Phillips Edison & Company, Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

Phillips Edison & Company, Inc. is a real estate investment trust (REIT) that owns and operates grocery-anchored shopping centers across the United States.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

PECO’s business is relatively straightforward: it owns real estate, leases it to tenants, and receives rent. The main challenge lies in evaluating the sustainability of their cash flows and their ability to compete in their market. The company is focused on necessity-based tenants like grocery stores which are less prone to economic downturns.

Business Overview

  • Revenue Distribution:

PECO’s revenue model is straightforward. It primarily generates income through leases on its retail properties. As such, the amount of leased square footage and rental rates are significant drivers of revenue and profits. * The company’s revenue is predominantly derived from rent collection from the 271 neighborhood shopping centers it owns, with the majority being anchored by grocery stores. As of September 30, 2023, 99.4% of all leased spaces had lease agreements. * A substantial majority of income is recurring and stable and is based on long-term contracts, providing consistency and predictability.

  • Industry Trends: The retail real estate market is undergoing a transformation due to the rise of e-commerce and changing consumer habits. However, grocery-anchored shopping centers have shown relative resilience due to the essential nature of the businesses they host and the importance of the “in-person” shopping experience. Within grocery anchored centers, the trends have been to prioritize locations that offer more and diverse amenities to create traffic and better retain tenants.

The shift to omnichannel retail (i.e., combining online and offline retail channels) may present a challenge to some of PECO’s tenants, but the inherent stability of grocery stores as anchor tenants provides a degree of protection against broader market changes. That is why management has made a special effort to increase their “necessity-based” tenants.

  • Competitive Landscape: The market for REITs that hold shopping centers is competitive, with players ranging from large, well-capitalized firms to smaller, regional operators. PECO differentiates itself by its focus on grocery-anchored centers and its ability to offer property management services. Competition in this industry is driven by factors such as location of properties, quality of tenants, lease terms, occupancy rates, and the ability to provide a full range of services to tenants.

PECO’s focus is on suburban and community-oriented properties, not the luxury malls, puts the company in a position where it has more of a focus on essentials than discretionary spending, giving the company more stability.

  • What Makes PECO Different:
    • PECO focuses on acquiring, owning, and managing grocery-anchored shopping centers, which provides a relatively stable revenue stream compared to other types of retail properties. These stores can be very durable during economic downturns.
    • The company’s goal is to maintain its portfolio with necessity-based, grocery-anchored tenants, and make them more relevant to its neighbors and their needs. This is through adding amenities, better retail and service offerings.
    • PECO also has several strategic partnerships with large grocery store chains.

Financials Analysis

  • Income Statement
    • Revenues: A significant portion of the revenue is derived from rental income. As of September 30, 2023, the company generated $224.9 million in income, which is mostly lease income. This figure is higher than the $218.1 million in the corresponding quarter in 2022.
    • Same-store rent increased from $13.28 per sqft in 2022 to $13.85 in 2023.
    • Net income: Net Income was $28.3 million for three months ended September 30, 2023, compared to $37.1 million in the same period last year. A decrease in Net Income has primarily been due to an increase in interest expense and decreased lease termination income.
    • Operating expense has increased to 128.1 million compared to 120.6 million.
    • The increase in earnings is partly offset by the rise in interest rate costs over the period, which reduced profits from higher revenues.
  • Margins: PECO has a net operating margin of 67%, which is an indicator of a solid business model.
  • Balance Sheet
    • Assets: As of September 30, 2023, the total assets were at $7.58 billion. Of these, a large proportion are in real estate assets, at 6.2 billion, followed by investment in unconsolidated joint ventures and net assets held for sale ($1.19 billion). Other asset categories, such as cash, restricted cash, and other investments are much smaller.
    • Liabilities: The total liabilities are equal to $4.15 billion at the end of the latest quarter. The company’s debt profile looks healthy.
    • Equity: The equity at end of Q3 is $3.44 billion. The market cap is $3.65 billion as of end of trading on 02/03/2024.
  • Liquidity and Capital Resources:
    • The company has access to a $900 million credit facility with more than $700 million of borrowing power left. The current debt profile looks robust and they don’t need to seek new capital in the short term, unless needed for acquisitions.
    • As of end of Q3 2023, the Company has $172.7 million of total cash.
  • Cash Flow: The operating cash flow has grown by more than 11% compared to prior year quarter.
  • Total Cash from operations is 131.8 million vs. 118.4 million for the comparable period in 2022.

The overall financial position of the company is strong. The company has a good asset base of high-quality real estate assets, and a robust liquidity position to support its operations and future expansion. The low debt burden and stable sources of income are further positives. However, higher interest rates and any possible changes in regulations may affect future profits and financials.

Moat Analysis

  • Moat Rating: 2/5 (Narrow Moat): PECO’s moat rating can be considered at a narrow level with moderate durability. Here is why:
    • Intangible Assets: The brand equity of its anchor tenants (e.g., Kroger, Publix) helps attract tenants to their shopping centers. It’s hard to replicate the customer loyalty that these stores have. But this doesn’t prevent another shopping center from having a similar anchor tenant. The company has a brand name and reputation, but it’s not very differentiated from other quality shopping center operators.
    • Switching Costs: The customer (grocery stores) switching cost is very low because there are multiple good locations that have many customers. These are often leased on long-term contracts for predictable revenue. However, these are less valuable, because the market rate can change dramatically in longer term. And this switching cost isn’t that important for the tenant.
    • Network Effect: There isn’t any network effect here.
    • Cost Advantages: Location is important here, and PECO does secure strategic locations, but this is not an absolute protection. These locations can be developed by others or become undesirable over time due to demographic changes. In the case of highly specialized real estate that is required for some business, and there aren’t many such real estates available, the size advantage and location advantage can work together to provide a small moat.

  • Why is the Moat Not Wide? * Because other companies can still copy PECO’s business model. They can also seek similar locations, have similar tenants, and offer similar amenities. * While grocery-anchored centers offer some stability, they are still susceptible to competitive pressures, including overexpansion, changing consumer behavior, and the advent of new retail technologies.

  • Durability of the Moat: * Some of the moat attributes come from the scale advantage and location of their properties, but these factors can erode as they are not unique and can be acquired by others over time. The brand is valuable, but less so than a consumer brand. The switching costs offer some advantage in current tenant retention but not for bringing new tenants. So the moat is not very wide or long-lasting and that is why it has a rating of 2/5.

Risks to the Moat and Business Resilience

  • Interest Rate Risk: A major portion of the debt is floating rate debt, which means if the Fed increases rates further, the debt obligations will become higher and lead to increased interest payments. This might reduce profitability.

In addition, the credit market can become volatile which will make it more difficult to refinance existing debt on favorable terms.

  • Vacancy and Rent Reduction: The performance of PECO depends on its ability to maintain stable tenancy and attract high quality tenants. If some of the anchors suffer and decide to leave, it could negatively affect the revenues of PECO.
  • Tenant Concentration Risk: While the company has a large and diversified portfolio, its dependence on some tenants exposes it to risks associated with their financial health. The company has made a deliberate effort to lessen the concentration risk and no single tenant accounts for more than 4.1% of total revenues.
    • Competition: The company will continue to face competition from other real estate operators and companies with similar assets. It also has to deal with e-commerce and the shifting preferences of the consumers.
  • Economic Factors: The general macro economic situation like interest rate changes and recessions has a direct impact on consumer spending and ultimately on the business operations of PECO and its tenants.

PECO has a management that is both capable and committed to operating the company with strong ethics and long-term goals. It has taken decisive action when required and taken advantage of opportunity. They have also prioritized safety and security of their facilities.

Understandability Rating: 2/5 * The business model is straightforward-buy real estate, lease it to tenants, and earn rent. While the core operation is very simple, the financial instruments and accounting are more complicated and have many nuances to them.

Balance Sheet Health Rating: 4/5 * PECO has a relatively well-managed balance sheet. The company has a low debt to asset ratio. Their long-term debt has low interest rates, with 13% as variable rate debt. However, recent economic uncertainties and interest rates are something they should keep a look out for.

Recent Concerns/Controversies/Problems

  • The company expects a slight decline in same store occupancy for 2024.
  • It is looking to sell some assets to maintain a low leverage and low-interest rate expenses, as they are both expected to remain high this year.
  • The overall industry is competitive, and the company is facing a bit of pricing pressure from competitors for rent.
  • The general economic outlook is unpredictable.

In conclusion, PECO is a solid company with an established business model. It operates in an industry that has a long history, and it is expected to continue to be stable. However, the company has few competitive advantages, which means that investors should be careful about how much they pay for shares. Its solid financials are a big plus, which helps give it a stronger position than competitors. Management is also good, but it is only one component of overall strategy, and has a smaller impact on the value than people tend to think.