Four Corners Property Trust Inc

NYSE:FCPT

Earnings Call Transcript 2022-Q4

[Operator]

Ladies and gentlemen welcome to the FCPT Fourth Quarter 2022 Financial Results Conference Call. My name is Glen, and I’ll be the moderator for today’s call. [Operator Instructions]

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

[Gerry Morgan, CFO]

Thank you Glen. 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 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 on our website at fcpt.com. All the information presented on this call is current as of today, February 16, 2023.

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 on our website.

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

[Bill Lenehan, CEO]

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

The existing portfolio continued to perform exceptionally well 99.9% collections for the year ended December 31 and occupancy remaining at 99.9%. We reported fourth quarter AFFO $0.41 per share, and $1.64 per share for the full year, which represents 5% growth for 2022 over 2021.

We grew cash rental revenues 11.4% on a year-over-year basis, including the benefit of rental increases, and $286 million of acquisitions in 2022. This included the acquisition of 42 properties in the fourth quarter for 120 million at an initial cash yield of 6.6% reflecting rents in place as of December 31. 33 of the 42 acquired properties are corporate operated, and we remain highly confident we are aligning our portfolio with best in class operators at attractive rent levels. Patrick will discuss the current investment environment in more detail, but in the fourth quarter we continue to see acquisition pricing improve in response to the higher cost of capital environment.

The Q4 acquisitions average cap rate reflected that dynamic at 6.6% versus 6.3% in Q3. The Blended Q4 figure included deals priced earlier in the year prior to the shift in cap rates, with more recently priced deals above the average for the quarter. We note that sale leaseback transactions have more appeal now to operators versus other forms of financing in recent years. Equity capital, term loans CMBS all have become more expensive in the last six months. And this has led us to more opportunities in discussions with tenants looking to expand operations or monetize their real estate.

I wanted to note, two very specific but very minor headwinds we experienced in the quarter in regards to FFO. First are restaurants subsidiary Kerrow experienced at much lower EBITDA margin the quarter, sales remain strong and in line with prior quarters but Kerrow experience higher food and beverage, labor, utility and other services have costs impacted by inflation. Kerrow has already started to see some relief and the increase in beef and other costs. So we expect this impact to moderate in the first quarter of this year.

The second minor headwind was higher interest expense. 90% of our one, just over a billion of debt is fixed currently at a rate of 3.39%. However interest rates on the remaining 10% of our debt are variable, and pricing increased an average by over 145 basis versus the third quarter. A reminder to our investors that we think 90% fixed 10% variable rate debt is appropriate for our business, and we’ve benefited some quarters, but unfortunately, we’re impacted in quarters like last quarter. Our current run-rate as of the quarter end is 3.6%. In the quarter, we sold one property for a sales price of 4.9 million representing a gain of 600,000. For the full year 2022, we sold eight properties for 26 million. The strong demand for our properties provides us an attractive alternative source of capital while also improving the overall quality of the portfolio.

Moving to our tenant’s performance. Restaurant operators continue to have strong sales results in the most recent quarter. Although many are experiencing pressure on margins as cost increases in food and labor are not fully passed on to the end consumer. However, as I mentioned earlier, while discussing, it looks like restaurants are seeing a slowing of commodity costs increases, especially meat prices. Sales continue to hold up as restaurants are operating approximately 120% of pre COVID weekly sales levels, and approximately 109% of last year’s weekly sales levels. According to bearish restaurants survey reported February 6. Our estimated EBITDA to rent corrects to their four times for the 72% of our portfolio that reports this statistic. This is amongst the strongest coverage within the net least industry. Three, reorder point we make almost every quarter.

Focusing on low rent provides a cushion when inflationary input prices impact store levels. Turning to the balance sheet. We raised 72 million of equity in the fourth quarter and an average price of $26.70 per share. We also raise 30 million of incremental debt proceeds as part of extending our credit facility in October. We would also expect to continue to utilize dispositions as another solid source of capital.

Finally, one comment on the team. We were very excited to announce in January the promotion of Jim Bratt to serve as FCPT’s Chief Operating Officer. Jim has been with us since inception, and during this time FCPT has acquired 624 properties grow his employee base from six to 35 and invested significantly in operations. Jim has been an integral part of all of this and our effort to drive value for our shareholders, given his unique skill set and operations, real estate transactions and legal judgment. Thank you, Jim.

With that, I’ll turn it over to Pat.

[Patrick Wernig, MD, Acquisitions]

Thanks, Bill. Like to start by discussing the sector mix of the $120 million of closed investments in Q4. For the quarter restaurants accounted for 40% of new investments. Auto Service was 33%. Medical retail is 24% and the remaining 3% consisted of other retail. Amongst others, these investments included a portfolio for Buffalo Wild Wings properties in Illinois for $14 million at a 7.3% cap rate. A medical retail portfolio in Chicago for $12 million at a 6.8% cap rate, and a sale leaseback of five [Indiscernible] properties in Indiana for $8 million at a 6.5% cap rate.

As Bill mentioned, the impact of higher interest rates allowed cap rates to trend upward last quarter. Ultimately, because of how quickly the market moved in the second half of 2022. We did go back to several sellers and discuss price adjustments. I’d also note that deals priced in the latter part of Q4 and now into 2023 have generally been above the 6.6% cap rate average for Q4.

We remain highly focused on protecting our positive investment spreads. So far in 2023. We’ve observed cap rates give back a bit of the pricing gains we are enjoying as buyers in q4 but not much. We believe this is a direct result of lower interest rates in 2023 and some net lease investors reentering the market. That said we continue to bid on properties 50 to 75 basis points above where they priced in the first eight months of last year. We’ve also had several sellers that previously refused our pricing and Q4 come back to us with adjusted expectations this year. We remain active on the acquisition front and as we look at our pipeline, we expect to have a busy March with a number of deals closing in the latter half of the quarter. I’d like to remind everyone that Q1 typically ends up being our lowest deal volume quarter for the year, for example, in 2021 and 2022 Q1 was 15% of acquisition volume for those years.

Regarding the pipeline, we’re seeing some very interesting outparcel and sale leaseback opportunities, we’ve been able to remain selective on tenant and real estate quality, while finding deals that fit in our target yield profile. Momentum on our dispositions efforts has also continued. Bill mentioned we completed the sale of eight properties in 2022 for $26 million. We’ve also sold another two red lobsters and one burger king so far in 2023 for $12 million. These stories were specifically selected at disposition candidates based on relative underperformance versus their respective brands. We expect to continue recycling capital opportunistically into new acquisition, particularly where we can improve portfolio quality.

Now turning to Ferry for discussion on our portfolio and financial results.

[Gerry Morgan, CFO]

Thanks, Pat. We generated 49.2 million of cash rental income in the fourth quarter after excluding 0.9 million of straight line and other non cash rental adjustments. We reported 99.7% of collections for the fourth quarter at the end of the year and 99.9% for the full year. There were no material changes to our collectability or credit reserves nor any balance sheet impairments in the quarter. On a run rate basis current annual cash base rent for leases in place as of the end of the year is 194.9 million and our weighted average five year annual cash rent escalator is 1.42%.

Cash G&A expense excluding stock based compensation for the quarter was 3.9 million, representing 8% of cash rental income for the quarter and cash G&A for the year was 15.1 million. For your modeling purposes we expect cash G&A for 2023 will be approximately 16 million, representing around 6% growth. The increase is tied principally to compensation expenses. We focus on retention of our existing team, additional team and additional team members to bolster our investment operating prowess. We continue to focus on technology and systems to help us with the increased complexity of the portfolio and improve efficiency. Since inception, we have grown from six team members to 35 today.

Turning to the balance sheet. We are well capitalized to fund growth. As Bill mentioned, we raised 72 million of equity via our ATM program in the fourth quarter, and an average price of $26.70 per share. On December 31, we held 26 million in cash and had 2.5 million shares under forward sell agreements, with anticipated net proceeds of 68 million upon settlement, including the 250 million of undrawn revolver capacity we start the year with over 343 million of capacity. We discussed last quarter but to remind everyone that in October, we announced an amendment to our credit facility, which reduced pricing extended maturities by five years on 150 million of existing term loans and raise 30 million of additional proceeds. The facility was converted from LIBOR to SOFR. Credit margins were improved by five basis points, and our overall leverage remains conservative.

Our debt maturities are fully staggered with the first maturity of 50 million, not due until June 2024. We have an ongoing programmatic interest rate hedging program where we extend hedges on regular basis to fix the rate on much of our variable rate term loans. As of the end of the year, we are hedged on 325 million of the 430 million a term loans currently at an average all in rate of 2.79%. And as Bill mentioned, when you add the fixed rate private notes, we are over 90% hedged at a 3.39% rate.

With respect to overall leverage, our net debt to adjusted EBITDA in the fourth quarter was 5.6 times. Our fixed charge coverage ratio remains at a healthy 4.7 times. Pro forma for settling and deploying the remaining equity. Our leverage is approximately 5.5 times and well below our target of 6. As we discussed in the earnings press release, as of December 31, we have 75 million and forward starting swaps in place, effectively fixing the 10 year treasury base rate at 2.6% for that portion of our next long term private note issuance.

And with that, I’ll turn it back over to you Glen for investor questions.

[Operator]

Thank you. [Operator Instructions] We have our first question comes from Rob Stevenson from Janney. Rob, your line is now open.

[Rob Stevenson, Janney]

Good morning, guys. Bill. I appreciate the color that you guys gave on the dispositions being some relative underperformers, but anything to the underperformance to Red Lobster, specifically, since you’ve been selling a number of those over the last six, eight months.

[Bill Lenehan, CEO]

Yes. Over the years, Rob, we’ve bought 24 red lobsters 75 million-ish, they have long lease term. And we bought them at about a 6, 7 cap. We’ve sold three of them, as you mentioned, for just over 14.5 million. So that is a couple million dollar gain that puts Red Lobster at under 2.5% of our rent. We have five that are on the market. And so that would, and they may or may not sell but we’ve had good luck thus far. That would leave 16 properties, half of those are in a master lease that has two times coverage and 21 years of term.

And the rest are low rent, ground leases that we bought in our Outparcels strategy. We think those probably have coverage over five times. So those eight properties, I think this is an important point, have the ground leases have just over $100,000 in rent. That would get if we sold those we’d be under 2% like just over 1.5% of rent. But I think the two important things to consider on red lobsters have those 16 remaining they have 40% lower rents than the universe of red lobsters that we’ve underwritten to date which is 65 of them and 11 of the 16 are next to an olive garden or a Longhorn adjacent to and the remainder are also very well located. So we feel pretty comfortable. And union who owns red lobster discussed red lobster during their call and they’ve, provided more credit support. They are changing out management. So we feel very good about our position there.

[Rob Stevenson, Janney]

Okay, and in the restaurant category, in general, are you seeing whether or not it’s by price point or by offering between QSR and unlimited and full service. Anything where certain people are having more pricing power in order and able to raise the entree prices to offset some of the higher food input costs? And others are struggling with that or is it fairly even across the board? How should we be thinking about that as long as food input costs remain high?

[Bill Lenehan, CEO]

Yes. So we were seeing some brands, raise prices, and others, really trying to attack market share, and not raise prices as much. But I’d also say we’re seeing these commodity costs now sort of recede a bit. So I think it’s across the board and the branded restaurants, the kind of restaurants we own, have dramatically outperformed chef owned and local restaurants and gained significant share. I’d also say, dine out inflation has been more moderate than supermarket or dine in inflation.

[Rob Stevenson, Janney]

Okay, and then last one for me. You guys talked about how the, in the owned Longhorn portfolio, that the expenses were the combination of food input and labor. What was the sort of breakdown, I mean, how much of the additional expenses was the food input costs that may be coming down versus labor costs, which don’t appear to be abating in the near term and anything tenants are able to do technology wise, these days to reduce staffing needs and mitigate some of the labor costs?

[Bill Lenehan, CEO]

Yes. It’s a really small number. I mean, our business is so predictable that on a $3 billion business, even $100,000, here or there seems to be noticeable, because we’re so predictable, generally. So the Delta on Kerrow was staffing up over last year where we were struggling to find labor. We had a specific training program that increased hours in the quarter, which was sort of a one off thing. And then beef prices, which are moderating, but Kerrow is an exceptionally well run business. We’ve had it now for 35 quarters. This is the first quarter that it’s had a result that was a little lower than we expected. So I don’t think there’s anything to read into that. And probably most folks wouldn’t even mention it, but we thought it would be worth calling out just because it was a couple $100,000 lower than we thought it would be.

[Rob Stevenson, Janney]

Okay, and then anything on the technology side that either you guys with your own stuff, or you’re seeing widespread among the tenants apply to reduce staffing needs.

[Bill Lenehan, CEO]

I mean, in our acquisition effort, we use the old path to manage the process, we’ve actually taken a number of investors through that. We find that helps efficiency keeps us very organized. When you buy a building every one and a half days, like we did last quarter, it really you need to be organized, and that helps us. We use place for AI to track traffic. I think that’s directionally helpful. But those I think would be the two call outs for our business. And then in the restaurant level, I think the big call out would be QSR becoming almost an entirely drive thru business. It was already majority drive thru business, but almost entirely a drive thru business during COVID. And I would imagine over time, it will settle not at the peak of near 100% during COVID But it will settle at a higher level of drive thru than pre COVID.

[Operator]

Thank you Rob. [Operator Instructions] We have our next question comes from [Indiscernible] your line is now open.

[Unidentified Analyst]

Hey good morning everyone got a question on the little follow up on the Red Lobster. Obviously some very low ground rents there now. I guess ideally, would you want to get those back and I guess a broader picture are you seeing much distress on the restaurant side where maybe you’re in do you still have that JV with Lupard Adler, could this all come into play at some point?

[Bill Lenehan, CEO]

Yes we’ve actually had pretty favorable luck on getting properties back. But the sample size is really small. Thankfully, we got back to Ruby Tuesday’s in Maine and released it to Darden to put an olive garden there and have a little bit of a pickup. It’s not our strategy, it can be distracting. But you’d much rather be going into those discussions with very low rents, very low rents. I’m not speaking to Red Lobster, specifically, I’m just speaking in general, very low rents are more likely to be reaffirmed in restructuring. All else being equal. We’re not seeing a ton of distress in the restaurant space, as sales are so much higher rent, as a percentage of sales has moderated. And construction costs are so expensive, that people are repurposing old buildings, and they don’t want to move out of existing buildings. So I think that addresses the question.

[Unidentified Analyst]

And then I’m just curious, I think you’ve commented that the pipeline this quarter would be back half loaded but just curious how much visibility you have into the end of the year? Is it more like a six month view on the pipeline that you have visibility on understanding that some of these deals are large complex, where you have to do a lot of work on the ground leases and carbon stuff out? So just kind of curious how much visibility you have?

[Bill Lenehan, CEO]

Yes. We have substantial visibility over the next three months, I would say, and then some of the properties we know we’re going to purchase them. But we know that there are steps that need to take place, and sometimes in the old parcels that could take a year, or at certain jurisdictions more. And so we try not to be overly fussed with managing the pipeline quarter to quarter. Once you own these buildings, you have to live with the consequences of your decision to buy them. So the last thing you want to do is lower your quality expectations in order to even out a quarter. But as Patrick mentioned, it’s typically busy at the end of the last the end of the year, as it was last year, and then a little softer, and Q1. So this is, frankly, the same dynamic we’ve had for the last three years.

[Unidentified Analyst]

Got it, then maybe just one for Gerry. How should we think about timing of a debt deal once you get to the line to a certain level? Just take down the debt issuance?

[Bill Lenehan, CEO]

Yes, great question sometime this year, would be the answer I would give, obviously, our line of credit, was zero balance on that at the end of the year. We’ve got forwards at the start of the year. So we’re in we’re in great shape. But we will also be opportunistic to take advantage of that market when we see margin rates. In the private note market, you can forward fund. That forward funding option has actually extended as the curve is negative now and invest or insurance companies are more willing to do that. So I think we have a lot of optionality around when we do it.

[Operator]

Thank you, Wes. [Operator Instructions] We have our next question comes from John Massocca of Ladenburg Thalmann. John your line is now open.

[John Massocca, Ladenburg Thalmann]

On the acquisition side of things, as you think about the competitive set, when we’re going into kind of CDs deals are closing deals and what’s been happening with the 1031 buyer over the last couple of months? Is that faded away a little bit as the year has ended, has that strengthened and I save I tend to be one buyer and just individual buyers, high net worth buyers, etc.

[Bill Lenehan, CEO]

Sure. So 1030 ones require what’s called the down leg, the asset that they are selling, where the proceeds gets crowded and then reinvested in assets they’re buying. And so the transaction market for the down leg, which is very often not net lease, it’s usually an apartment building, very typically. So the transaction volume of those have fallen and consequently, with a lag the amount of 10, three one buyers in the market has fallen. That doesn’t mean it’s not still competitive. But those are often levered buyers and their cost of financing has gone up. So there was a dynamic as Patrick alluded to in his comments were properties that were on the market over the summer and fall, had to redress their pricing. Those properties are have either been pulled from the market or were actually sold.

And now we’re in the process of new properties entering the market with different pricing expectations. I would also maybe add on that we were anticipating in 2021, heading into 2022 in a large influx of private equity, new private equity vehicles in net lease, those obviously much more levered focused. And as cost of financing has gone up, their ability to create attractive yields has declined. So we’re seeing less competition from private equity funds than we thought we would experience.

[John Massocca, Ladenburg Thalmann]

That makes sense. And then maybe in terms of the input credit or credit on potential acquisition. How are you thinking about franchise versus kind of corporate owned, especially given some of the pricing pressures that are kind of being seen industry wide? You mentioned kind of Davidson, personally in the care side of your business?

[Bill Lenehan, CEO]

Yes, I think we’ve always been pretty thoughtful, and conservative around the kind of credit. Credit is roughly half of our underwriting model, roughly, the remaining half is real estate matters. But I wouldn’t necessarily draw the line franchise versus corporate to literally. There are some very, very large franchise businesses, and there are some very small or levered corporate operated property. So we’ve never really played in the very small franchisee financing game that some of our peers have. And you’ll see, our cap rates are relatively consistent, adjusted for what’s happening in the market. So we’re not going out the risks curve by any means.

[John Massocca, Ladenburg Thalmann]

Okay, I mean, if you look at kind of either the financials that are being recorded, or financials on new transactions, and what are you seeing in terms of responses to some of these pricing pressures in the casual dining space versus the QSR is actually perfect. Rather than responses, more just kind of the impacts of some of those pricing pressures?

[Bill Lenehan, CEO]

Yes, I think what we felt at Kerrow is pretty consistent in what’s happening in the industry. In 2021, in many cases, you couldn’t get to the staffing levels you wanted to so that led to sort of abnormal profitability, but it was at the, what the consequence of not being able to serve the guest. So I think you’re seeing more staffing, you’re seeing commodity costs increased. But again, both of those factors are moderating in real time. And what’s happened is a number of the weaker brands are over levered, franchisees have struggled and we don’t play in that sandbox.

[Operator]

Thank you, John. [Operator Instructions] Now we have our next question comes from [Indiscernible], your line is now open.

[Unidentified Analyst]

Yes, thank you. Good morning, everyone. Bill, just getting some of your comments around, kind of what’s happening with restaurants and generally what’s happening with retail. If you guys would consider at any point in looking beyond the world of retail for acquisition opportunities.

[Bill Lenehan, CEO]

Yes, we were always looking at strategies acquisitions that are adjacent to what we have purchased in the past. We have a formal process with our board where we review adjacencies annually. We started restaurant only. We’ve now bought, obviously a number of medical, retail and a number of auto service retail. We continue to try to expand the aperture of our acquisition apparatus thoughtfully. But I wouldn’t expect us to buy hotels or apartment buildings or office or anything like that. I think it’s more of a natural progression. And if you look at some of the older and larger net lease REITs, they follow that same path over a long period of time. And it’s worked quite well for them.

[Operator]

Thank you. [Operator Instructions] We have no further questions on the line.

[Bill Lenehan, CEO]

Great, thank you everyone and management’s available for Q&A if anyone is interested. Thanks again for joining the call.

[Operator]

Thank you. Ladies and gentlemen, this concludes today’s call. Thank you for joining. You may now disconnect your lines.