Public Storage (NYSE:PSA) Q4 2022 Earnings Call Transcript

Public Storage (NYSE:PSA) Q4 2022 Earnings Call Transcript February 22, 2023

Operator: Ladies and gentlemen, thank you for standing by, and welcome to the Public Storage Fourth Quarter and Full Year 2022 Earnings Call. At this time, all participants have been placed in a listen-only mode and the floor will be opened for your questions following the presentation. It is now my pleasure to turn the floor over to Ryan Burke, Vice President of Investor Relations. Sir, you may begin.

Ryan Burke: Thank you, Chelsea. Hello, everyone. Thank you for joining us for our fourth quarter 2022 earnings call. I’m here with Joe Russell and Tom Boyle. Before we begin, we want to remind you that certain matters discussed during this call may constitute forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are subject to certain economic risks and uncertainties. All forward-looking statements speak only as of today, February 22, 2022 (sic) , and we assume no obligation to update, revise or supplement statements that may become untrue because of subsequent events. A reconciliation to GAAP of the non-GAAP financial measures we provide on this call is included in our earnings release.

You can find our press release, subsequent reports, SEC reports and an audio replay of this conference call on our website, publicstorage.com. We do ask that you initially limit yourself to two questions. Of course, after that, feel free to jump back in queue with additional questions. With that, I’ll turn the call over to Joe.

Joe Russell: Thank you, Ryan, and thank you for joining us. I’m going to begin by providing color on two recent announcements. We’ll then move on to our performance in 2022 and outlook for 2023. First, on February 5th, we announced a 50% increase to our quarterly common dividend, a raise from $8 to $12 per share on an annualized basis. It is a result of a great effort by the team that has produced record performance over the last few years and a validation of our ongoing confidence in the strength of our platform. Second, as announced separately, we made a proposal to acquire Life Storage at a substantial premium after several attempts to engage in negotiations privately. I’d like to highlight a few important reasons why we think this combination is poised to unlock superior growth and value creation for shareholders.

First, there is significant opportunity to accelerate growth and profitability as Life Storage’s portfolio benefits from Public Storage’s industry-leading brand. Our platform achieves approximately 80% same-store operating margins compared to Life Storage’s margins at approximately 73%. And we see an opportunity to narrow that gap with their real estate assets as part of our industry-leading platform. Second, we believe there is significant upside to grow revenues and earnings in our respective ancillary business lines, including storage insurance, third-party property management, business customer offerings and lending. Third, we see expanded portfolio growth opportunities as we leverage Public Storage’s fully integrated in-house development team, the only one of its kind in the industry, to capitalize on additional development and redevelopment opportunities to enhance Life Storage’s existing portfolio.

And finally, all of this will be supported by an industry-leading balance sheet with low pro forma leverage, an advantaged cost of capital and significant capacity to fund future growth in conjunction with retained cash flow. Since announcing the proposal, we have received overwhelmingly positive feedback from both companies’ shareholders who clearly recognize the significant benefits uniquely achievable through a combination with Public Storage. As you likely saw, on February 16th, Life Storage issued its own press release rejecting our proposal. Nothing in that response changed our thinking. We have a high level of conviction in the strategic and financial merits, and we are committed to pursuing a potential combination. We are encouraged, in that February 16th release, Life Storage indicated openness to opportunities to enhance shareholder value.

We look forward to engaging in good faith discussions regarding a mutually agreeable combination. While we appreciate that analysts and shareholders have ongoing questions with respect to our proposal, the purposes of today’s call is to discuss our fourth quarter earnings and our outlook for 2023. As such, we will not be addressing questions related to the proposal at this time. Now, turning to our performance and outlook. 2022 was a year of milestones for Public Storage, including celebrating our 50th anniversary. The team and platform achieved record results in our same-store and non-same-store portfolios, elevating the customer experience through technology and operating model transformation, enhancing our properties through the Property of Tomorrow program and growing the portfolio through acquisitions, development and redevelopment and third-party management.

We did all of this while maintaining the industry’s best balance sheet, which is poised to fund growth moving forward in conjunction with significant retained cash flow. To name just a few of our collective accomplishments, we achieved an 80% stabilized direct NOI margin through the combination of revenue generation and expense efficiency that only Public Storage is capable of. We grew beyond 200 million owned square feet and $4 billion in total revenues. We built our property development pipeline to approximately $1 billion. We received the prestigious Great Place to Work award based on feedback provided directly by our employees. And we achieved top-scoring U.S. self-storage REITs across the leading sustainability benchmarks. We are firing on all cylinders while strengthening the already formidable competitive advantages we have across our business.

And those competitive advantages are heightened in the type of macro environment we are in today on top of two consecutive years of record 20%-plus core FFO growth. Simply put, we have the people, technologies, platforms and brand which lead us to a position of strength in 2023. Demand for self-storage remains strong, as you see with our move-in volume up more than 11% during the quarter. The aspects of the business that have historically made it resilient are on display. This is a needs-based business with demand drivers that are multidimensional and fluid throughout economic cycles. We also continue to benefit from a newer driver in the form of people spending more time at home, which has increasing permanence with remote and hybrid work here to stay.

Our customer lengths of stay are at record levels, a positive trend, given rent increases to existing customers are a key driver to our revenue growth. The outlook for new competitive supply is also in our favor. We are seeing less new property development nationally due to higher interest rates, cost pressures, difficult municipal processes and concern over the macro landscape. With continuing strong demand, less pressure from new supply and our numerous competitive advantages, we are very well positioned in 2023. Now, I’ll turn the call over to Tom.

Tom Boyle: Thanks, Joe. I’ll start with a review of capital allocation for the year. We invested $1 billion between acquisitions and developments in 2022, including the $190 million Neighborhood Florida portfolio in the fourth quarter. That portfolio added to our over 400 properties that we’re operating with our remote property management platforms. Overall, the 2022 acquisition environment was impacted by a shift of cost of capital with transaction volumes down and driven by smaller deals compared to 2021. We expect that trend to continue this year with our forecast for $750 million of transaction volume for Public Storage consistent with last year. We are well positioned as an acquirer today, given our industry-leading balance sheet and cost of capital.

And adding to acquisitions, our development pipeline stands at approximately $1 billion as we seek to expand the portfolio with our in-house team. The development environment is challenging today across the industry, as Joe highlighted. Against that backdrop, Public Storage is planning on delivering $375 million of new generation 5 properties in 2023 and more in 2024, as we lean on our development competitive advantages. And we look forward to putting these new properties on our national platform to drive outperformance. Now, on the financial performance. We finished the year strong, reporting core FFO of $4.16 for the quarter and $15.92 for the year, ahead of the upper end of our guidance range and representing 22.4% growth over the fourth quarter of 2021, excluding the contribution of PS Business Parks.

Let’s look at the contributors for the quarter. In the same-store, our revenue increased 13% compared to the fourth quarter of €˜21. That performance represents a moderation from last quarter’s 14.7% growth and a return to seasonality and tough comps comparing to 2021. Now on expenses, same-store direct costs of operations were up 5.3%. In total, net operating income for the same-store pool of stabilized properties was up 15.8% in the quarter. In addition to the same-store, the lease-up and performance of recently acquired and developed facilities remained a standout, growing 51% compared to last year. Now, I’ll shift to the outlook. We introduced 2023 core FFO guidance with a $16.45 midpoint, representing 5.5% growth from 2022, again excluding the contribution of PS Business Parks.

As we enter the year, there’s no question there’s a wide range of potential macroeconomic pathways that will influence customer demand and behavior. The consumer has held up well to this point in the year, but the Fed is certainly signaling they’re not finished. If we look at the same-store revenue outlook, I’d characterize the low end of the range of the outlook as a recessionary pathway and the higher end as a softer landing for the economy. We anticipate occupancy will be lower throughout the year and follow a typical seasonal pattern. Rate will be the driver of revenue growth with the moderation through the year based on lower move-in rents and tougher existing tenant rate increase comps. That moderation results in a trending towards longer-term averages of growth.

Our expectations are for 5.75% same-store expense growth, driven primarily by property tax and marketing expense. That leads to same-store NOI growth at the midpoint of 3.2%. Our non-same-store acquisition and development properties are again poised to be a strong contributor, growing from $448 million of NOI contribution in 2022 to $520 million at the midpoint. And looking ahead to 2024 and beyond, the incremental non-same-store NOI to stabilization from those properties acquired or completed at December 31st is an additional $80 million of NOI. This pool of lease-up assets will continue to be a powerful growth engine over the next several years. Last but not least, our capital and liquidity position remain rock solid. We have a well-laddered long-term debt profile with limited floating rate exposure and over $4 billion of preferred stock with perpetual fixed distributions.

Our leverage of 3.4 times net debt and preferred to EBITDA combined with nearly $800 million of cash on hand at quarter end puts us in a very strong position, heading into 2023. So with that, I’d like to open the call up for questions.

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Q&A Session

Operator: Thank you. And our first question will come from Steve Sakwa with Evercore ISI.

Steve Sakwa: Thanks. Good morning, out there. I guess maybe, Tom, for you, as you thought about setting guidance for this year, I can appreciate a number of the different components that you laid out, and there’s kind of a wide range there. But I guess which components do you feel like have the most potential upside and downside risk, I guess, both on the revenue side and on the expense side where you could come back and be positively surprised or negatively surprised?

Tom Boyle: Sure. That’s a good question, Steve. So, I want to make a couple of comments here. One, I’d like to comment a little bit around how the year has started, which is pretty consistent trends with what we saw through the fourth quarter. So move-in, move-out trends pretty consistent. We’ve seen move-in volumes up circa 10%, move-in rates that have been down mid-single digits. So consistent with that, we call it, 5% plus or minus that we saw in the fourth quarter. So, we’re seeing continued good demand for storage through the first part of the year. But I do think in response to your question, I’d like to break the year of 2023 into two halves. The first half, as we think about it, consistent trends as we’ve seen through the fourth quarter into the first but facing really tough comps as we move through the first part of the year.

And that’s going to lead to some of the moderation I spoke to. The second — but ultimately, with higher levels of absolute revenue growth, given we’re starting the year from a position of strength. But if you think about the second part of the year, there’s a couple of things to highlight. One, the comps will be easier in the second half of the year, given we’ll be comping against a more seasonal end of 2021 — or 2022, rather. But the flip side is the macro uncertainty is significantly higher. And so, as you think about the pathways that I described for the outlook, at the lower end, a recessionary pathway that we highlighted in some of our disclosures, that recessionary pathway likely leads to negative year-over-year revenue growth as you would be typical to see in a recession.

But towards the higher end, certainly, that would lead to positive growth and easier comps and could result in better revenue growth performance as we move through the second half. And I’d say, as we think about the year, the second half has much more uncertainty towards it than the first half does.

Steve Sakwa: Okay. And then second question, I don’t know if it’s for you or for Joe, but just as you think about capital deployment, you still have $1 billion of development but you mentioned that doing new deals is challenging. Just help us understand kind of where you think acquisition yields are in relation to new development yields. Kind of where does that spread stand today? And how do you think that might trend over the next kind of one to two years?

Joe Russell: Yes, Steve. There certainly is a continuing trend that played through in 2022 that we think still applies to 2023. First of all, on the acquisition side, likely to be lower volumes of transaction activity. Certainly, we’re seeing that by virtue of how the year started off. It’s not a typical year in and year out where the first quarter or so might be on the light side. That’s definitely the case as we speak. So, we’re looking for and evaluating the trends tied to impacts from higher cost of capital, limited availability of capital, again, how sellers are looking at this environment to transact assets. Typically, more stabilized assets are going to command stronger cap rates. I’d tell you today compared to maybe where we were a year ago, cap rates are still up in that 100, 125 basis-point range where stabilized assets might have a 5 handle on them, whether it’s low, mid or high-5, cap rate’s going to depend on location, quality of the asset, et cetera.

And then, depending on this stabilized level of the asset, there’s going to be more flexibility in the cap rate. And you’re going to see different pricing mechanisms tied to those types of assets. Our focus, as it has been to actually look for those kinds of assets because that’s where we see the higher value creation. That certainly played through the acquisition volume that we captured that Tom talked about, in 2022. So we’re still out hunting for good quality assets. Our backlog right now between closed and under contract’s approximately $70 million. But frankly, the market is a little slow right now, so we’ll see. It’s not unusual for though the market to start picking up toward the summer months so we’ll see again how that plays through on that set of opportunities.

Now, on the flip side, from a development standpoint, as you mentioned, yes, our pipeline continues to be quite robust. It’s more difficult to do development not any different than what we’ve been talking about for the last year or two. Our team is working hard to extract prime land sites. We’re actually finding some very good opportunities there. But frankly, we’ve got skills and abilities that our competitors in the private world particularly do not have. And with that, we’ve been able to extract prime sites, good opportunities to actually get the types of returns that we’ve been speaking to for the last couple of years, where we’re expecting plus or minus 8% or north cash-on-cash yields on these investments. So, we’re very encouraged by our own pipeline.

We’re encouraged, as Tom mentioned, relative to the lease-up and the contribution those types of assets have to our overall revenue and NOI performance. And our non-same-store portfolio continues to be very vibrant. So, we’re very encouraged that we’ve got the right skills and the fortitude and the ability to look long term through what could be still a very challenging development cycle, which frankly, is a good thing. It gives us more ability to actually go out and capture, as I mentioned, those great land sites, put our Gen 5 properties into a variety of different markets. And nationally, we’ve got good opportunities across the spectrum, so we’re going to continue to focus on that as we speak.

Operator: Our next question will come from Michael Goldsmith with UBS.

Michael Goldsmith: On the guidance, you said the low end of the range is for a recession scenario while the high end’s a soft landing. Do you see a 50% probability of a soft landing, you end up at the high end, and a 50% probability of a recession, you end up at the low end, or is it more 75-25 or another combination? I’m trying to understand the likelihood of where you see yourself ending up within that range at this time.

Tom Boyle: Sure. Good question, Michael. So, I think there’s a couple of things there. The first is we wanted to provide a range that encapsulated multiple pathways because we know everyone on this call probably has their own point of view as to what percentage probability a recessionary pathway is or a soft landing is. And so, we thought it was appropriate to provide that wide range, and obviously, investors can make their own perspective. As we look at it, we look at the potential outcomes as relatively balanced within that range, but we don’t obviously know what the Fed is going to do and how the consumer is going to react. 3 or 4 weeks ago, interest rates were lower. There was talk of a no landing over those 3 weeks. We’ve gone back to the fact that maybe that no landing is off the table.

So, I think that’s going to ebb and flow as we go through the year. And our objective was to provide investors and analysts a framework to understand what could play out through the year according to those macro pathways.