Kite Realty Group Trust (NYSE:KRG) Q4 2022 Earnings Call Transcript

Kite Realty Group Trust (NYSE:KRG) Q4 2022 Earnings Call Transcript February 15, 2023

Operator: Thank you for standing by and welcome to Kite Realty Group Trust Fourth Quarter 2022 Earnings Conference Call. As a reminder, today’s program is being recorded. And now I’d like to introduce your host for today’s program, Bryan McCarthy, Senior Vice President, Corporate Marketing and Communications. Please go ahead, sir. Bryan McCarthy, you may begin.

Bryan McCarthy: Thank you and good afternoon, everyone. Welcome to Kite Realty Group’s fourth quarter earnings call. Some of today’s comments contain forward-looking statements that are based on assumptions of future events and are subject to inherent risks and uncertainties. Actual results may differ materially from these statements. For more information about the factors that can adversely affect the company’s results, please see our SEC filings, including our most recent Form 10-K. Today’s remarks also include certain non-GAAP financial measures. Please refer to yesterday’s earnings press release available on our website for a reconciliation of these non-GAAP performance measures to our GAAP financial results. On the call with me today from Kite Realty Group are Chairman and Chief Executive Officer, John Kite; President and Chief Operating Officer, Tom McGowan; Executive Vice President and Chief Financial Officer, Heath Fear; Senior Vice President and Chief Accounting Officer, Dave Buell; and Senior Vice President, Capital Markets and Investor Relations, Tyler Henshaw.

I will now turn the call over to John.

John Kite: Alright. Thanks, Bryan and good morning or good afternoon, everybody. Look, to say that we are proud of what we accomplished here at KRG during the course of 2022 would just be a massive understatement. We are currently at the lowest leverage levels and highest fixed charge coverage ratios in KRG’s history. Our ABR per square foot, leasing volumes and blended cash leasing spreads are at a high watermark for KRG. For those reasons, amongst many others, we achieved the highest total shareholder return among our peer group, which is a testament to our team’s ability to operate our platform at the highest level. I want to thank the entire team for all of its hard work, focus, and dedication. Our best days are clearly ahead of us and we are committed to extending our current streak of outperformance across every metric.

Before I provide further commentary on 2023, I’d like to highlight some key metrics from a spectacular 2022. KRG generated FFO as adjusted per share of $1.93, which represents a 29% increase per share over 2021 and a $0.21 increase over the midpoint of our original 2022 guidance. Our same-property NOI growth for the year was 5.1%, beating the original midpoint of our guidance by 310 basis points. Heath will lay out the components of our outperformance to provide additional context later on. Our ABR per square foot has now eclipsed $20 and has still plenty of room to grow, as demonstrated by the $27 rents per square foot achieved on all comparable new leases in 2022. Our net debt-to-EBITDA continued to trend down to 5.2x and we have over $1 billion of liquidity.

We leased nearly 4.9 million square feet at 12.6% blended comparable cash leasing spreads, which represents approximately 17% of our total GLA. Excluding option renewals, blended cash spreads for comparable new and non-option renewals were 18.1%. Our leasing volume and rent spreads clearly showcased the demand for our high-quality shopping destinations and our team’s ability to capitalize on a strong retail environment. More importantly, returns on capital for our new leasing activity in 2022 were nearly 36%. Leasing our existing space continues to represent the best risk-adjusted return of our capital. Not only did we execute on the leasing side, but our development, construction, and tenant coordination teams delivered spaces on budget and ahead of schedule in a very turbulent year for construction.

We opened 245 new tenants, representing approximately $40 million of annualized NOI throughout 2022, which is another reason we believe our construction and development roots remain a competitive advantage for our platform. Our strategy for the next 18 months is straightforward. We still have 150 basis point spread between our current and pre-COVID leased rate, which represents the most near-term upside amongst our peers. As we navigate an uncertain macro environment, we have the luxury of producing internal growth by doing what we do best, leasing space. Additionally, we have a healthy $33 million signed-not-open pipeline to help buffer any potential tenant disruption in 2023. The issues around Bed Bath & Beyond and Party City are well documented, and Heath will detail how we plan to address those tenants in terms of our guidance.

Any disruption from those tenants could impact our lease rate in the near term, but they are not a read-through to the broader retail environment. We continue to see strong demand from a variety of anchor tenants with whom we have recently signed leases, including ALDI, Lidl, Trader Joe’s, Total Wine, DICK’S Sporting Goods, HomeGoods, pOpshelf, Ulta, and Five Below, amongst many others. Successful retailers continue to implement an omnichannel strategy across their fleets, where the physical store is an integral distribution point to deliver products and services to consumers. Supply of high-quality open-air retail space remains low, and demand continues to be strong as demonstrated by our ability to grow rents at compelling returns. Our focused plan for 2023 is supported by one of the strongest balance sheets in the sector and limited future capital commitments.

We have the flexibility to primarily focus our capital allocation efforts on leasing as we only have $44 million remaining to spend on our active developments. Our measured approach to future development opportunities mandates that we take our time to establish the best risk-adjusted returns for KRG. Each development has its own nuances, and during the course of 2022, we made significant progress in preparing our entitled land bank as a lever for future growth. In various instances, we’ve demonstrated our willingness to monetize parcels, joint venture with best-in-class partners, serve as a master developer and earn fee income, or take on projects solely ourselves. At KRG, we prefer the optionality to evaluate each scenario with the duty of achieving the best risk-adjusted return for our stakeholders.

On the transactional front, we remain opportunistic. And like last year, we intend to transact in pods of activity that are either neutral or accretive by match-funding acquisitions in our target markets with dispositions of non-core assets. For the time being, we feel this is the most logical approach provided the strength of our balance sheet will allow us to immediately pivot should a compelling opportunity arise. KRG is in a very strong position. We will continue to operate the company with our signature focus and vigor to showcase the quality and upside embedded in our portfolio. I will now turn the call over to Heath for further color.

Heath Fear: Good afternoon and thank you for joining us today. It’s impossible not to feel an overwhelming sense of accomplishment when looking back at what the KRG team achieved during this past year. There is a lot to unpack for 2022 and 2023, so let’s get right to it. KRG generated $0.50 of FFO per share as adjusted for the fourth quarter and $1.93 of FFO per share as adjusted for the full year. For the fourth quarter, same-property NOI grew by 6.2% with the main contributors being a 420 basis point increase in minimum rent and recoveries and a 230 basis point increase in overage rent, slightly offset by higher bad debt. The increase in overage rent is seasonal in nature but a strong sign that retailers are thriving in our centers.

For the full year, same-property NOI growth was 5.1%. Minimum rents and recoveries contributed 460 basis points to the full year growth. As a reminder, we reported FFO, as adjusted, and same property NOI, excluding the impact of prior period collections to provide the best view into our core results. Looking back, we significantly exceeded internal and external expectations and beat our original 2022 FFO guidance by $0.21 per share. Given the magnitude, I’d like to bridge our original guidance to the full year actuals to provide additional context. $0.08 of the beat is strictly related to operational outperformance by way of higher leasing spreads, an 89% retention ratio versus our initial budget of approximately 80%, lower bad debt and an increase in overdraft.

$0.05 is related to development fees and recurring but unpredictable items, which is in line with the numbers we laid out in our third quarter investor presentation. An additional $0.05 were merger-related items, namely outperformance on initial non-cash rent expectations and lower G&A. The remaining $0.03 is primarily due to transacting accretively and beating our development pro formas, specifically on the One Loudoun residential project. The past year was simply remarkable. As John alluded to earlier, we are providing NAREIT FFO guidance of $1.89 to $1.95 per share. While many of you thanked us for the transparency and simplicity of our as adjusted disclosure. For 2023, we plan to guide and report NAREIT FFO as the prior period collection bucket is de minimis at this point.

Included in our guidance are a few key assumptions at the midpoint, same-property NOI growth of 2.5%, a full year bad debt assumption of 125 basis points and an additional 75 basis points of assumed disruption for Bed Bath & Beyond and Party City. As you may recall, Regal Cinemas rejected the only lease we had with them effective January 1, 2023. So no additional reserves are necessary and the 75 basis points of revenue disruption is solely attributable to Bed Bath & Beyond and Party City. On Page 4 of our fourth quarter investor presentation, we set forth a bridge to quantify the impact of year-over-year trends on our 2023 NAREIT FFO guidance. Our net debt to EBITDA stands at 5.2x, which is on the lower end of our long-term target. Additionally, our debt service coverage ratio now stands at over 5x.

Our balance sheet is one of the best in our sector and KRG has never been in a more opportunistic posture. Subsequent to quarter end, we retired 3 secured mortgages for approximately $129 million using our $1.1 billion revolving line of credit as a temporary solution until the fixed income market stabilizes and our credit spread more accurately reflects the strength of our balance sheet. In the meantime, we are actively pursuing alternative solutions to satisfy our remaining 2023 maturities. Thank you for joining the call today. Operator, this concludes our prepared remarks. Please open the line for questions.

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Q&A Session

Operator: Our first question comes from the line of Todd Thomas from KeyBanc. Your question please.

Todd Thomas: Yes, hi, thanks. Good afternoon. Hey, John, Heath, you both talked about the company’s low leverage being at 5.2x. Can you remind us of your long-term target leverage level and whether you are still looking to take that lower in the near-term or is now the right time to begin putting some of that dry powder to work either in the form of stock buybacks or acquisitions?

Heath Fear: Todd, this is Heath and thanks for your question. We communicated before that our target is low to mid-5s and I don’t think now is an appropriate time to change that target. We also said that on occasion, you may see it float above that based on transactional activity, and you may see it float below that. But again, I think our long-term target still is at the low to mid-5s and it’s 5.2%, we are actually towards the lower end of our target.

John Kite: Yes. And in terms of deploying capital, Todd, as we pointed out in the prepared remarks, we still have lease-up to do. We’re getting very high returns there. That’s really our focus in capital allocation right now. And who knows what happens down the road with a few of the tenants that we may or may not get back. So I think we’re going to remain really flexible. We’ve got dry powder. We’ve got free cash flow. The balance sheet is the best it’s been in the history of the business. So I think what we were trying to point out is business as usual right now, get this stuff leased, generate more free cash, grow internally. But to the extent that something really unique is out there, we’re in a position to take advantage of it. And so that’s just a great place to be.

Todd Thomas: Right. Okay. And I guess, are you starting to see more attractive acquisition opportunities begin to surface. I think, John, it sounded like the plan is to, at least in the near-term, look to match fund acquisitions with dispositions. I am curious, is there sort of a segment of the portfolio that has maybe steadier or lower growth characteristics that you are looking to offload or are you just aiming to upgrade the quality of the portfolio and maybe you expect to see those opportunities in 2023?

John Kite: Yes. I mean we are just getting started in the year, Todd. So it’s just beginning to evolve. But I think as things, we’re still in a little bit of a volatile world. Everybody waits with bated breath for every Fed meeting. And so until we get to this point when things are a little more stable, then I think you’ll see opportunities maybe come to the surface more. We do see some things out there that are interesting in terms of one-off transactions. And so we will €“ again, we will €“ that’s our job is to try to figure out where we can be unique and find things that aren’t heavily, heavily shopped. So we’ll continue to look for that, Todd. But I think it’s a little early right now, but things are starting to evolve. And you are seeing, I think people start to figure out how to transact. And we are just €“ we will wait for the right one or right ones, I should say, and see what happens.

Todd Thomas: Okay, great. And just one last one, Heath, on €“ in terms of the guidance, can you give us a sense €“ I think in the bridge, it looks like interest expense is just about $0.01 per share headwind relative to 2022. But can you give us a sense €“ I know you had settled some of the forward starting swaps, which I think you were expecting about a $3 million annual benefit. Can you just provide a little bit more color there? And I guess whether there is any additional balance sheet activity or financing activity that’s embedded in the guidance to get to that sort of $0.01 increase?