Four Corners Property Trust Inc

NYSE:FCPT

Earnings Call Transcript 2022-Q2

[Operator]

Hello everybody, and welcome to the FCPT Second Quarter 2022 Financial Results Conference Call. My name is Sam, and I'll be coordinating your call today. [Operator Instructions]

I will now hand you over to your host Gerry to begin. Gerry, please go ahead.

[Gerry Morgan, CFO]

Thank you, Sam. During the course of this call, we will make forward-looking statements which are based on beliefs and assumptions made by us. Our actual results will be affected by known and unknown factors, including uncertainty related to the remaining scope, severity, and duration of the COVID-19 pandemic 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 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, July 27, 2022.

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 the website.

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

[Bill Lenehan, President & CEO]

Thank you, Gerry. Good morning. Thank you for joining us to discuss our second quarter results. I'm going to make some introductory remarks, Patrick will review some details around acquisitions and the pipeline, and then Gerry will discuss the financial results.

The existing portfolio continues to perform exceptionally well with collections at 99.9% for the quarter and our occupancy remaining at 99.9%. We reported second quarter AFFO of $0.41 per share, which represents an 8% increase year-over-year. We grew cash rental revenues over 12.5% on a year-over-year basis, including the benefit of rental increases and $274 million of acquisitions over the trailing 12 months. This included the acquisition of 26 properties in the second quarter for $54 million at an initial cash yield of 6.4%, reflecting rent credit at closing and near-term rent increases, or 6.1% on rents in place as of June 30.

100% of the acquired properties are corporate-operated and we remain highly confident we are aligning our portfolio with best-in-class operators at attractive rent levels. We've built the portfolio since inception to be conservative and not stretch on credit underwriting. We believe we are well positioned even in this challenging macro environment to continue to execute on our strategy.

Patrick will discuss the investment environment in more detail, but we are seeing a structural change. Pricing has started to improve in response to higher cost of capital and more [indiscernible] sellers, which will lead to a busy second half of the year.

In the quarter, we also sold three properties for a combined sales price of $12.8 million, representing a 4.7% weighted average cash cap rate. The strong demand for our properties provides us with an alternative source of capital and validation of our portfolio quality.

Moving on to our tenants' performance. Restaurant operators continued to have strong results in the most recent quarter. Quick service restaurants are operating at approximately 115% and casual dining is operating in line with 2019 weekly sales levels according to Baird's most recent weekly restaurant survey reported on July 18.

Of course, all of our operators are experiencing the effects of inflation on food, labor, and other input costs, which is pressuring margins. Interestingly, inflation in grocery and at-home food prices has outpaced inflation in restaurant for the past nine months. We've added a slide from Baird Research to this quarter's Investor Presentation to highlight this trend. Baird estimates inflation in grocery stores of 11.6% in Q2, compared to 7.4% in restaurant. Consumer behavior is difficult to predict, but generally a faster rise in grocery prices should provide restaurant operators flexibility to increase prices as well. We know the June's 1% increase in consumer spend at restaurants marks the fifth consecutive month of increased restaurant spending.

Turning to the balance sheet, we have raised over $186 million of capital year-to-date to support our investment program. This included the closing of a $125 million private note that funded in March, but it was priced last December at a 3.1% coupon and $61 million of equity via forward sale agreements. We settled $4.6 million of this forward in the second quarter and expect to settle the remaining $56 million over the next period of time to fund acquisitions. Additionally, the $13 million of dispositions help fund our pipeline in the quarter at accretive rates.

Finally, a few important comments on the team. Over the last three months we have hired two additional investment analysts to the acquisition team, a new Associate General Counsel, an HR Manager, and an Operation Director, and have added new rolls in property management. Along with the additional investments we are making in our financial and property systems that improve automation and efficiency, this staffing set us up well to support continued portfolio growth.

With that, I'll turn it over to Pat.

[Patrick Wernig, Director of Acquisitions]

Thanks, Bill. I'd like to start by discussing the cap rate environment and our acquisition mix for Q2. We spoke on the last call in April about the tightening cap rates we observed in 2021 and how that trend had helped study in the first four months of '22. We also stated that we were seeing the initial signs of that momentum slowing and our expectation that cap rates would moderate as borrowing costs rose.

Over the past three months, we've witnessed upward movement in cap rates. We're seeing transactions come back to us where other potential buyers cannot secure accretive debt financing and the decrease in competition is allowing us to increase our pipeline for the coming quarters, while also being more selective in our asset screening. We're very pleased with the state of our pipeline, and in particular, the opportunities that has grown for us over the past month.

FCPT maintained price discipline over the past several years and avoided any real cap rate compression in the assets we acquired. As a result, our investment spreads continue to be positive. We will continue to exercise price discipline with what we introduced to the pipeline. We've also seen increased engagement from mall and shopping center owners on outparcel transaction. A big example of this is the 11 property, $33 million outparcel transaction that we announced in June with PREIT. The portfolio includes eight restaurant properties.

We also announced the seven property outparcel portfolio in Texas earlier this month for $17 million, which includes six restaurant properties. We expect the $50 million of combined outparcels will close mainly in the third quarter and we are actively engaging other parties to continue building out the outparcel pipeline. For the quarter, auto service accounted for 62% of our investments, medical retail for 23%, and the remaining 13% consisted of casual dining and well-located investment-grade bank branches.

Turning to our pipeline for the rest of the year, we built out a stable of properties with high-quality tenants and well-located retail quarters. The pipeline sector mix for restaurants, auto service, and medical will shift to be more in line with past years in the second quarter as deal timing led to a higher number of auto service transactions closing in Q2.

On the disposition front, as Bill mentioned, we completed the sale of three properties in the quarter. These are comprised of a Bob Evans and an Olive Garden, both at 4.5% cap rates as well as the franchisee-operated outback at a 5% cap rate. Each of these stores' sales volumes underperformed the brand average and so removing them from the portfolio at such attractive pricing was particularly compelling.

Just one final reminder, historically, Q1 and Q2 have been lower acquisition volume quarters than the second half of the year. For example, in 2019, 2020 and 2021, each year's first six months represented approximately 31% of total closings for that year. While we don't provide acquisition guidance, if you looked to the pipeline, we do expect the dynamic of higher volume in the second half of the year to continue.

Now, turning to Gerry for a discussion of our portfolio and financial results.

[Gerry Morgan, CFO]

Thanks, Pat. We generated $46.8 million of cash rental income in the second quarter after excluding $1.1 million of straight line and other non-cash rental adjustments. As Bill mentioned, we reported 99.9% collections for the second quarter with no material changes to collectability or credit reserves or any balance sheet impairments. On a run rate basis, our current annual cash base rent for leases in place as of June 30 is $181.2 million, and our weighted average five-year annual cash rent escalator is 1.45%.

Cash G&A expense, excluding stock-based compensation for the quarter was $3.7 million, representing 7.8% of cash rental income for the quarter. For the second quarter, we estimate that tenant rent coverage was maintained at 4.6 times, so the 75% of our tenants will report financial results, which continues to highlight how low FCPT rents are.

On the capital front, as Bill mentioned, we have entered into equity forward agreements in the first half of the year totaling $61 million. Based on the initial average forward price of $27.28 per share, we settled the $4.6 million in the second quarter and we'll expect to settle the remainder in the second half of this year to fund acquisitions.

Net debt to EBITDA for the quarter was 5.7 times. Pro forma for settling and deploying the remaining equity forwards, we estimate our leverage is 5.6 times and well within our range of 5.5 times to 6 times for our leverage target. In May, we received a second investment grade rating of Baa3 from Moody's in addition to the upgrade in Q1 from Fitch to BBB flat. This second rating allows us to decrease the credit margin on our existing term loans and our revolver by 25 basis points. This will lead to at least $1 million in annual interest expense savings on the term loan, incremental savings when we use the revolver and will benefit future private note and bond offerings.

We ended the second quarter with over $267 million of liquidity, comprising $70 million of cash and full availability on our $250 million revolver. We remain focused on maintaining a conservative balance sheet, extending and layering our debt maturities, and thinking thoughtfully about our repayment obligations. Our next debt maturity of $50 million is not due until November of 2023.

And with that, I'll turn it back over to Sam for investor Q&A

[Operator]

Thank you. [Operator Instructions] Our first question comes from Sheila McGrath of Evercore. Sheila, your line is now open. Please go ahead.

[Sheila McGrath, Evercore]

Yes. Good morning. Bill, I was wondering if you could help us understand the differential on cap rates on acquisitions versus the assets sold. I see the acquisitions lease term was like just under six years and the assets sold was 12 years. Would you say that a lot of the differential in cap rate is driven by the remaining lease term?

[Bill Lenehan, President & CEO]

I think, Sheila, there is some of that. But what I would say is, the assets that we sold -- we are relatively reactive, we don't sell many assets. We get incoming inquiries, we only accept those at very strong pricing. And then what we've been purchasing have had moderate lease terms, but we score the properties holistically and they scored quite well, because the rents are low. In many cases, they are ground leases and they have good corporate credit.

[Sheila McGrath, Evercore]

Okay, great. And then on the PREIT and the other outparcel transaction that you mentioned. Are most of those ground leases, are they improvement?

[Bill Lenehan, President & CEO]

Yeah. They're mostly ground leases.

[Sheila McGrath, Evercore]

Okay. Great. I guess last question for -- Okay, sorry. Go ahead.

[Bill Lenehan, President & CEO]

Sheila, so much about these outparcel transactions is the low rents and they are corporate-operated tenants. So we look on those very favorably.

[Sheila McGrath, Evercore]

Okay, great. And then on -- this one is for Gerry. On the investment grade rating, that helps the pricing of the line of credit, I believe, and maybe the term loan. Can you provide a little bit more detail on interest savings and did you get any benefit of that in 2Q?

[Gerry Morgan, CFO]

Great. Thanks, Sheila. Yes, we get -- with the second rating and with the BBB flat rating from Fitch, we qualify on a pricing grid that reduced our margin on all of our term loans by 25 basis points and also the revolver. We've started to benefit from that roughly in the middle of the second quarter on our term loans. We didn't have any usage on our revolver in the second quarter. And so, you'll see that continued benefit on the $400 million of term loans for all of the third quarter and beyond.

[Sheila McGrath, Evercore]

Okay. Thank you.

[Bill Lenehan, President & CEO]

Thank you, Sheila.

[Operator]

Our next question comes from Anthony Paolone from JP Morgan. Anthony, your line is now open. Please go ahead.

[Anthony Paolone, JP Morgan]

Great. Thanks. I guess, Patrick, you mentioned some cap rate movement in the last few months. Would you be able to put maybe some brackets or numbers, and maybe by product type kind of what the order of magnitude has been? And also, maybe if you think that's -- we're done or there is more to go there?

[Patrick Wernig, Director of Acquisitions]

Yeah, sure. I think it's hard to place an exact amount because there are so many variables, as Bill was alluding to earlier. Certainly, you could be comfortable saying 15 basis points, maybe 20 basis points. But I think there is more of a dynamic of what this allows us to do from a quality filtering perspective and making sure that we can be even more stringent in what we're introducing to the portfolio versus just taking incremental 10 basis points or 15 basis points.

And then on your second question, yes, our view would be that there is more to come, but we're waiting for what the Fed does today, what the Fed does for the rest of the year, and a lot of other factors in the macro environment.

[Bill Lenehan, President & CEO]

The only thing I'd add is that, there is a delay between identifying a property, doing due diligence, getting it under LOI purchase and sale agreement, further due diligence and closing very easily takes several months. So we do -- I would reiterate exactly what Patrick said, that we're seeing higher cap rates that allows us to be a little bit more selective, but it will take months for that to filter into its announced results.

[Anthony Paolone, JP Morgan]

Okay. And then, Bill, you had mentioned or talked to this a little bit to Sheila's question, but just wanted to revisit the shorter lease lengths that you did this past quarter and you've done some of that in the past. Anyway to give us a sense as to what you kind of get in return, like either your IRRs, where you think yields go by doing some of these shorter duration deals versus if you were to do something like 10 years or something more down the fairway like that?

[Bill Lenehan, President & CEO]

Well, I think it really is something you can do when you finance at the corporate level, so we're not putting property mortgages on the individual properties, which lenders are very focused on having lease duration well past their mortgage maturity. So we don't finance it that way. And then, what I would say is, you want to be very careful that you're selecting good credits with low rents, so the renewal probability is very high. But we've had very good success in having high renewals and in the very, very unusual circumstance where a tenant hasn't renewed, we've backfilled with other tenants in some cases at much higher rents. But maybe more of that -- these are one or two properties per annum, but we've had very good results so far.

[Anthony Paolone, JP Morgan]

Okay. But is it the sort of thing where as opposed to doing something with a percent or two bump every year, you feel confident that if it works out six-year goes to a seven or what's kind of -- like what do you kind of playing for there?

[Bill Lenehan, President & CEO]

I wouldn't look at it that way. Most of the time the tenants do have renewal options, not always, but very often they have five-year renewal options. So it's not -- we're not doing this to get a big jump on renewal, it's that you can find better tenants with better located real estate with low rents. But with shorter lease term, the pricing is still pretty reasonable. And so you have to be confident in your ability to underwrite the renewal probability.

[Anthony Paolone, JP Morgan]

Got it. I understand. And then last question, just any desire to increase dispositions just given the execution you showed relative to the stuff you're buying?

[Bill Lenehan, President & CEO]

I think you'll see -- last couple of years, we haven't sold anything. You've seen us do a couple of sales this year, you'll see that continue through the second half of the year and the theme will be very consistent, which is, pruning the portfolio, but still getting very attractive cap rates.

[Anthony Paolone, JP Morgan]

Okay. Thank you.

[Operator]

Our next question comes from the line of RJ Milligan from Raymond James. RJ, your line is now open. Please go ahead.

[RJ Milligan, Raymond James]

Thanks. Good morning, guys. We've been hearing from some of your peers, not just in the net lease space, but maybe elsewhere in retail, that their expectation is that, cap rates will continue to rise to the back half of the year, so maybe they are taking a little bit slower approach at least in the very near short term on acquisitions. And I'm just curious if that's something that you guys are considering or thinking about?

[Bill Lenehan, President & CEO]

Yeah. It's a great question. In the history of the company we've always tried to have as large of a pipeline as we could, but be thoughtful about the quality. Going into this year, we felt like the second half of the year would be better and offer us fatter pictures to swing at. So we were a little conservative earlier in the spring.

I think, and as Pat mentioned, we've seen cap rates go up 15 basis points, 20 basis points at least. And then in the last month or so, we have become more aggressive on acquisitions. And so, we do agree that maybe the last seven months of the year will be better than the first handful. So, that dynamic is definitely the case with us. And as Pat said, it's not just pricing, it's quality of the portfolio, are we -- how difficult it is to source. And because we're well capitalized with low leverage and a favorable stock price, we do think this is the time to be a bit more aggressive and build the pipeline and the acquisition cadence into the second half of the year.

[RJ Milligan, Raymond James]

Okay. That's helpful. And then maybe you guys could talk about the competition out there for Corners. Obviously, it has a slightly different sandbox that they are playing, given the small price points, more of a restaurant focused at least on the restaurant side. And I'm just curious what you're seeing out there given the move in interest rates, does that impact the [1031] (ph) market at all or what does the competition look like out there for competing for assets?

[Bill Lenehan, President & CEO]

Yeah. I think I would highlight. On one hand, the one-off market, individual buyers are going to their banks and finding that mortgages on the properties are significantly more expensive than six months ago, given what's happened in rates. So, folks whose business was to buy using a local bank mortgage, that's less attractive. And then, on the other hand, we had a lot of concern in the fall with new entrants from the private equity arena. Again, they use more financings, so their business is not nearly as attractive when the tenure is at 3% and their borrowing costs are in the mid to high-5s. So we feel like the competitive environment is meaningfully more favorable.

And I would also say the sellers, going into this year, had extreme confidence, right? They felt like if they didn't get exactly the price they want, they would just hold out and another buyer would come in next week and their financing was attractive. So there will be cash flowing significantly. Now, financing has re-ratcheted to higher rates, so their incremental cash flow is lower. They've had buyers who are relying on the mortgage market walk away. So, we've actually, RJ, got a number of properties that we call rebounds. Whether they're fallen out of contract with someone else and we've been able to acquire them at more favorable pricing.

[RJ Milligan, Raymond James]

Great. Thank you, guys.

[Operator]

Our next question comes from John Massocca from Ladenburg Thalmann. John, your line is now open. Please go ahead.

[John Massocca, Ladenburg Thalmann]

Good morning. Just a couple of quick detailed questions from me. I guess first off, our cash G&A expectation is still at around the $50 million mark for full-year '22?

[Bill Lenehan, President & CEO]

I'm sorry. John, I missed the first part of the question.

[John Massocca, Ladenburg Thalmann]

Sorry. Cash G&A expectations for this year, are they still at around $50 million?

[Bill Lenehan, President & CEO]

That's correct.

[John Massocca, Ladenburg Thalmann]

Okay. And then maybe just, could you provide some color on the differential between the 6.1% cap rate at June 30 and the 6.4% when all the kinds of credits and rent escalations are factored in. I mean, it’s not going be the exact details, but just kind of broad strokes, what's going into that 30 basis points?

[Bill Lenehan, President & CEO]

Yeah. We just had an unusual result this quarter. This dynamic happens all the time, but it was -- the 30 basis points was a little higher -- well, much higher than it's been in the past. It's essentially when you buy a property, let's say, in May, and there is a 10% rent bump that happens in August. If you use the May rent, it's 6.1%. If you use the August rent, it's 6.4%. And we're very often getting credited at closing for the differential. So, I think, John, most folks would put -- talk about it closely as a 6.4% cap, but we wanted to make sure we were being conservative in pointing out the difference. But it's basically working very near-term rent bumps and instances where were credited for additional rent on the closing statement.

[John Massocca, Ladenburg Thalmann]

Okay. And then maybe in terms of kind of in-place tenant credit and even as you look at the acquisition environment, are you seeing any kind of conservatism, if you will, from tenants around some of these kind of recessionary concerns? I know, obviously, it doesn't seem like it from some of the public names in the portfolio today, they've reported pretty strong earnings, but just anything you're seeing out there about any kind of concerns about the health of the consumer and its impact in flow through to your tenants?

[Bill Lenehan, President & CEO]

Yeah. We're definitely seeing it in the marketplace, just not in our portfolio. I mean, if you look at inflation, fuel prices, obviously, has impact on dollar stores. Other retailers of goods, they also have supply chain issues. Obviously, gas stations with very significantly fluctuating gas prices and the impact that has on demand and therefore, their C-store business. We're seeing it across the board, but our portfolio seems quite immune to it and we feel like that's going to put us in a position where from a management standpoint, we can be very focused on acquisitions and not working out problem credits.

[John Massocca, Ladenburg Thalmann]

Okay. That makes sense. And that's it for me. Thank you very much.

[Bill Lenehan, President & CEO]

Thanks, John.

[Operator]

Thanks. [Operator Instructions] Our next question comes from Wes Golladay of Baird. Wes, your line is now open. Please go ahead.

[Wes Golladay, Baird]

Hey. Good morning, guys. I want to look at the shorter-term lease deals that you are doing. Are there a lot of tenant options with those deals?

[Bill Lenehan, President & CEO]

Yeah. Typically, there is multiple tenant options. Usually, two to three, five-year options with rent growth continuing on the option periods.

[Wes Golladay, Baird]

Got you. And I guess, maybe, Bill, a quick question for you. Just say we are in a little bit more inflationary environment, sort of like Fed can’t get the 2%, it's more of a 3% plus environment. I guess, how are you going to approach the business if you get more conviction that, that may be the case?

[Bill Lenehan, President & CEO]

It really doesn't have as much effect on us as you might think. We don't use much debt. If our stock price hangs in there where it is, it's still quite accretive for us to buy things, and it makes it -- what we found is, it makes it easier to procure acquisitions as owners of assets who finance the property level are challenged to finance assertively.

And if you think about it, I think one of the really interesting dynamics right now is, we have a very high-level net lease capital competes against capital in the high yield market. It competes against mortgage capital, it competes against equity multiples. And historically, when all the economy retailers were trading to private equity firms at 15 times to 18 times multiples, net lease is less attractive, because the private equity firm will pay for your business at a very high multiple. When high yield was 4%, it was a very attractive source of capital versus doing net lease -- sale leaseback.

If you could get a mortgage on your property at 3%, again, very attractive compared to doing a sale-leaseback of 6.5%. So I think we are quite excited that we're going into a period where net lease capital at a very high level is much more attractive on a relative basis than it has been in the last half decade on post-financial crisis.

[Wes Golladay, Baird]

Great. Thanks for the detailed answer

[Operator]

There is no further questions. I would like to hand the call back to Bill for any closing remarks.

[Bill Lenehan, President & CEO]

Thank you, Sam. Well, I hope you can tell that we're quite excited about the second half of the year and we'd be more than happy to do any investor outreach. Please reach out to Gerry, and thank you, everyone for their time.

[Operator]

Thank you, everybody. This concludes today's call. Thank you for joining. You may now disconnect your lines.