Phillips Edison & Co Inc

NASDAQ:PECO

Earnings Call Transcript 2018-Q3

[Operator]

Good afternoon, and welcome to Phillips Edison & Company's Third Quarter 2018 Earnings Call. My name is Brandon, and I will be your conference operator today. Before we begin today's call, I would like to remind our listeners that this live conference call is being recorded and being simultaneously broadcast via webcast. The webcast and a copy of the slide presentation can both be accessed on the Investors section of the Phillips Edison website at www.phillipsedison.com. A webcast replay of today's call will be available on the Investors section of the Phillips Edison website at www.phillipsedison.com. I would now like to turn the conference over to Mark Addy of Phillips Edison & Company. Please proceed.

[Robert Addy, executive]

Thank you. Good afternoon, everyone, and thank you for joining us. I'm Mark Addy, Executive Vice President of Phillips Edison & Company. Joining me on today's call is: our Chairman and Chief Executive Officer, Jeff Edison; and our Chief Financial Officer, Devin Murphy.

During today's presentation, I'll give an overview of our portfolio of grocery-anchored shopping centers. Then Jeff Edison will review our proposed merger with Phillips Edison Grocery Center REIT II and provide some details on the joint venture we recently entered into with Northwestern Mutual. Following Jeff's comments, Devin Murphy will go through our financial results for the periods ending September 30, 2018. And lastly, I'll provide an update on our share repurchase program or what we refer to as the SRP. Upon conclusion of our prepared remarks, we'll address your questions. For those of you logged into the webcast, you're able to submit a question by typing it in the webcast text box and then clicking Submit Question. We encourage you to submit your questions as soon as possible.

Before we begin, I'd like to remind our audience that statements made during our prepared remarks and the question-and-answer session may contain forward-looking statements which are subject to various risks and uncertainties. Please refer to Slide 3 for additional disclosure and direction on where you can find information regarding potential risks.

In addition, we will also refer to certain non-GAAP financial measures. Information regarding our use of these measures and the reconciliation of these measures to our GAAP results are available in the earnings release, which was issued November 5, 2018, as well as in the slide presentation for this webinar, which is available on our website for your download.

Now turning to our portfolio on Slide 4. As of September 30, 2018, the company's portfolio consisted of 233 properties, anchored by 34 leading grocers, representing multiple banners located in 32 states and totaling 25.9 million square feet. This compares to 159 properties on September 30, 2017, which was prior to the October 2017 acquisition of Phillips Edison Limited partnership, which we refer to as PELP, when we were located in 28 states with 25 [ banners ] totaling 17.4 million square feet.

As of September 30, 2018, our leased portfolio occupancy was 93.9%, and 76.9% of our rent came from grocers and national regional tenants. Our overall annualized base rent, or ABR, was $11.63 per square foot, and our in-line tenant ABR was $18.21 per square foot.

Slide 5 shows a breakdown of our ABR by tenant type and tenant industry as well as our top 5 groceries by ABR. As we look at tenant type, 36% of our total ABR came from our grocery anchors, and 41% was generated by other national and regional tenants. We focus on these classifications because it gives a sense of the credit quality and stability of our portfolio. Looking at our tenants' industries, 75% of our ABR came from grocery, services and restaurants, which we believe offer products as well as services that have proven to be more Internet-resistant and recession-resilient than general merchandise and thus, drive shoppers to our center on a regular basis.

Now turning to our top 5 groceries by ABR. We continue to have a diverse mix of leading grocers in our portfolio. Our largest tenants, Kroger and Publix Super Markets contributed 9.1% and 6.1% of our ABR, respectively. These operators continue to maintain their status among the country's leading and most innovative grocers by adapting to new trends and changes in the grocery industry.

From organic to meal kits to prepared foods to pick-up and delivery services, these grocers are among the best at knowing their customers and evolving as their customers' needs change.

Now I'd like to turn the call over to our Chief Executive Officer, Jeff Edison, who will be going over the highlights for the quarter and provide some details on our announced merger with Phillips Edison Grocery II and [ Phillips Edison Grocery Center ] with Northwestern Mutual. Jeff?

[Jeffrey Edison, executive]

Thanks, Mark. Good afternoon, everyone. If you turn to Slide 6. The third quarter of 2018 was the third full quarter since the acquisition of 76 shopping centers in the investment management business from PELP in October of 2017. Our operating results for the quarter continue to illustrate the meaningful accretion from the PELP transaction as well as robust -- the robust shopping center revenue growth at the property level, which highlights the continued strength of the current operating environment for leading grocery-anchored shopping centers. At that point, our pro forma same-center NOI increased 6.1% to $62.4 million, driven by our best-in-class fully integrated operating platform.

FFO per diluted share increased 54.5% to $0.17, which represents -- which represented 99% of the total distributions made during the quarter. And our MFFO per share -- per diluted share increased 13.3% to $0.17, which was -- fully covered our distributions by 102%.

Further, we recognized comparable leasing spreads of 13.5% for new leases, which is calculated as the increase in rent for spaces which were occupied within the past 12 months. These strong operating results continue the momentum we saw last quarter and reflect sustained, healthy tenant demand for well-located, grocery-anchored shopping centers.

During this quarter, we announced another important step in our strategic plan when we entered into an agreement to merge with Phillips Edison Grocery Center REIT II. And lastly, we announced the new partnership with Northwestern Mutual through 2 seeded joint ventures totaling $415 million in contributed asset value. I'll provide more details on this in a moment.

But first, turning to Slide 7. Our merger with REIT II is both strategic and transformative, and it provides a number of meaningful benefits for the combined company: first, the merger improves our portfolio demographics and diversity while maintaining our exclusive grocery focus; second, it increases the size, scale and market prominence of the combined portfolio, which better positions the combined company for liquidity; third, it simplifies our business model and improves the quality of our earnings; and fourth, it maintains a healthy leverage ratio and strong balance sheet, which positions us for future growth.

Upon the close of the proposed merger, REIT II shareholders will own approximately 29% of the combined company, and PECO stockholders will own approximately 71% of the combined company. Management will continue to be the combined company's largest stockholders, owning a combined 7.3% or $262 million worth of equity. This meaningful investment by management highly aligns management with stockholders' interests. These important benefits are all positive steps towards the full-cycle liquidity event for both PECO and REIT II stockholders. This remains a top priority of our board and our management team.

Slide 8, I'll outline the time line for the merger. We entered into the merger agreement on July 17, 2018 and subsequently issued a press release and held a conference call discussing the benefits of the merger for both PECO and REIT II stockholders. Shortly thereafter, on August 28, 2018, we filed a joint proxy statement with the SEC. And since then, we have been soliciting our stockholders' votes on the merger. On November 14, 2018, we expect the annual PECO and REIT II stockholder meetings to take place. And we anticipate closing the merger transaction later this month.

We'd like to remind our stockholders that your vote is very important. And we hope that you will see the many benefits of this merger and vote in favor of it if you have not already cast your vote. For additional information on the proposed merger, please review the announced -- announcement materials filed with the SEC on July 18 and 19 and the joint proxy statement that we filed with the SEC August 28 of this year.

Now turning to Slide 9. We just entered into a new real estate joint venture agreement with Northwestern Mutual, one of the largest and most experienced commercial real estate investors in the country. Northwestern Mutual will acquire an 85% interest in 17 of our grocery-anchored shopping centers valued at $368 million. We'll maintain a 15% ownership in the portfolio, and we'll continue to provide asset management and property management services. We anticipate generating around approximately $4 million of fee income from the venture on an annual basis. We plan to use the proceeds received from this transaction to delever our balance sheet, fund redevelopment projects and capitalize on high-growth opportunities.

Additionally, Phillips Edison Grocery Center REIT, which is one of our sponsored and managed REITs, entered into a similar joint venture where Northwestern Mutual will invest in 3 grocery-anchored shopping centers currently owned by PECO III. Under this agreement, Northwestern Mutual will acquire a 90% interest in the properties, which have now an aggregate value of $46.5 million. PECO III will maintain a 10% ownership in the portfolio. PECO will continue to provide asset management and property management services to this PECO III joint venture, and we anticipate generating approximately $700,000 of fee income from this venture on an annual basis. The Northwestern Mutual joint ventures are another very positive step in the continued growth of our third-party investment management business. And we are excited to have Northwestern Mutual as a business partner.

These seeded joint ventures, which have a long investment objective of generating predictable cash flow, join the Necessity Retail Partners' joint venture, which was formed in 2016 between Phillips Edison Grocery Center REIT II and TPG Real Estate. It is current -- still currently managed by PECO. Under this joint venture, PECO provides asset and property management services for the JV's 14 properties. The TPG joint venture is focused on value-added investment opportunities. This venture is expected to generate approximately $2.4 million of fee income on an annual basis.

Altogether, these joint ventures are examples of growth potential of PECO's third-party investment management business, as they provide opportunities for growth and scale on a leverage-neutral basis. Partnerships with first-class institutional investors like Northwestern Mutual and TPG Real Estate are a meaningful positive affirmation of the PECO brand and the quality of our asset management team and our asset management skills.

With that, I'd now like to turn the call over to our Chief Financial Officer, Devin Murphy, who will go over our results for the quarter and the 9 months ended September 30, 2018. Devin?

[Devin Murphy, executive]

Thank you, Jeff. Good afternoon, everyone. Turn to Slide 10. This slide reviews our third quarter 2018 same-center NOI results. Same-center NOI compares the performance of properties that were owned and operational since January of 2017. In light of the acquisition of PELP on October 4, 2017, we present pro forma same-center NOI, which includes both PELP and PECO same-center properties. This gives perspective on the organic growth in the majority of our portfolio. As such, our pro forma same-center NOI includes 221 properties that were owned since January of 2017. These 221 properties represent 95% of our owned assets.

During the third quarter of 2018, same-center NOI increased 6.1% when compared to the third quarter of 2017. This increase was driven by a 2.5% increase in total revenues, coupled with a 5.5% decrease in total expenses. The third quarter's revenue increase was the result of an increase in recovery income, a $0.24 or 2.1% increase in minimum rent per foot and a $1.4 million decrease in operating expenses, primarily driven by synergies from the PELP transaction as compared to the third quarter of 2017. These expense synergies noted relate to the reduction in property management costs. We now manage our assets for ourselves and are able to do it for less than the fees we previously paid to our external adviser. We also have synergies in our leasing and construction costs.

Lastly, we continue to be vigilant in controlling expenses and are having success in moderating real estate taxes, insurance costs and other common area maintenance expenses. The reconciliation of net loss to same-center NOI is available in the appendix.

If you'll turn to Slide 11, this slide reviews our year-to-date 2018 same-center NOI. During the first 9 months of 2018, same-center NOI increased by 5.1% when compared to the first 9 months of 2017. This improvement was driven by a 1.9% increase in total revenues, coupled with a 5.2% decrease in total expenses. The improvement in total revenue was driven by the previously mentioned increase in recovery income and an increase in minimum rent per square foot coupled with a $4.1 million decrease in operating expenses, primarily driven by cost synergies achieved through the PELP transaction that we discussed earlier. We are now able to manage our properties and service our tenants at a lower cost as a result of having acquired PELP last year.

If you'll turn to Slide 12, this slide outlines our financial results for the 3-month period ended 9/30/2018. The company recorded a net loss of $16.3 million, which compares to a net loss of $8.4 million for the same period in 2017. This result was primarily driven by a $17 million increase in depreciation and amortization from owning an additional 74 properties when compared to the 9/30/17 period as well as the $16.8 million asset impairment charge taken during the quarter. We recognized impairment charges associated with certain disclosed properties, anticipated property dispositions or where potential impairment indicators exist.

We continue -- we continually evaluate opportunities to recycle capital through the disposition of assets that we do not believe meet our growth objectives. Through the sale of 5 noncore assets this year-to-date, we have been able to recycle capital into more accretive properties. Often, this activity can result in gains and losses or impairments on the sale of real estate. As we go through transformational change, we expect this to continue. This quarter, we had a net loss of $16.3 million, which was primarily driven by $16.8 million of impairment charges on certain real estate assets. We do expect to continue our recycling program, which we believe will create long-term benefits for our portfolio.

For the quarter ended September 30, 2018, the company generated FFO of $38 million, which was a $17.7 million increase from $20.3 million during the same period in 2017. On a per share basis, FFO totaled $0.17 per diluted share, which was a 54.5% increase from $0.11 per diluted share during the third quarter of 2017. This increase in FFO is attributed to income from the PELP transaction, including NOI from its properties and investment management business, decreases in nonrecurring expenses and same-center NOI growth from [ our core ] properties. This quarter, the company paid gross distributions of $38.4 million, including $7.8 million reinvested through the dividend reinvestment plan for net cash distributions of $30.6 million.

Our FFO totaled 99% of our gross quarterly distributions.

For the 3 months ended 9/30/18, the company generated MFFO of $39.4 million, which was a 40.4% increase from MFFO of $28.1 million for the same period in 2017. MFFO fully covered our distributions for the quarter, totaling 102.7% of total gross distributions made. On a per share basis, MFFO totaled $0.17 per diluted share, which was a 13.3% increase from $0.15 per diluted share during the third quarter of 2017. This increase was due to synergies from the PELP transaction and growth in same-center NOI.

If you turn to Slide 13, this slide outlines our financial results for the 9-month period ended September 30, 2018. The company recorded a net loss of $32.2 million compared to a net loss of $8.5 million for the same period in 2017. This net loss was primarily driven by a $54 million increase in depreciation and amortization as a result of owning an additional 74 properties when compared to the 9/30/17 period as well as $27.7 million of impairment charges.

For the 9 months ended 9/30/18, the company generated FFO of $117.1 million, which was a 54% increase from $76 million for the same period in 2017. FFO fully covered our quarterly distributions at 101.6% for the first 9 months of 2018.

On a per share basis, FFO increased by 24.4% to $0.51 per diluted share, which fully covered our gross distributions for the first 9 months of 2018 at 101.6%. This increase is attributed to income from the PELP acquisition, including NOI from its properties and investment management business, decreases in nonrecurring expenses and same-center NOI growth from our properties.

During the first 9 months of 2018, the company paid gross distributions of $115.2 million, including $32.7 million reinvested due to the dividend reinvestment plan for net cash distributions of $82.5 million.

For the 9 months ended 9/30/2018, the company generated MFFO of $122.6 million, which was a 42.1% increase from MFFO of $86.3 million for the same period in 2017. This fully covered our gross distributions for the period at 106.4%. On a per share basis, MFFO increased by 15.2% to $0.53 per diluted share during the first 9 months of 2018.

In summary, we had a very solid quarter as the acquired properties from PELP, the synergies resulting from our internal management structure and continued strength in our overall operations drove growth.

If you'll turn to Slide 14, this slide outlines the company's debt profile as of September 30, 2018. The company's debt to enterprise value was 42.3% as of 9/30/18. Our debt had a weighted average interest rate of 3.5% and a weighted average maturity of 4.7 years. Approximately 85.5% of our debt was fixed rate, which is a strength in this rising interest rate environment. As we look at liquidity, we had $444 million of borrowing capacity available on our $500 million revolving credit facility.

This completes our financial overview. I would like to turn the call back over to Mark Addy for an update on the SRP.

[Robert Addy, executive]

Thanks, Devin. Slide 15 provides an update on our share repurchase program or SRP. During the 3 month period ended September 30, 2018, $3.5 million of common stock was repurchased by the company for death, disability and incompetence, or DDI, repurchases in accordance with the SRP. If you have any questions regarding the SRP, please contact our transfer agent, DST, at the following number: 1 [phone], or visit the following website, www.phillipsedison.com/investors.

Now please listen closely as we have an important update. Upon the close of the merger, which we expect to be before the end of the month, all PECO and REIT II stockholders wishing to participate in the SRP program of the combined company will need to submit new paperwork to our transfer agent, DST, to be included in the next standard repurchase. Even if an investor currently has a form that is on file and in good order, a new form will be required after the completion of the merger. To be included in the first repurchase after the close of the merger, which is expected to occur in July 2019, all the new forms must be on file and in good order with DST by July 24, 2019, at 6 p.m. Eastern Standard Time. After the merger closes, should the demand for standard redemptions exceed the available funding, then the combined company is expected to make pro rata redemptions. Subsequent to the first post-merger repurchase, standard SRP requests that have not been fully executed due to pro rata redemptions will remain on file for future redemptions. There will be no need to resubmit paperwork after each pro rata redemption. Upon the close of the transaction, the company will send each investor currently in the SRP queue a stockholder letter explaining their required changes and a copy of the correspondence will be provided to each financial representative.

We know the question that is on top of mind of many of our investors and advisers continues to be liquidity. As we evaluate our liquidity options, a public listing is a high priority. Looking at the public markets as of October 31, 2018, our public peers were trading at an average discount to NAV of 23% compared to 20% discount to NAV as of June 30, 2018. This discount is meaningful. We would like to see the share price of our public peers and the values of our shopping center REITs move closer to a net asset value reflecting their true value. The material discounts in net asset value in which our peers are currently trading at is a real concern to us as we evaluate a potential liquidity event. As a result, we believe that a patient approach to liquidity is prudent and that completing this merger enables us to be ready when the time comes to execute a full-cycle liquidity event at an attractive valuation.

Turning now to Slide 16, illustrates our post-merger SRP projections. This chart highlights the trends of the SRP for the first quarter of 2017 through the fourth quarter of 2018 and provides estimates for combined company through the fourth quarter of 2019, which are for your discussion purposes only and are subject to change. Our SRP states that cash available for repurchases, as illustrated by the gray areas in this chart, is limited to the DRIP proceeds, which are indicated by the light blue bars, during the preceding 4 fiscal quarters, less any cash used for repurchases, as indicated by the dark blue bars during the same period.

With that, I'd like to turn the call back over to Jeff for closing comments. Jeff?

[Jeffrey Edison, executive]

Thanks, Mark. Moving to our key takeaways on Slide 17. We're excited about the strategic initiatives that we have recently completed and believe they will position us for long-term success. Our joint venture with Northwestern Mutual provides significant capital to strengthen our balance sheet and capitalize on new high-growth investment opportunities. Additionally, it's another third-party affirmation of the PECO brand and our investment management and property management business.

Secondly, we believe our merger with REIT II has many benefits for stockholders of both companies and importantly, it is a step towards a full-cycle liquidity event. Management will remain the company's largest stockholders, together, owning approximately 7.3% or $262 million. This illustrates meaningful alignment between management and stockholder interests.

Our management and Board of Directors continually evaluate our liquidity options. We believe the combined company is positioned for a liquidity event when it can be achieved at an attractive price.

And finally, our team remains focused on driving results at the property level, which was reflected by our strong operational performance during this third quarter.

With that, I would now like to turn the call over to Michael Koehler, our Director of Investor Relations.

[Michael Koehler, executive]

Thanks, Jeff. Our first question comes from Mike Suttle, a registered investment adviser. Mike asks, can you give us more detail on the joint venture with Northwestern Mutual?

[Jeffrey Edison, executive]

Thanks, Mike, for that question. The joint venture that we entered into with Northwestern Mutual, we think, is real affirmation of the fundamentals of the grocery-anchored shopping center business. Northwestern Mutual has over 150 years of commercial real estate experience. It's one of the most well-respected real estate investors in the U.S. and really, across the world. The capital provided by this joint venture gives PECO our ability to deleverage, as we've said, to fund our redevelopment projects and pursue higher-growth opportunities in our portfolio. And we see a bunch of advantages here. But I think the main ones for PECO is it allows us to invest side-by-side with a great investor. It gives proof from a third party that really believes in our operating platform. Additionally, they -- we got price discovery that is at our NAV or slightly better than our NAV. This shows that a third party verifies our stock price and the value of our assets, which is always a good thing to have when we're not traded every day. And then our PECO REIT shareholders are -- they're invested alongside smart money. I mean, that's a great place to be. We think this investment recognizes, really, the fundamentals of our investment, which is a stabilizing value to your portfolio, inherent growth and strong cash flow. We think that, that's what the grocery-anchored Necessity Retail investment brings to your portfolio and brings to Northwestern Mutual's portfolio, and having someone move in scale like they have to verify that, I think should give you as stockholders a fair level of comfort. And the last piece about it is, it does give us an additional leg to our asset management business, which we continue to grow.

[Michael Koehler, executive]

I'd like to remind our listeners that they can submit a question on the webcast interface by typing it into the portal and clicking, Submit Question. The next question comes from Kenneth Nelson, President of Nelson Wealth Advisors. Kenneth asks, do you think the company would trade at a higher valuation if it were a publicly traded firm? If so, are you taking any steps to prepare the company to go public? And when do you expect the public offering to take place? Devin, do you want to take that?

[Devin Murphy, executive]

Sure. Kenneth, thank you for your question. I do not believe that we would trade at a higher valuation if we were publicly traded today. As we mentioned in our prepared remarks, our publicly traded peers are currently trading at material discounts to their net asset value. We believe that if we were publicly traded in this market, our equity would be priced below what we believe is the true value of our assets. As we indicated in our prepared remarks, the discounts to NAV that we are observing among our 9 publicly traded peers are between 19% and 23%. We believe that a patient approach to liquidity is prudent in order to successfully complete a full-cycle liquidity event at an attractive price. Remember, management will continue to be the combined company's largest shareholder, owning 7% or $262 million of equity in our company, and we value liquidity highly. Liquidity also gives us access to the equity capital markets, which allows us to raise capital to grow our business, which is another positive aspect of liquidity. We continue to actively monitor the public market and will pursue a liquidity event when we can realize the valuation closer to NAV or what we believe is the true value of our assets.

[Michael Koehler, executive]

Thank you, Devin. The next question comes from Tom [ Vital, ] an individual investor. Tom asks, when can we expect an increase in dividends? The dividend has made essentially flat, which means we're losing ground in terms of relative value due to inflation than the higher assessed value we invested. Devin, do you want to take that?

[Devin Murphy, executive]

Sure. Tom, as you know, our current annual dividend is $0.60 a share, which equates to a...

[Michael Koehler, executive]

$0.67.

[Devin Murphy, executive]

$0.67, I'm sorry. $0.67 a share, which equates to a 6.1% yield at our current NAV. Our board evaluates the distribution rate each quarter. We realize how important these distributions are to our shareholders who are relying on this income. That said, our FFO only recently began covering distributions, and we do not anticipate any material changes to the distribution rate at this point in time.

[Michael Koehler, executive]

Thanks, Devin. Next question comes from Bill [ Schmidt, ] an individual investor. He says, usually, impairment charges relate to the write-off of goodwill. Where was this goodwill generated? And why was it written off? Is this something we assumed in the purchase of a property? Or is it something we assumed when we consolidated holds? Devin?

[Devin Murphy, executive]

Okay. Bill, as you know, GAAP accounting requires the valuation of long-lived assets, including both goodwill and properties. This analysis is required by GAAP on a regular basis. These impairment charges are common for a real estate company of our size. Year-to-date, all of our impairment charges are due to assets that we have disposed of or plan to dispose of. And these impairment charges do not relate to a write-off of goodwill.

[Michael Koehler, executive]

Next question comes from Kyle Bryan from Calton and Associates. Why does the REIT continue to show a net loss each quarter? What needs to be done to get it [ into the block? ]

[Devin Murphy, executive]

Okay. Kyle, given that we've owned our assets, on average, for approximately 3 years, our biggest expense item is depreciation and amortization. You'll note that this quarter, we had $45.7 million of depreciation and amortization and year-to-date, we've had $138.5 million of this expense. As you know, depreciation is a noncash expense. And therefore, real estate investors look to FFO as the best proxy for a real estate company's earnings. Our Q3 FFO was $38 million. And year-to-date, our FFO was $117.1 million. In Q3, we grew FFO by over 50% to $0.17 per share.

[Michael Koehler, executive]

Thanks, Devin. The next question is, when will the next opportunity for the NAV to change? When will that be?

[Devin Murphy, executive]

As you know, we calculate our NAV on an annual basis. Our NAV will be calculated as of March -- the end of March 2019, and we disclose the updated NAV in May of 2019.

[Michael Koehler, executive]

Next question comes from [ John Bessey. John ] asks how much equity is left to invest in REIT II? And what is the acquisition market telling us as far as cap rates and product on the market is concerned?

[Jeffrey Edison, executive]

I'll take that, Michael. This is Jeff. We're fully invested in REIT II. We're at slightly over 40% leverage. We think that's prudent leverage at this point. So we do have room on our line where we could buy additional properties, but we don't anticipate buying more on II at this time, [ John. ] The -- in terms of cap rates, we have seen interest rates pop up basically 100 basis points, we think, realistically for buying. So we do anticipate there being some movement in cap rates. But to date, there continues to be such strong demand, and as you can see it from the Northwestern Mutual acquisition, these are -- pricing remains strong in the grocery-anchored business. I think what people are -- private individuals are looking at is that it's still a very good spread to what they're borrowing at, the point at which they're buying stuff, and they continue to see the grocery and the necessity-based retail as a safe place to put your capital in a time where we're starting to see more volatility in the marketplace. And I think that was one of the reasons Northwestern Mutual did the transaction with us, but it's also one of the reasons that cap rates have not expanded more than they have at this point.

[Michael Koehler, executive]

Thanks, Jeff. Next question comes from Dennis [ Chou ] from Wellsprings Consulting. He asks, can you touch again on the traded peers you're monitoring and the companies trading at a discount?"

[Devin Murphy, executive]

Certainly. In alphabetical order, the 9 public peers we benchmark ourselves against are: Brixmor, Cedar, Kimco, Kite, Regency, ROIC, RPAI, Ramco-Gershenson and Weingarten.

[Michael Koehler, executive]

The next question is, why do you need to deleverage with Northwestern Mutual since you chose how much to deleverage to begin with?

[Jeffrey Edison, executive]

I'll take that, Michael. The -- we don't have to deleverage. We are -- but I -- over the last 12 months, our public peers have lowered their leverage. When we looked -- we look at 40% leverage as sort of our target. They have come down -- they've been reducing their leverage over the last 12 months. When we look at a liquidity event, we think we're going to have to do that, and we'd rather use less expensive capital like selling -- like what we raised with the Northwestern Mutual versus IPO capital, which is very expensive. That's how we are thinking about it. But we are also anticipate using part of that capital to buy into some strong opportunities that we currently see in the marketplace.

[Michael Koehler, executive]

This afternoon's final question is as follows, will PECO shares be diluted by the merger with REIT II? Devin, you want to take that?

[Devin Murphy, executive]

Yes. So PECO shareholders will own less of the combined company, post completion of the merger, than their own prior to the merger. Obviously, PECO shareholders own 100% of PECO at the -- prior to the merger closing. And post the merger closing, they will own 71% of the company, and the REIT II shareholders will own 29% of the company.

[Michael Koehler, executive]

All right. This concludes our prepared remarks and Q&A session. I'd like to turn the call back over to Jeff quickly for some closing comments. Jeff?

[Jeffrey Edison, executive]

Yes. Thanks, Michael. I just want to reiterate the benefits of -- that we see of this strategic transaction, the merger with NTR II. We believe it's going to materially improve the portfolio and maintain our grocery focus. It's going to increase our size, scale and our market prominence. It's going to position the company for liquidity, which is both our shareholders' and management's focus. It improves our earnings quality and maintains our distribution coverage. It maintains healthy leverage ratio and a very strong balance sheet. It -- which we -- actually augmented by the things that we've done with our debt stack, and it accelerates the strategy to simplify our business model. When you put all of those together, we think, in addition to the fact that it's consistent with the strategy that we've had for a long period of time to get to a scale where we can get liquidity at a good price, we think this is -- that's the reason we've pursued it and we're very excited about the benefits that we think the merger is going to bring to PECO and to all of our shareholders. So again, thank you all for being on the call today. Michael, any last things that we need to cover?

[Michael Koehler, executive]

No. That will do it. Thanks, Jeff, and thank you for joining us today. The conference call has ended, and you may now disconnect.