National Retail Properties Inc

NYSE:NNN

Earnings Call Transcript 2018-Q3

[Operator]

Greetings, and welcome to the National Retail Properties Third Quarter 2018 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Jay Whitehurst, President and CEO. Please go ahead, Mr. Whitehurst.

[Jay Whitehurst, President and Chief Executive Officer]

Thanks, Jerry. Good morning, and welcome to the National Retail Properties Third 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 for more details on our results.

National Retail Properties continued its consistent performance in the third quarter. Our solid results reflect our strategic focus on creating shareholder value by consistently growing our FFO per share on a multiyear basis. During the third quarter, we increased our annual dividend by 5.3% to $2 per share. We’ve now increased our annual dividend for 29 consecutive years, a feat that’s been accomplished by only 3 REITs and by fewer than 90 public companies in the United States.

On the capital markets front, in September, we successfully executed our largest-ever bond offering. We raised a total of $700 million, which included the inaugural issuance of $300 million of 30-year bonds at an interest rate of 4.8%. Kevin will provide more details and color in his comments, but I do want to highlight that National Retail Properties is one of very few REITs to have ever issued 30-year bonds. We greatly appreciate the support and confidence of our fixed income investors.

We also announced the repayment of our 5.5% 2021 debt maturity in the amount of $300 million. Effectively, we’re using the proceeds from the 30-year bond offering to accretively derisk our balance sheet and push our next debt maturity to the year 2022. I want to congratulate Kevin and his team for this important series of transactions.

Based on our results to date, we’re pleased to tighten our 2018 guidance and raise the midpoint for core FFO per share guidance. We’re also pleased to introduce 2019 guidance for AFFO and core FFO. Although Kevin will provide more details in his comments, I want to highlight that our guidance for both 2018 and 2019 remain consistent with our business strategy to generate consistent per share growth on a multiyear basis.

Looking more deeply into our quarterly results. During the third quarter, our broadly diversified portfolio of almost 2,900 single-tenant retail properties remained healthy with an occupancy rate of 98.7%. As we’ve commented before, the average property in our portfolio is typically a small box retail site located along a high-traffic road or at a signalized intersection with good visibility, signage, access and fungibility.

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 disruptions by Amazon or other Internet-based retailers. Moreover, our top tenants continue to perform well in their respective businesses and grow their store count.

In the third quarter, we invested just under $80 million in 18 new single-tenant retail properties at an initial cash cap rate of approximately 6.9%. While this level of volume is less than our typical acquisition run rate, the cause is completely due to the timing of closings. As our press release indicates, we’ve increased our 2018 acquisition guidance to a range of $600 million to $700 million for the full year. We continue to do business primarily with our portfolio of relationship tenants. And through the end of the third quarter, over 3/4 of our dollars invested this year have been with over two dozen relationship retailers.

In closing, I want to emphasize that National Retail Properties is extraordinarily well positioned for continued success as we approach 2019 and the years thereafter. Our balance sheet is in great shape. Our portfolio is healthy with primarily e-commerce-resistant retailers on well-located parcels, and our acquisition pipeline is robust, driven by our long-standing tenant relationships.

For the future is always uncertain, we believe there are no REITs in a better position to weather economic challenges and take advantage of marketplace opportunities than National Retail Properties.

Before turning the call over to Kevin, I want to take a moment to congratulate Sumit Roy on his appointment as CEO of Realty Income. Sumit is a true professional, and it’s a pleasure to see his talent, hard work and dedication recognized. I also want to applaud John Case for his tremendous eight year term as the departing CEO of Realty Income. Well done to both of those gentlemen.

And with that, let me ask Kevin to provide his additional comments on our results and our guidance.

[Kevin Habicht, Chief Financial Officer]

Thanks, Jay, and I’ll start with my usual cautionary statement that we’ll make certain statements that may be 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 results of $0.67 per share for the third quarter of 2018. That represents a 3.1% increase over prior year core FFO results. Core FFO per share of $2.02 for the first nine months of 2018 represents a 6.3% increase over prior year results.

So we remain well positioned to grow 2018 per share results 5% to 6% over 2017’s results, which is consistent with the past several years and our multiyear growth goal. And 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 was 71% for the first nine months. Occupancy ticked up 20 basis points to 98.7% at September 30.

We continue to drive additional operating efficiencies with G&A expense decreasing to 5.6% of revenues for the first nine months of 2018 compared to 5.8% a year ago. For purposes of modeling 2018 results, the annual base rent for all leases in place as of September 30, 2018, was $609.7 million. This allows you to take some of the guesswork or estimation out of the timing of Q3 acquisitions and dispositions for purposes of projections that might start October 1. We issued 1.9 million shares of common equity in the third quarter at approximately $45 per share via our ATM.

Year-to-date common equity issuance has totaled $218 million. Combining this equity issuance with $121 million of property disposition proceeds plus approximately $91 million of free operating cash flow after all dividend payments, that has provided a total of $430 million of equity-like capital in the first nine months, which funded 109% of the $396 million we invested in new acquisitions during that nine-month period.

Based on our current estimates, we believe that for the full year, we will fund approximately 70% of our total 2018 acquisition investments with the combination of common equity issuance, disposition proceeds and free operating cash flow. So this leaves us with very good leverage and liquidity position to maintain an active acquisition effort into 2019. Additionally, as Jay mentioned, late in the third quarter, we raised $700 million of long-term unsecured fixed-rate debt. $400 million of that had a 10-year maturity with a 4.3% coupon and a 4.39% effective yield, and $300 million of it had a 30-year maturity with a 4.8% coupon and a 4.89% effective yield. This was our first issuance of 30-year debt, and we were very pleased with the strong investor demand we had.

We craved duration in our capital structure, so we were pleased to be among the few 30-year unsecured debt issuers in the REIT industry. We view the fairly modest incremental 50 basis points between the 10-year and 30-year as another reason to issue the longer duration 30-year debt. Shifting to guidance. We did tighten up our 2018 core FFO guidance by raising the lower end $0.02 per share to a revised range of $2.64 to $2.66 per share.

Additionally, we increased our acquisition guidance to $600 million to $700 million, but otherwise, the underlying assumptions are largely unchanged. I will note that this guidance excludes the $18.2 million make-whole prepayment charge that will show up in the fourth quarter in connection with the early redemption of our 2021 notes. In addition to this prepayment charge, we will expense approximately $3.8 million of no-cost, no-discount treasury lab costs associated with that 2021 note redemption.

And that will flow through interest expense and, I will point out, was not added back in calculating our core FFO and AFFO guidance for 2018. This morning, we also introduced 2019 core FFO guidance of $2.71 to $2.76 per share and AFFO guidance of $2.76 to $2.81 per share, which implies 3% to 4% growth in per share results over 2018, which is fairly consistent with the growth rate where we started the year with 2018 guidance.

Assumptions in our 2019 guidance include $550 million to $650 million of acquisitions in the mid-to high fixed-cap range, G&A expense of $35.5 million to $36.5 million. We don’t anticipate any notable change in occupancy. Property expenses, net of reimbursement, of $8.5 million to $9 million; and lastly, property dispositions of $80 million to $120 million.

All that can be found at the bottom of Page 6 of our press release. We don’t give guidance on our capital markets plans, but you should expect our behavior to remain consistent with the past 20 years, meaning we’re going to maintain a conservative leverage profile and get capital when it’s available and well priced, all with a multiyear view of managing the company and the balance sheet.

Shifting to the balance sheet. We ended the third quarter with no amounts outstanding on our $900 million bank line, and we had $600 million in cash. In October, we used $318 million of that cash to redeem our 5.5% notes due in 2021.

As I mentioned, this resulted in an $18.2 million prepayment penalty charge in October, which is excluded from our 2018 core FFO and AFFO guidance results. Our next debt maturity is in 2022, and our weighted average debt maturity is now 9.6 years. So we remain very well positioned from a liquidity perspective and a leverage position. I will note, too, that all of our outstanding debt is fixed-rate debt.

Our balance sheet is in good position to fund future acquisitions and weather potential economic and capital market turmoil. Looking at a few of the quarter-end leverage metrics. Net debt-to-gross book assets was 33.4% at quarter-end. As you know, we’ve not found market cap-based leverage metrics particularly relevant and, therefore, don’t manage our balance sheet around them. More relevant, we believe, is net debt-to-EBITDA, which was 4.6 times at September 30.

Interest coverage was 5.1 times for the third quarter of 2018, and fixed charge coverage was 3.9 times for third quarter 2018. Only five of our 2,846 properties are encumbered by mortgages totaling $13 million. So in conclusion, we believe 2018 will be another year of solid growth and operating results, and the comps for multiple prior years, frankly, have not been easy. When sourcing capital and making capital allocation investment decisions, driving per share results on a multiyear basis is at the forefront of our minds. Similarly, we think about making 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 and tenant type and our balance sheet strategy have all been very consistent for many years. With that, Jerry, we will open it up to any questions.

[Operator]

[Operator Instructions] The first question is from Christy McElroy, Citigroup.

[Katy McConnell, Citigroup]

This is Katy McConnell on with Christy. Now that you’re expecting acquisitions to be more back-end-weighted, can you provide any more color on transactions you have in the process currently or opportunities you’re looking at in the pipeline just to get a better sense for timing in Q4 as well as the mix of sale-leaseback versus in-place tenant deals?

[Jay Whitehurst, President and Chief Executive Officer]

Yes. Good morning, Katy. Welcome to coverage of National Retail Properties to both you and Christy. We’re glad to have you on board. As I mentioned in the comments, the lighter activity this quarter was totally driven by just some delays in closings that drifted into the fourth quarter – slipped into the fourth quarter.

And our guidance for $600 million to $700 million for the year, we’re very comfortable with. Our hope and expectation is that we will be at the high end of that guidance come the end of this year. The properties that are in the pipeline that we expect to close in the first quarter really fit right down the middle of the fairway with our overall portfolio and our overall acquisitions. So it’s a broad mix of tenants and different lines of trade, a lot of relationship deals, but it looks very similar. The pipeline for the fourth quarter looks very similar to our year this year and our portfolio in general.

[Katy McConnell, Citigroup]

Okay, great. Thanks for the color.

[Operator]

The next question is from Vikram Malhotra, Morgan Stanley. Please go ahead sir.

[Vikram Malhotra, Morgan Stanley]

Thanks for taking the questions. Could you just – just real quick, could you give us a sense of what were the cap rates on the disposition this quarter and maybe this year so far?

[Jay Whitehurst, President and Chief Executive Officer]

Yes. So I mean, generally, they’ve been running in the low 6s in terms of dispositions for us on average. For the fourth quarter and for the year, it’s actually been lower than that as a result of a very low cap rate, large transaction in the first quarter this year, which is actually closer to 5% cap rate for the year, nine months. Vikram, strategically, our disposition – we look at dispositions as kind of a barbell, some defensive sales of properties that we don’t want to – we don’t think are good long-term holds and then some offensive sales from – we’re in situations where people really value the properties that we’ve got at a cap rate that allows us to accretively redeploy those proceeds.

And as Kevin mentioned, this year, we’ve had a strong focus on harvesting some of the value from some of the properties in our portfolio that are trading at very low cap rates. And so we do – it’s really a strategic driver for us to be able to access capital from dispositions at cap rates below where we’re investing new dollars and is another arrow in our quiver when it comes to capital availability.

[Vikram Malhotra, Morgan Stanley]

Yes. That’s actually a good segue. It’s part of my next question, which was – you talked about sort of funding for the fourth quarter. Just looking into 2019, kind of where we are in terms of the rate environment. You’ve managed your balance sheet very well. Just kind of get a sense of like could dispositions be a bigger part of next year’s capital.

[Julian Whitehurst]

Yes. We’ve chopped a lot of wood in 2018, so we see 2019 pretty well to not need to do a whole lot of anything in terms of capital markets and/or dispositions. But as you can see from our guidance, we put out $80 million to $120 million for next year. And I’m guessing we’ll lean to the high side of that, much like we are this year. So I want to anticipate 2019 probably looks a lot like 2018 on that front is my guess at this point.

We try to be opportunistic on some of that, so we don’t have clear visibility on where that number will end up. But we do think dispositions is a core competency of our company, and we’ve sold over $0.5 billion in properties in the last 10-plus years. And so what we – it’s an important part of what we do. And as Jay said, there’s a qualitative aspect to it as well as quantitative in terms of cap rate.

[Vikram Malhotra, Morgan Stanley]

Okay, great. And then just last one. Any large restaurant-related sale-leasebacks you can talk about? Anything out there in the market that you may be looking at?

[Julian Whitehurst]

Vikram, we get to – we hit this – it is important to us to be able to see and underwrite all the transactions that are going on out there in the market, and we do that. And then we sort through those for where do we think is the best risk-adjusted return. A big filter for us on restaurant transactions or any property type is low cost per property, low rent per property, which allows for better store-level coverage. Upfront, it makes it easier for the tenant to succeed over the long term if the rent and occupancy cost is lower. And it makes it easier for National Retail Properties to deal with the site in the event it happens to come back to us over time. So no other particular comments than that but to just reiterate that we are being very focused and very highly selective on looking for and underwriting good real estate locations leased to strong operators at reasonable prices and rents that are at or close or in the vicinity of market rent.

[Vikram Malhotra, Morgan Stanley]

Thanks.

[Operator]

The next question is from Brian Hawthorne, RBC Capital Markets. Please go ahead sir.

[Brian Hawthorne, RBC Capital Markets]

So my first question, I guess, was just, within your pipeline, are you seeing more portfolio deals? Or I guess, what’s kind of the split between portfolio deals and single assets?

[Julian Whitehurst]

Yes. Brian, our focus on acquisitions is on doing repeat programmatic business with our portfolio of relationship tenants. So in that instance, we are dealing directly with retailers and acquiring properties directly from them and not looking in the open market at either one-off properties or portfolios that are being broadly marketed.

We do look at all of those portfolios and underwrite them. But at the end of the day, most often, most of our dollars invested end up with our portfolio of relationship retailers. All of that said, there are good portfolios out there to look at and analyze.

And I would say that the market right now is kind of consistent with where it’s been throughout the year. We are just very selective and very picky about the portfolios that we choose to pursue because we really like the quality of the real estate and the quality of the lease document and the economic terms that we’re able to get in dealing directly with our relationship retailers.

[Brian Hawthorne, RBC Capital Markets]

Okay. And then, I guess, are you seeing – well, I guess you’re probably not seeing much change in the competition for them, so you’re kind of just picking them off old relationships.

[Jay Whitehurst, President and Chief Executive Officer]

Cap rates are not moving, and the competition feels like it always is. We are always in competition with public companies, with private companies, with debt and, sometimes, just with the mindset among sellers for properties. And it feels about the same as always.

[Brian Hawthorne, RBC Capital Markets]

Okay. All right, thanks for taking my question.

[Operator]

We have a question from Jason Belcher, Wells Fargo. Please go ahead, sir.

[Jason Belcher, Wells Fargo]

Just wanted to see if you all would talk a little bit more about your Q3 acquisitions, maybe share some details around lease term and occupancy level for those from the quarter as well as if you can give us a range of cap rates that you saw across those properties.

[Jay Whitehurst, President and Chief Executive Officer]

Sure, Jason. Good morning. It’s a small sample set, so I wouldn’t draw much conclusion from it. As I mentioned in my comments, our initial cash yield was 6.9%. I think there was something around 15 different relationship tenants that we did business with to make up that – my recollection is that there was one kind of medium-sized portfolio and then some other one-off deals that all kind of fit right within our typical line of trade dispersion.

These – I’m trying to think here – I’m trying to remember on lease term. I think for this quarter, the lease term was a little bit less than the 19-plus year lease terms that we’ve been doing in the previous quarters. I do believe that for year-to-date, the term – average term of our lease acquisitions is around 18 years. So that’s something that we’re very focused on, is getting long-term leases whenever possible.

[Jason Belcher, Wells Fargo]

Thank you. And just one other kind of housekeeping question as we think about modeling the 2019 acquisition guidance. Is it fair to spread that fairly evenly across the quarters? Or is there some reason why we might front-end or back-end load a larger portion of that?

[Kevin Habicht, Chief Financial Officer]

I’d call it probably 40% first half, 60% second half as a general guidance.

[Jason Belcher, Wells Fargo]

Great, thanks a lot guys.

[Operator]

[Operator Instructions] We have a question from Spenser Allaway, Green Street Advisors. Please go ahead, sir.

[Spenser Allaway, Green Street Advisors]

Thank you. Going back to the dispositions for a second. How many of those were vacant in the quarter? And can you provide a little color on whether the re-tenanting environment has changed at all in terms of trying to resolve some of the properties that become baked-in in the portfolio?

[Kevin Habicht, Chief Financial Officer]

Yes. So the 18 properties we sold, four were vacant, which is a lot for us, to be quite honest. All four of those related to the batch of SunTrust properties we got back, so that’s why that’s running a little higher than what I’d call normal. Just for some context, our dispositions – the sale of vacant properties for the full year of 2015 was six vacant properties. For 2016, it was only three vacant properties. 2017 was nine vacant properties plus SunTrust. But yes, it was a little bit more than typical for us.

[Jay Whitehurst, President and Chief Executive Officer]

And Spenser, you asked about vacant – about leasing kind of sentiment out there, and I would say that it’s been consistent. We’re not seeing anything that would lead us to feel like it’s much harder or much easier than it’s been in the past. Our leasing team is working all of these assets. And any particular quarter is kind of a small sample set. But they – the market feels like it’s about the way it’s been in the past.

[Spenser Allaway, Green Street Advisors]

Okay. And then you also commented that the portfolio continues to be geared towards more service, experiential-based retail. It makes a ton of sense, obviously, given the evolving retail environment. But just curious, if you look out into maybe 2019 and beyond, are there any specific industries that you guys want to increase your exposure to given the sort of parameters that you guys are setting?

[Jay Whitehurst, President and Chief Executive Officer]

I think the primary filter you should take away is that what we are going to look for in 2019 and every year in the future are well-located parcels with good access, visibility, signage and, at reasonable rents, leased to strong regional and national operators. If we – what we’ve learned is that if we buy good real estate locations, that the current operator finds a way to succeed on that property, or it ends up in the hands of someone who is able to succeed there, that there really is no substitute for the old saying " Location, location, location." So there are industries that we are focused on looking forward, but it is always with the filter of where are the good, fungible pieces of real estate that we can own.

[Spenser Allaway, Green Street Advisors]

Okay. Thank you.

[Operator]

There are no further questions at this time. I’d like to turn the call back over to Mr. Whitehurst for closing comments. Mr. Whitehurst?

[Jay Whitehurst, President and Chief Executive Officer]

All right. Thank you very much for listening. We look forward to seeing many of you at – in the next few weeks as the fall conference season approaches. Have a good day.

[Operator]

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.