Earnings Call: Q2 2021

Jul 28, 2021

Good day, and thank you for standing by. Welcome to the Slate Grocery REIT second quarter 2021 financial results conference call. At this time, all participants are in a listen-only mode. After the speakers' remarks, there will be a question and answer session. I would now like to hand the conference over to Jennifer Pyper in investor relations. Please go ahead. Thank you, operator. Good morning, everyone. Welcome to the Q2 2021 conference call for Slate Grocery REIT. I am joined this morning by David Dunn, Chief Executive Officer, and Andrew Agatep, Chief Financial Officer. Before getting started, I would like to remind participants that our discussion today may contain forward-looking statements. Therefore, we ask you to review the disclaimers regarding forward-looking statements as well as non-IFRS measures, both of which can be found in Management's Discussion and Analysis. You can visit Slate Grocery REIT's website to access all of the REIT's financial disclosure, including our Q2 2021 investor update, which is available now. I will now hand over the call to David Dunn for opening remarks. Thank you, Jennifer, and thank you to all the participants for joining the call this morning. While the last 17 months certainly presented us all with novel challenges, there's no doubt that there are positive takeaways for our business as the pandemic fades further into the rearview mirror in the U.S. Both the public and private market's view of the grocery industry has changed, and for the better. It's now clear to all that grocery-anchored real estate, due to its critical nature and cash flow durability, should be viewed as an asset class that is differentiated from broader retail. First, I'll touch on some recent trends within the grocery industry. Mobility data from Apple shows us that Americans are walking and driving around this month at the highest levels since the pandemic began, and their usage of various modes of public transportation has returned to 2019 levels. Even in a post-pandemic environment, America's largest omni-channel grocers, who are also our largest tenants, continue to perform extremely well. Grocers have introduced a new metric, what they are calling two-year stacked sales, to compare their current year comparable sales versus pre-pandemic levels. On that basis, the two-year stacked sales metrics for the most recent quarter for Walmart, Kroger, and Ahold Delhaize were up 16%, 14.9%, and 15.5% respectively, and all three grocers increased their full year 2021 financial guidance. Put simply, grocers continue to experience elevated sales levels and there are broader trends in the food industry that give us conviction this will continue. The Food Industry Association recently completed a study identifying several interesting trends that point to grocers further increasing their share of wallet on food and essential spend. Number one, post-pandemic, people are more likely to cook at home for reasons associated with health, wellness, and cost savings. Two, people are keeping higher inventories of food and essential items on hand at home. Three, American households are spending more on groceries now than they did before the pandemic, with 2021 weekly grocery spend up 17% versus 2020 and up 26% versus 2019. These positive tailwinds will support continued capital investments by grocers in both their in-store infrastructure and their last-mile fulfillment networks, which will in turn make our tenancies stickier and our real estate more valuable. Next, I will touch on our strategic acquisitions. We are on track to close our transformational 25-property acquisition in Q3. We have been working with our new joint venture partners since the transaction was announced in March. Our partners have already completed more than 65,000 sq ft of new leasing with an incremental new leasing pipeline of roughly 60,000 sq ft. These deals can add up to $1.7 million of annual base rents and more than 250 basis points of occupancy, both of which represent improvements relative to our initial underwriting. For our $90 million portfolio acquisition completed in June of 2020, Slate's hands-on asset management approach has similarly enabled us to outperform the assumptions we made during due diligence, including year 1 occupancy is up 360 basis points to 93.5%. Year 1 net operating income is up $900,000, which is equal to 11.6%. The projected IRR over the 5-year hold period increased by 500 basis points to 21.5%. We are proud to have opportunistically acquired more than $540 million of quality grocery-anchored real estate over the last 13 months. These acquisitions will support further net asset value and net operating income growth for the REIT, creating a compelling total return investment opportunity when combined with the upcoming organic growth within our existing portfolio. Lastly, I'll speak to our organic growth and ancillary revenue initiatives. Our portfolio's strong performance continued in the second quarter. Occupancy increased for the fourth consecutive quarter and now sits at 93.2%, representing a 100 basis point increase since the onset of the pandemic. Two anchor leases commenced rent payment in the quarter, and two more are scheduled to come online in the second half of the year. The rent from these tenants and other recently completed lease deals will contribute $2.3 million of base rents in the second half of the year. Our team is also in the process of finalizing more than 90,000 sq ft of new lease deals, which we expect will be executed within the next 30 days. Looking back, spreads on nearly 100,000 sq ft of new leases completed thus far in 2020 have been a strong 10.5%. We're focused on completing deals with more essential tenants and have achieved net effective rents that are 10%-15% above historical levels, meaning we are spending less capital to complete a lease transaction in today's marketplace. Finally, we're making solid progress on our ancillary revenue initiatives that we introduced last quarter. Since the beginning of the program earlier this year, we've already executed contractual agreements that will generate $300,000 of net operating income on an annualized basis at no cost to the REIT. We are continuing to build out these initiatives and are targeting $750,000 and $1 million of recurring annualized net operating income by 2022 and 2023 respectively. In closing, we are pleased with the state of our portfolio and the strengthening fundamentals within the grocery-anchored sector as we put the pandemic behind us and drive our business forward. I continue to be grateful for the significant efforts put forth by our team at Slate Asset Management, and I'm excited to create additional value for our unitholders. On behalf of the entire Slate Grocery team, we wish you and yours good health, and we thank you for your continued support. I'll now hand it over for Q&A. Thank you. Your first question comes from Lee Chin of iA Capital Markets. Hi, good morning. My first question is regarding rising cases of COVID from the Delta variant. Vaccination rates have slowed down in the U.S., and more and more it seems that COVID could either become endemic or a seasonal thing. Just in regards to your non-essential tenants that are more sensitive to restrictions. In the U.S., this seems to be more of a contentious subject, but have you had conversations as to how they would balance public safety and the freedom of choice regarding wearing a mask or social distancing? Hey, Lee, good morning. Thanks for your question. I'm reading the same things, our team is reading the same things that you are, in the news. It's just simply not translating to an impact on our business. We were good partners with our tenants 18 months ago when the pandemic was first announced. We worked together, and we found a way to manage our respective businesses effectively. Right now, the economy in America is booming. GDP growth, they're looking at 9% annualized growth in 2021. Different states are approaching masks and the pandemic differently. As it relates to our business, we don't see any challenges or concerns today, and we think America will sort it out just as they did effectively nine to 12 months ago. Oh, that's great. Just last one from me. Regarding your ancillary revenue program, I know this is still early, but can you comment what the long-term percentage target would be? Do you believe that could significantly be a significant driver or contribute significantly more than 1% to your NOI? We do. Right now, we're very pleased with the progress we've made. We had high hopes for this program as it's materialized over the last six months, frankly, even management is impressed with the contractual revenue we've generated to date. We felt, given the 2 drivers of ancillary revenue in our minds was going to be 5G and solar panels on rooftops. 5G being installation of antennas with telco providers, including AT&T, Verizon, Google, Amazon, et cetera, was going to be the main source of revenue for us, we haven't done any of those deals, and we're already honing in on $600,000 of annualized revenue. We felt compelled to talk about some targets, $1 million in 2023 is north of 1% on an NOI CAGR. The nature of these deals will be recurring, and we feel that we can compound that and grow it over time. Right now, we're comfortable with the $1 million target in 2023, and we'll be assessing as we continue to make progress. Oh, that's great to hear. That's it for me. I'll turn it back. Thanks. Thank you. Once again, if you would like to ask a question, press star 1. Your next question comes from Himanshu Gupta of Scotiabank. Thank you, good morning. Just first on rent collections, how's the rent collection trending in June and July so far? Are there any category of tenants which are still not paying? Yeah. Hey, Himanshu, it's Andrew. Thanks for the question. Yeah, our collections continue at the same pace that we've seen since the start of the pandemic, which is about 97%. It's kind of creeping up higher, what we've seen. Most of our tenants remain in operation and continue to pay. Right now, I'd say maybe some of the restaurants is where we see a bit of the slow payers, but, for the most part, our collections continue to be strong. With reference to our pro program, as we're on this topic, we're now done. It's about $1.2 million that we've entered into start of the second half of last year, and since this quarter, we've now completed. To speak to David's point, there's positive sentiment around the U.S. Operations are running smoothly, and we continue to collect on rent. Okay. Thank you. I'm assuming the restaurants and fitness tenants are back to pre-pandemic or closer to normalized collections now. Yeah. Gym operators are back open. They've been open for, I mean, since late last year. We're seeing macro trends about retail spending, foot traffic, seated diners at restaurants in excess of 2019 levels. There's no COVID AR that we're dealing with, as Andrew described. We're 100% collected on the deferrals that we entered into. If there were an area where we're working with tenants, it would be in the larger restaurant, the 5,000-plus square foot restaurant space. We have a limited exposure to them. There's a handful of them. They're catching up on rent that may have been lagging even pre-pandemic. We're confident that we've addressed our bad debt provisioning appropriately. I'll note that the last 2 quarters it's been at or below sort of our historical run rate, and we feel like provisions have been adequately provided for, and we don't foresee any major swings from what we've been seeing recently. Got it. That's helpful. Turning to the leasing environment for small shop tenants. Obviously, we are hearing about an economic rebound. You mentioned about almost 9% GDP growth as well. Is all the economic rebound translating into better leasing environment as well from the landlord perspective? Since January, we have seen a robust leasing environment. I spoke a little bit last quarter about the types of deals we're seeing, essential tenants taking advantage of recently vacated premises to maybe upgrade a position in a trade area or to add scale, maybe open a new store. We've been the beneficiary of that, there's no doubt, Himanshu. That's the larger tenant set. As it relates to smaller tenants, they're also doing deals. I can't point to 1 specific maybe trend, but restaurateurs, entrepreneurs are seizing the moment and opening restaurants. There's a $5 billion of stimulus in the marketplace right now from the Feds. That's helping for sure. Unemployment is improving. One point I want to make is a trend that Morgan Stanley came out with a report a couple of months ago forecasting potentially up to 30% of enclosed malls may close in the coming years. There are viable tenants in these malls, and strip centers with strong positions in a trade area with good anchors stand to benefit. If you're a mall tenant leaving a mall to go find another location with a more vibrant tenant mix, in all likelihood, you're paying more rent at an enclosed mall. You can come to a strip center and get higher visibility. You can get signage on the street and above your front door. You can have your customers park directly in front of the store. All of these are compelling in our mind, and we believe that this type of trend will drive future new leasing velocity for Slate Grocery REIT as well. Got it. Okay. That's helpful there. Just turning on to the acquisition side. How's the acquisition pipeline looking? What are you seeing in terms of valuation or capital trends in the near term? We're always looking out for deals that are mispriced in the market. Whether we're buying deals on a portfolio basis from another REIT who's winding down a joint venture, or we're buying a business from a market participant like Annaly. We've been very creative in sourcing deals, and they're mispriced based on the purchase price. We're always looking at deals. Sentiment in the market right now has probably never been stronger for stabilized grocery-anchored real estate. Across America, but specifically in the Southeast. I'll point you to several transactions that speak to strong demand and increasing values. We've talked about this in the past, but obviously Kimco-Weingarten, which is a mid 5 cap transaction. PECO, which is Phillips Edison & Company, just IPO'd their about $300 billion market cap at $175 a foot, which is higher than our price per pound, which is $144 a square foot. The most compelling trade, and we think is the most like our portfolio, is a BentallGreenOak portfolio that's in the market right now. 10 assets, many of the trade areas and markets overlay with the Slate Grocery portfolio, $500 million. Guidance was a mid 5 cap. What we're hearing from brokers and on The Street is that activity has been very strong, and interest has been strong, and the expectation is that that will trade inside of a 5-5, probably closer to a 5 cap. All those are examples of strong velocity and interest in grocery anchored strip centers, and we like where our position is today, certainly. Awesome. Thanks for spelling out those transactions and especially the BentallGreenOak, which is in the market. Maybe just last question from timing perspective, when do you close the Annaly transaction? I know you mentioned Q3, but do you have any sense of more precise timing there from modeling perspective? Right. You probably saw the press release on Monday. The other component of the transaction closed. They were always separate and distinct, and were going to close at a different time. From our standpoint, Slate Grocery REIT is ready to go. The nuance with our bucket of assets is it requires consent from CMBS lenders, and that historically takes a little longer, hence the delay. We're confident it will close in Q3, very confident, and we're hopeful it's August. Again, we're working diligently with the lenders, but to a certain extent, they will dictate the speed at which we close. Thank you. All the best for the closing of that transaction. Thank you so much, and I'll turn it back. Thank you. Your next question is from Sumaya Syed of CIBC. Thanks. Good morning. Just, on the pending portfolio acquisition. Obviously, you achieved some occupancy gains there. Is there still some upside there remaining in terms of occupancy? If so, when do you think you can get there? Good morning, Sumaya. Thanks for your question. We purchased our year 1 occupancy for the Annaly 25 asset transaction was just a shade under 90%. Lots of legs to add value, add occupancy. We didn't assume any occupancy gains until year 3. To have already secured a few hundred basis point lift in occupancy, which is obviously adding NOI before we even close, is a very good place to be. We have been working with, since virtually the day after we firmed up the transaction with our new JV partners. As I've alluded to in some of my messaging, we really enjoy working with them. They're like-minded, they're strong operators, and they have been very open in sharing information with us, and we do transactions in a similar manner. Yes, we think there's incremental legs to grow it, and we're going to be tracking our performance specifically relating to underwriting on the $540 million of acquisitions we've made in the last 13 months, and we'll be pleased to update the markets every so often. The answer to your question is absolutely yes. We're striving for 95% occupancy, which would be a stabilized basis. Okay. Looking forward to the updates. On the Glen Lake acquisition, it's at a discount to replacement cost. On a stabilized basis, what would that valuation look like? I'll make a few comments on that. This pales in comparison to the portfolios we've purchased at a single asset at $8.5 million, we love this deal. It furthers our relationship with Kroger, who is a valued partner for Slate Grocery REIT. Sale-leaseback transaction in Indianapolis MSA, which is a 31st MSA, largest MSA in the U.S. The basis is $81 per sq ft, and the occupancy is 85%. I kind of think of this deal as a, call it an older-school Slate Grocery transaction, where we can add real value in lease up and stabilizing occupancy. We know we can do that because when Kroger had a change of their strategy, and they were letting leases expire in order to reposition the asset. There is going to be interest from co-tenants, with the new 15-year Kroger lease. When they reposition their store, we believe we can partner with them to drive value for the asset and lease it up expeditiously. Okay. You touched on the Kroger relationship. I don't know how much you can comment on their strategy, but what does that pipeline look like in terms of opportunities for Slate? We talk to a lot of our tenants on a regular basis, but we make a point of going to see in person our biggest grocer tenants. That builds relationships, it builds trust. We're looking forward to continuing to grow with Kroger. I'm not going to speak to their strategy, that wouldn't be appropriate. What I can say that if there are opportunities to grow together, we believe we're going to get an opportunity to do so. We've been able to secure these types of deals with other tenants, not only Kroger in the past. We've been focused on transformational growth off market portfolios, but there's always going to be an opportunity to talk to our key grocers and expand our relationships with them. Great. Thank you. Thank you. We have no further questions at this time. I will now turn the call back over to Jennifer Pyper for any additional or closing remarks. Thank you, everyone, for joining the Q2 2021 conference call for Slate Grocery REIT. Have a great day. Thank you. This does conclude today's conference call. You may now disconnect.