Postal Realty Trust, Inc. (PSTL) Q1 2020 Earnings Report, Transcript and Summary

Good afternoon. My name is David, and I will be your conference operator today. At this time, I would like to welcome everyone to the Postal Realty Trust First Quarter Conference Call. [Operator Instructions]. Thank you. Mr. Blaine Willenborg, Vice President of Business Development and Capital Markets, you may begin your conference.

Thank you. Good afternoon, everyone, and welcome to the Postal Realty Trust First Quarter Earnings Conference Call. On the call today, we have Andrew Spodek, Chief Executive Officer; Jeremy Garber, President; and Matt Brandwein, Chief Accounting Officer. Please note the use of forward-looking statements by the company on this conference call. Statements made on this call may include statements that are not historical facts and are considered forward-looking, including, among others, statements related to the COVID-19 pandemic and its effects on our business, the terms and timing of our pending acquisitions and the status of our ongoing negotiations with the Postal Service. These forward-looking statements are covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from those described in the forward-looking statements and will be affected by a variety of risk factors that are beyond the company's control, including, without limitation, those contained in the company's 10-K for the year dated December 31, 2019, and its other Securities and Exchange Commission filings. The company does not assume and specifically disclaims any obligation to update any forward-looking statements whether as a result of new information, future events or otherwise. Additionally, on this conference call, the company may refer to certain non-GAAP financial measures such as funds from operations and adjusted funds from operations. You can find a tabular reconciliation of these non-GAAP financial measures to the most currently comparable GAAP measures in the company's earnings release and filings with the Securities and Exchange Commission. Additional information may be found on the Investor Relations page on our website. With that, I will turn the call over to Andrew Spodek, Chief Executive Officer of Postal Realty Trust.

Good afternoon, and thank you for joining Postal Realty Trust's First Quarter 2020 Earnings Call. We hope you and your loved ones are safe and healthy as we continue to forge ahead through these unprecedented times. We would also like to give our sincere thanks to all the first responders and postal employees working each day across the country. We admire your bravery and are incredibly grateful. At Postal Realty, we continue to observe social distancing guidelines to support the health and welfare of our employees. Our business continues to operate efficiently as we safely work remotely. Throughout the recent months of the pandemic, the United States Postal Service remains an essential service to the American people. Their continued last-mile delivery of items such as stimulus checks, medical supplies and other essentials has given our communities the ability to stay home and focus on our health. While the public struggles with the uncertainty the pandemic has caused, the Postal Service's commitment has held absolute. Our business is focused around this federal agency, and we believe Postal Realty shareholders benefit from a revenue stream of continuous rental payments from an agency of the United States government. We believe this makes our company and its 100% occupied portfolio more stable in the face of the pandemic. I would now like to address some of the news coverage of the Postal Service in recent weeks. While we certainly appreciate the basis for the financial concerns, we must acknowledge that the Postal Service is a constitutional mandate and that it plays a critical role in the nation's infrastructure and supply chain which is essential to the delivery industry. It should be noted that the Postal Service is the only carrier that serves all Americans regardless of where they live. The result of its reach is a network of over 31,000 facilities reaching approximately 160 million delivery points throughout the country while handling 48% of the world's mail. It is also the leading delivery service for online purchases. This week marks our 1-year anniversary since becoming a public company. We fully believe in our business model and are excited by the progress we've made in such a short time. We're also energized by the next stages and the many opportunities that lie ahead. Our results reinforce the same energy. In the span of only a year, we have doubled the number of properties, the total square footage and the rental revenue in our portfolio. This success has allowed us to raise our dividend 3x since our IPO with the upcoming May payment growing to an AFFO covered $0.80 per share on an annualized basis. As we continue to make further acquisitions and grow our business, we look forward to reaching and covering our initial dividend goals. Although the current environment certainly presents some headwinds relative to the start of the year due to COVID-19, we believe our business' stable revenue stream is something that our shareholders can count on. While other landlords have had to take defensive measures during the first quarter of 2020, we completed acquisitions of 83 properties totaling approximately $30 million and have closed an additional 18 properties subsequent to quarter end for approximately $10 million. One of our primary motivations for going public was the confidence that we could consolidate the highly fragmented postal properties market. In a year since our IPO, we believe we have shown our capability to effectively execute on this plan, reaching our initial acquisition target of approximately $100 million by the end of our first year as a public company. Even in the midst of the current environment, our business and cash flow continues to grow. I will now provide an update on leases with the Postal Service. The Postal Service has adopted a revised lease form of our modified double net lease, which transfers the responsibility for additional maintenance expenses and obligations to the landlord. To date, we have not renewed or entered into these revised leases for any of our properties with leases that have expired. While the majority of the leases in our portfolio are comprised of a modified double net lease, not all of our leases are uniform with respect to the responsibility for specific expenses. As we have doubled in size, the variations of the leases we have inherited through acquisitions have increased. Given our 30-plus years of operating experience with the Postal Service and varying expense-related responsibilities, we believe that the consequence of entering into the new lease form, requiring us to take on incremental responsibilities, will not materially change our operations or our margin. Currently, 39 of our properties with expired leases are paying us on a month-to-month basis. 20 of these properties had leases that expired in 2019, and 19 have leases that expired in 2020. These 39 properties comprise approximately 148,000 interior square feet and generate $1.6 million in annualized rental revenue. The monthly rental rate on these 39 holdover properties are approximately 5.9% higher than the rental rate in effect at the time of the lease expiration. To date, the Postal Service has not vacated or notified us of its intention to vacate any of these 39 facilities. As we adopt the new lease form going forward, we anticipate our property operating expenses and initial leasing costs may increase. However, we also expect that the impact of these additional expenses would be generally neutralized by our ability to offset the additional expenses through our rental rates resulting in minimal change to our net income. We have agreed to preliminary terms of the Postal Service on a lease addendum where some of the incremental responsibilities that were to be transferred to us are mitigated. We have also agreed to preliminary terms on rental rates for 19 of the 20 leases that expired in 2019, and we remain in negotiation for the 2020 expirations. We have not entered into any definitive documentation with respect to the leases, and there could be no guarantee that any new lease that we enter into with the Postal Service will reflect our expectation on terms or timing. We are optimistic that the holdover leases will be resolved, and we are working diligently to that end. In summary, we have a 100% occupied portfolio of government agency-backed properties with no disruption in our rents. Year-to-date, we have closed over $40 million in acquisitions, and we have a growing pipeline of additional opportunities in place. Through our compensation structure, the management team is taking a portion of its cash compensation and stock. We believe we are fully aligned with our shareholders and our focus on creating long-term value. I will now turn over the call to Jeremy to discuss our first quarter results.

Thank you, Andrew. During the first quarter, we closed on 83 properties for approximately $30.5 million, totaling approximately 268,000 net leasable interior square feet with a weighted average rental rate of $10.83 per square foot. The highlight of these transactions was the acquisition of 2 portfolios. One was a 21-property portfolio for $13.6 million including the company's issuance of OP units for over half of the purchase price. The second was a 42-property portfolio that we acquired for $8.8 million. These acquisitions were completed at our target cap rate range between 7% and 9%. Subsequent to quarter end, we completed the acquisition of an additional 18 postal properties comprising 62,500 net leasable interior square feet for approximately $10 million. Moving on to our financial results. FFO for the quarter was $0.12 per share, which includes acquisition-related expenses of approximately $295,000 and approximately $200,000 of nonrecurring stock-based compensation. AFFO for the quarter was $0.21 per share. Moving on to the balance sheet. At March 31, 2020, we had $2.8 million of cash and $71.2 million of debt. During the quarter, we increased our available borrowing capacity to $150 million under our line of credit by exercising $50 million of the accordion feature. Please note all additional undrawn capacity is subject to certain financial restrictions in our credit facility, including restrictions on our borrowing base. We are currently working through an amendment to the facility to increase availability. The 39 properties that Andrew referred to earlier cannot yet be added to our borrowing capacity until a lease is executed. Furthermore, we currently have limited availability left on our line of credit to fund our pipeline. In the meantime, to support our growth plan, we have other options. This includes using property level mortgages on select properties, including a $9.3 million mortgage on 22 of the 39 holdover properties available for closing in the coming weeks. In addition, as we have experienced, sellers are attracted by our ability to use OP units as a form of currency. In fact, of the approximate $100 million of acquisitions completed since our IPO, 22% of the consideration has come from OP units. While we do not expect to rely on OP units as heavily in the future, we would be remiss if we did not point out this capability as a point of differentiation in our consolidation thesis. Looking forward, we believe our stable cash flow as well as our prudent dividend policy allows us to operate without disruption. As we look ahead with our 1-year anniversary of being a public company, we anticipate that we will have additional capital sources available to us to further support our growth. Subsequent to quarter end, the Board of Directors approved and we declared a quarterly dividend of $0.20 per share to shareholders of record on May 11, 2020, payable on May 29. This was our third dividend increase since our IPO, and it represents an 18% increase from our prior dividend. The increase also reflects our goal of scaling our dividend as we grow our platform and our intent to make sure that our dividend is fully covered by AFFO. We ended the quarter owning 1.7 million net leasable square feet with a weighted average rate of $9.66 per square foot. Inclusive of our post-quarter acquisitions, we currently own 1.8 million net leasable square feet with a weighted average rental rate of $9.83 per square foot. Our pipeline remains very active, and we remain focused on building on our past acquisition success. However, based on current market conditions, we expect our transaction activity to be weighted towards the second half of the year. A final note. Our team continues to work remotely and diligently on completing our Form 10-Q in order to get it filed by tomorrow. However, if that is not possible given the challenges presented by COVID-19, the SEC has granted public companies an extension for certain filing obligations for this quarter, and we will take advantage of this option. With that, I would like to open the call for questions.

[Operator Instructions]. Your first question comes from the line of Barry Oxford with D.A. Davidson.

Looking at the acquisitions, you said it was going to be sort of back-end weighted. Does that mean you're going to meet your acquisition target for 2020? And then also, if you could give us -- have there been -- or have you experienced any change in the pricing, i.e., the cap rates on the buildings -- on the post office buildings that you guys are currently looking at?

Thanks, Barry. I appreciate the question. This is Andrew. We have seen some pricing adjustments in cap rates. We are working towards the target that we previously provided to The Street, but it's important in the current environment that we are prudent and thoughtful about the approach of the acquisitions coming forward. The good news is that we have a very, very strong pipeline and a lot of interest in people selling. We just need to be thoughtful about how we'd lay it out.

So none of the sellers are kind of pulling back and saying, "I don't want to sell into this environment."

In this environment, I think that at least we're seeing different types of sellers, some that are more interested in having their consideration of selling and others that are taking pause just given everything that's going on around us. Luckily, even with both those different types of sellers, we're seeing a tremendous interest in selling, and our pipeline is just growing.

Your next question comes from the line of Ben Zucker with Aegis.

Congratulations on another strong quarter. Andrew, could you just quickly review some of the information you were going over in your prepared remarks about the changes in the USPS lease structure? And I guess what I'm most interested in is I couldn't understand whether you were saying this pickup in expenses should be offset by the fact that you get to reset your lease rates every 5 years as like a catch-up or if you were able to pick up additional rental increases above and beyond that typical step-up because of this change in the cost-sharing structure.

I appreciate the question. And so the additional -- the new lease document only takes effect on the properties that have expired. And the shift in responsibility that the new lease is going to provide for was all taken into account or is taken into account with both parties when they're negotiating their lease. And so what my prepared statement was referencing was that since both parties recognize the shift, it will be taken into account as part of the rental revenue, and we don't believe that there will be any adverse effect to the bottom line.

Got you. Okay. That's very helpful. I guess from the general view of things, it seems like you got -- the USPS continues to be a really strong tenant. I'm just kind of wondering, is there anything related to the COVID environment, notwithstanding just the extension of maybe the acquisition time line that you see as an actual like imminent threat or risk to your company or the properties that you own?

No, I don't. I believe that the Postal Service is a very strong, obviously, government-backed tenant. Our rental stream is secured by the U.S. government. And aside from slowing the pace of the acquisitions in the pipeline just given the current environment, we don't see any real change to the underlying business.

Well, I think you guys have done a prudent job in kind of managing the company along with the step-up in the dividend. And maybe some good news for the post office is, I guess, if it sounds like we're going to be moving towards mail and ballots for the next election, that's just yet another need for the post office down the road.

Agreed.

Your next question comes from the line of Rob Stevenson with Janney.

Andrew, what is the Board's thought on the dividend going forward here? I know that you guys just increased it to the $0.20 run rate. I mean given the fact that acquisitions may be slowed here for some period of time, what's the deliberations at the Board in terms of their thoughts these days?

Rob, it's Jeremy. I hope you're doing well. We came out of our last Board meeting in the midst of this environment. And we're uniquely positioned in that the stable cash flows allow us to support our business and to pay a dividend per the philosophy that we set out before we went public. We're looking at a covered dividend by AFFO. And so, so long as we can support that on a go-forward basis, we'll continue to pay out that ratio. I think looking forward, we had targets at the time of the IPO, and those targets were really driven by the pace of acquisition because our dividend growth is obviously driven by our acquisition pace. And I think the Board felt that we're in a position right now to continue to pay the dividend, that they're not ready to provide a view -- a forward-looking view. But our hope and our goal is to continue to grow the opportunity and, with that, the dividend growth as well.

Okay. And then what was the price that the 483,000 OP units were issued at the first quarter?

So as with all prior deals that were done through OP issuance, they were struck at our IPO price of $17.

Okay. And has there been any -- was there any OP units in the $10 million that you've done subsequent to quarter end or the 2.2 that you have under contract?

No.

Okay. And then just last one from me. I mean given the sort of capital environment and how low rates are, what are your thoughts about issuing preferred when that market reopens?

So listen, at this time, we're focused on preserving capital and being thoughtful and prudent. The markets are presenting opportunities for companies that are positioned differently. And we're -- we always think about where our opportunities are to enter the market, so we haven't really made a decision what market is best for us at this moment in time, but we continue to weigh our options. And at the end of the day, our focus is on shareholders. And as you know, management has a significant stake, so we wouldn't take any path that we didn't believe was in the best interest of shareholders.

[Operator Instructions]. Your next question comes from the line of Frank Lee with BMO.

Just want to touch on the acquisition environment. Have you seen any changes in what sellers are willing to take in terms of cash versus OP units? And in terms of acquisitions, were there any that were in contract or definitive agreements that sell out due to the pandemic?

I appreciate the question. So I'll answer the second question first. No, we have not had any contracts that sell out or changed as a result of the current environment with the exception of the change being the delay in time, right? And that's something that I think is important for us as a company and many companies out there. And I keep getting back to this is an unprecedented time. Everything that's going on is new to everybody. And so to kind of step back and let things play themselves out in a slower and more thoughtful manner seems like the right way to handle things. From a pricing standpoint and a cash versus OP unit standpoint, I think that when people go through something like what we're all going through, they reevaluate things. They reevaluate their properties, their states, their investments, and we're seeing the results of that in conversations. And so I can't give you a specific answer, but I can tell you that when these thoughts are happening in people's homes, they're resulting in the conversations with us. And hopefully, as time progresses, they will result in deals that -- both from the cash standpoint and the OP standpoint.

Okay. And then you mentioned that you're already seeing some pricing adjustments in terms of deals. The ones that were made post first quarter, were those already the new pricing reflected in those deals already?

So everything that we've been buying is in our stated cap rate range. The adjustment in pricing that we're seeing are deals that will happen further on in the year. And they're not reflected in the ones that we've closed already. Those are pretty fully baked.

Your next question comes from the line of Ed Groshans with Height Capital.

Congrats on this quarter. Jeremy, you talked about debt outstanding $71.8 million. You talked about using the accordion feature. Then there was a bit of a discussion on almost being at capacity on the line. Is that just a view of transactions that you're looking at in the future? Or does that have to do with the restrictions of not being able to use the line to fund the 39 properties until the leases are negotiated and finalized.

Ed, thanks for joining us and appreciate the question. To provide some context, the facility that we've put in place has covenants and restrictions that the holdover leases are just one component of the sort of restrictions on accessing the full availability. So it isn't just the holdovers. There are other sort of built-in covenants and restrictions around leverage and things like that. So it's not a function of deal flow in market. It is built into the facility.

Excellent. And then early on, so coming up on 1 year, and congrats on that, there's -- if we're looking at the IPO price of $17, there's a target yield, dividend yield of 6%. Do you feel like you're still on pace to get there? Is the pandemic going to slow that down? Does your current pipeline lead us to 6%?

So as we talked about the Board's approach to dividend policy, our dividend is driven by acquisition and pipeline. And we've talked about how in this environment we need to be prudent and thoughtful about the acquisition pace. And so at the moment, I can't provide any guidance in terms of where the yield moves in the next few quarters. Clearly, the Board with management are going to be focused on providing a dividend that is covered. And again, with that, it's driven by how the acquisition cycle rolls out over the remainder of the year.

Your final question comes from the line of Ben Zucker with Aegis.

I just had a quick question regarding company leverage. First part is just could you remind me of where that kind of long-term stated leverage range is? I think it was something around 50% like net debt to enterprise value. And then just my question was, was there any kind of change to that longer-term thinking in light of or in response to the current environment? I wouldn't expect anything just given the strength of your tenant right now but just wanted to ask about kind of your longer-term leverage goals real quickly.

Yes, Ben, no problem. Happy to take as many questions as you have. We've articulated a strategy that is conservative. It talks to our dividend policy. It talks to leverage and -- but what we've also said is, depending on the timing and environment and opportunity, the leverage could move. And what our targeted leverage is in terms of stabilizing levels, we've articulated around 40%, so not the 50% that you referenced.

There are no further questions at this time. I will turn the call back over to Mr. Spodek.

Thank you, and thank you, everybody, that dialed in to listen to our earnings. And thank you to all the research analysts that asked all those questions. I thank everybody for their time, and I hope everybody stays safe and healthy.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.