STORE Capital's (STOR) CEO Chris Volk on Q4 2016 Results - Earnings Call Transcript

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STORE Capital (NYSE:STOR) Q4 2016 Earnings Conference Call February 23, 2017 12:00 PM ET

Executives

Moira Conlon – Investor Relations

Chris Volk – President and Chief Executive Officer

Cathy Long – Chief Financial Officer

Mary Fedewa – Executive Vice President, Acquisitions

Analysts

Landon Park – Morgan Stanley

Laura Dickson – KeyBanc Markets

Dan Donlan – Ladenburg Thalmann

Michael Knott – Green Street Advisors

Vineet Khanna – Capital One Securities

Haendel St. Juste – Mizuho Securities

Todd Stender – Wells Fargo Securities

Operator

Good day and welcome to the STORE Capital Fourth Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded.

I would now like to turn the conference over to Moira Conlon, Investor Relations for STORE Capital. Please go ahead.

Moira Conlon

Thank you, Carrie, and welcome to all of you for joining us for today’s call to discuss STORE Capital’s fourth quarter and full year 2016 financial results. Our earnings release, which we issued this morning along with a packet of supplemental information, is available on our Investor website at ir.storecapital.com, under News & Market Data, Quarterly Results. I am here today with Chris Volk, President and Chief Executive Officer of STORE; Cathy Long, Chief Financial Officer; and Mary Fedewa, Executive Vice President of Acquisitions.

On today’s call, management will provide prepared remarks and then we will open the call up to your questions. In order to maximize participation, we’re keeping our call to one hour, we will be observing a two question limit during the Q&A portion of the call. Participants can then reenter the queue, if you have follow-up question. Before we begin, I would like to remind you that comments on today’s call will include forward-looking statements under the Federal Securities laws.

Forward-looking statements are identified by words such as will be, intend, believe, expect, anticipate, or other comparable words and phrases. Statements that are not historical facts, such as statements about our expected acquisitions or our AFFO and AFFO per share guidance for 2017 are also forward-looking statements. Our actual financial condition and results of operations may vary materially from those contemplated by such forward-looking statements. Discussion of the factors that could cause our results to differ materially from these forward-looking statements are contained in our SEC filings, including our reports on Form 10-K and 10-Q.

With that, I would now like to turn the call over to Chris Volk. Chris, please go ahead.

Chris Volk

Good morning everyone and welcome to STORE Capital’s fourth quarter and full year 2016 earnings call. With me today are Cathy Long, our CFO and Mary Fedewa, our Executive Vice

President of Acquisitions. We continued to be active on the acquisition front, investing $325 million during the quarter, bringing our total new 2016 investments to more than $1.2 billion. Net of approximately $75 million in gross asset sales, our investment activity for the year totaled over $1.1 billion. Our portfolio remained healthy, with an occupancy rate of 99.5% and approximately 75% of the net lease contracts rated investment-grade quality based on our STORE Score methodology.

Our dividend payout ratio for the quarter approximated 67% of our adjusted funds from operations, serving to provide our shareholders with a well-protected dividend and a company well-positioned for long-term internal growth based on anticipated tenant rent increases and the reinvestment of our surplus cash flow. During the year, we raised our quarterly dividend 7.4%, while also increasing our shareholder dividend protection. Our funded debt/EBITDA on a run rate basis continued to approximate six times at the end of the quarter, with our unencumbered assets standing relatively unchanged at $2.2 billion, or 43% of our total gross investments, providing us with flexibility in our financing options.

In August, we received a corporate credit rating of BBB- with a positive outlook from Standard and Poor’s, which adds to the BBB- rating we received from Fitch Ratings in 2015. We plan on continuing to access the unsecured term note market and are targeting an unencumbered assets ratio over 50% of our total portfolio in 2017. Meanwhile, we sold $200 million of ten-year A+-rated notes from our Master Funding conduit at a record low interest rate for us of 4%. In fact, for all of 2016, the weighted average interest rate on our term borrowings was about 4.1%, providing us with a very attractive investment spread of about 3.8% against the initial lease rates on our 2016 investment activity.

Our long-term aim of having two complementary investment-grade borrowing options is to lower our comparative long term cost of capital. Another way that we elevated our financial flexibility was to access At the Market equity issuances. During the fourth quarter, STORE raised almost $88 million in new equity. The ATM is perfectly suited to a growth company like STORE because we can manage our balance sheet as we grow it. Now, here are some statistics relevant to our fourth quarter investment activity; our weighted average lease rate stood at approximately 7.9%, down slightly from 8.2% last quarter. The average annual contractual lease escalation approximated 1.8%.

The weighted average primary lease term was approximately 15.6 years. The median new tenant Moody’s RiskCalc credit rating profile was Ba1. The median post overhead unit level fixed charge coverage ratio was approximately 2.25:1. The median new investment contract rating, STORE Score for investments made during the quarter was consistent at A1. We added 23 net new customers and expanded our profit center assets to include six new industries, reflecting both our diversification strategy and value proposition across industry sectors. Our average new investment was made at approximately 81% of replacement cost. 89% of the revenues from the net lease investments made during the quarter were subject to master leases. All of the 94 new assets that we acquired during the quarter are required to deliver unit-level financial statements, giving us required unit-level financial reporting from 97% of the properties within our portfolio. Our investment activity continued to be highly granular, with 37separate transactions completed and an average transaction size of $7.7 million.

At the end of the quarter, the proportion of revenues realized from our top ten customers continued to be highly diverse at 16.7% of annualized rents and interest. Further, no single customer exceeded 2.8% of our annualized rents and interest. Finally, during the year, we sold 31 properties, which represented an initial investment approximating $75 million. Just over half of these properties sold were what we would term opportunistic in nature. The remainder were comprised of strategic dispositions, which included three vacant assets. Now our GAAP gain on all of this after all selling costs was just over $13 million. But our gain on cost, which is more important, amounted to $7.3 million.

About $7 million of this was derived from our opportunistic sales activity, which equated to an average gain over our original investment of 26% and average cap rate compression of about 1% relative to our current investment cap rates. Now, we actually also made some money on our strategic dispositions. But to put that $7 million opportunistic property sale gain in context, this equates to about 22% of the investment in our eight vacant properties as of December 31, meaning that we could more or less get a 78% recovery from these assets and have virtually no economic impact to STORE. This is about as good an illustration as I can do of why our active portfolio management in 2016 fits together with property management activities like a hand in glove as a tool to manage portfolio risk.

Moira Conlon

Excuse me Chris, we’re hearing a lot of static it’s been very challenging. Carrie can you hear us?

Operator

Yes, I can but the static is persisting.

Moira Conlon

I think we should resume the call in about two minutes in the other conference room. Carrie, could you ask people to please stand by.

Operator

Yes, I can. [Operator Instructions]. This is the conference operator. We’ve reconnected our speakers’ line. Please start once again. Thank you.

Chris Volk

Hi, this is Chris Volk and having concluded my initial comments, I’m going to turn the call over to Mary Fedewa.

Mary Fedewa

Thank you, Chris and good morning everyone. 2016 was another strong year for acquisitions and the fourth quarter of 2016 was our best fourth quarter ever with acquisition volume of $325 million, up 19% from the same period last year. For the year, our gross acquisition volume was $1.2 billion consistent with 2015 volume. As Chris mentioned, our average lease rate for the fourth quarter was 7.9% and our average cap rate for the year was 7.95%. Since inception, our investment pricing of approximately 8.25% continues to deliver record spreads over our cost of debt. At year-end, nearly 85% of our investments were in customer facing industries with an emphasis on the service sector. Consistently, about 75% of the contracts we create are investment grade quality and 90% of the time we use STORE’s preferred lease form. VP customers accounted for over one-third of our business for 2016.

Now turning to the markets. The market we address is huge, with nearly 2,000 middle market companies with revenues between $10 million and $1 billion. If this middle market were its own country, it would be the third largest economy in the world behind only the U.S. and China. As a result, our pipeline of opportunities continues to grow. And with a market this size, we can and will, continue to be very selective in the investments we make.

Now I’d like to take a few minutes to highlight how we consistently get cap rates above the auction marketplace. It starts with a direct discussion with the customer around the solution we can provide. Those solutions range from growth capital to lease flexibility to tax advantage product. When you have B2B approach and you provide a valuable solution, you can ask to get paid for that value and that’s how our cap rates are agreed upon between us and our customers. Over 80% of our originations result from direct calling efforts on thousands of companies and financial sponsors. The remaining 20% is originated through our virtual sales force, tenant introductions through broker relationships. Both channels provide the following B2B benefits; higher lease rates, lower real-estate prices, longer lease terms, greater investment diversity and stronger contracts. Our customers view us as more than just a landlord. All of this translates to lower risk and higher value for our shareholders. The first quarter is off to a strong start. As of the end of February, we expect to have funded over $180 million in gross acquisition volume at a cap rate that is in line with fourth quarter 2016.

With that, I’ll turn the call to Cathy to talk about financial results and guidance.

Cathy Long

Thank you, Mary. I’ll start by discussing our balance sheet and capital structure, followed by our operating results for the fourth quarter and year-ended December 31, 2016 and then review our 2017 guidance. Please note that all comparisons are year-over-year unless otherwise noted. Our fourth quarter and full year operating results and financial position reflect a continued growth of our real-estate portfolio and a strong performance of our team across all functional areas of the company including originations, diligence, risk, finance and servicing. From a capital markets perspective, 2016 was a busy and productive year for STORE. Over the course of the year, we significantly enhanced our financing flexibility through multiple actions. We launched our $400 million ATM program in September, made structural enhancements to our Master Funding debt conduit, secured an investment grade debt rating from S&P and expanded our credit facility.

During 2016, we reduced our leverage target to around six times funded debt to EBITDA, plus or minus 25 basis points. We made this decision as part of our plan to add investment grade unsecured debt to complement our A+ rated Master Funding program. During 2016, we raised net equity proceeds of $463.9 million. We completed $304.6 million follow-on offering in May and raised a total of $159.3 million through our ATM program. This includes 2.5 million shares issued through the ATM in the third quarter and an additional 3.6 million shares issued during the fourth quarter. This program has proven to be an efficient and effective way to raise incremental equity at favorable prices. In October, we issued our seventh series of long-term fixed rate notes under our Master Funding debt program in the amount of $335 million. As we previously discussed, the unique structure of this note issuance enables us to retain $135 million of that debt for future sale.

We also completed our second offering of investment grade unsecured note issuing in aggregate principal amount of $200 million of 10 year notes. At the same time, we closed $100 million five year unsecured bank term loan. We also expanded our unsecured credit facility to $500 million by accessing the accordion feature, which permits us to expand the facility to as much as $800 million over the term of the credit agreement which expires in September 2019. Virtually all of our borrowings are long-term and fixed rate and our debt maturities are well laddered. At December 31, our total long-term debt outstanding was $2.3 billion with a weighted average maturity of 6.4 years and a weighted average interest rate of 4.6%.

At year-end, gross investment in our real-estate portfolio totaled $5.1 billion, of which approximately $2.9 billion have been pledged as collateral for our secured debt. The remaining $2.2 billion of real-estate assets are unencumbered. Through our effective liability management strategy, our goal is to achieve an annual gap between our free cash flow after dividends and our annual debt maturities of 1.5% of assets or less. Such a small gap is intended to insulate STORE from future interest rate volatility.

We entered 2017 with $54 million in cash and nearly the full $500 million available on our credit facility and virtually no exposure to floating rate debt. At the end of the fourth quarter, our leverage stood at a conservative 6.1 times net debt to EBITDA on a run rate basis or roughly 45% on a debt-to-cost basis. Our conservative capital structure and enhanced financing flexibility provides us with plenty of liquidity to fund acquisitions and effectively manage our cost of capital. We believe we are very well positioned with a variety of debt and equity financing options to successfully navigate any market or interest rate volatility we may encounter in 2017.

Now turning to our operating results. In the fourth quarter, revenues increased 28% to $102 million reflecting continuing growth in our real-estate portfolio. Total revenues for 2016 were $376 million, an increase of 32% over 2015 revenues of $285 million. Rental revenues again made up about 95% of total revenues, with the remainder largely attributable to interest income on mortgages and leases accounted for as direct financing receivables. Our portfolio has grown from $4 billion in gross investment a year ago representing 1,325 property locations to $5.1 billion representing 1,660 property locations at year-end 2016. The annualized base rent and interest being generated by the portfolio in place at year-end increased 26% to $419 million as compared to $332 million last year.

For the fourth quarter, total expenses increased 34% to $74 million compared to $55 million a year ago and total expenses for the full year 2016 were $266 million compared to $202 million last year. The increase in both the quarter and the year largely reflects the growth in the portfolio with just under half of that increase due to higher depreciation and amortization expense. Our interest expense increased about 28% to both the quarter and the year as we continue to finance a portion of our acquisition activity with long-term fixed rate debt. This increase was offset by a small decrease in the weighted average interest rate on our long-term debt. Rather than using our revolving credit facility to finance acquisitions during the year, we primarily funded them with long-term fixed rate debt. This reflects our decision to capitalize on historically low interest rates to lock-in attractive spreads for the long-term and reduce our exposure to future interest rate increases.

Property costs were $1.5 million for the fourth quarter and $4 million for the year. The year-over-year increase was primarily related to property taxes, insurance and maintenance cost on properties that were vacant during a portion of 2016, as well as properties where we determined that our tenant was unlikely to pay its obligations. As of December 31, eight of our properties were vacant and not subject to a lease. These properties represent a very small amount, less than 1%, of the annualized rent and interest generated by our portfolio. Property costs can vary quarter to quarter based on the timing of vacancies and the level of underperforming properties but are generally not significant to our operations.

G&A expenses were $8.7 million in the fourth quarter compared to $7 million a year ago. For the year, G&A expenses increased to $34 million from $28 million primarily due to the growth of our portfolio and related staff additions. As a percentage of portfolio assets, annualized G&A expenses decreased to approximately 67 basis points from a year ago, largely reflecting scale efficiency that come with portfolio growth.

Net income increased to $32 million for the quarter or $0.20 per basic and diluted share, compared to $24 million or $0.18 a year ago. Our net income for the fourth quarter included a gain of $3.7 million net of tax on the sale of 10 properties. This compares to a loss of about $600,000 on the sale of six properties in the fourth quarter of 2015. For the year, net income was $123 million or $0.82 per basic and diluted share compared to $84 million or $0.68 per basic and diluted share for 2015. We had a gain of $13.2 million net of tax on the sale of 31 properties in 2016. This compares to a gain of $1.3 million net of tax on the sale of 13 properties in 2015.

Our strong performance translated into healthy gains in AFFO and AFFO per share. For the quarter, AFFO increased 28% to $67.1 million or $0.43 per basic and diluted share compared to $52.6 million or $0.40 per basic and diluted share last year. For the year, AFFO increased 34% to $246 million or $1.65 per basic share, $1.64 per diluted share compared to AFFO of $184 million or $1.49 per basic and diluted share for 2015. Year-over-year AFFO per share increased 10%. Our dividend is an important component of our overall stockholder return and for the fourth quarter, we declared a quarterly cash dividend of $0.29 per common share. For the year, we declared dividends totaling $1.12 per common share which included a 7.4% increase during the third quarter.

Now turning to our guidance for 2017. We are affirming our 2017 guidance announced last November. Based on projected net annual real-estate acquisition volume for 2017 of approximately $900 million, we expect AFFO per share to be in the range of $1.74 to $1.76. As with prior years, AFFO per share in any period is sensitive to the timing of acquisitions. In 2017, we expect acquisitions to be spread throughout the year, though weighted towards the end of each quarter. Our AFFO guidance is based on a weighted average cap rate on new acquisitions of 7.75%.

Our AFFO per share guidance for 2017 assumes net income of $0.78 to $0.79 per share, plus $0.87 to $0.88 per share of real-estate depreciation and amortization, plus about $0.09 per share related to items such as equity compensation, the amortization of deferred financing costs and straight-line rent. While we don’t give guidance on capital markets’ activities, we are targeting leverage based on a run rate net debt to EBITDA of around six times, plus or minus 25 basis points; an interest cost on new long-term debt for 2017 is estimated based on a weighted average interest rate of about 5% which assumes a 10 year treasury rate of about 3%.

And now I’ll turn the call back to Chris.

Chris Volk

Thanks, Cathy. Before turning the call over to the operator for questions, I want to make a few comments. The spring of 2015 I spent a good deal of time on earnings call discussing Heald College which is the tenant discontinued operations. At that time, Heald amounted to about 1.4% of our revenue stream. Now just 18 months later, our AFFO and dividends per share for the fourth quarter of 2016 were 26.5% and 16% higher respectively. Heald that had minimum impact on our impressive performance just as many tenant vacancies that were at 35 year track record had little impact on our ability to outperform across three public companies.

Today, the talk turns to Gander Mountain which is likewise a small exposure, just 2.1% of our revenues at the moment, and which we expect to likewise have no material impact on our future performance or growth. As of today, Gander Mountain is in full monetary compliance of STORE’s lease agreements. We are on frequent discussions with them and we are encouraged by the constructive steps that they are taking to improve their business model. We benefit from Master leases, triple net leases, 15 year original lease terms and leases having unit-level financial reporting. Based upon our knowledge of the performance of the stores that we hold, we are not concerned. When we provide guidance to you, we always incorporate assumptions regarding portfolio performance. Across three highly successful public companies, we’ve always targeted middle market and larger mostly private businesses.

These companies need us and the solutions that we provide has helped them to create jobs and well, for our customers, a balanced relationship. In turn, we realize higher lease rate and lease escalations we would if we just sought larger tenants. We also have better alignment of interests. We paid less for real-estate and received better financial reporting from our customers who we can provide better reporting to our stakeholders. If you want to know what we believe to be the single contributor, biggest single contributor of our future expected performance, it will be the foundations that we’re establishing at STORE. Foundations in a company like this are not established in a day. It takes many years and a lot of focus. For example, it’s important to design at the outset a high level of internal growth which is our ability to create AFFO growth per share without issuing new shares of stock to fund growth.

The two biggest drivers of this are tenant lease escalators and the accumulation of free cash flow after dividend payment. Today, we have annual 1.8% lease escalators and a dividend payout ratio this quarter of 67%. Given our capital structure, our estimate is that these combine to grow AFFO per share a bit north of 5% annually. This is the best we have ever achieved, but we did not always achieve these relationships as we do today. Creating this foundation has taken both time and focus and so is choosing to only target profit center real-estate investing, together with 97% of required unit-level financial reporting which is without precedent. Our receipt much property level data permits us to variegate contract quality. Likewise, our careful creation of a dual investment grade borrowing strategy stands to create far better unencumbered real-estate ratios for unsecured note-holders than we could without the strategy. We ask, we believe, this integrated strategy will reap rewards in the future.

Now we have other foundational attributes. You cannot easily alter portfolio investment diversity. It has to be done intentionally. STORE is the most diversified firm we have ever created. Nor can you easily change investment granularity, we’re today creating an average of 17 new customers quarterly and in 2016 have invested over $1.2 billion with an average transaction size of just $8 million. Our organization structure is defining as is our investment at third generation servicing platform and the extensive data that we can capture. This is all foundational and impacts the type of investment disclosure we’re capable of providing.

Finally, we have a hallmark of B2B or direct investment origination. Fully 40% of our staff are devoted to this brick-by-brick origination activity. On February 1, we sponsored our first ever customer conference, the Inside Track Forum, which we did in conjunction with Arizona State University. The forum was a day of education, committed to the notion that a few actionable ideas could make all of the difference for a successful business future. And when it comes to that future, we continue to make tremendous progress and are optimistic. At our Inside Track Forum, we concluded our speaking day with an inspirational talk from Captain James Lovell, who travelled into space four times, two of those to the moon. He credited these accomplishments to careful planning and the teamwork of a talented staff that made it possible to have wide margins of error in the pursuit of success. We could not say it any better.

So with this, I’ll turn the conference call over to the operator and as always, I’m shared at the table by not only Cathy and Mary, but also Chris Burbach, Michael Bennett and Michael Zieg. We look forward to answer any questions you have.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Ki Bin Kim of SunTrust. Please go ahead.

Unidentified Analyst

Hey guys, this is actually Ian on for Ki Bin. Just a quick question about Gander. So now with the Gander and Heald College, has this kind of changed how you guys are thinking about acquiring properties going forward?

Chris Volk

No, not at all, I mean we acquired Gander, see the last time we committed to Gander would have been early 2014 we committed to do a Gander facility. At the time, if you looked at the contractual investment ratings, they would have been between the coverage and the store credit profile, you would have had sort of low end investment grade contract. We are strong believers in the hunting and fishing space and continue to be strong believers in the hunting and fishing space. We are believers in experiential retail and so – which Gander is a part of that. We believe that Gander has a business model that can be made viable and when you look at risk, risk is always about the contract. It’s not so much about the tenant credit quality which tends to be something that people think about. And so when you’re creating a contract -- I’m being reminded by Cathy that Gander’s currently on rent by the way, but if you’re thinking about the contract, that’s everything. So for example, last quarter, there was a company called Logan warehouse, we have a few of those and Logan warehouse immersed in bankruptcy in November. During the course of that, they closed down a bunch of stores. The stores that we had are today receiving virtually all the rights that they were entitled to and we didn’t miss a beat. And today by the way, we have a much better credit because they’ve reconfigured their balance sheet and I think it’s better. So we’re always focusing not just at the tenant credit level, because credit’s transient. What you cannot change is how much you pay for real-estate? How do you write a contract? How many unit-level financial reporting you got? These things are just important and they are ephemeral, they go on and on and that has not changed. If you think about Heald College, Heald College changed their attitude towards for-profit education in the sense that we found that the government was our partner and so they described the fact that Heald was a 150 year old institution was actually making money, they went out of business. So the contract actually looked good but we found that we had government control. But I think overall, you look at the performance, you look at our numbers -- we’ve raised our dividends 16% since then which I think is sector leading, but you can check it out, and you can look at our 26% AFFO increase since then per share. I think that that says a lot.

Unidentified Analyst

Okay. That’s helpful. And then just one other quick question, what type of tenants are you typically targeting? Is there anything specific or you’re pretty much open right now to anything?

Chris Volk

Can you repeat the question please?

Mary Fedewa

I’ll take it, it’s Mary. No, the pipeline is still very diverse and very similar to what we have in our portfolio today. I mentioned on my prepared remarks, 85% of what we have booked is in customer facing industries that are focused on the service sector and our pipeline is 88% in the customer facing industry. And so it’s essentially -- these are industries for us that are, when a customer goes for a service or an experience, fitness centers, restaurants, child care, furniture and these are industries we believe will be relevant for a long time as we sit and write 15 and 20 year leases. So the pipeline we’re still focused on that and the diversity we’re very diversed as you know, so no real change from that.

Chris Volk

We tend to love the service space the most and then manufacturing is around 15%, retail is going to be around 20% and the retail is going to be experiential. We have to go and - a very long-term view of what we’re doing and focusing on making investment grade contracts, and that’s who we are.

Operator

The next question comes from Vikram Malhotra of Morgan Stanley. Please go ahead.

Landon Park

Hi, this is Landon Park on for Vikram. If you could just touch a bit back on Gander again, can you give us a sense of the unit-level coverage, the distribution within your – portfolio and just from a more philosophical standpoint, how you might look to reposition a box of that size?

Chris Volk

I’ll make some comments on that. First of all, I’ll remind everybody that Gander’s currently under rent so I’ll start there. So nobody’s running around what we’re going to do with every single box, no. I’ll remind you as I said in the call that we get their unit-level P&L so we know exactly how they’re doing. And those P&Ls they have a January 31 fiscal year – so the P&Ls that we have most recent ones are from October 31 and they would include a pretty difficult fourth quarter from 2015. And based upon a trailing 12 number or look back outside most if not all of our properties, cash flow at the – level and we feel good about that. We have three master leases, so when I tell you we’re not concerned, it’s because we believe that the company today have a business model that can be made viable and we believe that the economics of our STORE’s are pretty attractive. So, that’s our view. And in terms of what we’re going to do when we get back, we will cross that bridge when we get to it, but we’re obviously in the step for -- replacement cost we’re in their [indiscernible] that are competitive in the marketplace. We bought these assets by the way, one at a time not from developers which was a typical way Gander assets were acquired by most investors. We bought them from people having short-term leases, they couldn’t sell their properties. So we bought them at very attractive prices, and then we restructured the rent with Gander which is why we have 15 year leases, and why we have financial reporting, we have master leases, and there may be Gander leases out there that do that but I think that it’s pretty rare. So out of the 165 plus Gander scores, we have certainly some of the best leases in the entire system.

Landon Park

Great, great. Really appreciate the transparency on that and it’s well understood that they are current on their rent. On a more positive note, can you touch on the occupancy increase you saw in the quarter and may be thoughts on leasing out the remaining vacancy?

Chris Volk

We have fight vacant properties to this point. We are -- during the fourth quarter, we sold two vacant assets, we let two other vacant assets and in terms of any -- I guess we had no new banking assets. So basically they’re no problems that happen and we’re just going through inventory and so, right today it’s still what we’re doing and maybe we have, as of this moment, we are not picking assets relative to the fourth quarter -

Operator

The next question comes from Craig Mailman of KeyBanc Markets. Please go ahead.

Laura Dickson

Hey everyone. This is Laura Dickson here with Craig. So I think I missed the first part of the question in the prepared remarks, but I was just curious what the size of the investment pipeline looks like right now? And then, also wondering if you’re seeing any signs of period of price discovery following the increase in the tenure following the election?

Mary Fedewa

This is Mary, how are you doing? The pipeline is $8.6 billion as of the end of the year. And I don’t know if you missed, in fourth quarter we did $325 million and we did $1.2 billion gross last year. And in terms of cap rate, cap rates have been stable throughout 2016 and going into 2017 stable. You’ll see quarter-to-quarter sort of bumps, so that’s timing of asset reimbursed, but CapEx have been very stable.

Laura Dickson

Okay. And then, I think we’ve discussed before like, potential for period of price discovery following an increase, has there been any kind of signs of slowdown in activity or your making as a result?

Mary Fedewa

No, nope.

Laura Dickson

Okay.

Operator

The next question comes from Dan Donlan of Ladenburg Thalmann. Please go ahead.

Dan Donlan

Thank you and good afternoon. Just going back to Landon’s question, of the assets that are vacant, is Right College still one of those assets and just curious if it has been sold, and may be what is the lease re-leasing prospects are there, I know that was pretty big chunk of – at one point of time?

Chris Volk

We’re still cautious, it’s still baking as we speak. It’s had a lot of activity in terms of working out but it’s still baking at the moment and we will fix it.

Dan Donlan

Okay. And then just lastly on your guidance, was just curious you talked about you always have vacancy or credit losses [indiscernible] your guidance, was curious if that has changed when you provided your guidance in November if anything has changed on that front versus kind of where we are today?

Cathy Long

Hi, this is Cathy. No, there hasn’t really been a change in what I bake-in so consistent with what we have in November. Obviously, I update the model for the portfolio that actually exists at December 31 whereas when I was in November, I was projecting where I thought the portfolio would be, so they were could have been a couple of tweaks there, but nothing big changed.

Operator

The next question comes from Michael Knott of Green Street Advisors. Please go ahead.

Michael Knott

Hey everyone. Chris, just curious a question for you I guess, with your focus on contract quality and rightly so, just curious how your portfolio today stacks up in terms of any potential tenant purchase options, particularly that may be below potentially the initial investment value if there’s any of those in the portfolio today and how do you think about concept in general?

Chris Volk

- we have none of those. If you have a purchase option that’s below value, then you’ll have to book it as a capital lease actually so wouldn’t actually be an operating lease, so change your accounting treatment because we have fixed price purchase option. I would tell you that in the wake of lease accounting changes that will happen in 2019 is likely to – purchase options after that happens, just because purchase options won’t impact the accounting treatment leases will [indiscernible]

Michael Knott

Okay, that’s helpful. And then just any thoughts you might have on the inclusion now of Captain D’s on the top concept list, I presume there’s some acquisition in the quarter, just curious any thoughts on that now appearing on top of that list?

Chris Volk

Yeah, it’s just one at a time. We did some business with Captain D’s corporate at the time that was acquired by Sun Capital and -

Mary Fedewa

Early 2011, when we were getting started.

Chris Volk

Yeah 2011, and we sort of added that exposure and then later on it was acquired by Center Partners right and then we added more to the exposure. And then, we have done some business with ample of franchisees so we’re seeing today I think some of the franchisee activity.

Operator

The next question comes from Vineet Khanna of Capital One Securities. Please go ahead.

Vineet Khanna

Yeah hi, sir, thanks for taking my questions. So your sector leading weighted average annual lease escalation of 1.8% was up 10 bps year-over-year, but then the median unit fixed charge coverage and - wall coverage is down slightly over the same period. So is the weaker coverage been driven by stronger rent and rental growth or business condition softening or…

Chris Volk

I mean the change in median coverage is so modest that from a statistical perspective, I don’t even pay any attention to it. There’s nothing that moves - the average rent increase went from 1.7% to 1.8% so that reflects some better work that we’ve had on lease escalations but it’s again, it too is incredibly modest. If you look at proportion of our portfolio it is investment grade, which is around 75% it has remained at that number for the last two years, I mean give or take, so give or take like a percent and a half, it’s kind of been in that ballpark for the last two years which shows just incredible – between how the assets perform, some do better, some are doing a little worse, but it’s all been kind of the same and of course our occupancy rate 99.5% so it speaks for itself too.

Vineet Khanna

Sure, sure. And then just bigger picture given STORE’s going in yields and annualized – are at least 75 bps better than peers at the portfolio level, how do you guys think about pricing - how do you price underwriting for expected credit loss and how do you think it compares to peers?

Chris Volk

You’re asking kind of a lot of question, I mean I would say if you – we’re big believers in doing business directly with customers and providing solutions. I find that analyst often times think we’re in a real-estate business. We have real-estate, is on the left side of our sheet, we have $5.2 billion for real-estate, but the reason we’re allowed to buy all these really nice pieces of properties because tenants are willing to part with them, and the reason they want to part with them is because they have a choice about owning or renting their properties and then they choose to rent for very important reasons and then, they choose to rent from us because we add to those reasons dramatically by giving a lot of flexibility. And so we are creating enhanced business values for these tenants and in turn, we’re also getting value for our shareholders. I do not and no one in our team wants to buy asset that you can buy at cap rates you can get, we want to be able to buy assets you can’t buy, at least rates you can’t get, contract characteristics that you cannot get that are not available at the market. When you look at us sawing off opportunistically a number of properties this year and generating 26% profits on those assets, it’s precisely because we’re able to buy north of the marketplace. When you look at us selling strategic assets which are basically not the best performing assets in the – and actually not losing money on an aggregate basis, it’s also because we’re able to book assets proper real-estate values and proper cap rates. So this is incredibly important to the value that we create for our shareholders and then for the customers, we have made a lot of customers incredibly wealthier over the years. So it is a balanced transaction, and you are pricing what they do based upon their alternatives. If they wanted to go sell their stuff one-off in the auction market place at lower cap rates, they can probably do that, but they’ll end up with inefficient leases and they’ll end up with less corporate flexibility and that corporate flexibility will work a lot. It can double the value of a business. And when you understand that, then you can understand how it is that we’re able to generate the kind of numbers that we can do, without taking risk, I mean you’re taking a risk.

Operator

The next question comes from Todd Stender of Wells Fargo. Please go ahead. I’m sorry our next question is from Haendel St. Juste from Mizuho.

Haendel St. Juste

Hey, good morning out there.

Chris Volk

Hey, Haendel.

Haendel St. Juste

So some of your peers have mentioned rising cap rates in the marketplace given the rise of 10 year policy uncertainty and your comments today and year-to-date transaction activity suggests you’re not seeing that. So I’m just curious what I’m curious, it isn’t being more driven by this – deal that you’re pursuing more -- just the smaller deals and generally pursuing in direct Mom n Pop approach versus larger deals and portfolios where we’ve heard that cap rates are creeping higher. So curious is that the dynamic you’re seeing? How big do you estimate the gap between kind of smaller and larger deals is? And would you be interested in doing bigger deals to perhaps to take advantage of that arbitrage?

Chris Volk

I’ll answer this and Mary will correct me if I’m wrong. I would say that we have seen if you’re looking at larger transactions, larger portfolio type transactions, the cap rates are less pressured than it used to be. And I think that that’s perhaps the loss for example some of the private REITs in the marketplace that can be so dominant in terms of buying and really large portfolio transactions, the lack of – the players has caused the cap rate compression to be less on large transactions. So we’ve seen some cap rate increases on larger portfolios, but not always I mean there’s been a lot of portfolios done over the last quarter and some of those have been done at very competitive level. So, at the sort of middle market granular contract level which is what we really focus mostly on and we’ve been doing for the last year and a half sort of like 100 million bucks a month give or take of transactions, so $8 million a whack, we haven’t really seen a lot of movement in cap rate.

Mary Fedewa

Yeah, Haendel and I think you’re correct in terms of it does stem from the way we approach the marketplace and as I mentioned, both of our channels, both the direct channel and the tenant relationships we get through brokers are all basically approached the same way. We’re talking to the customer and customers are looking for solutions and we’re looking to get paid for those solutions. So, we’re not looking to set any cap rates based on an auction marketplace, based on what someone else is paying for it, that’s not what we’re interested in, what we’re interested in is having a solution even if there is a broker in the middle of the transaction and getting paid for that solution. So we’re pretty – we’re studying these cap rates ourselves.

Haendel St. Juste

Gotcha. Okay. And one more, acquisitions clearly have been a big part of your earnings over the last couple of years here. There’s been something – about your ability to sustain your acquisition volume given your decline in stock price since last summer. So maybe can you spend a minute or so addressing some of the concerns or even plans for funding the $900 million of net acquisitions for the year and maybe throw in some comments on how much may be incremental leverage you’re comfortable taking on and how prominent the role that ATM will play this year? I think you have $240 million left if I’m not mistaken.

Chris Volk

Haendel, so in Cathy’s estimates for the year, we’re assuming the acquisition pace that we mentioned, we are taking into account where the stock price in making that assumption. We would sure like to have a better stock price because that obviously would make the new acquisitions more accretive. But the acquisitions are nonetheless accretive anyway, I mean you as a shareholder would stream me up for not making acquisitions that we can do on an accretive basis. So, we’re making accretive acquisitions. If stock price would be nicer, I would be – all that much more creative. From a leverage perspective, we’re not expecting to lever up. If we were privately held like we were by Oaktree, they wouldn’t mind having a higher leverage in a public vehicle, people tend to gravitate towards leverage. We’ve been telling people that our guidance is 5.75 6.25 times which Cathy reaffirmed and so that’s kind of the bandwidth that we’ll generally stay within the guiderails of. Our goal is not to be a BBB- unsecured REIT company, our goal is to be BBB or better. So there’s no point being 2B- company to me, so you want it to be better than that and so to do that, you really have to have that kind of leverage numbers and outperform that in that fashion.

Operator

The next question is a follow up from the location of Craig Mailman of KeyBanc Markets. Please go ahead.

Laura Dickson

Hey, it’s Laura Dickson again. Just sort of following up on the last question I guess, you’re about 40% done with the ATM and it’s been about four months since you established the ATM. Are you -- could this be completed in 2017 or what are your thoughts on expanding the program?

Mary Fedew

Yeah, I think the ATM has proved to be a very efficient way to raise capital for us. As you know, our transactions happen almost every day and they’re small transactions. So an ATM is really a very nice way to sort of match fund our purchases with equity versus doing a larger chunk, but we’re mindful that there are other ways to raise equity I mean we have done overnight transactions, follow on transactions last May and that’s still an option for us. So basically as the year goes on, we will continue to make use of the ATM, but we’ll consider other ways to raise equity as well.

Laura Dickson

Okay. Thank you. And then just one other question, for the 2017 AFFO guidance, how much contribution do you need from 2017 investments to hit the midpoint of the range?

Cathy Long

Well I gave you the amount of annualized base rent and interest that the portfolio will create, that the portfolio was existing then. If you kind of think about it this way, because we acquire properties all throughout the year, the weighted average – suppose we do $1.2 billion a year, the weighted average is about half of that in any year. So really the other half is what the revenue impact would be the following year, does that make sense?

Laura Dickson

Yeah, I think so, so most of it, sounds like most of it is covered…

Cathy Long

A lot of it, a lot of the increase in AFFO is already baked-in because you have a full year of revenue from what you bought the prior year. And as we acquire properties in 2017 because there’ll be spreads throughout the year, you really baking in revenue for 2018 as well, right, because if I do $900 million this year, probably about the weighted average would be about $450 million. So I’m not getting full revenue because they’re not outstanding all year. Does that answer your question?

Laura Dickson

It does. Thank you.

Operator

The next question comes from Todd Stender of Wells Fargo.

Todd Stender

Okay. Sorry about that, got disconnected. Cathy just to stick with you, can you speak about may be your appetite for longer duration debt, I know the recent stuff has been closer to 10 years, when you look at your lease terms, they are pushing out towards 20 years. Just wanted to see about the match funding and now that you have the investment grade rating, how does that coincide with how long you’ll go?

Cathy Long

Well, I’ll start and I know Chris will add some color. From my perspective, I would like to have longer debt, I mean walking in these spreads for as long as possible makes sense to the extent that that is economically feasible right. When we started this business in 2011, long-term was less than seven years. And it is getting better now that we’re farther and farther away from the great recession, but I would love to see longer debt, 15 year debt would be great. And Chris will add some color.

Chris Volk

Yes, so I would say this, Todd, you can’t look at lease terms and think about making debt that commensurately – what Cathy is talking about that as CFO running a company and the management running a company, obviously if you can lock-in the spreads for a longer term, it’s just nice to do that. But what you’re really are doing is match funding cash flows. So if you look at our balance sheet, we have basically this year and next year $25 million, $30 million of debt coming due. In 2019, we have more than that coming due, but it’s about 6% debt from an interest rate coupon and some of that, - it’s actually callable this year.

So we may be able to do that, change this year or next, actually push it out to the end. So that means, you hope almost you might have potentially a runway of three years where you have no debt maturities. After that the median debt maturity is $250 million. So, what we’re targeting here is to have a median debt maturity that’s basically 2.5% of assets or less, somewhere in that neighborhood. So if you think about a whole balance sheet and your interest rate sensitivity is only 2.5% of assets, that’s almost nothing. But then, since we have a dividend payout ratio, say at 67%, our free cash flow this year after dividends was between $80 million and $90 million, okay?

So if you basically take your free cash flow and you net it against your debt maturities, you might get to say, $250 million of exposure or just $150 million in which case now your interest rate exposure is really only 1.5% of asset. So the conclusion you get to is you build out this stuff like you’re almost impervious asset to interest rate increases if you do this right, if you ladder up the maturities right, these are not interest rate companies in lease, interest rate companies in lease – the only thing that’s interest rate sensitive here is stock price, but in terms of just the balance sheet, in terms of where the cash flow has come from and how you’re laddering up maturities, there’s almost no interest rate sensitivity.

Todd Stender

Thank you for that. Appreciate it.

Chris Volk

Sure.

Operator

The next question is a follow up from Michael Knott of Green Street Advisors. Please go ahead.

Michael Knott

Hey Chris, just to follow up on your Gander comments which I appreciate, just curious just going into that a little bit more I’m curious if your confidence in that is born more sort of your contractual protections or your coverage at the facilities or the actual dirt of those particular locations or maybe even the steps that they’re taking to improve you had to sort of choose one or more of those, which ones would you choose in terms of your underlying confidence in this situation?

Chris Volk

I’m going to choose all of the above. I mean we’re looking at this, we’re not focusing on our contract, although the contract includes what is our rate per square foot? How much do we pay for the real-estate? So, do we buy the real-estate at the right price, what can we do with it? I mean these are well traffic properties. There are definitely alternative users for these types of assets in virtually every market, but we’re also not thinking that’s going to happen. So we’re thinking basically, the STORE’s doing well, and by the way, the fact that the STORE’s been doing well since [indiscernible] real-estate -- the fact that people go there and STORE’s crank it and do the volume says something about how good these assets are.

Todd Stender

Could any of those contractual protections be -- could they go away if there is a bankruptcy filing?

Chris Volk

Well, you can’t change the price you paid for real-estate, that contractual protection doesn’t go away and you can’t change where they give us financial reporting, that doesn’t go right? You can’t change STORE’s at master leases, that doesn’t go away. So, this is why - credit can be transient but the contract characteristics just don’t change. If you are doing a transaction for example, often times sort of the notion that if I’m doing business with an investment grade tenant, I must have an investment grade contract, that’s not true. I mean if you are doing an investment tenant, I’ve got 15 or 20 year lease, there’s a well better than 50% or may be 75% chance that over 15 years a BBB companies becomes non-rated.

So your credit just changes over time. But contract doesn’t change. How STORE perform is really important, I mean if STORE does $10 million of sales, it does $10 million of sales, it says a lot about the marketplace, and you can’t change that with any kind of bankruptcy filing and in fact, in bankruptcy, every single landlord including all the Logan’s – were there, I think they closed out 34 locations, all those landlords found out then and there that the slower pace in the rent, not the credit. So understanding how - why your STORE deal is important.

Operator

And that concludes our question-and-answer session. I would now like to turn the conference back over to Chris Volk for any closing remarks.

Chris Volk

Sure, I have a few comments, first of all we really apologize for the static. We actually – for those of you who know pretty well, we’ve moved into the new office about three months ago. This is actually our first conference call out of the new office and it didn’t go as expected. So, we’re going to post scripts though of the prepared remarks, so if you didn’t everything that I had to say and there was too much static, you’re going to get to see all that in writing. And then also, before signing off, I would like to note three things for you. First, we will shortly be filing a brand new corporate presentation for you to take a look at, so you can look after that. Also, for those of you who have been glued to STORE University, we are launching the second semester and so lesson four should be on our website shortly.

And then finally, in November-December 2016 and January-February 2017 issues of Commercial Investment Real Estate Magazine, which is published by CCIM Institute, you can find a two part article I draft on the importance of tenant credit quality as a consideration when investing in profit center net lease real-estate. And as always, we are around if you have any questions and thanks for listening and goodbye.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect your lines. Have a great day.

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