Earnings Call Transcript - PSTL Q3 2022

Operator, Operator

Greetings and welcome to Postal Realty Trust Third Quarter of 2022 Earnings Call. At this time, all participants are in a listen-only mode. The question-and-answer session will follow the prepared remarks. As a reminder, this conference is being recorded. I would now turn the conference over to your host, Mr. Jordan Cooperstein, Vice President of FP&A, Capital Markets. Please go ahead.

Jordan Cooperstein, Vice President of FP&A, Capital Markets

Thank you. Good morning, everyone, and welcome to the Postal Realty Trust’s third quarter 2022 earnings conference call. On the call today, we have Andrew Spodek, Chief Executive Officer; Jeremy Garber, President; Robert Klein, Chief Financial Officer; and Matt Brandwein, Chief Accounting Officer. Please note the use of forward-looking statements by the company on this conference call. Statements made on this call may include statements that are not historical facts, and are considered forward-looking. These forward-looking statements are covered by the Safe Harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those described in the forward-looking statements, and will be affected by a variety of risks and factors that are beyond the company’s control, including, without limitation, those contained in the company’s latest 10-K and its other Securities and Exchange Commission filings. The company does not assume and specifically disclaims any obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise. Additionally, on this conference call, the company may refer to certain non-GAAP financial measures, such as funds from operations, adjusted funds from operations, adjusted EBITDA, and net debt. You can find a tabular reconciliation of these non-GAAP financial measures to the most currently comparable GAAP measures in the company’s earnings release and supplemental materials. With that, I will now turn the call over to Andrew Spodek, Chief Executive Officer of Postal Realty Trust.

Andrew Spodek, CEO

Good morning and thanks for joining us. We are pleased to share that Postal Realty had a strong third quarter and we are well positioned to continue executing on our goal of creating and growing shareholder value. Postal Realty's business model is anchored with stable cash flows supported by our credit tenants and is further enhanced with organic growth from our short-term lease duration, which allows for the continual mark-to-market of rents. With minimal exposure to variable rates, low leverage, and no notable debt maturities until 2026, our balance sheet is ideally situated to continue executing our growth strategy. We continue to consolidate this highly fragmented market through sourcing accretive acquisition opportunities, particularly core last mile and flex property, while maintaining our conservative leverage ratios. In the third quarter, we completed approximately $21 million of acquisitions, bringing our year-to-date value to $109 million, already achieving our target set at the beginning of the year. As we discussed last quarter, we have been seeing the market slowly adjust to macro concerns as cap rates attempt to find higher footing to close the gap between buyers and sellers. In the third quarter, we targeted higher cap rate transactions, which impacted volume relative to prior quarters. This trend will likely continue into the fourth quarter, and we remain well positioned to capitalize on attractive opportunities as they emerge. We are the largest owner, manager, and consolidator of the Postal Services’ Irreplaceable Logistics Network. However, we are still in the early innings of our growth story and have plenty of runway ahead. Our management team has over 30 years of cycle-tested experience and a strong network of relationships built over time, which we believe are meaningful differentiators. We are encouraged by both our internal and external growth initiatives and will continue to be prudent stewards of capital and deploy it in an accretive and appropriate manner to drive growth in this dynamic environment. I’ll now turn the call over to Jeremy to discuss our operating metrics.

Jeremy Garber, President

Thank you, Andrew. As we like to remind our investors, our tenant has historically made all of its rent payments on time throughout all economic environments. Consistent with quarters past, we collected 100% of our rents in the third quarter. This predictability of cash flow is a significant differentiator for Postal Realty. In the third quarter of 2022, we produced a 29% increase in rental income from the third quarter of 2021, reflecting a strong existing portfolio, as well as contributions from the accretive acquisitions made over the last 12 months. We have maintained a 98.8% historical weighted average lease retention rate over the past 10-plus years, which reflects the strategic importance of these properties to both the Postal Service and the communities they serve. This high rate continues to validate our due diligence process in identifying locations that are vital to the Postal Service. Year-to-date, we have not received any notices of termination from the Postal Service. In the third quarter of 2022, we acquired 66 properties for approximately $21 million, excluding closing costs. These acquisitions added 170,000 net leasable interior square feet to our portfolio, inclusive of 61,000 square feet from 41 last mile properties and 109,000 square feet from 25 flex properties. Subsequent to quarter end and through October 26th, we have acquired seven properties for $5.9 million. We placed an additional 10 properties, totaling $4 million, under definitive contracts. I’ll now turn the call over to Rob to discuss our third quarter 2022 financial results.

Robert Klein, CFO

Thank you, Jeremy, and thank you, everyone, for joining us on today’s call. Touching upon what both Andrew and Jeremy discussed, we are pleased to deliver the results of another productive quarter as we remain well positioned to capitalize on external growth opportunities. For the third quarter, we delivered funds from operations or FFO of $0.25 per diluted share, and adjusted funds from operations or AFFO of $0.26 per diluted share. We have maintained a conservative balance sheet, and as of September 30, 2022, we had approximately $189 million of gross debt with a weighted average interest rate of 3.63% and only $31 million of floating rate debt outstanding on our revolver. Inclusive of all interest rate hedges, approximately 84% of our debt was at a fixed rate, and our weighted average maturity was 5.4 years. As Andrew highlighted earlier on the call, we have no notable debt maturities until 2026. Our liquidity position is strong with $119 million undrawn on our revolver, $225 million of accordions on our facilities, and approximately $5 million of cash. For the third quarter 2022, net debt to annualized adjusted EBITDA was 5.3 times, and net debt to enterprise value was 34.6%, well below our leverage targets of 7 times and 40%, respectively. Recurring CapEx for the third quarter was under $0.04 per square foot, and based on the timing of projects, we anticipate it will be closer to $0.06 per square foot in future quarters as we continue to invest in our assets. Cash G&A in Q3 came in below our prior guidance due to cost savings, as well as intentionally spreading out some costs into 2023. Our guidance still remains that cash G&A as a percentage of revenues will continue to decline on an annual basis, and we believe Q3 is a good run rate for Q4. Our Board of Directors has approved an increase in our quarterly dividend to $0.2350, which annualized to $0.94 per share, a 4.4% increase from the third quarter 2021 dividend. This continues our history of increasing the dividend every quarter since our IPO. We believe Postal Realty is uniquely positioned for resilience through economic climates, and therefore, we remain confident in our ability to execute our strategy. Our conservative balance sheet, market-tested and experienced management team, predictable cash flows, and a history of 100% rent collections provide a steadfast foundation that will allow us to continue to deliver value for our stakeholders. This concludes our prepared remarks. Operator, we’d like to open the call for questions.

Operator, Operator

Our first question comes from Rob Stevenson of Janney.

Rob Stevenson, Analyst

Good morning, guys. Across all real estate asset classes, it seems like the smaller investors have been the last to realize that prices have changed, and unless facing some sort of event, seem to have pulled the assets back from the market waiting for debt and everything else to stabilize. Given that there are a bunch of smaller players in your business, how are you guys seeing the transaction market today in terms of the availability of assets out there relative to past quarters, as well as the ability for the sellers to be reasonable in terms of market pricing?

Andrew Spodek, CEO

Hey, Rob. Yeah, so as everybody knows, we’re kind of living through a very strange time. The assets are available; we’re just not seeing sellers change their expectations for where pricing is supposed to be today, relative to where it was a couple of months ago. So we are patiently working with the sellers to adjust, trying to get cap rates to where we want to execute on them. The good news is that we’ve always focused on a different range of asset types and sizes, and we’ve always stated that the range of cap rates in our asset class is wide. Thankfully, we have the ability to execute at the higher end of our range, which is what we’ve been trying to do.

Rob Stevenson, Analyst

Okay. And then in recent conversations with the Postal Service, how willing are they and their representatives to acknowledge the inflationary environment and the need for potentially higher rent increases on renewals going forward?

Jeremy Garber, President

Yeah. Hey, Rob. It’s Jeremy. So we continue to have productive discussions with the USPS on our 68 leases that are expiring in 2022, and as we shared in prior calls, we’ve been focused on introducing a new concept of an inflationary adjustment. We’re confident we’ll achieve a result that will allow us to continue to deliver our annual NOI growth of 2% to 3%.

Rob Stevenson, Analyst

Okay. And then the last one for me, Rob, where is your best source of financing today when you look forward, if there's a portfolio that comes to market that you guys want to bid on, etc.? Where are you seeing the best data availability and pricing for you guys today?

Robert Klein, CFO

Hey, Rob. So it’s a mix of everything. We’re fortunate to have access to capital in multiple ways in the equity markets, through an ATM when active, through regular common offerings, and then through operating partnership units. And on the debt side, our credit facility has a good spread and a good rate, with a lot of availability. We can turn things out when the swap rates are attractive, or we can keep afloat when we want. As you know, we’ve tried to maintain a balance sheet with a higher proportion of fixed rate debts to be conservative. I feel like we’ve got access across the board. The market is very dynamic; rates move up and down a lot, and so does our share price and our pipeline. So it’s really a day-to-day game, and we’re lucky to have access to all these sources.

Rob Stevenson, Analyst

Okay. Thanks, guys. Appreciate the time.

Andrew Spodek, CEO

Thank you.

Operator, Operator

The next question comes from Tony Paolone of J.P. Morgan.

Unidentified Participant, Analyst

Good morning, guys. You have someone on the line for Tony this morning. I guess my first question, I’m just a little curious if you could speak on acquisitions and current market conditions if you’ve seen buyers are less willing to maybe accept OP units, opting instead to trade cash?

Andrew Spodek, CEO

Appreciate the question. We actually see sellers still very interested in the operating partnership unit currency. We haven’t been very proactive in using that currency over the past quarter, just given where our stock price was trading, but the interest in the currency is still very much there.

Unidentified Participant, Analyst

Got it. Okay, thanks. And I guess, given where inflation is, should we expect maybe a drag from the operating expenses that the company is responsible for on your properties?

Robert Klein, CFO

It’s a good question. Look, it’s something everybody’s facing, whether it’s with CapEx or operating expenses, but because of the short-term duration of our leases, we do have the ability to mark those rents to market, which should overcome the increases in operating expenses. So, net-net, I don’t see it being a drag, but it’s definitely more challenging than it was in prior years.

Unidentified Participant, Analyst

Okay. Thanks, guys. Appreciate the time.

Andrew Spodek, CEO

Thank you.

Operator, Operator

The next question comes from John Kim of BMO.

John Kim, Analyst

Thanks. Good morning. Year-to-date you have stayed away from acquisitions in the industrial sector. I was wondering if you could talk about pricing; has it helped with lower cap rates versus the other two appetites that you look at?

Andrew Spodek, CEO

Yeah, so in the current environment, we really haven’t been focused on the industrial assets. The market for those assets has been quite heated, and even though the cap rates on some of the deals we have looked at in that particular asset class have moved, they’re still at the lower end of the range, if not below it. In this environment, those are not deals we’re looking to pursue. Thankfully, we’ve already surpassed our target for the year, and we’re not looking to do deals unless they’re priced right and unless we believe it’s a good fit for our portfolio today.

John Kim, Analyst

In this current environment, is our portfolio premium still there, or is our performance now trading on par with individual asset sales or potentially at a discount?

Andrew Spodek, CEO

In general, larger owners are more sophisticated sellers, and we’ve seen less willingness for them to adjust to the current market conditions. As a result, those assets and portfolios are typically trading at the lower end of our range.

John Kim, Analyst

Okay. And my final question regarding the impact of inflation. I guess you were saying that you were discussing some kind of inflation adjustment potential in lease renewals coming up, while also maintaining 2% to 3% organic growth. I was wondering if there is a potential for upside in the rental numbers to more than offset inflationary pressures.

Jeremy Garber, President

As we go through our lease renewals, we spend time reviewing markets and comps and trying to achieve lease rates that allow us to overcome the current environment. The inflationary adjustment is just an additional element that we’re trying to introduce due to the ramp-up in costs over the past year and a half. This is why we’re confident we will achieve an adjustment over market rents that will allow us, as I described, to continue delivering the NOI growth we’ve historically provided.

John Kim, Analyst

And would that adjustment be CPI based on local geography? Or would it be capped? I’m just wondering if there are any more details you can share.

Jeremy Garber, President

At the moment, that conversation with USPS is ongoing; we haven’t agreed on how the adjustment is going to work. So I don’t have any more information to give you at the moment.

John Kim, Analyst

Okay. Thank you very much.

Andrew Spodek, CEO

Thank you.

Operator, Operator

The next question comes from Barry Oxford of Colliers.

Barry Oxford, Analyst

Great. I know you guys don’t want to give too much more information on the inflation adjustment leases, but typically, doesn’t the government want a flat rate for five years? So if you were to have an inflationary adjustment, do you think that rate might move year-to-year? Or would you do some sort of blended rate so it would be fixed for five years?

Jeremy Garber, President

Yeah, again, Barry, it’s Jeremy. You're right — historically, these have been five-year flat leases. I think we’ll probably achieve a similar outcome with that adjustment embedded. However, I can’t provide further details as we haven't concluded those conversations yet. They continue to be fluid. Once we have a definitive agreement, we will share that.

Barry Oxford, Analyst

Okay. Great, great. And another quick question on the G&A line item as far as how we should think about that. G&A was a little lower — not a lot lower, but a little lower here in Q3 versus Q2. How should we think, excluding non-cash comp, about G&A going forward into 2023?

Robert Klein, CFO

Barry, good question. I think I alluded to it in the prepared remarks that we believe Q3 is a good run rate for Q4 in that respect. But I think your question is more about how does this roll forward? Earlier this year, we provided guidance stating that our cash G&A was projected to increase by $2 million to $2.5 million based on our reported figures, but based on new projections, it's probably closer to an increase of $1.5 million over last year. That puts us $500,000 to $1 million lighter than our initial guidance earlier this year for 2022. Some of that comes from the reduction of expenses in '22, but most of it is projected to be spent throughout 2023.

Barry Oxford, Analyst

Got it. Okay, thanks for that clarity. That’s all I have, guys.

Andrew Spodek, CEO

Thanks. Thanks, Barry.

Operator, Operator

The next question comes from Jon Petersen of Jefferies.

Jon Petersen, Analyst

Great, thank you. I think Rob earlier you were asked about potential sources of capital, and you mentioned the ATM when that’s available to you. So, could we discuss that from two different angles: today’s market pricing — what kind of stock price do you need to see before equity or ATM issuance makes sense to do acquisitions? Or inversely, where do cap rates need to move to make today’s stock price viable for new ATM issuance?

Robert Klein, CFO

As you know, we always want our stock price to be higher. The higher, the more attractive it is for us. It’s a constant analysis; we do have where our pipeline is. When we issue equity using our ATM, we aim for it to be accretive to our acquisition pipeline and the use of capital. So it’s dynamic, but even at today’s prices and the guidance Andrew has given for where cap rates are, we can still do acquisitions in an accretive manner.

Jon Petersen, Analyst

Okay, got it. And then, I just wanted to clarify on G&A; I think Rob, in your prepared remarks, you mentioned you spread some G&A costs into 2023. Can you provide more details on what those costs included?

Robert Klein, CFO

Earlier this year, we discussed that some of the increase this year was related to internal projects, infrastructure, IT, and some new hires. It’s a blend of all of that, and some of these projects that we’re using to harness information and improve our internal processes. We’ve done some of that this year, and there’s more planned for next year.

Jon Petersen, Analyst

Okay. That's great. Thank you so much.

Andrew Spodek, CEO

Thanks.

Operator, Operator

We have a follow-up question from Rob Stevenson of Janney.

Rob Stevenson, Analyst

My questions have been answered; thank you.

Operator, Operator

Thank you. That does bring us to the end of our question-and-answer session. I would now like to turn the conference back to Mr. Andrew Spodek for closing remarks.

Andrew Spodek, CEO

Thank you. On behalf of myself and the entire team, thank you all for your continued support and for taking the time to join us today. We look forward to connecting with you over the coming months. Have a great day, everybody.

Operator, Operator

Thank you, ladies and gentlemen. That concludes today’s teleconference. Thank you for your participation, and you may now disconnect your lines.