This article is a follow up to my original article on National Retail Properties (NYSE:NNN) dated September 3, 2013. There was much to be considered about the investment merits of the company and its stock and I did so in that eight-page article. Whereas I was bullish about NNN's fundamental-growth prospects, I was not willing to buy the stock at that time because of technical weakness in the stock's price chart. The price of NNN at that time was $31.50.
In this article I will present (1) a summary of NNN's fundamental investment merits (which have not changed) followed by (2) some comments relating to the current status of commercial real estate markets and then conclude by (3) stating my reason for buying some shares on Wednesday, September 25, at $31.40.
Re: Fundamental Overview
NNN is one of the best managed companies within the REIT universe. Its corporate development program has three stated goals: (1) to achieve consistent and recurring FFO growth, (2) to pay a secure and increased annual dividend to the shareholders, and (3) to achieve those results while taking below-average lease portfolio and balance sheet risks.
Blessed with a rapidly growing portfolio of properties that are 98% leased under long term contracts, most of NNN's earning power is recurrent and locked in at the beginning of each new year. Hence, management's continuous job is to grow FFO by coping with economic conditions as they evolve and managing the real estate portfolio by writing new leases while disposing of non-core properties.
Quarter after quarter, NNN has shown that it can source attractively priced and well underwritten leases at an initial yield comfortably in excess of their cost of capital. The volume of new leasing activity during each last-four-quarter period has a big influence on the size of the YOY incremental gain in FFO that it realizes in each coming quarter, as it annualizes the recurrent contribution from the previous quarters.
NNN also has a fortress balance sheet and management continues to find ways to expand and/or strengthen it.
So without having to cope with major legacy lease-portfolio or balance-sheet problems, with each passing year management is in a recurrent position of writing new leases, disposing of non-core assets, and tweaking the balance sheet while growing FFO and increasing the dividend.
Re: Growing FFO
In Q2, the acquisition team acquired 209 properties and thereby invested $438 million at an initial cash yield of 7.7%. The deals were finalized in 23 separate closings at an average purchase price per property of $2.1 million, which management considers the sweet spot. The largest transaction was the purchase of 139 southeastern bank branches leased back to the SunTrust Bank, making it one of NNN's largest tenants. It paid some $1.7 million per branch, which management figured was about 75% of replacement cost. This $237 million acquisition will contribute significantly to recurrent FFO for many years to come.
For the first half of 2013, FFO was $0.92 per share, an 8.2% increase over 2012's $0.85 per share. Compared to 2012's second quarter, rental revenue increased $15 million (19%) primarily due to the acquisitions made in 2012. The in-place annual base rent as of June 30 was $391 million at an annual run rate. Property expenses net of tenant reimbursements for the second quarter totaled $1.2 million and that sum has been ticking down for several quarters.
Re: THE BALANCE SHEET
Management used the recent low interest rate environment to strengthen the balance sheet and reduce leverage to build financing capacity for future growth. In Q2 it raised $877 million of attractively priced long-term capital that included $255 million of common equity, $278 million of 5.7% perpetual preferred, and $344 million of 3.3% fixed rate 10-year debt (down from the 3.8% that it paid on $325 million of 10-year debt last year.)
So far this year, there was a net $69 million decrease in debt. Management also called for redemption the $223 million principal amount of 5.08% convertible notes. The notes will be paid off with cash in Q3 and any premium over par will be paid in common shares. The $480 million of acquisitions made through Q2 were funded by using only permanent capital, that being common and preferred equity. While de-leveraging was a restraint on near-term per share results, it was prudent to raise more rather than less capital than currently needed because of the attractive terms and thereby focus on the long-term rather than the near-term.
Despite significant acquisition activity during the last two years (about $1.8 billion,) NNN's balance sheet is in a very good shape. On June 30, total debt net of cash to total gross book assets was 33.7%; that compares with 39.0% at the beginning of the year. Debt net of cash to EBITDA was 4.4 times for the quarter. Interest coverage was 3.7 times and fixed charge coverage is 3.0 times. These are very conservative coverage ratios. Only six of its 1,838 properties are currently encumbered by mortgages. And it has full access to its $500 million bank credit facility. Financially, the company is well positioned to deliver attractive absolute and relative total shareholder returns in coming years.
Re: FFO Estimates and the Dividend
In Q3 the dividend rate was increased by a penny to 41 cents per share. Nine analysts follow the stock and their consensus estimate of FFO for 2013 is $1.89, up 8.4% from 2112's $1.74. Their consensus estimate for 2014 is $2.02. The indicated dividend payout of $1.64 is 87% of the 2013 FFO estimate. At $31.40, the stock is priced at 16.4 and 15.5 times the FFO estimates for 2013 and 2014, respectively. The current indicated dividend yield is 5.2%. The next ex-dividend date is on or about October 29.
Re: Commercial Real Estate in a Slow Growth Economy
With the slow growth being experienced in the U. S. economy, these are not the best of times for the REITs. According to the National Association of Realtors, about 10% of all retail store square footage is vacant at this time. But it isn't just the retail sector that is being adversely affected. The industry trade group forecasts vacancies of more than 15% for office buildings and 9% for industrial buildings for the remainder of 2013. The sluggishness is expected to continue until there is significant improvement in the general economy.
Data from Jones Lang LaSalle (NYSE:JLL), a company that is involved in many commercial real estate activities, shows that vacancies in major retail markets vary greatly based on the type of real estate asset.
The vacancy rate (10.3%) is highest among shopping center properties; they make up more than a third of the totals in major markets. The lowest vacancy rate (4.7%) exists among single-tenant properties. Among all types of commercial real estate, single-tenant freestanding properties are typically leased on 10-20 year contracts and the properties are usually customized to fit a particular kind of business. NNN is single-tenant and it owns better quality real estate than the national average. And with 98% of its lease portfolio committed to long term leases, it is not being adversely affected significantly by the sluggishness in the economy.
Re: The Stock's Technical investment Merits
The price chart shown below was constructed from data in my workbook.
(1) The bold black line on top is price and the bold pink line below it is relative strength. (2) The three dotted lines (black, blue, and red) are moving averages and there is a set of those for price and a similar set for relative strength. They are used to define trends and detect trend reversals. (3) The 5 sets of gray parallel lines and the 10 sets of orange parallel lines (the two overlap half of the time) that frame the price action are 22-day and 11-day trading ranges. Their progression shows how the trading ranges shifted during the 110 days charted. And (4) the two wavy-blue hashed lines that straddle the price line are Bollinger Bands. They are used to detect overbought or oversold situations.
Any of the items listed as (2) or (4) is independent of the others and it could be considered as a valid technical indicator for making buy or sell decisions. But in order of importance, the moving averages are of primary importance while the trading ranges and the Bollinger Bands are of secondary and tertiary importance, respectively.
During the first 22 days of the 110 days charted (and for the 88 days, or four months, prior to that) NNN and the REITs as a group outperformed most industry groups in the market by a wide margin. Since peaking four months ago, they grossly underperformed the market and most major industry groups. While the market as measured by the popular averages peaked when the REITs did, it rallied after a brief sell-off and went on to make new highs for the year. It backed off in recent days but is still trading near its high. NNN and many other REITs couldn't sustain their attempted rally and are now priced at or near their lows for both the five months charted and 2013 to date.
During the past 22 trading days, as shown on the chart, the price action of NNN was such that (1) the price line is now on the verge of completing a reversal of its moving average trend lines, (2) the relative strength line also shows improvement and the stock could start to outperform the market instead of underperforming it as has been the case, and (3) the trading range is on the verge of shifting upward. Stocks tend to trend upward and collapse downward. The narrow trading range that existed during the past 22 days is indicative of a bottom, especially so if NNN can hold above $32.00 for the next few days.
I was reluctant to buy NNN at $31.50 when I wrote my original article on September 3 because there was no indication where the bottom might be. And as an investor, I want to have the bottom of the price chart behind me when I buy a stock. If it was to be in front of me I would be stuck with a paper loss for buying too soon. For reasons explained in the preceding paragraph, I am now willing to speculate that NNN is making a bottom on its price chart. So I took a small position in the stock and I intend to add to it in the days ahead as the price chart shows strength.
I am well aware of the fact the country has significant economic and possibly explosive political problems. And, the market levitated upward to where it is now due, in good part, to the policies of the Fed which may soon be diminished. But as an investor I have to cope with the situation extant and not some salubrious investment climate that I would prefer. Nevertheless, buying shares of NNN was the right decision for me to make at this time.
I have not been ordained to preach so I am not going to pound the table and tell you (the reader) that you must do as I do. I just wrote the article on a company I think has considerable investment appeal and told you what I am doing with the stock. It is up to you to discount what I wrote as you see fit and make your own decision according to your personal investment criteria.
Disclosure: I am long NNN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.