STAG Industrial, Inc. (STAG) Q1 2022 Earnings Call Transcript

Greetings. And welcome to the STAG Industrial, Inc. First Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Steve Xiarhos. Please go ahead.

Thank you. Welcome to STAG Industrial’s conference call covering the first quarter 2022 results. In addition to the press release distributed yesterday, we have posted an unaudited quarterly supplemental information presentation on the company’s website at www.stagindustrial.com under the Investor Relations section. On today’s call, the company’s prepared remarks and answers to your questions will contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. Examples of forward-looking statements include forecast of core FFO, same-store NOI, G&A, acquisition and disposition volumes, retention rates and other guidance, leasing prospects, rent collections, industry and economic trends, and other matters. We encourage all our listeners to review the more detailed discussion related to these forward-looking statements contained in the company’s filings with the SEC and the definitions and reconciliations of non-GAAP measures contained in the supplemental information package available on the company’s website. As a reminder, forward-looking statements represent management’s estimates as of today, STAG Industrial assumes no obligation to update any forward-looking statements. On today’s call, you will hear from Ben Butcher, our Chief Executive Officer; Bill Crooker, our President; and Matts Pinard, our Chief Financial Officer. Also here with us today is Steve Mecke, our Chief Operating Officer; and Mike Chase, our Chief Investment Officer, who are available to answer questions specific to operations. I will now turn the call over to Ben.

Thank you, Steve. Good morning, everybody. And welcome to the first quarter earnings call for STAG Industrial. We are pleased to have you join us and look forward to telling you about our first quarter results. To say the least, we live in interesting times. The daily headlines are dominated by ongoing and escalating geopolitical turmoil, many inflation and firmly entrenched political polarization. The Fed has a long commitment to a rising interest rate cycle and a post-pandemic new normal continues to evolve. None of this has dampened the viable demand for industrial real estate. Consumers are consuming, supply chains are being reworked and optimized, and inventory levels are expected to increase, if not exceed, pre-pandemic levels. The recently announced cooling off by Amazon is only a small part of the overall strong demand story. A variety of other market participants are aggressively pursuing additional space. New supply, though elevated, continues to struggle to keep up with this heightened level of demand, good news for owners of this asset class. These dynamics are reflected in the results from our operating portfolio. We continue to experience significant proactive commitment to our spaces from new and current tenants. This has allowed us to achieve greater rental growth and secure record levels of contractual rental escalations. Our team is energized and performing at a high level. Our opportunity set is as large and attractive as at any point in our history. This was a great quarter, and portfolio fundamentals support the belief that this strong performance will continue. The beauty of the STAG investment thesis and our underwriting model is their flexibility; they give us the ability to react in real-time to fluctuating market conditions such as share price, debt rates, cap rates, rent growth projections, etc. Our simple mantra will continue to serve us and our shareholders well: if we can buy it for less than it’s worth, we will; if somebody will pay us more than we think it’s worth, we will sell. With that, I will turn it over to Bill to discuss our operational results.

Thank you, Ben. Good morning, everyone. I want to start off by thanking our team for their hard work this quarter. We are coming off one of the best years we have had as a public company and our Q1 performance continues that trend. As Ben noted, the industrial fundamentals story is very much intact, with demand drivers exceeding expectations and supply in check. Peculiar demand drivers including e-commerce, widespread supply chain reconfiguration, and an expected increase in inventory levels continue to be strong tailwinds. Rent remains a small fraction of overall logistics costs; adding space in strategic locations is increasingly the norm for many businesses, a strategic goal for them and a positive demand driver for STAG. The current inflationary environment has caused construction costs to elevate significantly. This drives up rents on both new supply and uncompetitive existing assets, benefiting our portfolio of fungible industrial buildings. As I mentioned at the outset, this positive backdrop helped our team put together a very strong quarter. Our core FFO per share was $0.53 this quarter, an 8.2% increase over the prior year. Same-store NOI was a big contributor to this growth. We continue to improve our leasing spreads and expect those spreads to be consistent with Q1 as we move through the year. Rising interest rates have caused a slight slowdown in the longer-term lease transaction market. Fortunately for STAG, our disciplined process for identifying and closing on industrial acquisitions is focused on relative value. This allows us to still accretively acquire assets that will deliver long-term returns to our shareholders. Acquisition volume for the first quarter totaled $166.4 million across eight buildings with stabilized cash and straight-line cap rates of 5% and 5.2%, respectively. There are a few larger transactions I would like to highlight that closed this quarter. In January, STAG acquired a 7,200 square foot warehouse distribution facility located in Kansas City for $60.4 million at a 4.8% stabilized cash cap rate. The building is well-located within Kansas City’s largest industrial submarket near the I-35, I-435 interchange. Lease for five years to a large national retailer, the building serves as the tenant's sole e-commerce facility. This transaction includes 17 acres of land available for potential expansion or additional parking for the existing or subsequent tenants, providing an opportunity to add additional value to the site. In March, we acquired a 156,000 square foot warehouse distribution facility located in the Greenville, Spartanburg market for $16.4 million at a 4.6% stabilized cash cap rate. Located in the Matrix Industrial Park in the IE-5 self submarket, the building is leased for just under three years to an investment-grade tenant. The tenant has occupied the facility for over 13 years and has a large capital investment in the facility. Rents are well below market, providing an attractive opportunity to create additional value at lease expiration. Also in March, we acquired a 289,000 square foot warehouse distribution facility also located in the Greenville, Spartanburg market for $28.3 million at a 5.7% stabilized cash cap rate. Well located in the Exchange Logistics Park, in the I-85 self submarket, the building was 78% leased upon acquisition to three credit tenants, with the ability to add value through the lease-up of the remaining space. We have seen a high level of activity on the vacant suite and are currently negotiating terms with an existing STAG tenant for the suite. As I mentioned in our last call, we continue to focus on capital recycling in this environment. During the quarter, we sold one building for $35.9 million at a 4.4% stabilized cash cap rate, with the proceeds accretively redeployed into our acquisition closing schedule. There are several other capital recycling opportunities in various stages of evaluation and we look forward to updating the market as we move through the disposition process. We continue to expect disposition proceeds in the range of $200 million to $300 million this year, representing an amount higher than the previous years to take advantage of the current pricing environment. With that, I will turn it over to Matts, who will cover our remaining results for the quarter and provide an update to our 2022 guidance.

Thank you, Bill, and good morning, everyone. Core FFO was $0.53 for the quarter, an increase of 8.2% as compared to the first quarter of last year. Cash available for distribution totaled $82.4 million for the quarter, an increase of 13.8% as compared to the prior period. Leverage remains near the low end of our range with net debt to run rate adjusted EBITDA equal to 5.1 times. During the quarter, we commenced 29 leases totaling 3.1 million square feet, which generated cash and straight-line leasing spreads of 15.2% and 25.1%, respectively. Retention was 58.4% for the quarter. When accounting for immediate backfills, adjusted retention equals 87.1%. Cash same-store NOI grew 4.8% for the quarter, the highest level on record for STAG. Included in this quarter, same-store is a payment of past due rent as a result of a settlement reached with the prior tenant. The tenant vacated the building in September and was subject to cash basis accounting. The building was re-leased with zero downtime. This payment contributed 40 basis points to this quarter's same-store results, with the full year benefit of the same-store expected to be 10 basis points. Moving to capital market activity and beginning with equity. In January, we sold 128,000 shares via the ATM at a gross share price of $45.03, resulting in gross proceeds of $5.8 million. We have not issued incremental equity since January 2018. On March 29th, we fully settled the remaining forward equity proceeds related to our November equity transaction and received $49.7 million in net proceeds, which we used to fund first quarter acquisitions. Subsequent to quarter end, on April 28th, we closed a $400 million private placement transaction with a coupon of 4.12%. The tenure notes are expected to fund in June. In terms of guidance, we have made the following updates. Our core FFO per share guidance is increased to a range of $2.16 per share to $2.20 per share, an increase to the midpoint of $0.01. We have increased our same-store guidance to be between 4% and 4.5% for the year, an increase in the midpoint of 75 basis points. This increase was driven by the robust demand we are experiencing for buildings and leasing results have exceeded our initial expectations. Finally, we have reduced G&A guidance to a range of $48 million to $50 million, a decrease of $1 million at the midpoint. We continue to expect net debt to run rate adjusted EBITDA to be between 4.75 times and 5.5 times. I will now turn it back over to Ben.

Thank you, Bill and Matts. Strong results indeed with a bright outlook for the remainder of the year. As many of you are perhaps aware, this will be the final time I participate in a STAG earnings call as your CEO. As previously announced, I will be moving to the Executive Chair role on July 1st. Bill Crooker, currently our President, will succeed me as CEO. I have full confidence in him, the rest of the STAG team, and the direction of the company. Thank you for your time this morning. I will now turn it back to the operator for questions.

Thank you. [Operator Instructions] Your first question comes from Sheila McGrath with Evercore. Please go ahead.

Yes. Good morning. Ben, I was wondering if you could drill down a little bit more on your Amazon comments. Their commentary really drove the industrial REITs down last week when they said they have too much space. What are you hearing from brokers and what is your view on their retreating impact on demand?

Well, I mean, it’s obviously big news and was taken by a lot of people to be more meaningful than perhaps it was. Amazon has been signaling in their activity and in their earnings calls for some time now and generally known in the market that they were slowing the pace of the build-out of their supply chain systems. I think that if you look at the numbers, they were a bigger part of the overall absorption in 2020 than they were in 2021. What we have seen from numbers is that they are tracking this year at a rate, again in terms of percentage of overall absorption, pretty similar to last year, but certainly they signaled that slowdown. Now what we are seeing anecdotally across our buildings is very aggressive demand from other tenants, other e-commerce tenants, tenants not in e-commerce, etc.; very aggressive, and that’s reflected in our operating results. So I think a little bit of a tempest in a teapot with the announcement, but certainly something that people are paying attention to.

Okay.

Yeah. And Sheila, just to add on to that. Our exposure is only 3.2% of ABR. We have seven buildings leased to Amazon. Only one was a build-to-suit for Amazon, which has 12 years remaining lease term. And our near-term lease roll, we have two spaces rolling next year leased to Amazon, which are averaging about 25% below market.

Okay. Great. And one other quick question. Just your perspective on cap rate trends in industrial with interest rates moving higher, your thoughts there? And are you seeing any evidence that the highly leveraged buyers may be less aggressive on acquisitions in this environment?

So, yeah. So, Sheila, obviously, the most important interest rate is the 10-year treasury for the real estate market and the -- I think the Fed’s moves are likely to affect the short end of the curve more than the 10-year. But what’s really important for us is, well, first of all, we really haven’t seen any impact on cap rates yet. What was really important for us is the impact on our competition. We typically are competing with smaller, local buyers of individual assets who typically use more leverage. So our expectation is that cap rates on the individual transactions, at some point, we will probably go up as their cost of capital is negatively affected by a rise in interest rates. Bill, do you want to?

Yeah. I mean, that’s right. I mean we typically, as you said, Ben, we see a lag in terms of the change to cap rates when interest rates rise; we haven’t seen anything yet. But if interest rates stay elevated, there may be a potential rise in cap rates in the back half of the year.

Okay. Thank you.

Your next question comes from Emmanuel Korchman with Citi.

Hey, everyone. Good morning.

Good morning.

Just given the dislocation in your own stock price, you mentioned that you haven’t issued any equity since January. How do you think about your acquisition pipeline, is there a chance that you simply buy less because your cost of funding has changed or how do you offset that?

Hey, Manny. We currently have about $800 million of liquidity with the private placement we executed. As we see the market today, we are still comfortable with our guidance of acquiring $1 billion to $1.2 billion, but it is with some elevated dispositions that we expect to transact on in at least the first half of the year and some of the back half of the year. So there is no change to guidance; we have plenty of liquidity and are comfortable with the guidance we have out there.

And the distribution comment you just made, that’s in excess of what you have guided to or you are saying that their increase versus your typical levels of disposition?

No. We are at an increase versus our typical levels; we are comfortable with our guidance range of $200 million to $300 million.

Okay. And then maybe to follow-up on the Amazon question and answer, there has been some discussion about them potentially putting space in the sublease market. Do you think that’s enough to change the rent conversations that we have been having for some time here?

In our assets, I am not familiar with that as a widespread concern in the market. Certainly, if they decided that they want to dump a lot of space to the market, it would have an impact, but we certainly haven’t seen that or heard much about that.

Great. Helpful. Thank you.

Your next question comes from Blaine Heck with Wells Fargo.

Great. Thanks. Good morning. Just digging into the pricing environment and expanding on that a little bit more. There was a pretty wide range in terms of waltz on your acquisitions from 2.9 years at the low end to 9.9 years at the high end. Can you just walk and talk a little bit about whether those short deals are pricing differently than those with longer waltz and how you are thinking about rent bumps on acquisitions with a lot of lease term remaining; are you able to find deals within embedded rent bumps that are sufficient to offset the increasing rate and inflationary environment?

Yeah. Blaine, so I mean, obviously, every lease or every transaction that we look at has different parameters. Some have short leases, some have long leases, bigger rent bumps, lower rent bumps, higher expected market rent growth, lower expected rent growth, mark-to-markets. There are all sorts of different parameters that affect the return. What doesn’t change? Generally speaking, is the return threshold that we utilize to make sure that we are getting good long-term accretive returns for our shareholders from the acquisition. So, where I am going to use this word as much as I usually do, we are agnostic to most of those parameters, we are just not agnostic to the required returns. Bill, do you want to add?

Yeah. And as I said, Blaine, we haven’t really seen any pricing changes yet. It’s a little too soon for that. We have always bought various lease terms whether via a vacant asset or a long-term lease. As I mentioned, the 2.9-year lease term asset that we acquired in Q1 is well below market and we will be able to unlock some value there in three years, and the 9.9-year lease term was a very strong credit at a straight-line cap rate of 5.7%, so very accretive to our bottom line.

In terms of rent bumps, as you alluded to, we are getting, not only in our leasing activity but our acquisition activity, we are seeing higher contractual rent bumps.

Got it. That’s really helpful color. And then retention during the quarter, it was obviously a little lower than the guidance range. Can you just talk about whether that was expected in the third quarter, what drove that lower retention? Was it just expansions as we talked about on prior calls, or was it kind of the drive on your part to increase the rate that maybe wasn’t well-received by some tenants, just a little color there would be helpful?

Yeah. I was expected, Blaine, and part of the expectation was driving rates on those leases. So, you saw some average occupancy decline in our same-store pool that was because of these non-retained tenants. But we did backfill a lot of those spaces in the second quarter already. So, yes, it was in our budgeted numbers; a big driver was us rolling those leases up to market.

Yeah. And Blaine, one of the things that is sort of a hallmark of this very, very strong industrial market is that downtime, not only for us but all market participants, is much lower than sort of long-term trends; so retention becomes less of an issue as you have lower downtime.

Great. Thanks, guys.

Next question Michael Carroll with RBC.

Yeah. Thanks. I want to go back to, Bill, your comments on cap rates; you kind of implied or said that cap rates could potentially rise in the back half of the year. I mean, could you give some color on that; how much do you think that they could rise and just -- that is just assuming interest rates stay where they are right now?

Historically, the correlation has been above 50% of the rise in the 10-year is impacted to cap rates with the demand in industrial. I am not sure cap rates will rise that much, just because of the fundamentals we see. But right now, as I said, we haven’t seen anything today, but if these interest rates stay elevated, we certainly could see some increases in the back half of the year.

Yeah. And if you look at the 10-year, we have seen 100-basis-point and 125-basis-point increase. What Bill alluded to in terms of the depth of the capital chasing industrial, I think will lessen how long it takes for that impact to occur, but I think it will find its way into the market over time, the rising of cap rates, especially on the individual transactions where we are most active.

And then we are looking at new acquisitions, are you adjusting your underwriting for those longer lease duration type properties? I mean, are you increasing what you are -- the returns that you need on those specific assets?

The answer to that is no, because we are looking at returns over a long period of time. So the feature of those deals is that they have a fixed rent for longer periods of time. That doesn’t mean that they are less attractive to us. It may mean that we can’t justify paying as much in the interest rate environment, etc. But now we -- our model is able to analyze those transactions at the same time we analyze shorter-term transactions and produce by analyzing the cash flows over time, looking at them on effectively a risk-neutral basis.

Yeah. We are constantly updating our model with the forward curves. So that’s obviously impacting pricing on longer-term leases when the forward curve increases.

Okay. And then just last one from me, I mean, how comfortable are you increasing leverage and kind of hitting the top end of that range maybe with minimal amount of equity and more focused on asset sales? I know historically, you like to be towards that lower end. I mean, are you willing to kind of creep towards the top end, just given some of the dislocation that we are currently seeing, if it persists at least?

Yeah. Hi, Mike. It’s Matts. So let me walk you through our guidance and the reason why we set it up this way. So as we sit here today, we can operate within our current guidance at the low end of acquisitions, the high end of dispositions, and not issuing any additional dollar of common equity, and we would hit that 5.5 times. We are very comfortable with the balance sheet now. We are comfortable at 5.5 times. This is a promulgated leverage range driven by our investment grade ratings. Now, speaking to either Fitch or Moody’s, they’re comfortable levered higher than that. We have a guidance of 5.5 times; we could operate there. We have room to go higher and not in general any rating issues. But really kind of the takeaway here, Mike, is we can run this business while we can run this guidance that we have right now without leaving common equity this year.

Great. Thank you.

Next question Jamie Feldman with Bank of America.

Great. Thank you. I guess just going back to your Amazon comments. I think you said you had two expirations with them next year. Do you have any sense of their plans for those spaces?

Not for now, Jamie. They are fully utilizing the spaces. They are fungible space. One is a second-gen space to Amazon. One is the building we developed in Burlington, New Jersey. The buildings fit the markets really well. We don’t have a view on whether Amazon will want to renew or not. But as I noted, those -- the average of those two spaces is about 25% below market.

Okay. And you have a view on a lot of markets, given your portfolio diversification. As you sit here today, do you think about that news? I mean, do you think there are certain markets or certain types of buildings that you would be more concerned about or just any buzz from market leaders about what may be hearing that you might be able to share?

Yeah, I would say, if there was a build-to-suit Amazon building that had a year or two left to lease term, I would be concerned about that. We have one build-to-suit for Amazon in our portfolio, which has a little over 12 years of lease term. It’s really the specialized buildings, Jamie, with three or four levels of mezz that would cause us some concern as those are probably priced well above market. Again, we don’t -- even the build-to-suit that we have in our portfolio that has 12 years lease term is at market. So, fortunately for us, our underwriting contemplates specialized buildings and it really dings that in our underwriting. So we don’t have many, if any, of those buildings in our portfolio.

Okay. Thank you. And then to your comments on potentially cap rates backing up, can you just talk to us about how you are modeling your IRRs now? I mean, how do you think about what’s changed in your underwriting assumptions, whether it’s rent growth or exit cap rates or anything else?

Yeah. So, Jamie, obviously, we try and update in real-time everything that’s going to affect cash flows going forward, and that is basically everything you can think of that will affect the future results from owning that asset. We have at least, in the temporary backup, our thresholds a little bit because of the fact that the fluidity in the market allows for the re-pricing, if you will, of assets to occur. So we have given ourselves a little bit of extra cushion. But given that and our experience in the market to-date that is not affecting at all our expectations as the guidance.

Okay. That makes sense. And then as you think about, so you are starting to get better same-store rent with better leasing spreads which means more cash flow flowing to the bottom line. How should we think about your prospects to grow the distribution going forward if this with better kind of internal growth metrics?

Hey, Jamie. This is Matts. So, our first-quarter payout ratio is 80%. We communicated a couple of years ago that we wanted to bring that payout ratio to the 80% level. We would like to be there for this year. We will continue to evaluate it, but we are getting close to the point where we think that we can begin growing the dividend distribution in line with our CAD per share growth. It may not be this year, but we are getting close to the moderation level that we had communicated.

Okay. All right. Thank you.

Thank you, Jamie.

Thank you. I will now turn the floor over to Ben Butcher for closing remarks.

Well, I will start off by saying I am surprised nobody asked me what I was going to be doing in July. But I appreciate the fact that nobody focuses on the business, and I am happy to have us focus on the business in this call and for you all to focus on the business, because our operational results were reflective of the really good place that STAG is in terms of its portfolio and its people. As I step down in July from CEO, as I said in our prepared remarks, I am highly confident of our ability to move forward under Bill’s leadership as CEO and with a really strong rest of the team, and as I said, great prospects for the future. So thank you.

This concludes today’s teleconference. You may disconnect your lines at this time, and thank you for your participation.