Earnings Call Transcript - ARE Q3 2022

Operator, Operator

Good day, and welcome to the Alexandria Real Estate Equities Third Quarter 2022 Conference Call. All participants will be in listen-only mode. Please note this event is being recorded. I’d now like to turn the conference over to Paula Schwartz with Investor Relations. Please go ahead.

Paula Schwartz, Investor Relations

Thank you, and good afternoon, everyone. This conference call contains forward-looking statements within the meaning of the federal securities laws. The company’s actual results might differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the company's periodic reports filed with the Securities and Exchange Commission. I’d now like to turn the call over to Joel Marcus, Executive Chairman and Founder. Please go ahead, Joel.

Joel Marcus, Executive Chairman and Founder

Thank you, Paula, and welcome everybody to Alexandria’s third quarter earnings call. With me today are Peter Moglia, Dean Shigenaga, and Hallie Kuhn. First of all, thank you to our Alexandria family team for their continued exceptionalism in the face of a challenging macro environment, mostly self-inflicted by a really deleterious set of government actions and policies, coupled with the Fed, which has been slow to act. I would characterize the third quarter as really exceptional. When you look at earnings in this challenging macro environment delivering 9.2% and 8.3% FFO per share growth for the third quarter, and then 2022 year-to-date is really exceptional, especially again given the size and scope of the company with almost 75 million square feet in its total asset base. The health and resilience of the broad and diverse life science sector, the niche we pioneered, remains strong and there is a continuing strong R&D investment, Hallie will speak to this. In general, we’ve seen life science R&D funding in 2021 approaching almost $500 billion. The number is actually about $480 billion, which is astounding, and $1.8 trillion since 2017, and we expect totals in 2022 to be a very strong continuation of that. It’s also important to recognize that the strong life science sector employment trends remain positive, and core strength of the life science industry and our key cluster markets remains resilient and continuing strong. The long-term healthcare needs of this country certainly aren’t going away. Innovation in medicine is a national imperative, just look at the mental health problem across this country as one simple example. There are about 10,000 known diseases to humankind, but we’ve only addressed as a society about 10% with addressable therapies and very few real cures. Biotech remains resilient. Clinical data, regulatory updates, and M&A can be idiosyncratic events that really are unaffected by economic trends, and Hallie will talk about that. Demand continues solidly for our high-quality and well-located assets, powered by asset-level operational excellence. Alexandria has the greatest knowledge and unique experience and expertise in the life science real estate niche, informed by our over 1,000 client tenants, 87% of our leasing comes from. We have a level of understanding of the true life science real estate demand that just isn’t out there if you hang a for lease sign and hire a broker. Alexandria continues to experience strong leasing spreads and rental rate increases, and we’re very proud that we’ve got 99.9% collections this quarter, truly stellar. Our industry-leading roster of the 1,000 tenants creates and drives stable long-term cash flows, and our high-quality and diverse industry mix is unmatched. Among industry-leading fundamental metrics for the third quarter are a 10.6% same-store NOI growth, increasing over the last few years. Dean will talk about some of the details there. Despite having lived through the financial crisis of 2008 and 2009, today we have matured and have a fabulous fortress balance sheet. Alexandria out of 127 REITs as of June 30 has the second best debt maturity profile of all of them, which is pretty amazing. Dean will highlight our liquidity of over $6 billion. We strategically executed both equity and debt transactions in January and February of 2022 before the Ukraine invasion. I think it’s important to note that the remaining debt term is over 13 years, with an average weighted interest rate of about 3.5% and almost 96% of our debt is fixed rate, with no debt maturities into 2025. As many of you know, we are crafting a well-thought-through set of alternative plans for 2023, which we’ll unveil at Investor Day, taking into account potential significant black swan events.

Hallie Kuhn, SVP of Science and Technology and Capital Markets

Thanks, Joel, and good afternoon, everyone. This is Hallie Kuhn. As Joel mentioned, today, I’m going to provide an update on the life science fundamentals driving the long-term growth of the industry and how Alexandria proactively works with the vanguard of this highly dynamic industry in a challenging macro environment to continue to grow our unique company. While we are in a cyclical downturn, innovative medicines take on average over 10 years to develop, meaning that the life science industry is not cyclical but is mostly event and product-driven. The life science industry is still in its early innings and poised for growth. The recent expansion of complex modalities such as cell, gene, and RNA-based therapies reflects this. Every day in the U.S., approximately 1,670 people pass away from cancer, every four minutes an individual dies from a stroke, and every 37 seconds someone passes away from heart disease. Not to mention, 90% of known diseases have no available treatment. While the macro market conditions are serious, the life science industry is on a steep, long-term growth trajectory. Let’s go through the multiple sources of life science funding. Through the third quarter of 2022, venture capital funds have raised an all-time high of $149 billion, eclipsing 2021’s historic year with $144 billion raised. The significant amount of dry powder will continue to translate into well-funded private biotech companies for years. Companies possessing the most innovative technologies continue to successfully raise capital, and we continue to see healthy demand across this segment. Although the IPO window remains largely closed, the market is responding positively to meaningful data readouts. For example, two tenants in our San Francisco Bay Area region recently announced positive Phase 1 and Phase 1/2 clinical data, sending shares up 60% and 70% respectively. The majority of our ARR comes from tenants with marketed products, including many large-cap tenants with strong balance sheets such as Vertex and Moderna. Notably, large pharma continues to outperform broader markets, with significant cash on hand for internal growth and external M&A and partnerships. Biopharma R&D spending totaled $262 billion in 2021, with the top 20 biopharma putting over 20% of revenues back into R&D. At the end of the third quarter, 17 out of the top 20 biopharma were Alexandria tenants; this stat has now increased to 18 of the top 20. While M&A focuses on bolt-on acquisitions, partnerships are an important source of non-dilutive funding for private and small-to-mid cap bio companies. Government funding continues to grow, with the NIH budget proposed at $49 billion, a 9% increase over 2022. Notably, this total does not include an additional $12.1 billion for pandemic preparedness and an additional $1.3 billion for program evaluation, reaching a total NIH budget of $62.5 billion for 2023. The fundamentals remain strong despite a volatile and uncertain economic landscape. Our asset base boasts a 99.9% collection rate and a historic occupancy of 96%. Our life science tenant roster is diverse, and maintaining the health of our industry-leading tenant roster is an ongoing effort involving deep understanding of life science fundamentals and a dedicated team focused on operational excellence. I’ll leave you with a quote from David Ricks, CEO of Eli Lilly, who mentioned, the games for winners are bigger than ever. Being nimble and fast, having the right people, all these basics matter more than ever. This sentiment applies broadly beyond the life science industry and we hold it deeply at Alexandria.

Peter Moglia, Chief Operating Officer

Thank you, Hallie. I would like to start by thanking all the teams of the company for your never-ending dedication, high-quality work product, and collaborative spirit that made Steve's transition to retirement seamless as we all expected it would be. Steve continues to be actively involved in certain projects, and we consider him an invaluable resource to the executive management team. Since Steve is no longer on the calls, I’ll cover leasing as well as updates on other key topics such as the development pipeline, construction costs, and the harvesting of our value creation. As of today, Alexandria has an equity market cap and credit rating in the top 10% among all publicly traded U.S. equity REITs. We have a North American asset base of 74.5 million square feet across 431 properties in operation, development, or redevelopment, and over 1,000 innovative tenants inform our investing and operating strategies. It’s taken over 28 years to reach these milestones. One cannot create such a dominant position in an industry overnight; it takes far more than great real estate. Our network, operational excellence, and technical know-how are a few reasons we are a company in a class by ourselves. The life science industry has grown significantly in recent years with the success of new modalities like mRNA and cell therapy, and we have grown with it by capturing investment opportunities. With market volatility, we are witnessing a normalization of demand, and while we don’t expect the same level of activity we saw in our record-breaking year of 2021, we continue to see healthy demand manifesting into solid leasing numbers. Our value creation pipeline is expected to add approximately $645 million in incremental annual rental revenue from Q4 2022 through the third quarter of 2025. We leased approximately 330,000 square feet in the third quarter, which is 18% higher than the previous five-year average. Our 7.6 million square feet of projects under construction are now 78% leased, up 4% over last quarter. The third quarter results show Alexandria’s ability to outperform even in turbulent times due to our significant differentiation among those seeking to participate in life science real estate, which can be summarized with four attributes: irreplaceable AAA locations, operational excellence, mega campuses, and a curated roster of over 1,000 tenants, including the most impactful research companies worldwide.

Dean Shigenaga, Chief Financial Officer

Thanks, Peter. Good afternoon, everyone. Our team delivered truly remarkable results for both the three and nine months ended September 30. Total revenues were up 20.5% and 24.8% for the three and nine months of 2022 compared to 2021. FFO per share diluted as adjusted for the three and nine months was $2.13 and $6.28, up 9.2% and 8.3% over 2021 and importantly, beat consensus. The strong financial and operating results reflect the strength of our brand, our scale, well-located properties, and operational excellence serving the needs of innovative entities globally. Congratulations to our entire team for truly outstanding execution over many quarters. This really stands out within the REIT industry, especially during this challenging macro environment. Our strong balance sheet and liquidity management illustrate exceptional execution by our team over many years. Our corporate credit ratings rank in the top 10% of the REIT industry, and we are pleased to have strengthened our balance sheet in the third quarter with increased liquidity. We amended our line of credit, increasing aggregate commitments to $4 billion, up $1 billion over the prior credit facility. A huge thank you to our important lending relationships for providing this liquidity. As of September 30, our total liquidity is now at $6.4 billion; we are one of the very few REITs with no debt maturities until 2025. 96% of our outstanding debt is long-term fixed rate, with net debt to adjusted EBITDA on track to hit our target of 5.1 times by year-end. The execution of our capital plan this year was exceptional given the macro environment, with $1.8 billion of 12 and 30-year bonds completed in February. Additionally, through September 30, we’ve completed $2.2 billion in real estate sales, with gains or consideration in excess of book value of $1.2 billion. This strong performance positions us advantageously at year-end with approximately $250 million of cash that will reduce our debt needs for 2023. As we look forward, we will remain disciplined and careful with our capital allocation. Dividends have grown consistently over the past decade, supported by strong cash flow growth. Cash flows from operating activities after dividends are projected at approximately $300 million for 2022. Our occupancy continues to trend upwards at 30 basis points since the beginning of the year and is expected to increase by year-end, demonstrating the strength of our brand and partnerships with our tenants.

Joel Marcus, Executive Chairman and Founder

Thanks, Dean. And if we could go to questions, please?

Operator, Operator

Thank you. We’ll now begin the question-and-answer session. Our first question comes from Michael Griffin from Citigroup. Please go ahead.

Michael Griffin, Analyst

Peter, it seemed like you talked pretty favorably about the properties, the attractive cap rate, particularly at the certain asset in San Diego. I’m curious if these properties are so attractive, why did it make sense to dispose of these?

Peter Moglia, Chief Operating Officer

We have a number of properties on the docket to do the same thing, too. We’re recycling capital and putting it back into great projects we have in our value creation pipeline. So it was efficient capital to harvest and reinvest.

Joel Marcus, Executive Chairman and Founder

We have some fabulously large opportunities on the Mesa and Torrey Pines, two large-scale development sites that we’re working on. We have no shortage of Class A opportunities in the best submarket in San Diego.

Nick Joseph, Analyst

You touched on the macro concerns and Black Swan events and disruption in the construction market. So when you blend that all together, how do you think about the impact on development plans, at least in the near-term?

Joel Marcus, Executive Chairman and Founder

I think we’ll give you a very good view at Investor Day. We have interesting alternative plans based on potential outcomes that may unfold in 2023. Where we have strong leasing opportunities, we’ll look for ways to accelerate those opportunities carefully.

Dean Shigenaga, Chief Financial Officer

We sit in a pretty unique position. We have some of the best-located land parcels for life science in these core markets, meaning we have the tenant roster that generates 87% of our leasing activity. We have the land sites to meet demand.

Nick Joseph, Analyst

With the impairment charge in the quarter, can you walk through that project and the decision to walk away from it?

Dean Shigenaga, Chief Financial Officer

The impairment charges related to a development project located in California. Our investment primarily involved significant costs related to the entitlement work for the site. The financial outlook for the project led to the decision not to move forward.

Anthony Paolone, Analyst

Your seven near-term development projects, are those yields locked up?

Dean Shigenaga, Chief Financial Officer

For the most part, yields are close to being locked up as both sides work through detailed budgets before executing a lease. We’ve had no unfavorable changes in cost completion for any of our projects.

Anthony Paolone, Analyst

Should we think about expected development yields to go higher given incrementally higher funding costs?

Dean Shigenaga, Chief Financial Officer

It's tough to speculate about yields on specific projects because each project is unique. We generally aim to push yields higher by managing construction costs effectively, while rental rates support upward movement.

Joel Marcus, Executive Chairman and Founder

Demand for life science real estate is inelastic; companies need to continue advancing their revenue-producing projects. We saw little change in occupancy from 2008 to 2009 during the financial crisis, showing our resilience.

Georgi Dinkov, Analyst

With supply catching up with demand, which markets have the most supplier risk?

Joel Marcus, Executive Chairman and Founder

It's difficult to break it down market-by-market on this call. Take New York as an example; while there's a lot of planned development, the demand has been modest as we build the cluster.

Hallie Kuhn, SVP of Science and Technology and Capital Markets

The majority of our tenants are in the large-cap category. Our team undertakes extensive diligence to understand the risk profiles and health across sectors, continually monitoring their progress.

Peter Moglia, Chief Operating Officer

Our focus has always been on great companies with innovative technologies. Down markets often present interesting opportunities to invest in groundbreaking technologies.

Joshua Dennerlein, Analyst

What gets you to the high and low end of same-store cash guidance?

Dean Shigenaga, Chief Financial Officer

For nine months, we’re right on the midpoint. Occupancy growth significantly impacts our NOI, as well as early lease renewals from earlier in 2022 driving strength.

Michael Griffin, Analyst

I’m just curious about GE moving out of 5 Necco. What are the prospects to backfill this space? Would you attempt to sublease it?

Joel Marcus, Executive Chairman and Founder

There’s an existing lease with a credit tenant, but we don’t have much to comment on beyond that.

Operator, Operator

And this concludes our question-and-answer session. I would like to turn the conference back over to Joel Marcus for any closing remarks.

Joel Marcus, Executive Chairman and Founder

Thank you, and stay safe everybody.

Operator, Operator

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