National Retail Properties (NYSE:NNN)
Q2 2016 Results Conference Call
August 02, 2016 10:30 AM ET
Craig Macnab - CEO & Chairman
Jay Whitehurst - President
Kevin Habicht - CFO
Landon Park - Morgan Stanley
Nick Joseph - Citigroup
Rob Stevenson - Janney Montgomery
Vineet Khanna - Capital One Securities
Josh Dennerlein - Bank of America Merrill Lynch
Tyler Grant - Green Street Advisors
Greetings and welcome to the National Retail Properties Second Quarter 2016 EarningsCall. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded.
I would now like toturn the conference over to your host, Mr. Craig Macnab. Thank you. Youmay begin.
Good morning and welcome to our second quarter earnings release call. On this call withme areJay Whitehurst, our President and Kevin Habicht, our Chief Financial Officer, who willreview details of our second quarter financialresults, following my brief opening comments. We are pleased to have produced another consistent strong quarter at National Retail Properties with continued predictable per share growth. Also we are delighted to be raising our dividend, which will make this our 27th consecutive year of increased dividends.
I would like to point out that our dividend remains very well covered by portfolio cash flow as Kevin will further describe. In the second quarter, we were very active growing our retail portfolio by investing $344 million at an initial cash yield of 6.9%. These acquisitions were all within our primary, retail lines of trade with noticeable activity taking place within the restaurant sector.
We’ve continued to remain highly selective in making acquisitions with our due diligence colleagues keenly focused on real estate metrics as they visit each and every property that we acquire. Field flow for quality acquisitions continues to be solid and of course our access to capital and the cost of net capital has seldom been more attractive.
The average lease duration for properties acquired in the second quarter is just over 18 years. Based on our current visibility, acquisitions in the second half of the year look good although not as robust as in the past six months. As a result, we are raising our acquisition guidance for 2016 to a range of $650 to $750 million. As a reminder, acquisitions in the first half of the year had more impact on calendar year results than acquisitions that closed in the months ahead.
Our fully diversified portfolio is in outstanding shape and we remain 99.1% leased. In general, our tenants continued to perform to our expectations. The convenience stores or sector has recently had the wind in their sails with lower gasoline prices which has led to wider than normal margins at the pump. After many years of positive same store sales growth, restaurants are all competing for market share in an environment of slightly growing sales however, their ability to pay our rent remains very good.
At a higher level, we’re encouraged about the outlook for consumer spending. If jobs keep getting created, at almost 200,000 per month and wages slowly creep higher, consumers will have more disposable income which results in modestly higher consumer spending which benefits all of our tenants.
This year, we’ve utilized our ATM consistent with our capital market strategy which includes tapping the markets when capital is available and well-priced. The amount of our equity issuance has occurred slightly earlier in the calendar year than we had budgeted. However, maintaining a strong balance sheet is integral to our goal of generating attractive per share growth rates over a multi-year timeframe. Kevin?
Thanks Craig. As usual I’ll start with our usual cautionary statements that we will make certain statements that may be considered to be forward-looking statements under Federal Securities Laws, 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 those 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 out of way, headlines from this morning’s press releaseannouncing second quarter results include reporting a 7.3% increase in core operating results per share, completing $344 million of new investments, while maintaining a low leverage profile and strong balance sheet liquidity. We believe these metrics and results compare favorably within the REIT industry and they are an important part of supporting our strong total shareholder return over the years.
Getting into some of the results, we reported second quarter core FFO of $0.57 per share and that represents a 7.3% increase over prior year results. But just so you know what we previously labeled recurring FFO is now being called Core FFO, which we think better describesthe term, but our definition and use of the metric is unchanged. Our AFFO per share increased 7.1% to $0.60 per share and our AFFO dividend payout ratio continues to drift slightly lower to 72.5% in the second quarter but will pick-up slightly going forward given our recently announced 4.6% increase in our third quarter dividend, which puts us on a path to make 2016, the 27th consecutive year of increases in our annual dividend per share.
Occupancy continues to hold up well. Craig noted ending the quarter at 99.1% and as of June 30, 2016, the annual base rent for all leases in place at quarter end was $517 million. We had strong acquisition pace of $469 million in the first half of 2016 with $344 million of that coming in the second quarter.
We have maintained our FFO guidance of 231 to 236 per share will suggest 5% growth to the mid-point compared to 2015 results. And we’ll know, we did increase our guidance last quarter.
Our current guidance is based on the assumptions, which are included in our press release and they include 650 million to 750 million of acquisitions in the high 6 cap range, G&A expense of $35.5 million to $36 million plus $700,000 of real estate acquisition transaction costs, $1.8 million of mortgage residual interest income, property expenses net of tenant reimbursements of about $5.5 million and lastly, property dispositions of $85 million to $100 million.
As usual, we don’t give guidance on our capital markets plans, but you should expect our behavior will remain consistent with the past 20 years, meaning, we’re going to maintain a conservative balance sheet, conservative leverage profile and we’re going to get capital when it’s available on the growth price. And all this based in a multi-year view not a quarterly view of managing the company in our balance sheet.
Turning to the balance sheet, during the second quarter we raised $128 million of common equity primarily through our ATM and for the first half, we raised $216 million with common equity. So if you take that $216 million of common equity, we also added $72 million of property disposition proceeds and $45 million of what I called retained AFFO after all dividend. That provides $333 million of total equity equivalent proceedsto fund 71% of our $469 million of first half acquisitions. We just want to remind investors we’re not generating per share growth by using more leverage. At quarter end, we had a 147.3 million outstanding on our $650 million bank credit facility which is our only floating rate debt. So we remain very well positioned from a liquidity perspective.
[Excluding] bank line, our weighted average debt maturity is 6.5 years with a weighted average interest rate of 4.5%. And [debt] maturity is 250 million of 6.875 percent notes that comes due in October of 2017. Now the balance sheet remains in great position to fund future acquisitions and weather potential, economic and capital markets term loan.
Looking at the June 30, 2016 leverage metrics, debt to gross book assets was 33.3% flat where we started the year. Debt-to-EBITDA was 4.6 times at June 30th. Interest coverage was 4.7 times for the second quarter and the first half. Fixed charge coverage was 3.4 times for the second quarter and the first half. Only six of our 2,452 properties are encumbered by mortgages totaling $17 million. So 2016, operating results look like they’ll continue to trend the recent years. We’ve been reminding investors of some of our distinctive which largely come from maintaining a consistent strategy for 20 plus years. We remain focused on a single property type; we believe retail properties offer better risk adjusted returns over the long-term compared to other single tenant net lease property sectors.
Additionally, our core competency and long track record is in retail properties. We’ve always maintained a conservative balance sheet profile and don’t plan to change that. We like the optionality of flexible balance sheet created, especially if the capital markets become less friendly.
And we’ve chosen not to use meaningful amount of short-term debt and/or variable rate debt using meaningful amount of that type of capital surely helps per share results in the short run but creates risk over multi-year horizons and that doesn’t seem prudent to us especially when long-term capital is so well priced.
So our strategy that we’ve been consistent for many years, our overwriting goal remains to grow per share results and manage our balance sheet on a multi-year basis and we think if we do this we’re optimistic, we’ll be able to perpetuate our 27th consecutive year track record of raising our dividend which has been an important part of consistently outperforming REIT equity indicesand general equity market indices for many years. With that, we will open it up for any questions.
Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Landon Park with Morgan Stanley. Please state your question.
Hi guys congrats on another solid quarter. Just had a few questions on some of your top tenants. I was wondering if you can give us an update on what’s happening on the SunTrust portfolio and we also saw there were a Gander Mountains that were potentially being marketed for sales, if you can comment on those?
Landon, good morning, it’s Jay, I’ll take this question. On SunTrust, just as a reminder, we earned 121 SunTrust Bank branches that are in seven different [master base pools]. And those leases don’t expire until April 2018 and under the leased documents the tenant is to give the landlord 18 months' notice of renewal, which would then be -- we’ll be getting our notice in September of this year, September 2016. One other reminder, the renewal rights under those leases are 10-year, the tenant renews is a 10-year renewable. And there is a minimum threshold requirement under each lease, the properties comprising 75% of the rent in each pool must be renewed or not at all.
All of Landon, we are under a comprehensive confidentiality agreement with SunTrust that doesn’t let us talk about what negotiations might be going on or where things might call out. So by September, once we’ve received the notice and we’re able to talk about that we certainly will. I do want to point out though that, we bought these prosperities rights. When we acquired this portfolio four plus years ago, we paid $1.75 million per property and these are very good bank branch corner locations at low rent, at $140,000 per property annual rent. So while we can'ttalk about what the outcome might be yet, we are very confident that it’s going to be a favorable outcome with SunTrust as we did to the renewal. And we will have a year and half to market any of the properties that are coming back to us. So that gives us plenty of time to address whatever vacancies occur.
I think your other question was on Gander Mountain and we are not marketing any of the Ganders at this time. So I’m not sure what you saw, but those are not, guys I don’t believe we have any on the market. We are happy with the locations we’ve got with Gander and certainly the sports category is under some duress. But we’re happy with those locations and everything is fine so far.
All right. And then just one last one just overall debt broader on the acquisition front. Can you just talk about what you’re expecting in terms of cadence for the back half for the year and maybe any larger portfolios in certain categories that you’re looking at, I know C stores was one in particular that you guys had your eyes on?
Yes. So the pipeline looks very good for the second half of the year. Remember, a lot of our acquisition efforts are focused on building relationships with retailers and doing off market deals. Early in the second quarter, we acquired the Bob Evans portfolio and that was $161 million there. We have not classified that as a relationship deal, because it was marketed before we can any kind of preempted the process. But separate from that, we have done deals with 30 different relationship retailers so far this year and 85% of the dollars that we’ve invested excluding Bob Evans has been with relationship retailers. So we are continuing to have very good success dealing with the portfolio of regional and national retailers that we do business with.
We still see all of the portfolios that are out there, we are selectively underwriting those and making a run at the properties that we are in the portfolios that are most appealing to us and you are right, there is convenience store deal flow out there. We do love that real estate, we love that industry, it’s done very well in our portfolio and we’re excited to be able to look at portfolios there going forward. All in all, it looks very similar to the pipeline and the deal flow I think was very similar to what’s been in the case took the last six months or year.
And that includes pricing?
Pricing, whether cap rates are coming down or going up kind of depends on where do you start from. If the premium for investment grade portfolios has disappeared and you’re not seeing a portfolio premium in our investment grade properties, but we were not acquiring properties in that market anyway. As Craig mentioned, our average cap rate for the quarter was 6.9%, I think one thing to remember there is that our leases contain red bumps that are on average, 1.5% per year and on a 15 to 20-year lease, that adds 80 to 100 basis points of anticipated growth, we don’t straight line that but it is built in to the cash flow coming from the leases. So if you start from a high six's cap rate basis with [red] growth, what we’re seeing is cap rates remaining flat or trending down a little bit.
Okay, greatthank you very much.
Our next question comes from the line of Nick Joseph with Citigroup. Please state your question.
Thanks. I wonder if you can touch on tenant health, maybe specifically thought in and then just across the portfolio, any changes in the rent coverage ratio and the watch list please.
Hey Nick. Yes, not a lot of change to be quite honest. We continue to see, we think we’re in a muddle through economy and so retailers are generally stealing chair from each other in some respects a lot of bigger teams but we’ve not seen a lot of movement in that. Our weighted average rent coverage is still a very solid number, we’re averaging in the mid-3s and so for our largest tenants as usual, well and we’ve talked about this before, there is always tenants who are moving up the credit line and down the credit line, if you will and we’ve talked about Gander Mountain in the past we’re comfortable there, we think there are on solid footing in terms of results, the one we talk about is [Logan's] that we do have concerns about and so we’re monitoring that. But generally I think, we feel like, we’re in pretty good shape.
Thanks. And maybe just specifically on Bob Evans. What was attractive of that portfolio?
Nick, its Jay Whitehurst. We talked about this on the previous call, I think you mentioned. The highlight of the Bob Evans transaction is the spectacular pricing that we got per property. We paid $1.35 million per property for those 117 Bob Evans properties that we acquired. That works up to $91,000 per property and annual rent. So it'svery safe, very secure rent for both the landlord and the tenant. The four wall rent coverage on that deal was around three times. Our peers often report kind of four wall coverage, so maybe that’s an apples-to-apples number with other subs. When we underwrite it and look at these things, we look at a coverage with overhead loaded in and that was even, that’s a mid-2s kind of rent coverage number.
And one other thing to point out on the Bob Evans transaction was the 117 units that we bought were self-selected by Bob Evans for sale lease-back. We visited with their CFO before the transaction and that’s why they chose these properties and their answer was, because these are the ones that there were committed to do a 20-year lease with. And that is some of the best due-diligence that you can have. So low rents, high coverage units selected by the retailer for sale lease-back is why we focused our efforts on calling directly on retailers.
And from a corporate perspective there you can see they’re pretty moderately leverage a public company so the date is out there but the company has been in business along many decades and it’s performed well over a long period of time, they seem to be continuing that trend.
Thanks. And just finally Kevin. What were the impairments in the quarter related to?
Yes. So we had some impairments we added back as it relates to FFO, which are just standard kind of real estate impairments with properties that the process of selling. The other impairments are the adjustment down in reconciliations from FFO to Core FFO really primarily relates to just for a little context are relatively small declining amount of mortgage receivables on our books. We have about $15 million in total at quarter end, they’ve we’ve been there for some period of time and have been declining those loans amortize off. And they consist kind of two parts, one was a more traditional notes receivable, mortgage notes receivable I should say, as well as what we call residual interest in a pool of mortgage notes, which we’ve always acknowledged is not the lowest risk investment out there, but it is small and declining part of our portfolio. So during the second quarter, we took an impairment charge on the mortgage receivables of about $3.6 million. We don’t anticipate any future sub-charges, but obviously can't rule that out. But for those that have followed the companies for some time, you’ll know that we’ve also taken periodic impairments when a commercial mortgage residual interest since they are requiredto mark thosethe market every quarter and we put the $632,000 impairment on that investment in the second quarter.
Since these valuation impairments are not related to depreciable property, they can’t be added back in calculating FFO like other real estate impairment loses and charges. And since these mortgaged investments have never been a part of our core business and it’s been a pretty small number in total on our balance sheet we’ve adjusted for these items in our core FFO calculation.
Lastly I guess Alfred just for some added context, as it relates to the commercial mortgage residual interest, we made a $9 million investment in that asset about 10, 12 years ago and over that time period that 9 million has returned over $60 million of cash to NNN. So despite the accounting noise which comes from mark-to-market accounting it’s been a very successful investment, but again these mortgage receivable investments on our balance sheet will likely continue to climb overtime as those loans are paid-off.
Thanks for the color.
Our next question comes from the line Rob Stevenson with Janney Montgomery. Please state your question.
Thanks. Just a couple of quick ones. It looks like you’ve got the early 6% of the leases acquiring 2018, are there any big concentrations other than the SunTrust portfolio that’s in there?
Rob, hey it’s Jay Whitehurst, no the SunTrust makes up two thirds of that. I think there is 50 to 60 leases other than the SunTrust leases and its spread across the entire portfolio.
Okay. The disposition guidance is staying at 85 to 100 million, you guys have done 73 million in the first half of the year. Is there a potential to go beyond that, I mean are you only marketing essentially you know and other 10 to 25 million over the remainder of the year?
Rob, there is a change,it's not going to be a big delta either way. So we’re always looking at selling sun properties. There is a possibility of selling one at a cap rate that defies belief. But we’ve got a long way to go and sell that, it’s got to close, the buyers got to come through but we’re always out there crawling if you will from within our portfolio but in a context of 2,452 properties, it’s a small delta.
And as a reminder, a bit of a chunkiness to it in the first quarter, we had one asset [that’s all] for $42 million and so that influences that number significantly.
Right, but I guess the other question was do you not really see too much of a sort of deltaas you get towards 31st and people having to execute 10/31s etcetera where you can get betterpricing on assets on the last, you know quarter or year last month of the year as long as you’re willing to take -- from you guys' perspective I am not sure that selling assets in December versus if it were to slip in to January makes any real difference given the size of the company. But seems like there is always a high demand year-end for a sort of 10/31 for quality 10/31 assets.
It won’t move the needle much as you pointed out and we don’t see a whole lot of seasonality I guess to that disposition opportunity with that.
Okay, thanks guys.
Our next question comes from the line of Vineet Khanna with Capital One Securities. Please state your question.
Yeah hi guys, good morning. Thanks for taking my question. You know in the past you guys just[indiscernible] capital markets well ahead of maturities and redemptions, you know just given sort of current market pricing. Would you consider capping the capital marketssooner rather later maybe [indiscernible] the redemption of the [indiscernible] become available in February?
I think that's an accurate observation in terms of our general interest over the years of obtaining capital when its available and well-priced even to the extent it may seem early and/or call some short-term disruptions to per share results. We think it'sright thing to do over the long-term. So we’ve been very active on the ATM given where the equity pricing has been today 10-year debt is very attractive probably in the low-3% for 10-year fixed rate. And preferred as you noted is cheap as well today for us probably in the low-5%. And so we just, we’re looking at all those opportunities and sorting through which one makes no sense.
The 20 -- the preferred you referenceddoesn’t become redeemable until February of 2017. So you really can’t call it early, we could pre-fund it I guess, if you will, but won’t be able to redeem that until next year some time. And as I mentioned earlier, we have some debt that comes due late next year. But your point is well taken and it’s not lost on us that capital is well-priced and available and we do have a history of taking advantage of that.
Okay, great. And then just Kevin, were there any one-time items that contributed to sort of the improved operating margin?
Improved operating margins in terms of property expenses or what, I am not…?
Correct property expenses over ADR.
Yes. I got the way, we think about that is, we think about net property expenses and so for the quarter net property expense is $1.3 million. We’ve always had a high percentage of our income drop to the bottom-line, in terms of revenues overtime. But I don’t know that it changed dramatically I guess from my read to the numbers this quarter 2Q 2016 versus 2Q 2015.
Okay. And then just lastly maybe can you guys provide an update on sort of Sports Authority that you guys having a portfolio?
Yes. This is Jay Whitehurst. Just as a reminder, we own four Sports Authority properties that really comprised 0.5% of our ramp, so not material at all. Two of those properties have already been released to existing sub-tenants that were on the properties and the other two are in Florida, I believe as we speak right now, one of those two has been rejected by Sports Authority the other technically hasn’t been rejected yet but will be. And our leasing team is on the case for those two remaining properties to get those really, they are in good locations, one of them is in a very good location, they are both in good locations. And we would anticipate being able to get those leased up in the ordinary course.
Great. Well, thanks for the time.
Our next question comes from the line of Josh Dennerlein with Bank of America Merrill Lynch. Please state your question.
Hey guys thanks for taking my question. Just curious on how you feel about your restaurant exposure, it’s over 20% now of your rent. Is there a kind of a target you want [indiscernible] over the long-term and if so, how long would you expect to pay to get there?
So thanks for the question and our approach is always bottom up property by property. We are not making capital allocation decisions based on percentages to any category or sector. So that place in time, it certainly goes up and then it tends to moderate overtime but as Kevin mentioned earlier, if you take about top 20 tenants, the rates coverage ratio is nicely over three times. So anytime we have an opportunity to purchase a well-covered good real estate location, we are going to be doing that, whether it’s in our convenience store category which is a single biggest sector, or the casual dining or the fast food restaurant sector or in any others. So, for us its property by property and carefully underwritten is the number one rule.
Thank you. Appreciate it. I guess I had just one more question from me. Funding cost if all the treasuries have fallen since the price has been low. Was there any move in the market on cap rates, do you expect any move to happen?
So, if you think about it on average, we are buying properties certainly this year at less than $2.5 million per property. And the alternative purchase maybe somebody who is investing $2.5 million is funding it in a market that is not led to the change in treasury. As a result, we don’t see any delta despite the perception, we see zero change in cap rates driven by a movement in the 10-year treasury. We do see movements in cap rate based on supply demand that drive for yield, returns for alternative assets et cetera.
So as Jay Whitehurst pointed out, we see for us for National Retail Properties, the type of assets we are buying, cap rates are essentially flat and maybe trending small basis points lower and that is not driven by the 10-year treasury.
[Operator Instructions] Our next question comes from the line Tyler Grant with Green Street Advisors. Please state your question.
Just to take you back on the last question there. You guys talk about the structure of cap rates, so for example have you see any change in terms of its [drive] between primary, tertiary type markets, investment grade tenancy versus non-investment grade tenancy and then have you seen any change in demand for certain types of categories?
Well I think that there is --- so let’s go geographically. For whatever reason people in California think that the cap rate should be low than it should be in Florida or in Texas. And that trend has applied for years and years and years. That trend has sort of migrated into the Nevada and some Arizona properties. So cap rates in geographically obtained it to be slightly lower. As you observed [related] to your question investment grade tenants command a lower capital rate, bank branches as it so happens command really low cap rates, especially when there is an advancement grade [cap] and when I say really low, I am talking at high fours or around 5%.
Just as a reminder, some of those leases even at that type of cap rates have no rent growth over the duration. So non-investment grade tenants for us are trading in the high fixed type cap rate range, which is in, as trended down slightly over the last several years as depending on the mix of what the tenant characteristics and the market location. There is right now a very small delta pick a number 25 to 35 basis points which we have seen based on the type of properties that we like to focus on. I think if you buy in very small franchisee or a tenant that as we call it internally very little body fat, you can capture an 8% type cash cap rate, but that is not the type of assets we chose to owe.
Tyler would you like to move -- I mean is there any.
No. That’s perfect, I appreciate it. Earlier in the call, I believe that you had mentioned that there is not as robust as an opportunityset in terms of acquisitions for the remainder of the year. What caused you to say that?
We purchased one large portfolio, which Jay referenced, which is the Bob Evans. So to back that out, the portfolio activity is generally the same in the second half as it is in the first half. In the first half, we just had one lumpy transaction where we purchased a large portfolio of Bob Evans.
Sure. And in terms of one-off transactions those opportunities out there is still pretty stable?
The business opportunity is very, very good. We’re always looking at portfolio dealers in addition to our regular course of business. And frankly what now we are looking at a portfolio as if we all put a lot of time and effort into it. My guess is somebody is going to be a little less sensitive about the quality of the lease than we are. Other than that, it looks like an exciting deal, but if somebody else is a little more flexible they will win it. We are not flexible about lease term.
Mr. Macnab, I’m showing no further questions at this time. So I will turn it back to you for closing remarks.
Thanks very much, we appreciate all of your interest in National Retail Properties. Business continues to be very good and we hope that you enjoy the summer just as much as we will here in Florida. Thanks very much.
This concludes today’s conference. Thank you for your participation. You may disconnect your lines at this time.
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