National Retail Properties Inc

NYSE:NNN

Earnings Call Transcript 2019-Q2

[Operator]

Good day, ladies and gentlemen, and welcome to the National Retail Properties Second Quarter 2019 Earnings Call. All lines have been placed on a listen-only mode and there will be a question-and-answer session following the presentation. [Operator Instructions]

At this time, it's my pleasure to turn the floor over to Mr. Jay Whitehurst, Chief Executive Officer. Sir, the floor is yours.

[Jay Whitehurst, Chief Executive Officer]

Thank you, Tom. Good morning, and welcome to the National Retail Properties' second quarter 2019 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 for more detail on our results.

Once again, National Retail Properties posted steady consistent results in the second quarter of 2019, which positioned us to increase our common stock dividend in July by 3% to $0.515 per quarter. 2019 will mark our 30th consecutive year of increased annual dividends, a feat matched by only two other REITs and by less than 90 public companies in the United States. With a dividend payout ratio of approximately 73%, we're well positioned to be able to continue this enviable track record into 2020 and beyond.

In an era when headlines and tweets move the markets in sometimes wild fluctuations, we continue to post steady, consistent per share results. History has shown that over the long term, our business model will achieve above-average returns for shareholders, while in our opinion taking below average risk.

Looking into the details, our broadly diversified portfolio of 3,043 single-tenant retail properties remained healthy, as our occupancy rate ticked up 60 basis points to 98.8%. As you've heard us say many times, our long-term occupancy rate is 98% plus or minus 1%. And due to the hard work of our asset management and leasing teams, we're pleased to end the second quarter at the higher end of that range.

We had a busy second quarter of acquisitions as well, investing almost $276 million in 71 new single-tenant retail properties at an initial cash yield of 6.9%. Year-to-date, we have now invested almost $393 million to acquire 104 single-tenant retail properties at an initial cash yield of 6.9% and with an average lease duration of 17.5 years.

Through the end of the first half of 2019, we've done recurring business with 25 relationship tenants operating in 13 different lines of trade. These relationship tenants accounted for over 80% of our total dollars invested so far this year, which is generally consistent with our long-term average.

It's time-consuming hard work for our acquisitions team, our asset management team and our senior management, to build and maintain these deep tenant relationships. But all that effort bears fruit, when we're ultimately able to acquire stronger real estate locations, with favorable lease terms and a lease document that's tailored to our long-term perspective. We also sold 13 properties during the second quarter, generating almost $42 million of proceeds.

Of particular note is our sale of a CVS drugstore at a 4.4% cap rate. This property was formerly a vacant box, which our leasing team re-leased to CVS on an as-is basis and our disposition group then sold for a gain of over $5 million. Year-to-date, through the end of June, we have raised over $61 million from dispositions of 30 properties at an average sale cap rate of just over 5%.

As we've discussed before, the ability to accretively recycle capital by selling properties at disposition cap rates meaningfully below our acquisition cap rate is a strategic advantage of our business model. Kevin will discuss our balance sheet and financial metrics in more detail. But I do want to highlight that we raised over $80 million of well-priced equity in the second quarter through our ATM program.

We recognize that issuing equity may create some short-term dilution, but our long-term strategy is to raise capital when it is well priced, while remaining disciplined in our selective acquisition process. Sticking to this long-term strategy has resulted in a balance sheet that continues to be one of the strongest in our sector and positions us very well for the second half of 2019 and beyond.

In closing, let me reiterate that we run our business with a long-term focus, characterized by consistent per share growth on a multiyear basis. Our second quarter results reflect another steady consistent step along that path.

With that, let me ask Kevin to provide his additional comments.

[Kevin Habicht, Chief Financial Officer]

Thanks, Jay and I'll start as usual with the cautionary statement that we will make certain statements that maybe considered to be forward-looking statements under federal securities law. 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 these 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 quarterly core FFO results of $0.68 per share for the second quarter of 2019, which was flat with prior year results and is consistent with our projections and estimates. We are on track with our prior 2019 core FFO guidance of $2.71 to $2.76 per share, which we left unchanged from the prior quarter and which implies a 3.2% growth to the midpoint. We do this while maintaining a strong and liquid balance sheet.

Details of our 2019 guidance is on page 7 of today's press release. Our AFFO dividend payout ratio for the first half of 2019 was 72.4% which was the same as full year 2018 payout. As Jay noted, a recent increase in the dividend marks our 30th consecutive year of dividend increases.

Occupancy was 98.8% at June 30, which was up 60 basis points versus prior quarter. G&A expense was 5.6% of revenues for the second quarter and 5.7% for the first half of 2019 both of which were consistent with prior year level.

For purposes of modeling 2019 results, the annual base rent for all leases in place as of June 30, 2019 was $650.1 million. So this allows you to take some of the guesswork out of – or estimation out of the timing of Q2 acquisitions and dispositions for projections starting July 1, 2019.

As Jay noted, we raised $82 million of equity in the second quarter. That was at a $53.50 net price, primarily via our ATM. And as we've noted in the past and consistent with the past couple of decades, we expect to behave in a relatively leverage neutral manner over time.

Second quarter dispositions totaled $42 million and first half dispositions totaled $61 million. So for the first half these $61 million of disposition proceeds plus $87 million of common equity raise plus $62 million of retained operating cash flow after all dividends totals $210 million of equity-light capital raised in the first half of 2019 available to fund new investments.

As a reminder, we entered 2019 well ahead of the curve on terms of raising equity. So we remain in very good leverage and liquidity position, which will allow us to maintain an active acquisition effort into 2019. We entered the quarter with $63 million outstanding on our $900 million bank line continuing several years of very modest bank line usage and maintaining significant liquidity.

Leverage metrics remained very strong. Our next debt maturity is in 2022 and our weighted average debt maturity is now 8.8 years. So our balance sheet is in a good position to fund future acquisitions as well as weather potential economic and capital market turmoil.

Looking at quarter end leverage metrics net debt to gross book assets was 35.4%. As you all know, we have not found a market cap-based leverage metrics particularly relevant so we don't manage our balance sheet around that. More importantly, net debt-to-EBITDA was 5.0 times at June 30. Interest coverage was 4.9 times and fixed charge coverage was 3.8 times both for the second quarter and both of those metrics were 10 basis points higher than year-end 2018. Only five of our 3,043 properties are encumbered by mortgages totaling $12 million.

So 2019, looks to be another year of solid growth and operating results and the comps for multiple prior years are not particularly easy. When sourcing capital and making capital allocation investment decisions driving per share results on a multiyear basis remains at the forefront of our minds. Our investment strategy in terms of property type, tenant type and our balance sheet strategy have been very consistent for many years.

And with that, we will open it up to any questions.

[Operator]

Thank you, sir. [Operator Instructions] We'll take our first question from Christine McElroy with Citi.

[Katy McConnell, Citi]

Good morning. This is Katy McConnell on with Christine. Can you talk about any further progress you've made on acquisitions to-date? And given your accelerated year-to-date pace versus your original expectation, what's your outlook for the remainder of the year? And would you say you see the high-end of guidance is more likely now?

[Jay Whitehurst, Chief Executive Officer]

Katy, good morning. Yes we didn't change our acquisition guidance. We had a busy second quarter. The first quarter was a little slower than usual for us. And so, we're comfortable very comfortable with kind of where we are and we're finishing in the range of the guidance that's out there. As you know, the future acquisitions are so fuzzy and we don't want to over-commit or overpromise. So -- but I will say that the pipeline looks very good. The acquisition environment still provides a lot of opportunities for us.

As I said, we do most of our business with our relationship tenants where we do repeat recurring off-market sale leasebacks with long-term leases. And that pipeline of business looks very good through the rest of the year. But at this point, we're not prepared to say that we're confident that we will materially exceed this year's guidance.

[Kevin Habicht, Chief Financial Officer]

And Katy, just as a reminder to the extent, we did exceed guidance which we're not confident about yet. To the extent that occurs later in the year call it fourth quarter, it really has precious little impact on 2019 results and it really is more of a 2020 story. So we'll see where the opportunity takes us.

[Katy McConnell, Citi]

Okay. Great. Thank you.

[Operator]

We'll take our next question from Brian Hawthorne with RBC Capital Markets.

[Brian Hawthorne, RBC Capital Markets]

Hi. My first question. With rates falling, do you see more opportunities for opportunistic dispositions?

[Jay Whitehurst, Chief Executive Officer]

Brian, hi good morning. We have a very effective in-house disposition platform. We run most of our dispositions internally. And cap rates in the disposition environment, its selling properties one-off to individual investors often 1031 exchange buyers. Those cap rates are remaining very low. So it really does provide us with a meaningful opportunity to continue to accretively recycle capital.

I should point out that our disposition -- our philosophy around dispositions is kind of a barbell strategy. We look at properties that for one reason or another, someone out there in the world really wants those properties and is willing to pay a very low cap rate for those. And in many cases, it's properties that have for us either flat leases or the residual value of the real estate may be to us is not so compelling. But there's some reason that we're -- we don't feel like we need to be a long-term holder of that property, but someone else wants it very badly. And so we'll sell into that market.

And then on the other end of the barbell, we're looking at properties where we think there's some reason that we would like to sell those before the expiration of the lease or vacant properties that have carrying costs. And so at the other end, it's kind of a defensive sale to keep the portfolio as clean as possible.

But between those two we are averaging a very low cap rate and it's really providing us a meaningful distinction, I think between our business and many other areas in REIT world where we are able to sell cap rates far below our acquisition cap rates.

[Brian Hawthorne, RBC Capital Markets]

Great. And then I guess why do the lines of trade seem like they have the most expansion plans?

[Julian Whitehurst]

Brian, the simple sentence that we often say is you can only buy, what’s for sale. What we're focused on are good real estate locations with good access and signage and visibility operated by strong tenants in their particular businesses in situations where we can acquire those properties at low cost and at low rent per property.

So if you look at the lines of trade that make up our portfolio in all of those lines of trade there are opportunities to do what I just described which is do business with strong retailers on good retail locations. And we are finding opportunities across all of those existing lines of trade.

[Brian Hawthorne, RBC Capital Markets]

Got you. Thank you.

[Operator]

We'll take our next question from Vikram Malhotra with Morgan Stanley.

[Unidentified Analyst]

Hi. This is Kevin on for Vikram. Just a quick couple questions for me. Just in terms of the guidance I know there's a slight increase in the real estate expense as well as to G&A. The real estate expense, I assume is from the moving up of the acquisition volume. But in terms of the G&A is there anything specific there we should be looking at?

[Kevin Habicht, Chief Financial Officer]

Not really. That was $0.5 million increase on a $36 million, $37 million run rate. Yes just fine tuning on our end. So yes nothing much to read in there.

[Unidentified Analyst]

Okay. And I'm sorry I may have missed this before, but I just noticed a non-controlling interest on the balance sheet it fell down quite a bit. Is that related to your dispositions for the quarter?

[Kevin Habicht, Chief Financial Officer]

Yes.

[Unidentified Analyst]

Okay. Sounds good. Thanks a lot.

[Operator]

We'll take our next question from Spenser Allaway with Green Street Advisors.

[Spenser Allaway, Green Street Advisors]

Hi, thank you. Can you provide some more color on the CVS asset sale? I know traditionally obviously the investment grade tenants such as CVS have garnered lower cap rates. But recent comps at least that I have seen in the drugstore space have certainly seen cap rates pickup.

Certainly north of the mid-cap -- the mid-4 cap you cited. Is there anything specific about that deal, the location or perhaps the expected performance of the properties that drove the cap rates so low?

[Julian Whitehurst]

Yes, good morning, Spenser. Yes, it's primarily I'd say is driven by the location. But you're absolutely right. This was a former, I won't get into too much detail. But this is a former Borders bookstore that was very well located here in Florida.

And when Borders went bankrupt or I can't remember -- I can't recall I think they went bankrupt. When the lease came back to us our leasing team did just a very good job of finding the best tenant to take that space. And we've got a long-term lease on that space on an as-is essence basis. But it didn't have a lot of growth in it and it was a very good location.

So it was exactly the kind of property that we look to sell through our disposition platform. It is one version of getting a credit upgrade on your properties when you can take a vacant box and re-lease it to a high-credit tenant in a good location and then turn around and harvest the value that it created that way.

[Spenser Allaway, Green Street Advisors]

Absolutely. Did you mention -- sorry did you already cite how long you said you signed the long-term lease? Did you mention the lease terms?

[Julian Whitehurst]

Spenser I didn't because I don't recall. Kevin do you?

[Spenser Allaway, Green Street Advisors]

Okay. I'll follow up on that. Okay, maybe just one last one for me. I know Kevin you spoke about the ATM program and I realize you guys have ample equity like capital to fund future acquisitions. But given where you guys are trading which appears to be a pretty substantial premium to asset value is there any kind of interest to pre-fund additional growth as you head into the back of the year?

[Kevin Habicht, Chief Financial Officer]

Yes. We always have interest in raising capital, when it's available low price. As I alluded in my comments, 2018 was a good example. So in 2018 between ATM equity and dispositions and pre-operated cash flow, we funded 84% of our $716 million of acquisitions with that kind of equity. So yes, we're -- which led to my point. We entered 2019 very well equitized. But 2020 is coming and we know we'll have more acquisitions to make. And so yes, to your point, we are inclined to get capital when it's available in low price and you probably shouldn't be too surprised if we do so.

[Spenser Allaway, Green Street Advisors]

Absolutely. And okay sorry last one but, would you expect to kind of wrap up the year probably funding via those three methods probably around the same 84% of acquisitions?

[Kevin Habicht, Chief Financial Officer]

I don't commit to 84%. 84% is very high give that we -- historically around 65%-or-so percent historically, so I won't commit to that. But our general approaches that we want to behave in a relatively leveraged neutral manner over a multiyear period. And we have no reason to believe that won't continue. And frankly, as you're alluding to well in recent times, we've ended on the lower side of the leverage profile that we're comfortable with. So I'm guessing that will continue.

[Jay Whitehurst, Chief Executive Officer]

Yes. And Spenser, just to highlight that one word Kevin said was multiyear focus. And that's really how we look at this. So to the extent of the opportunity to raise well-priced capital at the end of the year comes it may create a little short-term dilution. But it's a right thing to do for the long-term. You should expect us to do it.

[Spenser Allaway, Green Street Advisors]

Excellent. Thank you, guys.

[Operator]

We'll take our next question from Collin Mings with Raymond James.

[Collin Mings, Raymond James]

Hey, good morning, guys.

[Jay Whitehurst, Chief Executive Officer]

Hey, Collin.

[Collin Mings, Raymond James]

Just a quick question for me. Just can you expand on the incremental exposure to the equipment rental category sequentially? It's obviously up meaningfully year-over-year and then also again sequentially it looks like there's some activity during the quarter.

[Jay Whitehurst, Chief Executive Officer]

Yes. We did a portfolio acquisition with one of the large equipment retail -- equipment rental companies in the second quarter. It really fits our profile very well. It's a strong operator. These were small individual properties that it was north of a $50 million transaction. I think it was around an $80 million overall transaction portfolio sale leaseback transaction direct with this operator. But it was a -- one of the new relationship tenants that we've started to work with and very happy with the property very happy with the operator.

[Collin Mings, Raymond James]

Okay. Any details in terms of geographic focus their cap rates, or any other details you could give us on how it was underwritten just given the size of that deal?

[Jay Whitehurst, Chief Executive Officer]

The bandwidth of cap rates for our acquisitions is really pretty narrow. So I think it's kind of in the bandwidth of our overall average. And geographically, my recollection Collin is that it's just diversified across the United States.

[Collin Mings, Raymond James]

Okay. All right. Thanks guys.

[Operator]

We'll take our next question from Todd Stender with Wells Fargo.

[Todd Stender, Wells Fargo]

Thanks. Just looking at the mix of these second quarter investments, can you guys break out -- you acquired 71 properties, but how many of those were say call it a good-sized portfolio? And then maybe how many were relationship investing versus how many were broadly marketed? Just kind of characterize it.

[Jay Whitehurst, Chief Executive Officer]

Yes. Todd, I'll do the best I can on that question. And we've -- that Collin just before asked about the equipment rental piece. And so that was one piece of it. So a large -- a good chunk was equipment rentals. We also had auto service and some tire stores and a few car washes. And we did a few deals with discount retailers where we were very happy with those locations and that it was low-priced per property and low rent per square foot. So there was not -- there were very many convenience stores or fast-food restaurants in the second quarter, which is a little bit different from us. But otherwise, it was pretty much down in the middle of the fairway.

[Todd Stender, Wells Fargo]

And how many were existing tenants I guess and maybe how many you participated in auctions?

[Jay Whitehurst, Chief Executive Officer]

Almost all were existing tenants. A little over 80% of our dollars invested were with our relationship tenants. And then, by then I guess I mean, either existing or folks that we've built a direct off-market relationship with and did a first deal with.

[Todd Stender, Wells Fargo]

Okay.

[Jay Whitehurst, Chief Executive Officer]

It's relationship business where the retailer kind of holds back the properties that they're a little more concerned about. So we get slightly better real estate. And very importantly, we get to focus on the lease duration. I really want to highlight that for the first half of the year, our average lease duration is 17.5 years. And the second quarter is even higher than that, but I think one quarter is not a very big sample size. But the -- to do $400 million -- almost $400 million worth of deals with a 17.5-year lease duration is I think really setting ourselves up well for the long-term. And those are the kind of things you can negotiate when you're doing direct relationship business as opposed to getting in a bidding or buying existing leases where some of the term has burned off.

[Todd Stender, Wells Fargo]

Okay. Thank you for that. I guess Kevin, when we look at the -- back to the capital sourcing subject. What's a reasonable free cash flow estimate for you guys for 2019 just as we've modeled out capital sources?

[Kevin Habicht, Chief Financial Officer]

Yes. $120 million to $125 million.

[Todd Stender, Wells Fargo]

Okay. And then we don't see much activity in the preferred equity market I guess across all REITs, just because interest rates are so low, debts been more attractive. But I always think of the preferred pricing as a bit of 300 basis points spread to the 10-year if that's accurate. Are you guys looking at that market? You can essentially get perpetual capital, but just kind of seeing what pricing maybe you'd get it or even if you're looking at that.

[Kevin Habicht, Chief Financial Officer]

Definitely looking yes. So in our minds, when we pursue capital and particularly on that piece of the capital structure, we think about 10-year debt, 30-year debt and preferred pricing. And consider the relative pricing of those three pieces as to what might be more attractive what particular -- in the case of preferred whether the window really is open to issue that preferred tends to be a little more sporadic in terms of its availability. And so you tend -- if it's well priced and available, we can generally go get it. October 2016 was the last time we issued preferred equity and we had no intention of doing that as we entered 2016 and -- but it was well priced at a 5.2% coupon. We just said, look, we've got -- that’s a good perpetual cost of equity capital. Let's go get some.

So -- but it will consider it. Or I would, say our capital stack of preferred right now is I won't say full, but it's not -- it's on the upper half of full I guess. But it is definitely a consideration. I will say debt rates are fairly attractive right now, 10-year and 30-year competes very well with a preferred issuance in today's world. And so, we'll see where we go. And the answer may end up being sum of all the above. But yes, we definitely think about preferred as an important part of our capital stack. And as I think most on this call understand, we tend to view that more as equity than debt. We understand the coupons and obligations. The principal is an equity -- piece of capital on our minds and we treat it as such.

[Todd Stender, Wells Fargo]

Thanks, Kevin.

[Operator]

[Operator Instructions] We'll go next to John Massocca with Ladenburg Thalmann.

[John Massocca, Ladenburg Thalmann]

Good morning.

[Jay Whitehurst, Chief Executive Officer]

Good morning, John.

[John Massocca, Ladenburg Thalmann]

So most of my questions have already been answered, but on tenants, the occupancy and kind of the pickup in occupancy during the quarter, was that related to successful outcomes at some of the vacancies you had or expecting earlier this year some of the near-term stuff like the ShopKo and Virginia College? I know you're close on a couple of the Virginia Colleges, but just any update on that?

[Jay Whitehurst, Chief Executive Officer]

John, the short answer is no, not at all really. The portfolio is very healthy at almost 99% occupied. We're running it well above our regular average. But as it relates to the tenants you asked about the ShopKo’s, one is still open and paying rent. It hasn't been rejected yet; one we are -- have a pending sale; and one we have temporarily leased to a holiday store. Then we only own those three. And then we had three Virginia Colleges: two of those are under contract to sell but haven't those contracts have enclosed yet and may not.

We hope that we do kind of expect they do, but they're – that's pending. And one of the Virginia Colleges we're still working on. The real basis for the reduction in our – the drop in our vacancy, or the increase in our occupancy rates is just the hard work of our leasing team on all the other kind of individual smaller vacancies that we've got. They've worked those all the time and in the second quarter a number of deals matured and we got those properties either leased or sold.

[John Massocca, Ladenburg Thalmann]

Okay. And then have there been any kind of changes to the tenant watchlist recently particularly maybe within kind of the franchise restaurant segment?

[Kevin Habicht, Chief Financial Officer]

Not really. I mean, we've had our usual suspects on there for a while. Logan's Roadhouse has been on there. Ruby Tuesday's is on there. But no real change. Both of those are less than 1% kind of tenants, but no, no notable changes.

[John Massocca, Ladenburg Thalmann]

Okay. That's it for me. Thank you very much.

[Kevin Habicht, Chief Financial Officer]

Thanks, John.

[Operator]

We'll take our next question from Chris Lucas with Capital One Securities.

[Chris Lucas, Capital One Securities]

Hey, good morning, everybody. Most of my questions have been asked and answered. But I guess just Kevin going back to that capital market question. Given the stock performance so far this year relative to sort of the bond performance in the compression and yields is there a bias more towards debt rate now than equity?

[Kevin Habicht, Chief Financial Officer]

That's a hard one to answer. I like both. What a surprise there at the moment. So I think I have to choose. So I'd say no. I do think we're – well, I think the price we have we're itching to do long on the debt side longer term is better than shorter. And those who have followed us for a long time no we don't do anything shorter than 10 years. So but long-term debt is very well priced and equity's reasonably priced as well. So, no real bias one way or the other.

[Chris Lucas, Capital One Securities]

And then just going back to the preferred question, I guess the question I would have is that there – are you in a point now where you could refi one of the batches out at a more competitive rate or is that spread not wide enough at this point?

[Kevin Habicht, Chief Financial Officer]

Yes, we probably could. We have a 5.7% coupon series D preferred outstanding that is redeemable that we could redeem and reissue preferred at a cheaper rate. Again, we're going to put all of that in the context of working the issued 10- and 30-year debt as well and as well as common equity and kind of see where we come out. But that option is available to us.

[Chris Lucas, Capital One Securities]

Great. That's all I have this morning. Thank you.

[Kevin Habicht, Chief Financial Officer]

All right. Thanks, Chris.

[Operator]

And ladies and gentlemen, there are no further questions in the queue. Mr. Whitehurst, I'd like to turn the call back over to you for any closing comments.

[Jay Whitehurst, Chief Executive Officer]

All right. Thanks Tom, and we thank all of you for joining us this morning and have a good day.

[Operator]

Ladies and gentlemen, this does conclude today's conference. We appreciate your participation and you may disconnect at this time.