Modiv Inc

NYSE:MDV

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Good day, and welcome to Modiv Industrial Inc. 2Q '24 Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to John Raney, Chief Operating Officer and General Counsel. Please go ahead.

[John Raney, executive]

Thank you, operator, and thank you, everyone, for joining us for Modiv Industrial's Second Quarter 2024 Earnings Call. We issued our earnings release before market opened this morning, and it's available on our website at modiv.com. I'm here today with Aaron Halfacre, Chief Executive Officer; and Ray Pacini, Chief Financial Officer. On today's call, management will provide prepared remarks, and then we'll open up the call for your questions. Before we begin, I would like to remind you that today's comments will include forward-looking statements under the federal securities laws.

Forward-looking statements are identified by words such as will, be, intend, believe, expect, anticipate, or other comparable words and phrases. Statements that are not historical facts such as statements about our expected acquisitions or dispositions, joint ventures and strategic partner discussions are also forward-looking statements.

Our actual financial condition and results of operations may vary materially from those contemplated by such forward-looking statements. Discussion of the factors that could cause our results to differ materially from these forward-looking statements is contained in our SEC filings, including our reports on Form 10-K and 10-Q. With that said, I would like to turn the call over to Aaron Halfacre. Aaron?

[Aaron Halfacre, executive]

Thanks, John. Hello, everybody. Thanks for joining our second quarter conference call. Most of you would rather be tracking the stocks on your watch list in this volatile market. So our goal is to try to make this a snappy one. I said all my prepared remarks and I normally do in our earnings release. So let's just jump straight to Ray, and then we'll go to Q&A. Ray?

[Raymond Pacini, executive]

Thank you, Aaron. I'll begin with an overview of our second quarter operating results. Rental income for the second quarter was $11.3 million compared with $11.8 million in the prior year period. This 4% decrease primarily reflects a decrease in tenant reimbursements related to 13 properties sold to GIPR in August 2023, which included properties with modified gross leases and double net leases.

Rental income for the quarter also reflects the impact of 12 industrial manufacturing property acquisitions during 2023, partially offset by 16 dispositions of noncore properties from August 1, 2023 to February 28, 2024. Second quarter adjusted funds from operations or AFFO was $3.9 million, up 17% when compared to the $3.3 million in the year ago quarter.

The increase in AFFO primarily reflects an $834,000 decrease in property expenses with $179,000 decrease in G&A, which were partially offset by the $493,000 income. The increase in AFFO was impacted on a per share basis by $781,000 increase in diluted shares outstanding, resulting in AFFO per share of $0.34 compared with $0.31 in the prior year period.

The current period AFFO includes nonrecurring state and property tax refunds of $138,000 or $0.01 per share and a decrease in G&A expenses of approximately $179,000 or $0.02 per share due to timing of expenses that will be reflected in the third quarter. If our repurchase of 780,000 shares from First City Investment Group, on August 1 that occurred at the beginning of the quarter, pro forma AFFO would have been $0.37 per fully diluted share.

Cash interest expense for the quarter was approximately $25,000 greater than the comparable period of 2023 when we drew the final $80 million of our term loan in mid-April 2023. The current period expense included $550,000 of unrealized noncash net losses on swap valuations, which increased interest expense, while the prior year period included $3.7 million of unrealized gains on swap valuations, which decreased interest expense.

Now turning to our portfolio. Following the July 2024 acquisition, of [indiscernible] manufacturing property located in the Tampa-MSA, our 43 property portfolio has an attractive weighted average lease term of 13.6 years. Though the majority of our tenant credits are private, approximately 34% of our tenants or their parent companies have an investment-grade rating from a formally recognized credit agency of BBB- or better.

Annualized base rent for our 43 properties totaled $40.5 million on a pro forma basis as of June 30, 2024, with 39 industrial properties representing 76% of ABR and 4 non core properties representing 24% of ABR. With respect to our balance sheet and liquidity, as of June 30, 2024, total cash and cash equivalents were $18.9 million, and we had $280 million of debt outstanding. Our Tampa property acquisition and a repurchase of 780,000 shares from First City, reduced our cash position of $3.2 million following quarter end.

Our debt consists of $31 million of mortgages on 2 consolidated properties and $250 million of outstanding borrowings on our $400 million credit facility, and we do not have any debt maturities until January 2027. Based on interest rate swap agreements we entered into during 2022, 100% of our indebtedness as of June 30, 2024, held a fixed interest rate, with a weighted average interest rate of 4.52% based on our leverage ratio of 47% at quarter end.

We are actively evaluating the changing interest rate environment and presently intend to enter into new swap agreements on or before December 31, 2024 to continue our full cash hedge position. As previously announced, our Board of Directors declared a cash dividend per common share of approximately $0.095 for the month of July, August and September 2024, representing an annualized dividend rate of $1.15 per share of common stock.

This represents a yield of 7.9% and based on the 1476 closing price of our common stock as of yesterday. I'll now turn the call back over to Aaron.

[Aaron Halfacre, executive]

Thanks, Ray. Okay. And the fun part begins here where you guys get to ask your questions and I tend to talk too much. But before we do, jump to Q&A, I want to address 2 things. Mr. Maher, I know my missives tend to be dramatic, but they're not meant to be. They're meant to be cryptic though. And the reason is, is that there are a lot of constituents out there. And so there may be some messaging in those.

They're so cryptic though that sometimes they can be confusing. So to that end, Mr. Stevenson, I want to point out that the portfolio in the JV is not focused on the city of Miami. Just to be clear, it is diversified in its geography. So with that, operator, let's go to Q&A.

[Operator]

[Operator Instructions] And our first question comes from the line of Gaurav Mehta with Alliance Global Partners.

[Gaurav Mehta, analyst]

Yes. I wanted to ask you on the JV. Wondering if you are willing to disclose any more details on what's the size of the JV? And do you expect to derive any management fee, property management fees once you get into the JV?

[Aaron Halfacre, executive]

So appreciate the question, figure you get it. You should generally assume that I will try to tell you everything I can. So I will not tell you statistics on that portfolio at this stage. And I have my reasons, so you trust me on that. As it relates to the JV fee though, we're not doing this as sort of a fee generation thing. So this is a participation. So we will ratably be participating in the income and expenses, and we are not looking to make any fees on it at all.

[Gaurav Mehta, analyst]

Okay. Second question, maybe big picture. Any color on what you guys have seen in the transaction market for industrial manufacturing?

[Aaron Halfacre, executive]

Yes. I mean you're seeing one-off continue this whole year, it's been one-offs, you'll get something comes up. And sometimes the cap rates look attractive, but there's a reason they look attractive, but they're not really attractive. If the credit is pretty thin or they're desperate for cash or something like that.

Other times, on the more solid ones, and they're not in a rush to sell and the cap rates are too tight. So it hasn't been -- not unlike our stock. It's been a really choppy market for industrial manufacturing. Remember, we're pretty picky. I don't look and team sort of light assembly is manufacturing. I don't look at flex spaces as manufacturing. We're looking for things that are really durable in terms of their products in terms of where they are in their market segment.

So that narrows the universe. But it's been pretty choppy, as you can expect. I mean, it's just -- I mean, if you -- like, for instance, on the Tampa-based deal we did, the reason why we are comfortable doing that one, and obviously, it had a good client list that we're buying their products. They're making something that was sort of very durable and needed for infrastructure-based needs.

But more importantly, the money from the sale leaseback went and we tied it to this to make an acquisition overseas that did the same thing. So by doing this acquisition, they were more than doubling their top line and really getting synergies. So to us, that was a smart use of capital versus if it had been a PE shop who was just stripping out cash.

And so there's so many different motivations into why we chose or why we think is -- there's a good market or a bad market for assets. And right now, it's just been -- it's been hit or miss. So we look, but there's not a lot of volume. It's not like you're buying Walgreens.

[Operator]

The next question comes from the line of Rob Stevenson with Janney Montgomery Scott.

[Robert Stevenson, analyst]

Aaron, can you talk about the expected timing on the non-Miami-centric Battleship deal? Is this likely a third quarter event, if it happens?

[Aaron Halfacre, executive]

Yes. I think if it pulls together on the pace we're working on, it will happen before the Q3

[Robert Stevenson, analyst]

Perfect. And then can you talk about what is your role? Are you going to be in charge of managing these assets? Is it essentially a passive sort of ownership interest like how should we be thinking about these in your involvement?

[Aaron Halfacre, executive]

Yes, we'll plug them into our ecosystem. We'll manage them the PE sponsor, will actually be stepping into the position of a prior joint venture partner that had or has a much smaller percentage than right now than what we are anticipating acquiring. So it will be a more equitable partner relationship, but we will do the management on a day-to-day basis, including property management, accounting, all those aspects and the private equity sponsor will continue in what I would characterize as more of the passive role.

[Robert Stevenson, analyst]

Okay. And the materiality of the deal isn't such that given your current size that you'd need to get any type of approvals other than from the Board for the share issuance?

[Aaron Halfacre, executive]

That is correct.

[Robert Stevenson, analyst]

Okay. And then sort of switching gears here a bit. How should we be thinking about First City going forward? Is this just a staggered sort of deal or they want to sell out of their remaining shares and units? And going forward now, do they own primarily shares or units at this point?

[Aaron Halfacre, executive]

Great questions. First City is a wonderful investor, we think highly of them. And have had a dialogue with them for the last 2 years or 2-plus years. They're very smart investors. So even though on the surface, this was smart for motive. They have a history of making money in the space that they deal with, which tends to be in the automotive dealership space. So they now have only common shares. They are still a significant shareholder. So they have a meaningful size.

They have had those shares that were not -- they were converted from OP units to shares back, I want to say, in January. So they've had those at the possession. So those are freely tradable. They're allowed to do what they want. Obviously, I don't ask them about their business. But they -- if they are going to stay longer term, I don't know. We hope they do.

We think the world of them. And this was just a transaction that met the needs of both parties. So they have no more OP units, though, and this ended the OP units, which was the original cycle of the 721 transaction.

[Robert Stevenson, analyst]

Okay. That's helpful. And then how are you thinking about the most appropriate time to monetize the KIA asset. Is that a '24 event at some point in time? Is that a wait for rates to come down and probably more likely a '25 event? How should we be thinking about that in the current market environment?

[Aaron Halfacre, executive]

Yes. I think that is a great property with a great lease with a great tenant. And in my view, in this rate environment, you would only get punished. You wouldn't get the credit that you do. I think it's a natural candidate along with our Costco and OES as recycling because they are non core.

Costco, as we know, just previously disclosed is underway. The other tenant OES has indicated that they are, as I mentioned before, interested in exercising their option purchase option. It's an arduous process for them as a government entity. So we don't know until we know. But those are probably the natural first candidates. And then at the right time, we would execute on KIA.

And I think because there's a substantial embedded gain in that, we'd have to be tied very much to a 1031 exchange. And so that could be new assets out there, another portfolio, it could be the second half of this aforementioned JV. I think there's a lot of opportunities to naturally sequence that but I don't -- I have 0 expectations that it's in the near term.

[Robert Stevenson, analyst]

Okay. And then speaking of Costco, at this point, given the way that KB is moving, what's the sense is the earliest that, that deal closes for you guys?

[Aaron Halfacre, executive]

It's really up to the zoning and the final permits. But like we're earmarking sort of mid next year? And right now, we don't see any reason why that would be earlier, there is provisions for it to be earlier. I don't think it will be earlier in February of next year, so it's definitely a '25 event.

[Robert Stevenson, analyst]

All right. And then the last one for me. You mentioned in your comments that Adam and Curtis are leaving the Board. So you're losing your Chairman and your Lead Director, how are you thinking and the Board thinking about that going forward? Will the Board shrink? Is there anyone on the board currently going to step up and take on those roles and how committed are you in the company, keeping the CEO and Chairman roles separate at this point?

[Aaron Halfacre, executive]

CEO and Chairman role will be separate. That's best practice. There's nothing there. We will -- by the time we file a proxy, have all those items addressed in a thorough manner. And so we have put thought towards it. And I'd say we're not ready to get our proxy out yet. That will be soon. We wanted to get this JV due diligence underway.

And so by the time we do that, it will be fully vetted and out with it. But we'll maintain the same sort of professional integrity that we've always done with our Board, and it's disappointing to have rotation, but it's been 5 years. It's been a long time, and they've got other things to do. So I'm very grateful for their service.

And when whoever comes on next, they will have a high bar to measure to.

[Operator]

And the next question comes from the line of Bryan Maher with B. Riley Securities.

[Unknown Analyst]

This is Brandon on for Brian, but I will certainly pass along the message. Most of our questions have been answered, but 2 quick ones from us. So first one was just the probability on kind of the current strategic partnership going forward versus kind of the probability of the other strategic partnership option if you can delve into that.

[Aaron Halfacre, executive]

Yes. So I think there's some logic to sequencing them. And this one is one that we could fast track a little bit better. Look, during the course of the summer, I mean, our share price was at $15.75. It was at $13.95. We had so much market and rate volatility that it makes it hard to negotiate if you're trying to engineer a certain outcome. And so patience is key, and that's kind of what I talked about.

This one though is of the 2 and they're both great opportunities and they're both very strategic, but they're different in terms of the composition. And so this one is one that we can execute faster. And I think it also only dovetails. And so I think if anything, doing this one first helps strengthen the opportunity for the second one. And so that's how I would describe it. It wasn't an either/or decision.

In my ideal world, it will be the combination of 3 battleships.

[Unknown Analyst]

Got it. And you talked about your kind of acquisitions, but I was just curious on the disposition pipeline, whether you're receiving offers on existing properties or underperforming properties? Any color there? And that's all for me.

[Aaron Halfacre, executive]

Thanks, Brandon. There are no properties held for sale right now. Look, we've clearly signaled that non core assets, particularly the office assets are natural recycling candidate. We have some industrial assets that are less manufacturing and more distribution that could be candidates down the road. But right now, nothing is for sale. We did a big transaction last year with the 13 property portfolio, we obviously sold 2 earlier this year.

So I think we're always able to sell. And if we can find the right opportunity, we will execute. That said, if you've got a good property with good operations and you don't want to necessarily sell into this market because you're just going to get cut off at the knees unless you have to. And so we don't feel any urgency to have to do anything, and so we'll continue to be smart. Thanks.

[Operator]

The next question comes from the line of Sean Hostert with Net Lease Observer.

[Sean Hostert, analyst]

Aaron, curious if there's any specific watch list changes for you guys from a tenant credit exposure perspective? And then secondarily, I'm hearing a lot of talk in the market about pricing between investment grade and non investment grade assets. Just would love to hear how you and your team think about pricing assets depending on credit profile.

[Aaron Halfacre, executive]

Sure. I think the credit profile, IG, non-IG frame of mind is highly conducive to sort of traditional net lease? And what I think by traditional net lease. And what I think by traditional net lease is I think of NNN or O or agri or [indiscernible], they're buying a lot of retail and there's a wide spectrum of credit quality.

And that way of thinking about it is built into a lot of other net lease product types, and I think for good reason, right? Because these are not unlike bonds and so the credit matters.

I think when it pertains to industrial manufacturing, it's hard to fit that square peg into a round hole. And what I mean by that is you have a lot of private middle-market credits typically. We're not buying Intel manufacturing fabs that would be like 4x our market cap just to buy one of those. And so we're buying really durable infrastructure-based manufacturers that have typically been around for a long time.

They could either be individually owned. Some of them are public, I think our look-through basis on rated credits that are investment grade is 34% of the portfolio. I think O's is like 37%. But it's completely apples and oranges, right? There's no real comparison. So for us, if we can find someone that's investment grade and it makes sense, and that's the actual guarantor of the lease, that's fantastic.

Will we buy a crappy manufacturing location just because it's investment grade? No. We have to make sure that it's a durable tenant in terms of it's been around for a long time, what they're making is essential that they have a good market share of what they do make hopefully, all or at least the majority of their manufacturing is in our facility.

So it breaks it very very low likelihood of rejection, right? Because rejection in our case is a real dire outcome. It's not like a lenient thing where I can just go rebox it. And so we think about it differently. It's certainly important. We run internal and external credit every time we do a deal. But the IG thing doesn't always necessarily fit.

In terms of pricing, kind of what I alluded to go off, we're not seeing a ton out there. The pricing is either wide and because they're desperate and they're trying to debate someone in the taking it. So they'll say, hey, it's an 8 gap or 8.5 gap but it's really probably a 10 gap. If you looked at the true risk or it's a really good portfolio and they know it and say market is prevailing market, it might be 7.5 and they want 6.5.

And you're like, well, that was 2 years ago. And so it's kind of choppy. There's not a whole lot. Ours is really a case-by-case thing. There's not a lot of observations to draw a trend line from. So I can't answer that better. Thanks everyone in the call appreciate the time and until we speak again.

[Operator]

Ladies and gentlemen, this concludes today's conference. You may now disconnect your lines at this time. Enjoy the rest of your day.