steps in our leases and some recovery of expenses at certain properties that tenants have previously disputed.

General and administrative expense for the second quarter totaled $4.9 million and depreciation expense was $16.7 million. The increase in both expenses primarily reflects our acquisition activities since last year. Interest expense increased by $10.4 million to $13.9 million primarily due to a full quarter of expense on our $650 million mortgage loan that was obtained in January of 2019 as well as balance and interest rate increases on our revolving credit facility. At rates of 4.3% and 3.7% respectively, both provide attractive sources of low-cost capital to fund our external growth.

Our recurring capital expenditures for the quarter totaled $2.1 million. The majority of these expenditures were building improvement from the Mainland, including parking lots, building facades and sprinkler and roof upgrades. Our redevelopment capital expenditures were $2.6 million related to the building expansion in Iowa discussed on previous calls.

We finished the quarter with $608 million outstanding on our revolver, resulting in debt to adjusted EBITDA of 7.6x. We were opportunistic with the 2 portfolios we acquired but slightly exceeded our long-term target leverage. As mentioned last quarter, we remain comfortable operating the business at this level due to our stable, predictable and growing cash flows and a well-covered dividend.

Over time, we expect to have a fair amount of cash flows from our portfolio to organically reduce leverage, reaching mid-6x in the coming years. However, in light of investor feedback and the appreciation and value across our portfolio, we have discussed several capital-recycling strategies, including taking on a JV partner and we will keep you updated on any developments in the future. We want to reiterate that we will not raise common equity at our current share price.

That concludes our prepared remarks. Operator, we are now ready to take questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) The first question comes from Bryan Maher of B. Riley FBR.

--------------------------------------------------------------------------------

Bryan Anthony Maher, B. Riley FBR, Inc., Research Division - Analyst [2]

--------------------------------------------------------------------------------

John, thanks for that information on the leverage and the dividend thought process from the Board, that's helpful. But when we think about the leverage and the fact that most of the RMR REITs have kind of stayed in that 40% to 50% leverage area and have maintained investment-grade ratings, what's the thought process on ILPT kind of being above that? And what's the view on investment-grade rating over the long term?

--------------------------------------------------------------------------------

Richard W. Siedel, Industrial Logistics Properties Trust - CFO & Treasurer [3]

--------------------------------------------------------------------------------

Bryan, this is Rick. The one thing I would just point out, that leverage metric that you mentioned kind of net debt to total gross assets does look a little high at 53% compared to some of our other REITs but it is important to remember just how low our bases in these assets is. If you were to adjust just our Hawaiian assets that we put the financing on up to the $1.4 billion of fair value that's there, that ratio drops down to high 30s or about 40%. So it's really not out of line with peers or some of our other REITs but that metric does look a little higher. From a debt-to-EBITDA perspective, we are a little higher than our long-term target. But again, we are comfortable given the stability and strength of our portfolio, and we do have the ability to bring that down organically over time if we're patient and just let the portfolio generate cash and run. But again, as John mentioned, due to some of the investor feedback, we may take some steps to move a little faster on that, looking at various capital-recycling strategies and things like that, that would help us achieve our target faster. But overall, we're very comfortable with where it is.

--------------------------------------------------------------------------------

Bryan Anthony Maher, B. Riley FBR, Inc., Research Division - Analyst [4]

--------------------------------------------------------------------------------

And the thought process on an investment-grade rating over the longer term, I mean, given that RMR has typically had that with the REITs, what's the thought process at ILPT today?

--------------------------------------------------------------------------------

Richard W. Siedel, Industrial Logistics Properties Trust - CFO & Treasurer [5]

--------------------------------------------------------------------------------

I think when we did the secured financing on Hawaii, our rationale was that it was an attractively priced source of capital before we had finished the seasoning process for ILPT as a new company. It was less than a year old at that point. And just determined that we were able to get better pricing using other sources of capital.

--------------------------------------------------------------------------------

John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [6]

--------------------------------------------------------------------------------

I think -- longer time, I think we'd like to eventually get an investment-grade credit rating like some of the other RMR REITs because it allows you to access a very deep capital market and to do so pretty quickly and it makes it a lot easier to say you have no financing contingencies when you're making offers for properties. But I think we have a pretty good reputation for being able to raise capital so that isn't a huge concern for us. And so there is no specific time line. We're not trying to get there 2021 and 2022 necessarily.

We're more interested in growing our portfolio with high-quality properties, maintaining reasonably conservative leverage levels. As Rick pointed out, some of the metrics that people quote are a little bit disconnected because some of the -- there's valuation issues within the portfolio that maybe are underappreciated. So we are comfortable, for the next several years at least, to be primarily secured debt and not as focused on an investment-grade credit rating.

--------------------------------------------------------------------------------

Bryan Anthony Maher, B. Riley FBR, Inc., Research Division - Analyst [7]

--------------------------------------------------------------------------------

Okay. That's helpful. And then given how strong your activity was in the first half of the year, maybe this question is for Rick to a degree, what is your availability currently for new acquisitions? And then maybe for John, what would you need to see in the marketplace for attractive industrial assets on a cap-rate basis to actually pull the trigger on more acquisitions this year?

--------------------------------------------------------------------------------

Richard W. Siedel, Industrial Logistics Properties Trust - CFO & Treasurer [8]

--------------------------------------------------------------------------------

So to start with my piece, Bryan, this is Rick. I guess I don't think that the financing is necessarily a problem. Again, I think we've got a longer-term leverage target, but I think we've remained opportunistic, and we still have $150 million or so of capacity under our revolver today and still have plenty of room under our covenants. So I think the question really falls more squarely to John.

--------------------------------------------------------------------------------

John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [9]

--------------------------------------------------------------------------------

All right. Well, we're looking for reasonably new high-quality properties that are well located. And so from a cap-rate basis, it's -- as you know, it's very competitive. We've seen some large portfolio transactions announced in the last -- during the last quarter that have been in cap rates I think in the 4% to 5% range. I don't expect to see -- I mean, ILPT purchasing properties at that price point. You'll see us transacting, if we transact on other acquisitions in the near term, it would be in the high 5s, low 6s, if we can identify properties that are high quality that are available at that price level.

--------------------------------------------------------------------------------

Operator [10]

--------------------------------------------------------------------------------

The next question comes from Michael Carroll of RBC Capital Markets.

--------------------------------------------------------------------------------

Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [11]

--------------------------------------------------------------------------------

I guess, off of that last question, John, can you talk a little bit about your desire to deploy capital? Given where your leverage is right now, would you go out and acquire assets? Or would you want to kind of stay pat until you can put leverage closer to your long-term target?

--------------------------------------------------------------------------------

John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [12]

--------------------------------------------------------------------------------

Our primary focus is on managing the existing portfolio, asset managing it and bringing leverage down. As Rick said, we do have a small amount of capacity and if the right transaction came along and wasn't -- was bite size, we might take advantage of the opportunity. But we're not focusing on acquisitions currently, we're focused on asset managing our existing portfolio and reducing leverage.

--------------------------------------------------------------------------------

Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [13]

--------------------------------------------------------------------------------

Okay. And then can you talk a little bit about your goals to reduce those leverage metrics? I mean are you happy just letting it kind of trend a little bit lower by retaining cash flow? Or do you want to do something bigger such as a joint venture with some of your Mainland assets to accelerate that reduction?

--------------------------------------------------------------------------------

John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [14]

--------------------------------------------------------------------------------

Well, I think we're willing to allow leverage to drift down organically. However, there are a lot of opportunities in the marketplace and if we follow that route, we'd be -- probably have limited acquisition, limited growth for a couple of years. And so I think while we're pursuing that path, we're also pursuing other strategic opportunities, considering them and -- including joint ventures and we've done joint ventures in other RMR-managed REITs, and I think we could do something similar here with a select group of our Mainland assets to show how they've increased in value in the short period of time since we've owned them and how that'd be an effective way to provide new capital into ILPT to continue to grow. So...

--------------------------------------------------------------------------------

Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [15]

--------------------------------------------------------------------------------

Is it fair to assume that a joint venture transaction is likely in the horizon over the next 6 to 12 months? Or is that still kind of on the table and you're still debating on what to do there?

--------------------------------------------------------------------------------

John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [16]

--------------------------------------------------------------------------------

I think it's reasonable to expect within the next 12 months that we might announce a transaction like that we're -- yes, I think that's -- it may not happen but we are talking to -- we are talking about it and it may happen.

--------------------------------------------------------------------------------

Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [17]

--------------------------------------------------------------------------------

Okay. And then just lastly on the dividend. I don't know if you can provide us some insights on what the Board's thinking. I mean is it fair to assume that the dividend's going to stay at this current level, if the stock price stays in that low $20 range? Or is that something going to change as you improve leverage and you still have that healthy payout ratio? Would you think about increasing the dividend over the next several quarters?

--------------------------------------------------------------------------------

John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [18]

--------------------------------------------------------------------------------

Yes, I think our Board meets 5 or 6 times a year on a regular course. And at every one of the meetings, we discuss the dividend. And so I definitely would not rule out that we might increase the dividend. I think if we're organically lowering leverage and the share price is in the vicinity of where it is today, it's more likely that the dividend rate would remain flat. And if we do other transactions that bring in new capital and if the share price reacts favorably to any of the things that we've done, I think that increases the likelihood that the Board would be more open to the idea of a dividend increase.

We certainly have very secure predictable cash flows, and we certainly have very safe payout ratios. So the ability to raise the dividend, if we wanted to do so, is there. It's just that the Board feels like there's a message being sent that leverage reduction is more important than a dividend increase since our dividend is so high relative to our peers.

--------------------------------------------------------------------------------

Operator [19]

--------------------------------------------------------------------------------

The next question comes from Mitch Germain of JMP Securities.

--------------------------------------------------------------------------------

Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [20]

--------------------------------------------------------------------------------

Rick, appreciate your thoughts on the dividend and leverage. If you just organically try to reduce debt to EBITDA to targeted levels, how many quarters, how long would it take us to get to where your target is, assuming you don't pursue any sort of JV or asset sales?

--------------------------------------------------------------------------------

Richard W. Siedel, Industrial Logistics Properties Trust - CFO & Treasurer [21]

--------------------------------------------------------------------------------

Sure. So I guess one of the things that might be helpful to remember is that over 40% of our Hawaiian revenue either rolls or resets to market through 2023. So I think when I say next few years, that's kind of the horizon and that would take us down to mid-6x without doing anything else to the portfolio. So it's -- again, it's longer term than I think some of us are willing to wait but we are talking about some other capital-recycling strategies to do something sooner. So it is a little bit longer than we expected just because as the portfolio has grown, it takes a little bit more to move the needle.

--------------------------------------------------------------------------------

Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [22]

--------------------------------------------------------------------------------

Great. And just with regards to a potential JV, your discussion has always been regarding Mainland properties, correct?

--------------------------------------------------------------------------------

Richard W. Siedel, Industrial Logistics Properties Trust - CFO & Treasurer [23]

--------------------------------------------------------------------------------

That is more likely. I think we've already kind of demonstrated the value of our Hawaiian portfolio through the financing and getting that appraisal and things like that out there. Also, our Hawaii industrial land is somewhat irreplaceable. Real estate like that doesn't come along every day. We also -- I think, a lot of the investors we meet with understand the value of our Hawaiian properties and are -- there's probably more confusion on the Mainland assets. And I think we might have an opportunity to show just how opportunistic our recent acquisitions were if we were to take a handful or a select number of those properties and kind of demonstrate that we got a good deal on them.

--------------------------------------------------------------------------------

Operator [24]

--------------------------------------------------------------------------------

The next question comes from Alexander Pernokas of Bank of America Merrill Lynch.

--------------------------------------------------------------------------------

Alexander Mark Pernokas, BofA Merrill Lynch, Research Division - Analyst [25]

--------------------------------------------------------------------------------

I was just wondering if you could give me a better picture of your NOI breakdown as we move forward between Mainland and Hawaii. And are there any new submarkets or markets that you're looking to expand into through these acquisitions?

--------------------------------------------------------------------------------

John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [26]

--------------------------------------------------------------------------------

Currently about just a little over 40% of our revenues come from Hawaii and about right around 60% come from the Mainland. There is a limited amount of industrial land in Hawaii and what's there transacts very infrequently. So I think the expectation should be that the vast majority of our growth going forward will be on the Mainland and not in Hawaii. We'll try -- when we see opportunities in Hawaii. We've had very good experience there, and we'd love to own more property there. But it's -- those opportunities are few and far between and generally very expensive because of that value. So we'd be focused on the Mainland.

Over time, we'd like to -- we target top 25 markets. We try to target properties that are new. We may try to increase our concentration along the coasts. Again, properties are more expensive in some of those coastal markets. So a lot of the recent acquisitions have been in Indiana, Ohio markets, like that, more in the central part of the United States, but still top 25 markets predominantly.

--------------------------------------------------------------------------------

Operator [27]

--------------------------------------------------------------------------------

And the next question is a follow-up from Mitch Germain of JMP Securities.

--------------------------------------------------------------------------------

Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [28]

--------------------------------------------------------------------------------

Yes, quick question on the rent resets. Is it a safe assumption that over time, the number of leases scheduled for reset will decline to more traditional lease structure?

--------------------------------------------------------------------------------

Richard W. Siedel, Industrial Logistics Properties Trust - CFO & Treasurer [29]

--------------------------------------------------------------------------------

Mitch, we have said that oftentimes we'll be opportunistic and if we can negotiate converting a reset into a normal lease with rent steps, we've been more likely to do that. So we have seen the number of resets in the portfolio decrease. That's partly for the tenant so that they're not kind of shocked with a giant increase 1 year and it also helps us as we look to reduce our leverage and increase our cash NOI year after year. It's been a little bit more palatable that way. We generally do try to make sure that we do see stable growth over the period but I don't think there's anything particular interesting changing with the resets that we're currently working on.

--------------------------------------------------------------------------------

Operator [30]

--------------------------------------------------------------------------------

This concludes our question-and-answer session. I would like to turn the conference back over to John Murray, President and Chief Executive Officer, for any closing remarks.

--------------------------------------------------------------------------------

John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [31]

--------------------------------------------------------------------------------

Thank you everyone for joining us on today's call. Have a great rest of the summer.

--------------------------------------------------------------------------------

Operator [32]

--------------------------------------------------------------------------------

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.