CubeSmart (CUBE) Q2 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to the CubeSmart Second Quarter 2013 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Daniel Ruble. Please go ahead.

Thank you, Jessica. Hello, everyone. Good morning from Wayne. Welcome to CubeSmart Second Quarter 2013 Earnings Call. Participants on today's call include Dean Jernigan, Chief Executive Officer; Chris Marr, President, Chief Operating Officer and Chief Investment Officer; and Tim Martin, Chief Financial Officer. Our prepared remarks will be followed by a Q&A session. In addition to our earnings release, which was issued yesterday evening, supplemental operating and financial data is available under the Investor Relations section of the company's website at www.cubesmart.com. The company's remarks will include certain forward-looking statements regarding earnings and strategy that involve risks, uncertainties and other factors that may cause the actual results to differ materially from these forward-looking statements. The risks and factors that could cause our actual results to differ materially from forward-looking statements are provided in documents the company furnishes to or files with the Securities and Exchange Commission, specifically the Form 8-K we filed this morning, together with our earnings release filed with the Form 8-K and the Risk Factors section of the company's annual report on Form 10-K. In addition, the company's remarks include reference to non-GAAP measures. A reconciliation between GAAP and non-GAAP measures can be found on the company's website at www.cubesmart.com. I will now turn the call over to Dean.

Okay. Thanks, Daniel. Good morning to everyone. Thanks for joining us today. I'd like to lead off by offering a heartfelt thanks to all my associates at CubeSmart for the outstanding hard work over the years to get us to this quarter. Obviously, we had a good quarter. We're very pleased with the quarter. And it did not come easily. A lot of years of hard work, and I'd like to thank all my associates. I'd like to take a minute and look forward, as usual for me, leave the company comments up to Chris and Tim. But you can't help but read and hear an awful lot today about fed tapering. We're all expecting it in, of course, in September. Some of it's priced into the market, but it's very discouraging for me to see in corporate America, good earnings reports by other corporate companies, other companies, and see the REIT sector trade down, with all of us being painted with the same brush. And I think that's patently unfair and I would like to challenge someone on this call to write a very thoughtful piece on the Self Storage sector to paint us with the different brush. Clearly, we're an operating company, in the real estate business. We're not just a real estate play, that operating company has 30-day leases. We're very nimble, can be very nimble as it relates to pricing. So the basic question to me is, would you rather be in an environment of low growth or no growth with low interest rates, or a growth environment of 3% to 4% in GDP with higher rates and hitting a targeted 2.5% inflation rate? And I would tell you, I'll take the latter every time. We would -- we will operate better as a company in the Self Storage space with 2.5% targeted inflation with higher interest rates, and I'll tell you why. In an environment like that, and we've had that situation for many years that I've been in the business, the Self Storage sector will get 4% to 5% revenue growth. And with the operating leverage that we have, that will relate to 5% to 7% NOI growth. And when you compare that against that 2.5% inflation, that is terrific for real growth. And that's what we get in a growing environment. We have customers who will be coming back to us in that environment, the small subcontractor, the plumber, the carpenter, and more importantly, we'll have our discretionary customer coming back to us. And that, as you've heard me say over the years, could be as much as 7% to 10% of our customer base. You add all that together and that's going to mean higher operating rents -- higher rents. Because of our expense ratios being as low as they are and our margins being as good as they are, with our operating leverage inflation, of course, works against those expenses, but only in a marginal way. So that's, of course, what's gives us that 5% to 7% NOI growth in a normal economy. If you take that year in and year out, which, historically, is what we've had, that will give us better results going forward. Now clearly it will impact -- higher rates will impact our NAV as cap rates move up, but on an external growth opportunity, it will create more sellers for us. Higher rates will give us more opportunities to buy more assets and to continue to consolidate the sector. So I, again, strongly appeal to somebody to spend some time on the Self Storage sector and really look at what tapering, and eventually, higher rates, will do to the sector, and I am certain of the answer, and that is, we're an operating company and we will fare exceptionally well. And yes, cap rates will go up, we'll be buying properties at higher cap rates and those margins will drop through to the bottom line for our shareholders. That's how I look at the future for you. Clearly, it's coming. We know we're going to have higher rates. And rather than just sitting around and waiting for those to get here and take what comes our way, I think it's incumbent upon our sector to try to come up with a different paintbrush and show the investing public that Self Storage operates exceptionally well in a growing economy. With that, I'll turn it over to Tim.

Thanks, Dean, and thanks everyone on the call for your continued interest and support. We are delighted to report our second quarter earnings. In the second quarter, we continued to execute on our business objectives of generating healthy organic or internal growth, prudently growing and improving our property portfolio, and maintaining our healthy balance sheet and the financial flexibility that it provides. Financial performance for the quarter exceeded our expectations as we reported FFO per share of $0.23, a 28% increase over last year. On the internal growth front, our operational platform has been firing on all cylinders, same-store property portfolio generated historically strong 13.1% NOI gains, fueled by a 9% increase in same-store revenue. Revenue growth continues to be driven by occupancy gains and we're seeing positive trends in asking rates, as well as continued benefits from reduced discounting. Portfolio occupancy reached another all-time high of 90% at quarter-end, supported by continued operational execution as our marketing, pricing and customer service initiatives continue to produce strong results. Same-store operating expenses grew 1.5% in the second quarter and 3.5% year-to-date. Pressure on real estate taxes remains for the second half of the year as reflected in our guidance. We had an active quarter from an investment perspective. During the quarter, we acquired 9 assets for $87.5 million. We had no disposition activity during the quarter. Subsequent to quarter end though, we acquired an additional asset in New York City for $13 million and we exited the Knoxville, Tennessee market for disposition proceeds of $25 million. Year-to-date, we're at the high end of the investment targets that we set forth entering the year and notably, 8 of our 11 acquired assets year-to-date have come through our third-party management platform. We continue to fund our external growth with a focus on maintaining our credit metrics that are consistent with our current investment-grade credit rating objectives, as well as a focus on an attractive blended long-term cost of capital. We continue to fund the equity component of our growth through free cash flow, disposition proceeds and our at-the-market equity program. We did enter into a new ATM program in May with a group of sales agents. The new program replaces our old program and its entirety and allows for the issuance of up to 12 million shares. During the quarter, we raised $19 million under the program selling 1.1 million shares at an average price of $17.19 per share. On the debt side in June, we amended our existing credit facility in term loan agreements that cover $800 million in unsecured bank financing. And through this process, we markedly improved pricing and elongated and maintained our well-staggered maturity profile. Overall, our balance sheet remains incredibly well-positioned with a well-staggered maturity profile that averages 5.4 years to maturity, a diverse mix of both current and available capital sources and a secured debt-to-gross asset ratio of just 8%. Our core portfolio performance not only led to a Q2 B but also gives us good visibility to a second half that is stronger than our previous expectations as reflected in our upward revisions to guidance. We raised our full year FFO per share guidance 5% at the midpoint, to a revised range of $0.86 to $0.90, and we also introduced a guidance range for third quarter FFO of $0.23 to $0.24. Our press release last evening detailed all of our FFO expectations and the underlying assumptions. Before I turn the call over to Chris, I want to thank -- I want to also thank our dedicated team for all of their exceptional efforts and the exceptional performance that has resulted. And thanks again, to all of you for joining us for today's call. Chris?

Thanks, Tim. To recap, our team focused on executing against our strategy of creating a high-quality portfolio, leading-edge systems and an experienced and customer service focused team at CubeSmart, was evident in our second quarter results. We experienced strength in physical occupancy revenue and net operating income growth across all of our markets. We remain confident in our disciplined approach to investing and we'll continue to close on transactions that enhance the value and the quality of our portfolio. We opportunistically improved the strength of our balance sheet, leveraging our investment-grade rating and our excellent relationships with our capital partners. In summary, our brand change, investment in systems and people, our investment in upgrading our stores through our Superstore program and other capital improvements, our acquisition and disposition in third-party management programs, along with our focus on providing an outstanding customer service experience, have all contributed to our strong second quarter results and our increased guidance. At this time, operator, we would like to open the call up for questions.

[Operator Instructions] Our first question comes from Todd Thomas from KeyBanc Capital Markets.

Jordan Sadler is here with me as well. First question, Dean, your comments on the macro outlook, I was just curious, maybe for you or for Chris to comment also. I was just curious if that means that you've been changing your underwriting standards at all over the last few weeks as you look at new product, maybe adjusting exit cap rates higher or requiring higher going-in yields?

Todd, it's Chris. No, we haven't had a knee-jerk reaction to some of the changes in interest rates in our underwriting. I think it all only thing that has probably changed this year relative to our appetite is given the confidence we have in the platform and our ability to really drive occupancies and revenue. We have looked at more transactions on the acquisition side for assets that are in their lease-up periods, so we have been acquiring this year assets that are unstabilized, at lower levels of physical occupancy, newer product, with a confidence that we can drive those occupancies up and the revenue up fairly quickly.

And how does the pipeline look today? Are you seeing more product come to market? Or how would you kind of compare what you're seeing now versus maybe a few months ago?

It's similar, I think, to what we saw a few months ago. We're obviously very focused on opportunities that enhance the quality of our cash flows, that continue to be focused in our core markets, and that translates itself into a continued mining of our third-party management program. We've acquired 8 stores out of that program thus far this year and single-asset transactions where we can leverage relationships to get up a transaction that we think makes sense for our strategic objectives.

Okay, and then just a question on operations. I was curious if you can quantify what concessions and free rent were in the quarter and how that trended year-over-year?

As we look at discount activity or promotions, it was down across the Board, obviously, as our higher occupancies created lower discounts offered to new renters. So looking at it as a metric of discount dollars per new rental, they were down 15.1% in the second quarter of '13 compared to the second quarter of 2012. If you look at it on just new renters receiving promotions, that declined from about 82.5% of new renters receiving a promotion in 2012 2Q, down to 71.9% for 2Q 2013.

Okay. Is there -- I know occupancy ranges throughout the portfolio. But is there a level of occupancy where at a facility, where you say, "Okay, we're not offering any more free rent at this site at all, we're fully occupied."?

It's not at the store level, but at the cube size level within a store. And yes, certainly throughout this year quite frankly, we've had a reduction to 0 on free rent or any sort of promotion on certain cube sizes. So to give you an example, there are probably every store I think at this point that we own in New York City given the fact that collectively, those stores are up around 91% physical occupancy, the free rent opportunity there is largely limited to the locker-sized cubes.

Our next question comes from the Gaurav Mehta of Cantor Fitzgerald. Gaurav Mehta - Cantor Fitzgerald & Co., Research Division: A couple of questions on the operations. So your core growth has definitely benefited from large gains in occupancy and reduction in promotions, how do you think about pricing dynamic in your portfolio? Meaning that render occupancies hit such a level when you can get the real pricing power.

Thanks for the question. As we look at -- if you look at the metrics with our rent that we're asking for that new customer coming into the portfolio on a same-store basis, $13.27. So that's up from this time, June 30 of '12 of $12.89. So we've pushed street rates, and street rates now are up all about 3% from where they were at this time last year across the same-store portfolio. So as you look at the second half of this year, I think our guidance, on a same-store revenue basis, reflects the -- our best estimate of the range required for us to protect as much of that physical occupancy as possible. So at the one extreme, you hold street rate through the fall, you're able to protect that occupancy, and also you're able to continue to have the limited number of cubes available for discounting. Obviously, your levers on the other end are some combination of discounting and rental rates in order to protect that occupancy. But at this point, we're about 3% up and we've had some success, again, across the portfolio, more in some markets, less in others, but pretty consistent across the portfolio and pushing our asking rents to new customers. Gaurav Mehta - Cantor Fitzgerald & Co., Research Division: Great. Second question I have is on your other property income, it's running at 20% plus growth rate, can you talk about the composition of what's driving that and sustainability of that kind of growth trend?

Yes, the other property income is a combination of our tenant insurance net revenues, our merchandise sales and then other fees that are charged to our customers. We look at the tenant insurance business, it's a cash business. It's a monthly payment. So we look at that, really, no different than we look at our rental rates. So again, if you're $100 a month for a 10x10 in a market so it's $12 insurance, that $112 is paid monthly, it's cash, and we sort of look at the combination of rental rate and insurance as the cost of offering our product or the cost of the consumer of our product on a bundled basis. That growth has been driven by our ability to continue to get 93-plus-percent of new customers to sign up for insurance, which has also grown the overall penetration rate. So we continue to benefit from that. But as we've ramped that up over the last few years, the pace of that growth will start to modify and slowdown as we get into the future. So it's a good contribution. I think it is one that just mathematically will, going forward, continue to provide a little bit less contribution to the overall revenue growth each quarter.

Our next question comes from Christy McElroy of UBS.

My question is regarding the table on Page 16 of the supplemental where you break out same-store versus non-same -- same-store versus other. I just want to make sure I understand right. The other category is effectively the property management business, right? So tenant insurance revenues, management fees and property operating expenses associated with third-party managed properties?

That is correct.

Okay. So when you think about that business, the revenues are pretty straightforward. And on the expense side, the argument's always been that the growth in this business improves your overall margins because it allows you to spread out your resources to a greater number of properties. How do you think about how much of your operating expenses to allocate to property management? I know that you manage 133 properties and you own 386, but you're allocating 11% to 12% of your operating expense, your total operating expenses and the business is only driving 2% to 2.5% of top line revenue. So how do you think about allocating those expenses to that business?

Christy, it's Tim. We actually don't think all that hard about allocating specifically costs that aren't direct to those properties. So costs that are direct to third party management properties are passed through directly to the third party owner. What is also included under that other eliminations section there or columns are the cost of all of our non-property specific property overhead. So our district managers, our sales center, things of that nature. So we, in fact, don't try to allocate those costs and try to figure out how much time a district manager might spend on an owned property versus a third-party management property. All of those non-property specific property costs are included in that column.

Okay. So if I think about -- so obviously, we can't get to the profitability for the property management business. But if I think about the way that you see it, the profitability of that business, I mean, are you effectively breakeven today when you think about the cost of that business versus the revenues that you're driving and the higher margins that you're generating in your overall portfolio?

We're certainly better than breakeven. As we think about evaluating a new third-party opportunity, we would generally look at the costs associated with that to be, effectively, the average cost that we have in place today. And the reason we look at it that way is because, for instance, if we add 1 third-party managed property in an area of the country where we already have an infrastructure, a district manager, effectively, the cost to us to add that additional property to our platform are negligible to 0, because we won't hire an additional district manager, we won't hire any additional back office payables, accounting, HR for one additional property. So the effective margin to us in that hypothetical example, it all falls to the bottom line. When we look at it though, we realize that over time as we add, not 1 but 10, or 50 or 100 stores to the platform, that over time, you are going to have on incremental need for some additional staffing, whether it's at the field district manager level or back office support. So we look at it that way in underwriting the opportunity, but clearly, the third-party management business for us is better than breakeven. We're certainly making a nice margin.

Okay. The $13.27 rent that you quoted and you have in your supplemental, is that the actual -- because in the footnote it says asking rents. But is that actual contractual rent at which customers are moving into the portfolio? Or is that the average rent that you're asking?

That is the rent that we're asking. So that would be your rack rate. If you were to walk in to a store and be offered a full price rental, so again, no promotion, no other form of special, that would be effectively your rental rate, and then from that rate, you have all the variables around free rent and/or any other special or promotion that's being run.

Okay. And the $13.27, assuming that's the longer-term contractual rent, how does that compare to the contractual rent at which customers were moving out of your portfolio in the second quarter?

Yes. Today, that's about 1.5% higher than what the people are leaving with.

Okay. So that’s about 1.5% negative churn?

Other way. It's now...

A positive churn. Okay.

Positive churn. Yes.

Okay. And then just last question. This is the first quarter in about a year that you've raised average asking rents versus the prior year, can you disclose what that impact was on the year-over-year change in move-ins?

Well, that's not a direct correlation because the year-over-year change in move-ins is also a correlation to the amount of inventory we had to rent. So having fewer cubes available is an impact. If you look at just macro all of that and where we were from a rental and vacate percentage, our rentals in the second quarter relative to the second quarter of '12 were up about 4%.

And your vacates?

Vacates on a percentage basis were up about 5.5%.

Our next question comes from Brandon Cheatham, SunTrust Robinson Humphrey.

I just have a couple of quick questions here. Can you break out the cap rate on the acquisitions and dispositions you've done year-to-date?

Yes, if you think about it from a disposition perspective, if you have the Indianapolis, Houston and Knoxville, the average across all of that was mid-7%. And on the acquisition side, if you look at stabilized deals, so where we're buying an in-place stable cash flow, those for us, have been in a range, depending upon the asset, between a little bit north of 6% and 7%. The overall is obviously impacted by the fact that we had a good number of deals that we acquired thus far this year that we're not yet at a stabilization. So we really don't look at those pure cap rate going in basis. We look at those as our ability to drive a return over time.

Right. And that's because they weren't still going through the lease-up phase?

That's right.

Okay. But what was the occupancy on those?

On the non-stabilized, it hovered around, I guess, the range is between 30% and about 55% physical.

Okay. And expectations for the rest of the year on acquisitions and dispositions?

Yes. On the acquisition side, we continue to find opportunities, again, that enhance the quality of our portfolio, and we had a range of $75 million to $125 million and we haven't deviated from that. We'll see how the pipeline continues to build here for the balance of the year. On the disposition side, I think the strong demand for our product and the ability for some nontraditional buyers to get aggressive in the space, had us taking a look at some of the pace of our disposition activity. And I think if we can find some deals that make some sense for us, we may push up above the $40 million that we had previously articulated as a range, but that's an in-process discussion. But again, I think the market seems to be pretty favorable, and if we can perhaps accelerate some of our plans on the disposition side, we may choose to do so.

So even with the rising rates, buyers are still pretty aggressive on that front?

Yes. It's obviously a very strong cash flow performing product at this point, which has attracted some nontraditional buyers into the space.

Our next question comes from R.J. Milligan of Raymond James. R.J. Milligan - Raymond James & Associates, Inc., Research Division: Just curious, so with occupancy at 90%, discounts down, street rates move in a little bit higher, pretty typical increases to existing customers, I'm curious, over the next year, where you guys think you have the biggest opportunity for growth.

Yes, I think it's a balanced growth through next year from occupancy. We still have some opportunity relative to the peak. We peaked at the end of July at 90.8 on the same-store pool and I think we've got upside from there at the peak into 2014 and obviously, the average occupancy year-over-year will continue to produce some solid growth in the same-store pool. I think on the discounts side, operating at these levels, we've seen the ability to squeeze the amount of promotions being offered. I think that is a significant contributor to future growth. And then on the rental rate side to new customers, again, I think all of us have talked about pushing there. I think the ability to hold that through the fall and into the spring of next year is going to be the wildcard. R.J. Milligan - Raymond James & Associates, Inc., Research Division: Okay. And has Public Storage's 95% occupancy changed your expectations as to where you think peak occupancy can get within your portfolio?

Well, I think it certainly has demonstrated that to run a large portfolio can be done at those levels. I think, again, for our existing same-store portfolio, we've talked about a peak at 93, and I think that's probably realistically the right spot for us just given the levers of revenue management between rate discounting and occupancy.

Our next question comes from Paul Adornato, BMO Capital Markets.

Happy to see that third-party management business is still providing a good source of acquisitions. I was wondering if you could tell us, is it competitive that the third-party management business, that is, do your property owners shop around for the best deal?

Paul, it's Chris. I think, again, I think that is an answer of its unique to the individual owner or owners. Certainly, we have other, not just the public companies, but there is a property management industry out there has been for a while that also provides a service and is at the margin competition. So I think it goes back to relationships. It's a relationship sale, folks want to be comfortable with the entity and the people who are running their property. So I think it is a competitive business but I think the performance of the larger providers of that service far out shines, and I think then it kind of comes down to a relationship business from there.

And so, are your salespeople making the initial contacts with the property owners? Or is it the other way around?

It goes both directions. We have outbound folks who are in front of owners, letting them know the value that we can add to their portfolio. We certainly have existing owners who are our absolute best salespeople because we're doing such a great job for them that they tell others in the industry about how pleased they are with CubeSmart's management and we see opportunities that are a result of those referrals. And then we do get consistent inbound where folks are coming directly to us and want to talk about how we can help them with their store or stores.

Okay. And switching to the investment side. You talked about moving up the risk spectrum a little bit by investing in lease sub-properties. I was wondering what your appetite is and what you're thinking about in terms of new development, either through a JV partnership or otherwise?

Yes, we continue to look at opportunities with partners. We've talked about this on the last few calls. There are a small number of markets where, if we can develop a relationship with teams on the ground, we would be interested in taking some risk and creating the opportunity from new store development. Again, I think if you look at that relative to the size of the company and to our portfolio, it will be -- it certainly will not be a significant percentage of our growth relative to our acquisition efforts, but we would look at perhaps somewhere plus or minus around $50 million on an annual basis going forward, of investment in assets that are un-stabilized.

[Operator Instructions] Our next question comes from Jana Galan of Bank of America Merrill Lynch.

I just wanted to follow up a little bit on the guidance, and maybe Tim, if you can help us with how much of the guidance raise is from the better operations versus potentially being offset or helped by how acquisitions and dispositions are playing out this year.

Sure. Happy to. I kind of think about it if you go back to the prior midpoint of $0.835 and go to the new midpoint of $0.88, and so you're looking at $0.045 of FFO improvement in the guidance. Attribution of that is a little bit more than half of that is directly from the improved expectations on same-store NOI. So call it a little bit more than half of the $0.045 coming from the same stores, and then the balance of the improved guidance is split pretty equally between performance on non-same store properties as we entered our non-same store properties as we entered the year, are performing very, very well. Another part of the third that represents the balance of the increase is on reduced financing cost through our amended credit facility terms and then the final part that makes up the balance is coming from the impact of net acquisitions and dispositions. They're not as impactful as I think some have perhaps alluded to. I think on a net basis, we've grown, to date, net $86 million or so. And our intention on funding that is, as I've talked about in my prepared remarks, we continue to focus on maintaining or improving our existing credit metrics. So we think about funding that net growth through a combination of free cash flow, match funding the equity portion through the ATM and then the balance on the margin with a bit of incremental debt. So that's a rough attribution of the growth, if that's helpful.

Yes, it's very helpful. And just following up on the ATM, are you expecting higher share count at year end in your budget?

Again, we evaluate utilizing the ATM on an as-needed basis, thinking about where we have grown to-date, where we expect to grow, what the opportunities look like in the pipeline, combine that with the strength of the share price relative to a number of metrics. So it's part and parcel matched up with our expectations on the external growth side, which as Chris touched upon, we don't have great visibility at this point.

Our next question comes from Tom Lesnick of Robert W. Baird. Thomas J. Lesnick - Robert W. Baird & Co. Incorporated, Research Division: Standing in for Paul, this morning. Chris, just following up on the rate questions from earlier, given the change in the revenue management strategy implemented about a year ago, we had expected the rate comps to continue to roll down on a year-over-year basis be roughly flat sequentially, but actually, the opposite happened in 2Q. So I guess looking ahead with the rate cuts last year having cycled through and given the trends you're seeing, how should we be thinking about rate trends overall for the rest of the year?

I think if you take that term rate and then break it down into its components, you have the asking rents for a new customer coming into the store. As I said, those were up about 3%. And again, we're going to protect that occupancy through the fall and the hope is that we can continue to have those rents to the new customer coming in, stay at or above levels that we experienced in Q2. From the cycling out of the customers who had rented from us at lower rates in the past, I think as we get into the third and fourth quarter here, the rate in place for the occupied square feet should start to turn positive as we get into the latter part of the year, as we have those customers who moved in last year at lower rates moving out and as we also continue to pass along rate increases to the existing customers. So I think the trend that you're seeing within the rolling quarter information we provide in the supplemental, where you see the realized annual rent, the scheduled rent continue to move up and the in-place rent do the same thing, and then that narrowing gap between in-place rents and realized rents will continue to occur and converge. So I think everything is moving -- obviously, has moved through this quarter at or better than our expectation and I think we continue to see that through the year.

This concludes our question-and-answer session. I would like to turn the conference back to Mr. Dean Jernigan for any closing remarks.

Okay. Not much. Thanks for joining us today. We look forward to seeing you next time. Good day.

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