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National Retail Properties (NYSE:NNN)

Q3 2013 Earnings Call

November 05, 2013 10:30 am ET

Executives

Craig MacNab - Chairman and Chief Executive Officer

Kevin B. Habicht - Chief Financial Officer, Principal Accounting Officer, Executive Vice President, Treasurer, Assistant Secretary, Director, Director of CNL Commercial Finance Inc. and Director of Commercial Net Lease Realty Services Inc

Julian E. Whitehurst - President and Chief Operating Officer

Analysts

Daniel K. Altscher - FBR Capital Markets & Co., Research Division

Richard C. Moore - RBC Capital Markets, LLC, Research Division

Operator

Greetings, and welcome to the National Retail Properties Third Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Craig MacNab, Chairman and CEO for National Retail Properties. Thank you, Mr. MacNab. You may begin.

Craig MacNab

Yes, LaTonya, thank you very much. Good morning, and welcome to our third quarter 2013 earnings release call. On this call with me are Jay Whitehurst, our President; and Kevin Habicht, our Chief Financial Officer, who will review details of our third quarter financial results following my opening comments. Also, Kevin will update you on this year's guidance, plus provide some of the key assumptions in our 2014 guidance.

We have just completed another consistent, predictable quarter at NNN. As indicated in our press release, we are projecting a third consecutive year of excellent FFO per share growth. Equally importantly, we're also guiding towards steady growth in 2014, helped by the net lease retail acquisitions as we've already made this year, as well as those that we are anticipating making in the next several quarters.

In the third quarter, we acquired 35 properties, investing $90 million at an initial cash yield of approximately 7.7%. When the rental growth from these properties kicks in, we will receive an average yield from these acquisitions that will be approaching 9%. We acquired these properties from 13 different tenants, and each one of these tenants is what we describe as a relationship tenant. Thus far this year, we have acquired $570 million of acquisitions at an initial cash yield of 7.89%, which yield steadily improves each year with our annual bonds of 1.5% to 2%.

We are pleased to have again maintained a healthy balance this year between very accretively growing our portfolio without chasing some of the acquisitions that could have been made at low [audio gap] gap yields, which barely move the needle in terms of building shareholder value.

Finally, we continue to avoid acquisitions that do not have contractual rental growth.

In the third quarter, our in-house disposition team was a little more active than normal as we sold 22 properties realizing $36 million. The average cap rate from this capital recycling was right at 7%. Interestingly, we sold one of the SunTrust pools that we had purchased in the second quarter. This pool was 18 properties and generated a nice gain for us.

Our fully diversified portfolio continues to be almost fully occupied and is now 98.1% occupied. Within the portfolio, a very positive development is that many of our tenants have been or in the -- are in the process of being acquired by large investment-grade companies. This was very gratifying as it suggests to us that our selective acquisition effort in identifying well-managed retailers that operate well-located stores, where we are obtaining excellent yields, which have built in rental growth of 1.5% to 2% per annum. Examples of what I'm describing are evident when you review our top tenant list, which now includes 7-Eleven, and Energy Transfer Partners, otherwise, Sunoco, following the acquisition of 2 of our C store tenants.

Another meaningful new tenant for us is Lowes, which acquired Orchard Supply on the West Coast. And soon, Advanced Auto will be a tenant when they complete their pending acquisition of Genuine Parts next year. Obviously, we are delighted that these properties are now worth a lot more than when we purchased them.

National Retail Properties continues to be very well-positioned. We have 0 outstanding on our line of credit. Our balance sheet is a strong as it's ever been. Our portfolio is in excellent shape, and we're looking forward to another consistent predictable year in 2014. Kevin?

Kevin B. Habicht

Thank you, Craig. And I'll start with my usual cautionary statement that we will make certain statements that may be considered to be forward-looking statements under Federal securities law. The company's actual future results may differ significantly from the matters discussed in these forward-looking statements, and we may not release revisions to these forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in this morning's press release.

With that, this morning, we reported third quarter FFO of $0.49 per share, and AFFO of $0.50 per share. For the first 9 months of 2013, we reported FFO of $1.41 per share and $1.42 per share of recurring FFO. These strong results allowed us to both increase our common dividend during the third quarter and push our dividend payout ratio down to 81% and mark 2013 as an NNN's 24th consecutive year of increases in our annual dividend paid to shareholders. Additionally, we raised the bottom end of our 2013 FFO guidance range and introduced 2014 FFO guidance that is projected to result in 4% per share growth at the midpoint of our guidance ranges, which I'll discuss more in a minute.

As usual, these third quarter strong results were a combination of maintaining high occupancy and making new accretive investments, while keeping our balance sheet more than strong. Occupancy was 98.1% at quarter end. That's flat with prior quarter and up 20 basis points from a year ago. And as Craig mentioned, we completed $90 million of accretive acquisitions in the third quarter. Over the past 2 years, the last 8 quarters, we have acquired over $1.6 billion of properties while improving our balance sheet metrics and lowered our dividend payout.

A few details on our third quarter results. Compared to 2012 third quarter, rental revenue increased $15 million or 18% primarily due to the acquisitions made over the past 4 quarters. Property expenses net of tenant reimbursements for the third quarter totaled $1.3 million, and that compares with $1.2 million in the immediately prior second quarter, as well as the prior year third quarter.

G&A expense decreased to $7.5 million in the third quarter. The decrease is largely attributable to lower incentive compensation expense. We currently project full year 2013 G&A expense to be approximately $33.8 million. But big picture bottom line on this quarter's results are that core fundamentals, occupancy and rental revenue expenses are all performing well with no material surprises or variances.

As I mentioned, this morning, we also increased -- announced an increase in the bottom end of our 2013 FFO guidance by $0.02 to a range of $1.88 to $1.90 per share, and that translates into a range of $1.96 to $1.98 per share for AFFO. We now see total acquisitions for 2013 coming in at about $600 million to $650 million. There are no other meaningful assumption changes in that guidance. The midpoint of our new 2013 guidance produces an 8.6% increase in recurring FFO per share compared to 2012.

Despite the fact that 2013's results are on top of 8% growth in each of the prior 2 years, 2011 and 2012, as we've noted in the past, that 8% growth in per-share results is likely not a long-term sustainable per share growth rate for us nor, frankly, the vast majority of REITs for that matter.

Our initial 2013 guidance, I'll point out, made a year ago, was for 3% growth in recurring FFO per share. We increased that guidance in each of the past 3 quarters as acquisition visibility grew, and capital markets execution was completed.

In terms of noncash adjustments bring estimated 2013 AFFO result to $1.96 to $1.98 per share, with the primary AFFO adjustments being the noncash interest expense on our convertible debt and noncash stock-based compensation expense. We remain 1 of few REITs that produced AFFO that is higher than our reported FFO.

As I mentioned this morning, we also announced initial 2014 guidance of $1.94 to $1.99 per share, and AFFO of $2 to $2.05 per share. Hitting the midpoint of our 2014 guidance will represent 4% growth over 2013's FFO per share guidance midpoint. The primary notable assumptions in our 2014 guidance include $300 million of acquisitions, G&A expense of $33.4 million, no change in occupancy, $1.5 million of mortgage, commercial mortgage residual interest income, and that compares to $2.3 million in 2013, and $400,000 of lease termination fee income versus approximately $1.2 million in 2013.

Now turning to our balance sheet. After a busy first half of the year in the capital markets, we were able to stand aside in the third quarter when capital markets got more volatile and less friendly. For the cash on hand, we paid off all $223 million principal amount of our 5 1/8 convertible notes during the third quarter.

If you look at our September 30, 2013 leverage metric, total debt to total gross booked assets was 34%, and that compares with 39% at the beginning of the year. And we have full availability at quarter-end of our $500 million bank credit facility. Debt-to-EBITDA was 4.2x for the quarter. Interest coverage was 4.4x during the third quarter, and fixed charge coverage was 3.0x. Only 6 of our 1,850 properties, well under 1%, are encumbered by mortgages, totaling under $10 million. So despite the significant acquisition activity over the past 2 years, our balance sheet remains in very good shape.

And just if you step back and look at 2013 capital markets activity, we have effectively financed 100% of our $518 million of net acquisition year-to-date. The would be the $570 million of acquisitions less $52 million of dispositions. We financed that $518 million of net acquisitions with permanent capital, common equity of $250 million and preferred of $277 million. Yet, we were still able to guide to 8% FFO per share growth this year despite all this new permanent capital used to fund the acquisitions.

Additionally, this has left our balance sheet with the opportunity for growth in the coming quarters. We're in this for the long haul. Sometimes taking care of the long-term comes at the expense of the short-term, but in 2013, we have been able to achieve both short-term and long-term objectives in a strong fashion.

So 2013 is on track for another great year. We're positioned well to make 2014 another good year. We've not used this environment to push our leverage metrics higher, and our payout ratio's higher. To the contrary, we're using this favorable environment to grow per-share results while preserving capacity for future growth. We continue to believe we are well-positioned to deliver the consistency of results, dividend growth and balance sheet quality that have supported the track of absolute and relative total shareholder returns for many years.

With that, LaTonya, we will open it up to any questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Daniel Altscher with FBR.

Daniel K. Altscher - FBR Capital Markets & Co., Research Division

Kevin, I had a question about the guidance, and I apologize, but -- if I missed it. But the $300 million of acquisitions, A, is that a growth number, or is that net of dispositions? And also, can you give us a flavor on what maybe the cap rate assumptions might be?

Kevin B. Habicht

Yes. No, that is a gross number. We always pencil in some disposition activity. I think only in our guidance, we probably have $20 million or $30 million. So it's not a big number. So the $300 million is gross acquisitions. And our cap rate guidance for next year is in the low 7s.

Daniel K. Altscher - FBR Capital Markets & Co., Research Division

Great. And then maybe just a kind of higher-level, big-picture question for Craig. I mean, obviously, there's been a continuation of, I guess, inorganic or consolidation happening in the industry. Maybe it's not akin to any strategy, but just wondering how you think about that going forward. Is this going to be -- continue to be a consolidation industry, and are we going to see the big get bigger?

Craig MacNab

Daniel, it's an interesting question for us because we have watched it from the sidelines, so you probably need to ask those people. But I would say the following, that we obviously take a look at all of the deals that are out there, and National Retail properties continues to remain selective and disciplined about building shareholder value over, as Kevin mentioned a moment ago, a multi-year time line. For us, we're going to continue to focus on net lease retail, where we prefer the risk-adjusted returns. Also, I may add that our team has considerable domain expertise and knowledge of retail. We think that's important. Let me just say 1 or 2 more things. We think acquisitions, which contained built-in rental growth, are much more preferable to those that have no rental growth. And by the way, those are frequently investment-grade tenants. And then finally, we think that the quality of the real estate is important. We do visit and underwrite each and every acquisition we make. And of course, this is time-consuming and involves considerable travel, but I would point out that we're in the real estate business and we think it is location that ultimately matters, not the type of lease that you may have. I have no doubt that consolidation is going to continue to occur, and we hope that, that leads to the promised land.

Daniel K. Altscher - FBR Capital Markets & Co., Research Division

And then maybe just a quick follow up also. Craig, I think you mentioned also Orchard Supply and Genuine Parts getting acquired by, I guess, some bigger tenants, and that the properties now are worth a lot more than when we purchased. Can you just give us a little bit of a flavor as to what you meant there? Maybe numerically, have you done recent broker opinions to show that, I mean, what the potential unrealized gains, if you will, would be on those?

Craig MacNab

I'm sorry, I should have perhaps been a little clearer. With both of those tenants being Conquest, Genuine Parts, same company, and then Orchard Supply on the West Coast, at the time we purchased those, we -- our initial cap rates were in the 8% range, and that applies to those types of tenants. Obviously, Lowe's credit is very highly valued, and we have had some calls offering us in the 5% range for the properties that we now have with Lowe's credit on them. So the value creation is quite significant. The Advance Auto deal has not closed yet, so I can't speak to that one. But obviously, we could sell, if we chose to, some of those Orchard Supply properties at really low cap rates. Now we like the real estate in the first place, and frankly, the real estate just continues to get better. So we're going to stay with those, probably.

Operator

[Operator Instructions] Our next question comes from Rich Moore with RBC.

Richard C. Moore - RBC Capital Markets, LLC, Research Division

I'm curious, Craig. You were talking about real estate on those Genuine Parts and Orchard supply locations. Were you thinking in the beginning that those were 5% sort of locations, or is -- does the tenant help out a bit here, the fact that you got a credit tenant, make it seem more valuable, more from the lease standpoint, I would think, I guess, as opposed to the real estate standpoint?

Craig MacNab

Yes, Rich, thank you. A fair comment, and I think there are 2 things, just as a reminder. Your comment about the lease is very legitimate and valid. And just as a reminder, in general, Lowe's properties that are out there have no rental growth. So just like many investment-grade companies, the lease that you get -- the return that you get at day 1 is the same as the return you get at the end of the primary term of the lease. Pick a number, 15 years. In both of those tenants, or certainly, in the case of Orchard Supply, we have put nice growth over the duration. In addition, by virtue of this transaction, we have a meaningful credit upgrade. And I think that the big point that I'd like you to think about is that we are out there being very selective, looking to identify companies that, one, do business in good locations; two, are well-managed companies that, over time, are going to succeed. And I was just pointing out that in the recent past, we've had some success in executing that strategy.

Richard C. Moore - RBC Capital Markets, LLC, Research Division

All right, good. I got you. Now on the SunTrust portfolio, you had, I think, 18 assets you sold in the quarter. Was that a part of your original strategy, to get rid of those 18, or did that -- something special come up this quarter that you just couldn't resist?

Craig MacNab

We had an opportunity to do it. I think the thing that I'd focus on if I were you, is that clearly, given the amount of the gain and the cap rates difference between that which we purchased it at, and that which we could sell it less than 90 days later, just shows that National Retail Properties continues to be selective and identifies well-priced acquisitions. I got an e-mail from one of our investors in the last couple of days asking whether we are going to participate in this mud pie-eating contest, and it's sort of gets to Daniel's question a moment ago. I think what you've seen National Retail Properties do is remain selective and disciplined, and let's hope we could stick to that, Rich.

Richard C. Moore - RBC Capital Markets, LLC, Research Division

Okay, all right, good. And I think, Craig, there's no more of the SunTrust portfolio you're looking to sell, that was kind of the piece?

Craig MacNab

Yes, sir.

Richard C. Moore - RBC Capital Markets, LLC, Research Division

Perfect. Then one last thing I have for you guys. The -- on the acquisition side of things, maybe you could give us your thoughts on what you see out there, I guess, in terms of volume. But also, do you -- a lot of these guys are chasing the portfolio side of the equation. I'm wondering if you're shying away from portfolios in favor of one-off transactions because all these guys are out there hunting for the portfolios?

Julian E. Whitehurst

Rich, hey, it's Jay Whitehurst. I'll take this one. We -- I think, first and foremost, the -- our pipeline of relationship deal remains very strong. And so we are very comfortable with our off-market, if you will, pipeline of deals for the future, and we see all of the other deals. So I wouldn't say that we shy away from them, Rich. We look at them and evaluate all of them. But at the end of the day, to reiterate what Craig has said, we are going to be very selective about the ones that we pursue because we're going to look for real estate quality, a good business operation and rental growth.

Operator

[Operator Instructions] There are no further questions in queue at this time. I would like to turn the call back over to Mr. MacNab for closing comments.

Craig MacNab

LaTonya, thank you very much, and we appreciate all of you participating. We understand this is the height of earnings season. And the good news is we're going to have an opportunity to meet you in person with several of you up in San Francisco, at NAREIT. Thanks very much, and we look forward to talking to you in the near future. Much appreciate it.

Operator

Thank you. This does conclude teleconference. You may disconnect your lines at this time, and thank you for your participation.

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