Four Corners Property Trust Inc

NYSE:FCPT

Earnings Call Transcript 2024-Q1

[Operator]

Welcome to the FCPT First Quarter 2024 Financial Results Conference Call. My name is Carla, and I will be coordinating your call today. [Operator Instructions]. I would now like to hand you over to Patrick Wernig. Patrick, please go ahead.

[Patrick Wernig, executive]

Thank you, Carla. During the course of this call, we will make forward-looking statements, which are based on our beliefs and assumptions. Actual results will be affected by known and unknown factors that are beyond our control or ability to predict. Our assumptions are not a guarantee of future performance and some will prove to be incorrect. For a more detailed description of some potential risks, please refer to our SEC filings, which can be found at fcpt.com. All the information presented on this call is current as of today, May 2, 2024. In addition, reconciliation to non-GAAP financial measures presented on this call, such as FFO and AFFO, can be found in the company's supplemental report. With that, I'll turn the call over to Bill.

[William Lenehan, executive]

Good morning. Thank you for joining us to discuss our first quarter results. I will make introductory remarks, and Patrick, Josh and Gerry will comment further on the acquisition market and our financial results and capital position. We reported first quarter AFFO of $0.43 per share, which is $0.02 or 4.9%, up from Q1 last year. Our existing portfolio continues to perform very well with 99.7% rent collections for the quarter and 99.6% occupancy at quarter end. Our EBITDAR to rent coverage in the first quarter was 4.9x for the significant majority of our portfolio that reports this figure. This remains amongst the strongest coverage within the net lease industry. According to Baird Research, year-over-year sales for the restaurant sector as a whole remained positive in the first quarter in the 4% range after flat results in January, which was impacted by bad weather.

Similar to last quarter, casual dining saw small declines off strong levels in the prior year period. Darden reported a 1.8% decline in same-store sales for Olive Garden and a 2.3% increase for LongHorn for the quarter ending February 25. Overall, for Darden, restaurant-level EBITDA margin improved 70 basis points to 20.6%, reflecting commodity pricing and productivity improvements. We note that our second largest tenant, Brinker also announced positive results on Tuesday. Chili's same-store sales grew 3.5% and their restaurant-level EBITDA margin improved 90 basis points to 14.1%. FCPT acquired 4 properties in the quarter for $15.9 million at a 6.9% cap rate. All of the properties were in the medical retail sector, and we continue to benefit from establishing verticals in addition to restaurants, our historical core area of focus.

Similar to the fourth quarter of 2023, we slowed down acquisition activity in the quarter to reflect the current cost of capital of equity and debt in comparison to acquisition market pricing. The current capital markets backdrop and seller reticence to accept higher cap rates has made it challenging to deploy capital accretively. In this environment, we remain disciplined allocators of capital. As we've stated in the past, several quarters as well, we have established mental models and structure our team incentives to discourage deploying capital just to grow the company's size without also increasing per share metrics of earnings or intrinsic value.

Turning to capital sources. We issued $6.9 million of equity early in the first quarter at an average offering price of $25.38. In March, we issued $85 million of term loans, utilizing the accordion feature of our credit facility to achieve favorable borrowing costs. $50 million of the offering was used to pay down a private note debt maturity that was due in June of 2024. Our balance sheet is in great shape with our next debt maturity not scheduled until November 2025. The remaining $35 million was used to fund acquisitions. While we normally do not get into detail on individual tenants, we are aware of the public reports that Thai Union is exploring options for Red Lobster, including selling the brand or restructuring alternatives. Before going into detail, it is important to note that we own a group of stores with below average brand rents and above average brand EBITDAR to rent coverage.

Now on to specifics. First, I'll start with portfolio management. In 2022, we noticed a few stores beginning to show weaker performance through our monitoring of store level sales and profitability. Over the next 18 months, we sold some of our highest rent and lower performing stores at an average cap rate of 6.5% and a positive gain. This dropped our exposure from 2.9% of annual base rent to 1.7% today. Today, we own 18 properties, of which 10 are in a master lease with an average rent of $276,000. The remaining 8 are low rent ground leases and outparcels with average rent of $117,000. Blended together, this equates to an average rent of $206,000 per property. In both the case of the master lease and the ground leases, we have good rent coverage. Second, it's important to remember that we were highly selective in acquiring Red Lobsters in the first place. Over the years, we passed on a lot of Red Lobster locations where the rent was set very high for the underlying store performance was low.

We recently reviewed nearly 200 Red Lobster rent comps to compare to our 18 locations. We found that 15 of our 18 restaurants have rents below the brand median for this comp set and the remaining 3 were in the ballpark of brand median rent. While we hope Red Lobster avoids restructuring, if it does come to that, we feel that we are well positioned to manage the process. More importantly, in March, we announced Gerry's retirement from FCPT and Patrick's promotions as CFO. This transaction has been carefully planned over the last 1.5 years and will be completed tomorrow.

I would like to sincerely thank Gerry for his service and contributions in helping us grow from a spin-off origin in 2015, Gerry was here day 1 as part of 6 employees many years ago. Gerry has been a great financial steward and has been instrumental in helping make FCPT what it is today. While Gerry will be around in the interim advisory role to support the team, we wish him all the best in the future. I'm also very excited to have Patrick step up in the CFO role. Patrick was working on the creation of Four Corners at JPMorgan even before Four Corners existed. He was one of our first hires and brings a deep understanding of our capital markets, our acquisition process and our culture.

With that, I'll hand it over to Patrick to further discuss the investment environment.

[Patrick Wernig, executive]

Thanks, Bill. Before I get into specifics on investments, I'd also like to just echo your comments about Gerry and his significant contribution to our company and culture. I'd be remiss if I also didn't take this moment to thank him personally for over 8 years of mentorship and guidance over the last 12 months as we work through the transition process.

Now turning to our acquisitions outlook. We're seeing a lot of interesting opportunities that may be added to the pipeline. Said another way, there's no shortage of tenants seeking net lease capital and there are fewer buyers out there pursuing them. What is missing out was a stable pricing environment where sellers are comfortable transacting at pricing that makes sense reflect for Four Corners. And while we continue to see increases in seller cap rate expectations as interest rates remain elevated, we've also seen that net lease pricing adjust more slowly than capital markets. So the bid-ask spread between buyers and sellers while conversion still exists. That's resulted in transaction volume being down for the sector overall. It's worth pointing out that net lease can be lumpy. And while we have a slow start to the year in 2023, we also had a record acquisition year on the back of strong closings from April through July.

Overall, our portfolio now stands at 1,137 leases with Darden at 51% of our annual base rents and restaurants at 80%. Non-restaurant is now 20% of our portfolio with automotive as our largest non-restaurant sector at 9%, followed by medical retail at 8%. On the disposition front, we did not sell any properties in Q1, but we frequently receive reverse inquiries on our properties and continue to consider strategic dispositions as a potential attractive alternative to issuing new debt and equity capital as well as part of our active portfolio management strategy. We are fortunate that our portfolio continues to attract buyers and we can utilize dispositions for accretive capital recycling when needed or in capital markets are less attractive.

Josh, I'll turn it over to you.

[Joshua Zhang, executive]

Thanks, Patrick. Turning to leasing. We had 13 leases expire in Q1 with all but 2 tenants renewing. Those 11 leases had positive renewal spreads of 12.5%. We expect positive results on the 2 sites that did not renew, but we are early in the process there. These results reinforce our underwriting confidence that we are partnering with the right tenants and that the rents are set at attractive levels for the tenants in our portfolio. Portfolio occupancy stands today at 99.6% and remains well positioned with only 0.9% and 2.2% of annual base rent maturing in 2024 and 2025, respectively. This ticked up slightly for the quarter, but we already have strong leads at re-leasing at several locations. So continuing on Bill's statements on Red Lobster, we understand bankruptcy can be a complicated and uncertain process. But if the brand is unable to avoid it, we are prepared to respond.

Any offer made for rent reduction would be weighed against what we expect to be strong demand to backfill the properties given the real estate quality. Fortunately, a lot of Red Lobsters are located adjacent to Olive Garden and LongHorn Steakhouse stores, which means at least one of our preferred tenants already knows these sites well. Before turning it over, I'd also like to thank Gerry for the past 8 years of mentorship and service to FCPT. Gerry, I'll turn it over back to you.

[Gerald Morgan, executive]

Thanks, Josh. For the first quarter, our cash rental revenues grew 12.9% on a year-over-year basis, including the benefit of rental increases and $329 million of acquisitions over the last 12 months. We reported $58.0 million of cash rental income in the first quarter after excluding $0.6 million of straight line and other noncash adjustments and on a run rate basis, current annual cash base rent for leases in place as of quarter end is $219.6 million, and our weighted average 5-year annual cash rent escalator remains at 1.4%. We collected 99.7% of base rent in the quarter, and there were no material changes to our collectibility or credit reserves nor any balance sheet impairments. Cash G&A expense, excluding stock-based compensation was $4.6 million representing 7.9% of cash rental income for the quarter and compares to 8.4% for the prior year quarter.

Overall leverage, our net debt to adjusted EBITDAR in the first quarter was 5.6x, and our fixed charge coverage ratio was a very healthy 4.3x. We have $277 million of liquidity comprised of $27 million of cash and $250 million of full revolver capacity at the beginning of the quarter. We remain committed, and I know Patrick and the team will continue to maintain a conservative balance sheet and extend and layer our debt maturities as we can. We issued $85 million of term in March, as we mentioned, and that did take care of our only debt maturity before November 2025. The loan matures in March of 2027 with a 12-month extension exercisable by us in conjunction with the offering, we entered into $85 million of interest rate swaps to fix the reference rate of 3.94% through maturity.

Including the credit margin of 0.95% determined by our current investment-grade ratings, the effective interest rate is 4.89%. We are very appreciative of the support from our existing bank partners on the loan. As the others mentioned, this is my last quarter and earnings call at Four Corners. I, too want to thank all of my colleagues here at Four Corners for their support and collaboration over the last 8-plus years and our Board, which is an amazing Board. FCPT is a special place, and I know it is in great hands going forward. And with that, I'll turn it back over to Carla for investor Q&A.

[Operator]

[Operator Instructions]. Our first question comes from Anthony Paolone from JPMorgan.

[Anthony Paolone, analyst]

And first of all, thanks, Gerry, for all the help over the years. So good luck with everything. My first question is on just cost of capital versus yields. And so if we think about just like your blended cost of capital right now, it seems like maybe a high 6s thereabouts and you've been doing deals at 7. Like do you think that's enough? Or where do you think yields need to be for you to feel like you could lean into transactions more?

[William Lenehan, executive]

It's a great question, Anthony. It's darn close. We've been able to consistently acquire things with the 7 handle after 7, 8 years of 6.5 to 6.7 cap rates. So it's quite close. We've been a little cautious. It's not super accretive where the market is but with a slightly higher stock price, a slightly lower 10-year or slightly higher cap rates, it begins to really work. So we're being patient. We're not lowering our credit quality on our acquisitions. We're playing for the long term.

[Anthony Paolone, analyst]

And do you see a sizable pipeline that you like right now so that if your capital costs do line up a bit better, you could turn it on a bit faster and more robustly or does the pipeline has...

[William Lenehan, executive]

That's exactly right. And that informs our confidence to be patient that to the extent that the numbers lined up a little bit better, we feel like there's a buildup in the market and that we could be -- we could deploy capital accretively, again if the numbers were slightly different.

[Operator]

Our next question comes from Wes Golladay from Baird.

[Wesley Golladay, analyst]

Congrats, Gerry and Patrick. I just want to go back to the comment about the strong demand for the Red Lobster unit in a worst-case scenario. Just if you can just give us maybe some of your views on how quickly you can turn a unit, maybe where you see the mark-to-market and if you would, in this situation, having to release it, would you look to put in TIs, if you had the choice?

[William Lenehan, executive]

Honestly, Wes, I don't think there's a high likelihood that we will be getting these buildings back. I mean 8 of them are ground leases with $12 a foot rents. We get percentage rent from those properties. They're healthy. The master lease is well covered. We sold the weaker properties. So I don't think that that's likely. But to directly answer your question, these are in good locations. As Pat mentioned, they're very often next to a LongHorn or an Olive Garden, just to remind everyone, Red Lobster was a Darden brand a decade ago. So I think it's unlikely. I think if we get back the ground lease properties, we'd likely make money. I think it's highly unlikely they reject the entire master lease, but if they did, I'm not concerned.

As far as TIs, TIs on a couple of buildings in the context of a $3 billion company isn't terribly meaningful. It would be part of the whole bargain that you'd have with the new tenant. So I don't think we think about it as a hard now, it would be part of the negotiation. But again, I think it's pretty unlikely. But as Josh mentioned, restructurings, if it comes to that are uncertain. And I would just say that we have a lot of experience investing in distressed properties in my background and Jim's background, we're well equipped to handle it.

[Wesley Golladay, analyst]

Okay. And then when we look at the pipeline, what are you seeing as far as deal volume goes? Is it -- you've closed more deals on the medical retail? Is that just because of the more realistic pricing? Is the volume just bigger there? And are you seeing more opportunity for [ savings ] rather just third-party transactions?

[William Lenehan, executive]

Yes, that's just sort of low small numbers and how it happened. We're looking at automotive service. We're looking at medical retail. We're looking at restaurants. I think the only thing that I would note on the acquisition pipeline is there seems to be more larger portfolios being discussed now as it's been 9, 12 months with a difficult acquisition environment. And people are starting to face debt maturities. Equity partners are on private deals seeing higher cost of capital, just like the public markets. So we're seeing more of that, but nothing that's hit [ pager ] yet.

[Wesley Golladay, analyst]

Okay. And then just last one for me. On the disposition front, you do have a lot of assets that are in high demand in the private market. what type of spread -- an initial spread do you think you can get and redeploy the capital at? And then also another component of the value creation would be the annual escalators on the new properties. Do you think that will be higher for what you buy versus what you're selling?

[William Lenehan, executive]

It won't be lower, to answer the last question first. It won't be lower. We have seen some higher escalations. We've seen some more discipline on tenant-friendly lease extensions. As far as dispositions, we get incoming inquiries almost daily, certainly weekly. Very often, those are in the mid-5s but there -- we like our existing portfolio, so to be incentivized to sell something needs to be compelling. And so -- and I would also mentioned that very often the buyers, they need to get financing. They're part of a 1031 exchange. And so the closing rates are 50-50 and that means it's a bunch of work to do. So it's an option. As you say, we have hundreds of buildings leased to investment-grade tenants that are very desirable. But it hasn't been compelling mathematically for us just yet.

[Operator]

And our next question comes from R.J. Milligan from Raymond James.

[R.J. Milligan, analyst]

Actually, my questions have been answered, but I just wanted to stay in the queue, congratulate Patrick, on the new role. And more importantly, thank you, Gerry, for the relationship over the past 8 years. I really appreciate all of your help and congratulations on your retirement.

[Gerald Morgan, executive]

Thank you, R.J.

[Patrick Wernig, executive]

Thanks R.J.

[Operator]

[Operator Instructions]. Our next question comes from Jim Kammert from Evercore.

[James Kammert, analyst]

Bill, building on your comment that potentially there are some larger portfolios out there, which makes sense largely right, their pressures are magnified given the scale of what they have to refinance or pay off, et cetera. But does that mean -- how would you think about that from Four Corner's perspective, if there is a $300 million portfolio out there, would you require a bigger wider spread to your cost of capital at the time than a pipeline of one-offs because you maybe precluding yourself from optionality to see the market evolve over time. I'm just curious how you think about a bigger transaction versus the -- you've been a pretty steady cadence of one-offs.

[William Lenehan, executive]

Yes. It's a really great question. The crux of it though is, is it $300 million of one tenant? Or is it $300 million of a diversified pool that's for argument's sake is analogous to our existing portfolio? What we've seen in the market is that the $300 million of one tenant trades at a discount because you're buying tenant concentration when you buy that, a well-diversified pool less so. So I would look at a well-diversified pool that we're buying as very efficient. So I wouldn't demand a premium. $300 million of sale leaseback of one tenant in today's market would get discounted pricing or a premium cap rate, however you want to say it.

And I think the other thing that we've noticed in the market -- the other thing we've noticed in the market just to close the loop is that REITs generally, my feeling is that if acquisitions require capital raises, there's a higher level of hesitancy because bank debt capital is more dear, capital markets are more fickle and most people are a little bit where we are, where they'd like to see their stock price a little higher. So a transaction that requires a capital raise, 3, 4 years ago, that was an advantage. You wanted a reason to go to the capital markets today that causes pause.

[James Kammert, analyst]

Very good color. And just to close the loop, I know it's a fluid situation, but on those, let's just call them, larger portfolios from your perspective, what kind of dollar value that is in your shadow pipeline today, say, versus 6 or 9 months ago? Just ballpark, curious what you're looking at.

[William Lenehan, executive]

These are more quite large transactions that we're kicking the tires on, but I want to just be very clear, nothing is imminent or even probable. Just things that we're looking at, we have, we've looked -- we've had large transactions that we've been looking at since inception, we've done a handful of them with Brinker, with a bank that was selling some net lease a year ago, but nothing is imminent or probable. It's just an observation that they seem to be more prevalent than in the past.

[Operator]

And that was our final question, I will hand back over to Bill for final remarks.

[William Lenehan, executive]

Great. Thank you, everyone, and another efficient conference call. If anyone has any questions, please reach out. Thank you.

[Operator]

And this concludes today's call. Thank you for joining. You may now disconnect your lines.