National Retail Properties Inc

NYSE:NNN

Earnings Call Transcript 2018-Q2

[Operator]

Greetings, and welcome to National Retail Properties Second Quarter 2018 Operating Results. At this time all participants are in a listen-only mode and a brief question-and-answer session will follow the formal presentation. [Operator Instructions] And as a reminder, this conference is being recorded.

I would now like to turn the conference over to Jay Whitehurst, CEO. Thank you. Please go ahead.

[Jay Whitehurst, Chief Executive Officer]

Thank you, Brenda. Good morning, and welcome to the National Retail Properties Second Quarter 2018 Earnings Call. Joining me on this call is our Chief Financial Officer, Kevin Habicht. After some brief opening remarks, I'll turn the call over to Kevin to discuss our financial results in more detail.

National Retail Properties continued its consistent performance in the second quarter. To sum, our occupancy rate, acquisition volume and balance sheet management may appear to be the same old boring results. But to us, it's a validation of our business strategy to maximize shareholder value by consistently growing our FFO per share on a multiyear basis, and the outcomes achieved by consistently executing our strategy remain impressive.

In July, we announced a 5.3% increase in our annual dividend to $2 per share. This makes 2018 our the 29th consecutive year of annual dividend increases, a feat that's been accomplished by only 3 REITs and by fewer than 90 public companies in the United States. As of June 30, the total annual return for NNN shareholders once again outperformed REIT averages and most major equity indices over every time period of 1 year, 3 years, 5 years, 10 years, 15 years, 20 years and 25 years, respectively.

Looking more deeply into our quarterly results. During the second quarter, our broadly diversified portfolio of over 2,800 single-tenant retail properties remained healthy with an occupancy rate of 98.5%, which remains higher than our long-term average of 98%. The primary lines of trade in our portfolio focus on customer services, customer experiences and e-commerce-resistant consumer necessities with minimal exposure to apparel or other concepts that are struggling with perceived or actual disruption by Amazon or other Internet-based retailers. Moreover, our top tenants continue to perform well in their respective businesses and grow their store counts.

The drop in our occupancy rate from the first quarter is due largely to the expiration of 18 SunTrust Bank branches leases in April. As we've discussed on prior calls, these lease expirations were anticipated for over a year. And I'm pleased to report that as of the end of the quarter, all but seven of the former SunTrust properties are either resolved or in the process of being resolved.

The headline for the SunTrust transaction is not about these few vacant properties, but it's about the tremendous value created in these 80 [ph] SunTrust leases that were renewed for an additional 12-year term. The SunTrust portfolio acquisition was an excellent real estate investment. We now own numerous SunTrust properties with long-term leases that we can sell at very low cap rates into the private market, allowing us to harvest this value and reinvest the proceeds in accretive new acquisitions.

On the topic of acquisitions, in the second quarter, we invested $140.5 million in 59 single-tenant retail properties at an initial cash cap rate of approximately 7.1% and with an average lease duration of over 19 years. As usual, our primary strategic focus was on doing direct recurring off-market business with relationship tenants, including our portfolio sale leaseback transaction with GPM, the country's largest privately held convenience store operator.

For the first half of 2018, over 80% of our dollars invested have been with 20 different relationship tenants in 15 different lines of trade. It's also worth noting that for the 111 properties we acquired in the first half of the year, our average lease duration is 19.5 years.

Although Kevin will provide more detail in his comments, we were active in raising capital in the second quarter both through the use of our ATM program and through proactive dispositions of some of our single-tenant retail properties. It bears repeating that our portfolio contains many single-tenant retail properties that trade at low cap rates in today's market.

In those instances where we see less long-term upside due to real estate characteristics or other factors, we can sell those properties at low cap rates and redeploy the proceeds into new accretive acquisitions. This multifaceted approach to accessing well-priced capital, combined with our healthy portfolio and our relationship-based pipeline of new acquisitions, positions us to continue producing consistent, mid-single-digits per share growth on a multiyear basis, which we believe will continue to beat the REIT index averages over the long-term.

Let me now turn the call over to Kevin for his additional comments on our results.

[Kevin Habicht, Chief Financial Officer]

Thanks, Jay. And I'll start with the usual cautionary statement that will – we will make certain statements that may be considered to be forward-looking statements under federal securities law and the actual – the company's actual future results may differ significantly from the matters discussed in these forward-looking statements, and we may not release revisions to those forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in this morning's press release.

With that, headlines from this morning's press release report record quarterly results of $0.68 per share for the second quarter of 2018, which represents a 6.3% increase over prior year. Core FFO results – core FFO per share of $1.35 for the first six months of 2018 represents an 8.9% increase over prior year results. So a solid start to the year, which keeps us well positioned to grow 2018 results in that 5% to 6% range over 2017's core FFO and AFFO results and is consistent with the past several years and our multiyear growth goal. We do this while maintaining a strong and liquid balance sheet and not relying on large amounts of short-term and/or floating rate debt.

Our AFFO dividend payout ratio is 69.9% for the first half. And as Jay mentioned and as we noted on our last earnings call, the lease on 18 SunTrust properties expired on April 1, and as expected, our occupancy ticked down 70 basis points to 98.5% at June 30, which was fully baked into our guidance.

We continue to drive additional operating efficiencies with the G&A expense decreasing to 5.6% of revenues for the second quarter of 2018 compared to 6.1% a year ago. And for purpose of the modeling 2018 results, the annual base rent for all leases in place as of June 30, 2018, was $599.6 million, and this allows you to take some of the guesswork or estimation out of the timing of Q2 acquisitions and dispositions or any projections that you might be starting as of July 1.

We did maintain our 2018 core FFO guidance of $2.62 to $2.66 per share and do not change any of the underlying assumptions. We did issue 3.2 million shares of common equity in the second quarter, mostly in June via our ATM, which will obviously weigh on second half 2018 per share results a bit. Combining this equity issuance of $130 million with $84 million of property disposition proceeds, plus $63 million of free operating cash flow after all dividend payments, that combination provided a total of $277 million of equity-like capital in the first half, which funded 87% of the $317 million that we invested in new acquisitions. This leaves us in a very good leverage and liquidity position to maintain an active acquisition effort into 2019.

We ended the second quarter with only $167 million outstanding in our bank line, leaving $733 million of availability. We have not been big users of that short-term variable rate part of our capital stack for many years. We remain very well positioned from a liquidity perspective and a leverage position. With the exception of our bank line, all the outstanding debt is fixed rate. Our balance sheet remains in good position to fund future acquisitions and weather potential economic and capital market turmoil.

Quickly, our quarter-end leverage metrics debt-to-gross book assets was 34.7%. As you know, we don't manage our balance sheet around market cap-based leverage metrics. More relevant, we believe net debt-to-EBITDA was 4.8x at June 30. Interest coverage was 5.0x for the second quarter of 2018, and fixed charge coverage was 3.8x for the second quarter. Only five of our 2,846 properties are encumbered by mortgages totaling only $13 million.

So we believe 2018 will be another good year of solid growth and operating results, and the comps for multiple prior years are not easy. When sourcing capital and making capital allocation investment decisions, driving per share results on a multiyear basis is really at the forefront of our minds. Similarly, we think about making a long-term investment decisions with a long-term cost of capital view and not a short-term or marginal cost view. Our investment strategy in terms of property type, tenant type and our balance sheet strategy has been very consistent for many years.

With that, Brenda, we will open it up to any questions.

[Operator]

Thank you. [Operator Instructions] Our first question comes from the line of Collin Mings with Raymond James.

[Collin Mings, Raymond James]

Hey, good morning, guys.

[Jay Whitehurst, Chief Executive Officer]

Good morning.

[Collin Mings, Raymond James]

First question for me. Kevin, just in the past, you've discussed potential issuance of long-term debt later in the year and that was on – potentially on your radar. Can you just update us as to your thoughts on that front just in terms of sizing and pricing, particularly given the equity issuance in 2Q?

[Kevin Habicht, Chief Financial Officer]

Yes, fair question. Yes, that is still in our radar. As we've talked about, we've put in a couple of hedges earlier in the year to hedge interest rates around that. But yes, we're still anticipating that some time later this year, we will be issuing unsecured debt. I presume at this point in time, we're estimating a 10-year term fixed-rate debt. At the moment, it'd be priced somewhere in the mid-4s, 4.5%, call it, but we'll see how that all unfolds. And so yes, that is still out there.

And obviously, the timing of that does impact second half results. Whether we did that in September or whether we did it in December, it would have some impact on this year's second half results. We don't give any guidance around specific timing in part because we want to reserve the right to react to opportunities that the marketplace might present.

[Collin Mings, Raymond James]

Okay, that's helpful. And then just going back to the prepared remarks, can you maybe just expand on the GPM transaction, a bit more detail just in terms of how it came together and in terms of the transaction?

[Jay Whitehurst, Chief Executive Officer]

Yes, it's not really a whole lot more to expand upon. GPM is a relationship tenant that we've done a number of smaller deals with through the years. We've known that management team for a long time. They are the – as I mentioned, the largest privately owned convenience store operator in the country. And this was just a transaction that – where they were acquiring another company and doing a sale leaseback of some of that real estate that we were already familiar with.

In general, we are – we like convenience store real estate very much. It's some of our safest and best real estate, and this was – these properties were at a good price per property with a good national operator. And so we were happy to be able to do another deal with our relationship tenant.

[Collin Mings, Raymond James]

All right. And one last one and I'll turn it over. Kevin, can you just touch on the impairment charge in the quarter?

[Kevin Habicht, Chief Financial Officer]

Yes, that was primarily driven by some of the SunTrust that we got back as vacant property. So that triggered the vast majority of that impairment during the quarter.

[Collin Mings, Raymond James]

Okay, I’ll turn over. Thanks, guys.

[Kevin Habicht, Chief Financial Officer]

Thanks, Collin.

[Operator]

Our next question comes from the line of Nick Joseph with Citi.

[Nick Joseph, Citi]

Thanks. Just going back to maintaining guidance, just want to better understand what to assume. So core FFO in the first half was $1.35. And then if you take the 2Q run rate of $0.68, you get to a number about 2% above the high end of the guidance. You just mentioned you expected unsecured deal. But are there any other assumptions from an acquisition and disposition timing standpoint that impacts the run rate?

[Jay Whitehurst, Chief Executive Officer]

Nick, I’d say a couple of things. One, the 3.2 million shares we issued in the second quarter clearly weigh on per share results and they got, like I say, mostly issued in June and so it didn’t have much second quarter impact, so that will flow through. Two, we did have a little bit of lease termination income in the second quarter, $780,000. And we always have $100,000 or $200,000 of that kind of stuff, but it was a little heavy this quarter. So that – it’s not a lot in one sense, but those $0.005 per share kind of add up at some point.

Three, I’d say, yes, we’re probably comfortable towards the higher end of our guidance range rather than the lower end. And then lastly, speaking to that, I guess, would be our history as we tend to be cautious and conservative on changing guidance. So I think we’re just creating some flexibility for us, but that was the rationale.

[Nick Joseph, Citi]

Thanks. That’s very helpful. And then with 11 of the 18 SunTrust leases I think you said resolved during the process, what do you expect the occupancy to be in 3Q?

[Jay Whitehurst, Chief Executive Officer]

I think it will drift up a little bit from where we are, call it 40 basis points or something like that.

[Nick Joseph, Citi]

Thanks.

[Operator]

Our next question comes from the line of Vikram Malhotra with Morgan Stanley. Please go ahead.

[Kevin Egan, Morgan Stanley]

Hi. This is Kevin on for Vikram. Just a quick question in regards to cap rates. Just can you give any color around what you’ve been seeing the trends recently with rates going up?

[Kevin Habicht, Chief Financial Officer]

Hey, good morning, Kevin. No, we will once again report the cap rates remain flat for the small box types of single-tenant retail properties at least to good operators that we are looking for. We’re not seeing any drift upward in cap rates yet. Our cap rate was a little higher this quarter than we’ve been talking about in the second quarter, but that was really just driven by specific transactions that traded in the low 7s as opposed to lower. We still think that for the year, our cap rates for our acquisitions will be in the mid- to upper 6s.

[Kevin Egan, Morgan Stanley]

Okay, thank you for that. And then just in terms of disposition levels, could you think of anything that would possibly cause you to increase your disposition levels and just use that in sort of funding your acquisition?

[Jay Whitehurst, Chief Executive Officer]

Yes, you cut out a little bit, but I think you asked about dispositions going forward. Our portfolio -- as I mentioned in my prepared remarks, we have many single-tenant small box properties that we trade at very low cap rates in the one-off market, and so we are constantly reviewing the portfolio to look at which of those properties should we put on the market to harvest those proceeds for reinvestment. We’re -- as Kevin mentioned, we’re probably looking at being at the high end of our guidance right now. And it is a wonderful adjunct to have that ability to sell these properties individually at low cap rates to balance against where our stock is trading at any given time and just be able to decide if today, are we issuers via the ATM or are we more sellers of individual properties at low cap rates. Kevin, I don’t know if there’s anything you want to add to that.

[Kevin Habicht, Chief Financial Officer]

No, I think it’s still a good market for us to sell into. We’ve been able to take advantage of both ends of the spectrum in terms of selling weaker properties that we’d rather not own as well as selling some properties at very low cap rates at very strong pricing that we just think are more than fully valued. And so yes, it’s still a good environment.

[Kevin Egan, Morgan Stanley]

All right. That’s all from my end. Thanks a lot for the time.

[Jay Whitehurst, Chief Executive Officer]

Thanks, Kevin.

[Operator]

Our next question is comes from the line of Joshua Dennerlein with Bank of America. Please go ahead.

[Joshua Dennerlein, Bank of America]

Hey, good morning, guys.

[Jay Whitehurst, Chief Executive Officer]

Good morning, Josh.

[Joshua Dennerlein, Bank of America]

Sunoco is back on your top tenant list. Could you maybe provide some color on that transaction and maybe how those properties compare to the ones that 7-Eleven acquired earlier this year?

[Jay Whitehurst, Chief Executive Officer]

Sure. Yes, Josh, we think that all of that has now settled down, 7-Eleven -- between 7-Eleven and Sunoco. 7-Eleven acquired many of the Sunoco properties that we owned and had leased to Sunoco. Ultimately, due to regulatory matters, some 7-Eleven properties had to be transferred to Sunoco. And so in this instance, ultimately, 7-Eleven transferred some of their properties back to Sunoco, not the same ones that came over but some others and – to meet regulatory requirements. So at the end of the day, this is where it has all settled out. We're agnostic as to which of those two large investment-grade operators are running the properties. And one other point to make, I think, is on those 12, they were leased to 7-Eleven. Now they have been assigned to Sunoco, but the 7-Eleven lease is still in place. So we have both companies credit on those 12 leases, but they're being operated as Sunoco’s, and so we thought it was appropriate to put them in the Sunoco bucket.

[Joshua Dennerlein, Bank of America]

Okay, got it. A little tricky there but it makes sense. And then on the seven SunTrust properties that haven't been resolved, any kind of general color across maybe why people aren't interested in them or what – why that process is slower for those than the rest?

[Jay Whitehurst, Chief Executive Officer]

Right. No, in fact, it's the opposite of what you might be thinking. Job one with us is to re-lease our vacant properties, and we will spend a great deal of time and energy trying to re-lease vacancies before we throw in the towel and sell a vacant property. And I don't want to jinx our leasing team down the hallway here, but these seven are some of the better remaining vacancies. And so we are working hard to try to re-lease those as opposed to taking any other action. We had a year to get ready to market our – to get ready for the vacancies and to market those properties. And some of the ones that you've seen us sell are ones that we marketed and concluded that the best outcome was to go ahead and sell those properties. For these seven, we have not reached that conclusion.

[Operator]

Our next comes from the line of Todd Stender with Wells Fargo. Please go ahead.

[Todd Stender, Wells Fargo]

Thanks, guys. When going back to GPM investment transaction, does that come down to a competitive situation to be their capital provider? It seems like they're a growing aggregator of convenience stores. But if they bring you properties, do you have to fund them? What kind of arrangement do you have?

[Jay Whitehurst, Chief Executive Officer]

Well, when we build a relationship with any retailer, Todd, what we try to do is to say yes as much as possible to the deals that they bring us. In this particular case with GPM, we looked across the entire portfolio of what they were buying, and there were parts of that portfolio that made sense for us and had a dialogue with GPM about a portion of that portfolio. Often, with our relationship retailers, we may not take an entire transaction or there may be some properties that we think would be better owned by other folks. And in those instances, we actually help the relationship retailer try to find other capital for those other – for the properties that don't fit best with us. So it's all part of a long, thorough dialogue that we have with our relationship retailers. They are folks that we want to be supportive of but we have to – we’re always mindful of the quality of the real estate that we are trying to acquire from anybody including our relationship.

[Todd Stender, Wells Fargo]

Thanks. But did you guys just close the cap rate? And then two, is there any CapEx that the tenant will be responsible for? Does any rebranding or any money needs to be put into these? Are they newer? Do they need a little more capital upfront?

[Julian Whitehurst]

The cap rate was in the low seven, so it was in the vicinity of where we came out for the quarter. And they’re – these are – were existing properties that had a long – relatively long season in history. And no, as I sit here right now, Todd, I don’t recall any major kind of CapEx obligations on the tenant, but it is the tenant’s obligation under the lease to keep those properties up. And what we have found with our good operators under long-term leases is that they do a good job of keeping up their properties.

[Todd Stender, Wells Fargo]

Thanks. And probably for Kevin, just the last one. You tapped the ATM in the quarter. And I’d say any time we see anything over $100 million, it’s a pretty good number for a quarter. How many transactions was that spread over? We have not seen overnight from a lot of REITs, but that would be one big chunk pretty dilutive but this is kind of match funding. So how big of bites are these transactions?

[Kevin Habicht, Chief Financial Officer]

It is generally grinded out on a daily basis. It is – I will say we have one block in – as a part of that 3 million that was of some size. But other than that, it’s barely grinded out and really evaluated on the daily basis. This is a price that we can – we’re comfortable with. And two is the market tone sufficient that we feel comfortable with selling from shares because if it’s not trading well, we’ll stand aside. And so that’s the good news of maintaining a strong balance sheet is not meeting capital. It’s kind of the mantra and the key, we think, to managing the balance sheet. And so when you don’t need it then you can stand aside and let the market do what it’s doing and only participate when – on some strength.

[Todd Stender, Wells Fargo]

Great. Thank you.

[Jay Whitehurst, Chief Executive Officer]

Thanks, Todd.

[Operator]

And our next question comes from the line of John Massocca with Ladenburg Thalmann. Please go ahead.

[John Massocca, Ladenburg Thalmann]

Good morning.

[Jay Whitehurst, Chief Executive Officer]

Good morning, John.

[Kevin Habicht, Chief Financial Officer]

Hi.

[John Massocca, Ladenburg Thalmann]

It’s kind of a smaller tenant and is outside of your top tenant list, but how are you looking at your Applebee’s properties in the wake of a strong same-store performance there recently, but maybe offset by concerns and issues with RMH franchise? Are these potential disposition further going forward or might you actually even look to add your position giving kind of some issues with brand, probably price dislocation?

[Jay Whitehurst, Chief Executive Officer]

Well, John, yes, we do have a modest concentration with I think it’s – Kevin, is it like 0.5%?

[Kevin Habicht, Chief Financial Officer]

Yes, 0.5%. Yes.

[Jay Whitehurst, Chief Executive Officer]

Yes, 0.25% of our rent is with RMH, and that’s across 17 stores units, most of which were doing – are doing pretty well. So we’re watching that carefully and thinking about it, but it is not particularly a material number and it’s not causing us to lose a great deal of sleep. We – our focus whenever we are acquiring restaurant properties is on rent coverage and cost per property primarily. We want the – if you look at the restaurants that we have acquired, you'll see that generally, they are at very low cost per property and therefore, low rent per property, which builds in a margin of safety for both the tenant and the landlord. So we – to the extent other opportunities came up that fit criteria, good operator with low rent per property, that's the kind of thing we would look at.

[John Massocca, Ladenburg Thalmann]

That makes sense most of the questions have been answered that’s it from me.

[Kevin Habicht, Chief Financial Officer]

Thank you.

[Operator]

[Operator Instructions]. Our next question comes from line of Chris Lucas with Capital One.

[Chris Lucas, Capital One]

Hi, good morning guys. Just a quick housekeeping question, Kevin, on the below market rent amortization item, it spiked a bit from what your sort of historic run rate is. Is there anything specific that's going on there during the quarter that we should be thinking about?

[Kevin Habicht, Chief Financial Officer]

Yes, not really. I think that's probably related to some properties that we sold actually that had a lease in place that we had to write off or recognize that below market amortization. But no, you shouldn't read anything really into that.

[Chris Lucas, Capital One]

Okay. That’s all, I had this morning, everything else are answered.

[Kevin Habicht, Chief Financial Officer]

Thanks Chris.

[Operator]

Thank you. We've reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any closing comments.

[Jay Whitehurst, Chief Executive Officer]

Thank you all very much for attending today, and we look forward to seeing you as the fall conference season commences. Have a good day.