Four Corners Property Trust Inc

NYSE:FCPT

Earnings Call Transcript 2019-Q2

[Operator]

Good day, and welcome to the FCPT Second Quarter 2019 Earnings Conference Call and Webcast. All participants will be in a 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 Mr. Gerry Morgan, Chief Financial Officer. Mr. Morgan, the floor is yours, sir.

[Gerry Morgan, CFO]

Thank you, Mike. Joining me on the call today is Bill Lenehan.

During the course of this call, we will make forward-looking statements, which are based on beliefs and assumptions made by us and information currently available to us. Our 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 on the IR section of our website at fcpt.com. All the information presented on this call is current as of today, July 31, 2019.

And 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 also available on our website.

And with that, I'll turn the call over to Bill.

[Bill Lenehan, CEO]

Thank you, Gerry. Good morning. Thank you everyone for joining us to discuss our second quarter results.

FCPT's acquisitions volume reached $43 million for the second quarter with 18 of the 21 properties leased to large corporate tenants operating strong brands including Wendy's, Arby's, Texas Roadhouse, Olive Garden, LongHorn, and Red Lobster. The average price points for our acquisitions was $2 million representing a low basis entry point reflecting low rents.

Our average EBITDA rent coverage was 3.8 times for properties that reported financial results. The focus on tenant operator credit, store level performance, and low in-place rents remains paramount at FCPT.

We also announced last week the signing an agreement to purchase 20 additional outparcel properties from Washington Prime Group for approximately $38 million. WPG has been an excellent partner for us and we look forward to closing these properties and the 11 remaining properties from the first transaction. Closings will occur in rolling tranches as the properties become available to be conveyed.

I want to note a couple of important characteristics of this transaction. The per property purchase price averaged $1.9 million which reflects low in-place primarily ground lease rents. The transaction represents group of high quality and nationally recognized brands and 19 of the 20 leases are with the brands corporate entities. In addition, the properties in this transaction represent strong population traffic demographics that compares favorably to the original spin portfolio. The transaction includes eight non-restaurant retail properties marking our first investments outside of restaurant net lease. We've mentioned over the past year that we will branch out into adjacent retail sectors especially if by doing so; it facilitated our acquiring restaurants in great locations. These eight non-restaurant properties share similar qualities as our restaurant locations with comparable building sizes and net lease structures, and six of the eight properties are with investment grade tenants.

We look forward to leveraging our deal sourcing and closing infrastructure to grow in both restaurant and non-restaurant net lease sectors. The existing portfolio has continued to perform well as evidenced by the 4.8 times EBITDA coverage in the quarter and the restaurant industry as a whole looks to be reporting solid Q2 results. This includes Darden, which was led by its Olive Garden and LongHorn brands same-store sales growth of 3.9% and 3.3% respectively in the most recent fiscal year closed in May.

We also note the positive operating trends at our second largest tenant Brinker International, the parent company of Chili's which reported same-store sales expanding 2.9% at company-owned locations in the most recent quarter which represents the fourth straight quarter of positive same-store growth at the brand.

Overall, the restaurant industry continues to largely perform well but we do note some operators have highlighted headwinds from a slowing economy and rising labor costs, but others are being impacted by technological initiatives such as delivery and loyalty and increased competition. FCPT will keep an eye on these trends and continue to align ourselves with best-in-class operators and brands focused on addressing these challenges.

We received investor questions on whether we have any exposure to MPC International a large pizza hut franchisee and the second largest domestic franchisee overall which has recently been downgraded by the rating agencies. We have none of their properties.

Also there have been rumors about the financial situation at Perkins. We don't own any of those either.

We have good news on our efforts to continue building out our team in the coming weeks, we have a new acquisition associate and a new corporate finance associate. These additions along with the continued professional development of our current team will set us up well to continue executing our investment and funding strategies.

Finally, with respect to the overall investment environment, we did observe some tightening of cap rates on several transactions recently. This is potentially a reaction to the dropping interest rates over the last 90 days. And also we've seen a lot of equity capital raised in the first half of 2019 by our net repeaters.

Now, Gerry, will take you through our financial results. Gerry?

[Gerry Morgan, CFO]

Thanks, Bill.

We generated $32.2 million of cash rental income in the second quarter after excluding non-cash straight line rental adjustments. And on a run rate basis, the current annual cash base rent for leases in place as of June 30, 2019, is just under $130 million.

Our weighted average 10-year annual cash rate rent escalator remains at approximately 1.5%, and as Bill mentioned, but worthy of repeat, our EBITDA coverage was 4.8 times for the portfolio.

We reported flat FFO per share quarter-over-quarter results. As we were impacted in the quarter by approximately a $0.01 per share due to the short-term dilutive effect of not yet invested balance sheet cash.

Our results were also impacted by a higher average interest rate on our debt due to a greater mix of longer duration bonds and the rolling of interest rate hedges on our term loans and higher cash G&A as we build and invest in our team.

In the quarter, we reported $2.7 million of cash, general, and administrative expenses after excluding stock-based compensation and our guidance for 2019 remains of an annual cash G&A rate of approximately $11 million.

Turning to the balance sheet, we start the second quarter well capitalized to support 2019 second half investment activity. We ended the second quarter with net debt to EBITDA of 4.9 times, over $20 million of available balance sheet cash, and full availability on our $250 million revolver.

In addition, as discussed on last quarter's call, in April, we entered into a forward-sell agreement through our ATM program at an initial average sales price of $29.30 per share for gross proceeds of approximately $47 million. We have not yet settled any portion of the forward but continue to expect to do so on one or more dates prior to the end of 2019 to meet acquisition funding needs.

With that, we'll turn it back over to Mike for Q&A.

[Operator]

Thank you, sir. We will now begin the question-and-answer session. [Operator Instructions].

The first question we have will come from Collin Mings of Raymond James. Please go ahead.

[Collin Mings, Raymond James]

Just as you noted in the prepared remarks, you've communicated for a while now that you are open to potentially investing in properties associated with non-restaurant tenants. Clearly the WPG deal marks a formal move in this direction. As we think about moving forward can you just discuss how you plan to approach additional non-restaurant opportunities? Do you expect to pursue them on a one-off basis well or will these brands be brought into the portfolio only as part of call a larger transaction in a similar way to the WPG deal?

[Bill Lenehan, CEO]

Collin, we've been studying non-restaurant properties for well over a year as you have heard and this is our first announcement. I think you will see more announcements like this over the next few months as non-restaurant outparcels are included in larger old parcel transactions and we remain opportunistic in looking at other properties that we feel fit our portfolio. So I think you'll see a mix. But this was an organic way to start off a non-restaurant properties and I think you'll continue to see us do it that way for the near-term.

[Collin Mings, Raymond James]

Got it. Okay. That's helpful. And then just as you think about this move into non-restaurant properties, are there any specific sectors, box sizes that you want to particularly focus on or ones that you want to stay away from?

[Bill Lenehan, CEO]

Yes. I think we've historically focused on category killer concepts, bank branches with premium investment grade, tenants, and just other properties that naturally exist adjacent to our restaurant properties. I think generic retail is something we would likely stay away from. But if we can find good real estate with long-term leases and good credit behind it with low rents, we want to be opportunistic.

[Collin Mings, Raymond James]

Got it. Just maybe to clarify on that point, would you be open to outparcel if it may be associated with an office building or things like that or do you really want to get the retail?

[Bill Lenehan, CEO]

I think mostly retail, Collin.

[Collin Mings, Raymond James]

Fair enough. And then again in prepared remarks you alluded to the fact that there was a fair number of ground leases associated with the second WPG deal, can you maybe quantify that mix at all?

[Bill Lenehan, CEO]

Yes. I would say that historically we're looking at outparcels; I'm not specifically referring to WPG since we haven't provide that break-up. But historically when we looked at outparcel deals roughly 60% to 70% of the properties that we look at are both corporately operated and ground lease. And in this case, I think it's relatively similar on the ground lease percentage but higher on the corporate tenant basis.

[Collin Mings, Raymond James]

All right. And then, just last one here, just as again recognizing that you guys have put into place a pretty comprehensive due diligence process and underwriting process again historically focused on restaurants, what things are you changing on the margin from an underwriting standpoint as you think about some of these non-restaurant branded properties?

[Bill Lenehan, CEO]

Great question, Collin. I think it really fundamentally as you look at the properties that we're buying and you run them through our underwriting process there's a lot of overlap location, reuse, guarantor credit, is it a net lease, what's the rent growth et cetera and what we're finding is that the variables that we're swapping out let's say rent to sales for deposits in the case of a bank branch, they are really minor tweaks on the margin of our underwriting.

[Operator]

The next question today will come from Rob Stevenson of Janney.

[Rob Stevenson, Janney]

Good morning guys. Collin asked a couple of my questions but the one that I wanted to talk in greater detail, what do you guys like about bank branches at this point especially with Millennials starting to use the phone for deposits et cetera and assuming like maybe not today, maybe not tomorrow, but within the next 10 years you're going to need less bank branches out there. Obviously it sparks on a great piece of land that could be repurposed but that's generally not anybody's first choice. So when you've been doing the underwriting, what has you excited about bank branches in particular?

[Bill Lenehan, CEO]

Well I don't think there's anything in particular about bank branches that have us focused on them in any sort of specific way. These were properties that were intermingled with the restaurant properties we purchased. But I would call up that bank branch closure rates are actually far less than people expect.

Second they're primarily very large investment grade tenants. We've got good lease term. And then the boxes are more repurposable than restaurants and with the basis that we'd have in these buildings, we'd be in a very attractive economic proposition to repurpose them. So I think it's -- we're not solely focused on bank branches by any means, we're looking at a lot of different things, it just so happened. But the first couple in this announcement with Washington Prime happen to be bank branches but large investment grade tenants in this case very low rents and repurposable buildings.

[Rob Stevenson, Janney]

Okay. And where is the EBITDAR coverage on the non-restaurant assets versus where you guys are on the restaurant portfolio today?

[Bill Lenehan, CEO]

I don't think we disclosed that the EBITDAR coverage for bank branch is a little bit difficult to measure. Typically they use deposits as the key metric but it's such a small number of properties, we don't own them yet. So I don't think we've made any disclosures like that.

[Rob Stevenson, Janney]

Okay. But there's no material difference in the sort of coverage quality of like the jareds versus typical restaurant asset or something like that you're aware?

[Bill Lenehan, CEO]

As I mentioned we don't yet own those assets, so I don't feel comfortable talking about this financial performance. But obviously as we were underwriting them, we took a very careful look at how these stores perform and compare them to relevant benchmarks in the industries that they operate in.

[Operator]

And next, we have Nate Crossett of Berenberg.

[Nate Crossett, Berenberg]

Hi, good morning guys. Certainly there's been a lot of acquisitions that have come from Washington Prime. And so I was just wondering if you could give us a sense of how much remaining opportunity has left with them. And are there other REITs that you are in active discussions with or you could do similar type transactions and do these new property types open the door to more REITs that you could potentially do deals with?

[Bill Lenehan, CEO]

Sure. I think we've done a quite a bit with Washington Prime and we have a great relationship with their management team, we will continue to look to do additional with them. But frankly I think we are sort of well on our way to buying the outparcels from them that they are willing to sell and we're willing to buy. We are in conversation with a number of other peers, we are looking to purchase outparcels from them. I think you should expect that to be there have been a number of announcements through the remainder of the year along that theme. And, yes, obviously we've increased our aperture for what kind of properties we can buy. It does lead to the opportunity to make more acquisitions and given our cost of capital, we find that very attractive.

[Operator]

Mr. Crossett any further questions, sir. So we will go ahead and proceed to the next question and that'll come from John Massocca of Ladenburg Thalmann.

[John Massocca, Ladenburg Thalmann]

So touching more maybe on the restaurant side of things. Are you seeing placing a greater emphasis today on the value of corporate credit versus franchisees versus say like 12 months ago? And what percentage of portfolio today is corporate versus franchisee credit roughly?

[Bill Lenehan, CEO]

The vast majority is corporate because Darden, Brinker, and most of these outparcel transactions have been corporate credit. I don't know the exact percentage at my fingertips but it's very, very high. I don't think we would see that our emphasis has changed. We still think large franchise credit is attractive but clearly publicly traded large corporations especially if they're highly rated is sort of in a different league. So we do obviously feel like corporate credit is an advantage and it's one of the primary things we like about this outparcel strategy.

[John Massocca, Ladenburg Thalmann]

Okay. And then from a balance sheet perspective leverage crept up a little bit which you would obviously expect given its kind of well below target range but do you think the fact that you have or maybe if you even put more of kind of a forward offering out there that that gives you some flexibility because you have kind of a forward in your back pocket to maybe move leverage up towards your target levels quicker?

[Bill Lenehan, CEO]

I don't think we are in any rush to increase our leverage towards targets that will happen naturally. But to your point we have a tremendous amount of financial flexibility not just with a low overall leverage balance sheet but with the forward capacity. So we feel like our balance sheet is in a terrific place and what I found over a long period of time is conservatively levered REITs have a real advantage over the long haul. Obviously being over capitalized quarter-by-quarter lowers earnings growth but we feel like we're in a really good place to be able to advance our business model and create earnings growth going forward.

[John Massocca, Ladenburg Thalmann]

Okay. And then on the debt side, what are maybe your thoughts on the long-term plan for the 25% of the outstanding term loans that aren't currently swapped today especially given kind of the low interest rate environment we're in right now?

[Gerry Morgan, CFO]

Bill I will grab that.

[Bill Lenehan, CEO]

Okay.

[Gerry Morgan, CFO]

Our strategy is to have some unfixed debt in the 10% to 15% range which I think is typical in our sector. So I think we'll monitor that. But we're comfortable with having a portion of our term facility today remain unhedged.

[Gerry Morgan, CFO]

Mike, any additional questions?

[Operator]

Yes, sir. We do have another question. This is from Linda Tsai of Barclays.

[Bill Lenehan, CEO]

Good morning, Linda.

[Linda Tsai, Barclays]

Good morning. I know you're going in cash yields for your acquisitions have been pretty consistent and the recent Washington Prime transactions may be towards the low end of the range. Just in terms of the eight non-restaurant retail brands, did those components carry a lower cap rate versus the restaurants?

[Bill Lenehan, CEO]

No, they're very much in line.

[Linda Tsai, Barclays]

Okay. And then you alluded to the reuse potential of non-restaurant retail and the attractiveness is I guess is a function of more generic build-outs and smaller sized boxes. Is there a certain range of box size that you view as the sweet spot for reuse potential?

[Bill Lenehan, CEO]

Yes. I think it really depends on how the building would demise because there's some sort of larger buildings that cut up naturally. But we have historically stayed away from the really large boxes sort of department store size boxes that some uses like gyms or others have gone into. So our preference is to keep it small, keep our risks granular, and clearly with low rents and long lease term, you have a lot of positive optionality. But given the bank branch deposits that we have here and the operating performance of the other tenants, we think they're going to be in these buildings for a very long time.

[Linda Tsai, Barclays]

Thanks. That's it from me.

[Bill Lenehan, CEO]

Great, thank you, Linda. Mike any additional questions.

[Operator]

Yes, sir. We do have a follow-up from Nate Crossett of Berenberg.

[Nate Crossett, Berenberg]

Hey guys, did you hear my first question, my line dropped. So I wasn't sure if you answered it or not.

[Bill Lenehan, CEO]

Would you mind repeating it? I think we did.

[Nate Crossett, Berenberg]

It was about Washington Prime and if you kind of give us a sense of the remaining opportunity you lost with them?

[Bill Lenehan, CEO]

Yes, we did cover that, Nate.

[Nate Crossett, Berenberg]

Okay. And then okay, I will go back and look at the transcript. But maybe you can talk about how you're sourcing new deals outside of these larger transactions; I don’t know can you remind me the size of the sales team you mentioned you hired in associate?

[Bill Lenehan, CEO]

Right. So our investment team is comprised of myself and three others, we're adding a fourth in September. I would say that our sourcing has been very consistent for the last two years. It's just that now we have more experienced and more people that have been focused on restaurants and now that we've bought a couple hundred properties. Our name is out there perhaps a bit more but sourcing is very similar, our investment team is now just a little bit more experienced and we feel like evidencing our ability to execute on these outparcel transactions is a real differentiator.

I think it's still not easy. They require a lot of work in personalization and selection and kudos to Jim Brat, our General Counsel, especially for becoming really an expert in how to purchase these complicated transactions that are a lot of work upfront but long-term we're really excited about the percentage of corporate tenants, the brands that we're getting, the demographics and of course the very low rents.

[Nate Crossett, Berenberg]

Okay, that's helpful. And then just maybe one on -- I was just wondering what we should think about the dividend and dividend growth. What's the kind of AFFO ratio you guys target or how should we think about that?

[Bill Lenehan, CEO]

We've historically addressed the dividend with our board at the end of every year. We've typically targeted around an 80% AFFO payout ratio but of course a lot of factors are considered by our board but we typically do it once a year in the November, December timeframe.

[Nate Crossett, Berenberg]

Okay. Thanks guys.

[Bill Lenehan, CEO]

Thanks. Mike, any additional questions.

[Operator]

No, sir. We do not have any further questions at this time.

[Bill Lenehan, CEO]

Great. Well I'll just wrap it up by thanking everyone for joining us on the call today. We're excited about this Washington Prime transaction, we're excited about growing in non-restaurants and most importantly we're really excited about the team and how the team's growing. Thank you everyone. If you have follow-up questions please don't hesitate to reach out to Gerry or myself. Thank you.

[Operator]

And we thank you sir also for your time today and to the rest of the management team. Again, the conference call has now ended. At this time you may disconnect your lines. Thank you. Take care and have a great day everyone.