National Retail Properties: Dividend Stock Analysis

| About: National Retail (NNN)

National Retail Properties, Inc. (NYSE:NNN) is a publicly owned equity real estate investment trust. The firm acquires, owns, manages, and develops retail properties in the United States. National Retail Properties is structured as a REIT, which means that all profits, gains and losses, flow-through and are taxed at the individual investor's level.

This dividend achiever has managed to boost dividends for 23 years in a row. It prides itself for being one of 104 companies in the US, out of 10,000, which have managed to achieve that. Over the past decade, this REIT has managed to boost distributions by only 2.10%/year. Even the latest distribution hike in 2012 was for a meager 2.60%, to 39.50 cents/share. This is below the rate of inflation, and thus could expose investors eroding purchasing power of income over time. On the positive side however, National Retail Properties was one of the few REITs that did not cut distributions during the financial crisis of 2007 - 2009.

Investors can sign up for National Retail Properties' DRIP plan, by investing as little as $100. The beauty of this plan is that dividends are reinvested at a 1% discount, which allows for a much faster compounding of distributions. The REIT has managed to sell $93.50 million worth of shares using this plan in 2011. This is good from a liquidity perspective, since it allows cash to remain available for what the REIT seems fit. In comparison, in 2010 and 2009 National Retail Properties attracted $17.60 million and $67.30 million respectively from DRIP investors. DRIPs are more difficult to manage at an individual level, particularly investors who own more than 20-30 individual stocks, and could be a pain if good records are not kept. Check this listing of companies offering drip discounts.

The company focuses on single-tenant properties, under a triple-net lease. These properties are leased by large recognized retailers. Under a triple-net lease, the tenant is responsible for paying property taxes and ongoing operating expenses associated with the property. The lessor receives a base rent amount, with clauses for rent increases over the course of a contract based on inflation and store sales above certain thresholds. This provides for a very stable source of revenue. A few of the company's competitors include Realty Income (NYSE:O) and W.P. Carey (NYSE:WPC).

The company acquires single tenant properties, with 15 - 20 year leases. Its average remaining lease is currently 12 years. Properties are selected based on location, and the REIT has found that main street locations have better rent increase potential and also make it easier to find replacement tenants. National Retail Properties owns 1530 properties in 47 states in the US. Management expertise in selecting properties and tenants has resulted in pretty consistent occupancy ratios between 97% - 98%. The only exception occurred in 2009, when occupancy declined to 96.40%, mostly due to the financial crisis. This is helped by the fact that the REIT likes to build long-term relationships with managements of growing retail operations, and also is more focused on established locations and analyzing credit and business operational risks in properties.

Future growth could come from strategic acquisitions of properties, increases in rent and keeping occupancy levels high. The company made acquisitions worth $238 million in 2010 and $767 million in 2011 at average cap rates of 9.5% and 8.40%. As of Q3 2012, National Retail Properties had made acquisitions worth $431 million at an average cap rate of 8.40%.

Some of the risks behind National Retail Properties are related to rising interest rates, and a decline in portfolio occupancy. The company sold ten year unsecured notes at 3.98% in Q3 2012, which was a very good rate. In comparison, in July 2011, the company issued $300 million worth of ten year notes at a 5.50% yield. However, if interest rates were to go up due to general increase in benchmarks or due to debt downgrades, the company would earn much less on the spread between cap rates and interest cost of capital. Since REITs typically sell bonds and stocks in order to grow their asset base, increase in the cost of capital could make growth tough to come by and might also threaten existing business, if debt has to be refinanced at much higher rates. On the positive side, the debt maturities are well-laddered, with $150 - $200 million maturing every year between 2013 and 2017. After that, in 2021 and 2022 $300 million in debt matures each year.

A decline in portfolio occupancy is another risk that the company is facing. The risk is mitigated by the company's careful evaluation of each property and the analysis of tenants that would lease it for 15 - 20 year periods. However, if the economy experiences another recession, a portion of their tenants might have to break the leases. While tenants that look good today might be in dire conditions a decade from now, the fact that properties are located at attractive main street locations, would mitigate risks of excessive decrease in portfolio occupancy, as it would be easier to lease an attractive location. In addition, the company also tried to dispose of locations that it no longer deems fit for its strategic portfolio.

The company has less than 5% of leases expire each year through 2021. Looking at the past five years' worth of lease expiration activity, 87% of leases had been renewed. 59% of these had been renewed at higher rents, 26% at lower rents while the remaining 15% had been renewed at same rents.

The following fifteen tenants represent over 50% of National Retail Properties' rental income:

Because it is structured as a REIT, any income, gains and losses are not taxed at the entity level, but flow through proportionally to the individual shareholder's tax returns. For 2012, most of the distributions (77.71%) was taxed as ordinary income, while 17.77% was classified as a return of capital, which is nontaxable. The remaining 4.50% was taxed as capital gain distribution.

In general, I find REITs to be an alternative for individual investors compared to renting out individual properties. It is much easier to own a REIT, which owns and operates a diversified portfolio of properties, than tie-up large amounts of cash in a few individually owned locations. In addition, you would never receive the proverbial 2 AM call by tenants if you owned a REIT; if you owned a single property, then the chances of such a call increase dramatically.

Overall, I like what I found about National Retail Properties in general. One thing that I like to calculate is distribution coverage, in order to determine whether the dividend is sustainable. For REITs, the typical indicator used is Funds From Operations (FFO).

FFO is calculated as follows: net earnings (computed in accordance with GAAP) plus depreciation and amortization of assets unique to the real estate industry, excluding gains (or including losses) on the disposition of certain assets and National Retail Properties' share of these items from National Retail Properties' unconsolidated partnerships and joint ventures.

However, when I tried to find comparable FFO values over the past five years, I noticed that the company never provided this information on a per share basis in a consistent format. For example, FFO listed in the 2011 annual report is $1.57/share. The FFO listed in the 2010 report is at $1.45/share. However, the 2009 report discussed AFFO of $1.65/share, therefore eliminating any comparability to the 2008 report, which listed FFO of $1.99/share. I realize that the 2007 - 2009 recession made it very difficult on REITs to cover their dividends well. I also praise the firm for maintaining distributions at a very difficult time. However, the fact that FFO is not comparable and does not agree to prior year reports, mostly due to changes in the formula for calculating FFO looks like cheap trickery to me. This is not accounting wrongdoing, as FFO is not a GAAP term, and financial statements have been certified by E&Y, but it is very confusing for the person who reads financial statements. You can view the annual reports from this link.

The FFO payout has ranged dramatically over the past five years. Based on estimated FFO/share of $1.71 - $1.73 and annualized dividend of $1.58/share, the forward FFO payout comes out to roughly 91.30% - 92.40%, which is still rather high.

Year 2011 2010 2009 2008 2007 2006
Dividends Paid to Shareholders 133,720 125,391 120,256 110,107 92,989 76,035
Diluted Funds from Operations 139,665 108,328 89,506 132,996 110,589 86,749
FFO Payout Ratio 95.74% 115.75% 134.36% 82.79% 84.09% 87.65%

This is the data from the 2009 annual report:

Year 2009 2008 2007 2006 2005
Dividends Paid to Shareholders 120.256 110,107 92,989 76,035 69,018
Diluted Funds from Operations 90,087 142,355 121,602 96,416 81,803
FFO Payout Ratio 133.49% 77.35% 76.47% 78.86% 84.37%

At this point I view National Retail Properties as a hold that could be attractive on dips. The slow distribution growth is something that does not look very appealing at this point, particularly given the high payout ratio. The yield chasing crowd has taken the stock price to multi-year highs, and could probably go as high up as $39 - $40/share, for a yield of 4%. That being said, I might be interested in purchasing some shares of National Retail Properties on dips below $29 /share. I would be particularly interested in National Retail Properties on dips below $26/share.

Disclosure: I am long NNN, O. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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