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Greetings, and welcome to the National Retail Properties First Quarter 2018 Operating Results. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Jay Whitehurst, Chief Executive Officer for National Retail Properties. Thank you Mr. Whitehurst, you may begin.
Thanks Doug. Good morning and welcome to the National Retail Properties first quarter 2018 earnings release 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.
I am pleased to report that National Retail Properties posted impressive results for the first quarter of 2018 in every aspect of our business. Based on this strong start to the year, we're increasing our guidance for 2018 Core FFO per share by $0.02 per share to $2.62 to $2.66. At the midpoint, this equates to almost 5% increase over actual 2017 Core FFO per share results.
As we've said many times, our business model is designed and executed to produce consistent mid-single-digits per share growth on a multi-year basis and we believe we're on track to continue that outstanding record in 2018.
Perhaps the most notable highlight of our first quarter is the sale of a single property for almost $40 million at roughly at 2% cap rate. This is the disposition that we alluded to in last quarter's call and it exemplifies our focus on acquiring good real estate then actively managing our portfolio to maximize the value of each property.
I want to acknowledge the efforts of our dispositions asset management and legal teams for their hard work and dedication in the execution of this important transaction, including particularly Paul Bayer, our Chief Investment Officer; and Eric Nelson, our Director of Disposition.
This transaction plus our other property sales in the first quarter all together totaling $72 million at a weighted average cap rate of 4%, validates our business plan to utilize dispositions as a source of capital when the equity markets are choppy. Combining capital from dispositions with our retained earnings and the ample dry powder provided by our low leverage balance sheet, National Retail Properties is well positioned to maintain our anticipated acquisition pace and otherwise address any opportunities or challenges we may encounter.
During the first quarter of 2018, our broadly diversified portfolio of 2,800 single tenant retail properties remained healthy with an occupancy rate above 99%. The primary lines of trade in our portfolio focus on customer services, customer experiences and e-commerce resistant consumer necessities with little exposure to apparel or other more mall based concepts that are struggling and getting negative headlines. Moreover, our top tenants continue to perform well in their respective businesses and grow their store count.
During the quarter, 7-Eleven completed its acquisition of Sunoco's retail units and 7-Eleven is now our top tenant with 152 properties spread across five states and comprising 6.2% of our total annual basis rent.
I want to point out that our 7-Eleven stores were initially least to high quality regional operators with which we did recurring sale leaseback business. Our original tenets grew through expansion and consolidation and our stores were ultimately acquired by 7 Eleven. That we've ended up with leases to an investment grade tenant 7-Eleven on terms materially better than would have been possible in a direct transaction with such a credit worthy company.
On the acquisition front, in the first quarter, we invested $177 million in 52 single tenet retail property at an initial cash cap rate of 6.7% and with an average lease duration of just under 20 years. As usual, our primary strategic focus was on doing direct recurring off market business with relationship tenants and that relationship business accounted for over 75% of our dollars invested in the first quarter.
With a strong balance sheet and access to well-priced capital, a healthy portfolio and a solid acquisition pipeline, National Retail Properties remains well positioned to continue producing consistent mid-single-digits Core FFO per share growth on a multi-year basis.
Let me now turn the call over to Kevin for his additional comments on our results.
Thanks, Jay. And I'll start off as usual with the cautionary statement that we will make certain statements that may be considered to be forward-looking statements under federal securities laws. 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 record quarterly results of $0.67 per share for the first quarter of 2018, which represent 11.7% increase over prior year results and a 6.3% increase over the immediately preceding fourth quarter of 2017. So a solid start to the year, which positioned to increase our Core FFO guidance by $0.02 per share to $2.62 to $2.66 per share for 2018 which is a 5% increase over 2017 results.
We're optimistic, 2018 will be a continuation of our mid-single-digit per share multiyear growth goal, while maintaining a strong and liquid balance sheet and not reliant on large amounts of short term and/or floating debt.
Our AFFO dividend payout ratio was 70.9% for the first quarter, occupancy picked up 10 basis point to 99.2% at March 31. I'll note as the leases on 20 SunTrust properties expire April 1, the occupancy is expected to kick down a bit in the second quarter but that's also we baked into our guidance.
We continue to drive additional operating efficiencies with G&A expense decreasing to 5.7% of revenues for the first quarter of 2018 and that's compared to 6.3% a year ago and compared with 5.8% in the immediately preceding fourth quarter.
For purposes of modeling 2018's result, the annual basis rent in place for all leases as of March 31, 2018 $594 million. This allows you to take some of the guess or estimation out of the timing of Q1 acquisitions and disposition as you think about 2018 projections.
As I mentioned, we did increase our 2018 Core FFO by $0.02 per share implying 5% growth in annual results that only change in the guidance assumptions on page six of our press release was the $20 million increase in disposition volume to $100 million to $140 million for the year.
During the first quarter of 2018, we did not issue any common equity via our ATM equity program. However, the combination of our retained AFFO of $30.1 million that they after all dividend payments, plus the $71.6 million of disposition proceeds provided 58$% of the $177 million invested in new acquisitions, allowing us to maintain a leverage neutral posture, while still growing first quarter results versus fourth quarter 2017 result.
We ended the first quarter with only $176 million outstanding on our bank line leaving $724 million of availability. We've not been big users of that short term variable rate part of our capital stag for many years. We remained very well position from a liquidity perspective and a leverage position with the exception of our bank line all of our outstanding debt is fixed rate. Our balance sheet remains in good position to fund future acquisitions and whether potential, economic and capital market turmoil.
Looking at the quarter end, leverage metrics debt to gross book assets was 35.5% nearly unchanged from 12, 31, 17 members. As you know, we've never managed our balance sheet around market cap based leverage metrics, more relevant we believe is dead to EBITDA was 4.9 times at March 31 and that compares with 4.9 times for the fourth quarter of 2017 as well.
Interest coverage was 5.1 times for the first quarter of 2018 and fixed charge coverage was 3.8 times for the first quarter. Only 5 of 2,800 properties are encumbered by mortgages totaling only $13 million.
In clothing, I'll note that 2017, 7% increase in Core FFO per share results follows 2016, 6% growth. And we believe 2018 will be another year of solid growth in operating results. When sourcing capital and making capital allocation investment decisions driving per share result on a multi-year basis is that the forefront of our minds not lying on side.
So with that we will open it up for any questions, Doug.
Thank you. Ladies and gentlemen, we will not be conducting a question-and-answer session. [Operator Instructions] Our first question comes from line of Nick Joseph with Citi. Please proceed with your question.
Thanks. Could you just update on your plans for the SunTrust properties?
Nick, hey, good morning. If you're talking about the now vacated SunTrust properties, as Kevin mentioned, we've disclosed resolved eleven of them, we've got another ten that are pending. We don't want to count all those chickens yet, but we are just working our way through those vacant SunTrust properties in a timely fashion. The bigger headline or perhaps your question Nick was about the SunTrust that have renewed and we are - those 80 SunTrust properties that we own or the leases have been renewed for 12 years, remain excellent disposition fodder for future capital recycling. They didn't make up, I don't think any of this quarter, the first quarter's dispositions, but they are - some of those properties were marketing and they're very good fodder to very accretive to sell those properties and redeploy the capital into new acquisitions.
Thanks. And then what's the timing of potential resolution for the ten?
Our typical vacancies are in and kind of 9 to 12 month range. We've had time with these SunTrust, vacancy SunTrust to do a lot of marketing already. Job one is always to try to release the properties and if we just don't feel like there's a good fit there then we will sell the properties. So it's hard to say what the timing will be on these last units, but it's really not very material, it's immaterial to our numbers at this point. And probably I would expect by the end of 2018 almost all of them will be resolved.
Thanks. And then just given the rise in interest rates, curious to hear your thoughts on the transaction market and any changes that you've seen over the last 6 to 9 months?
Nick, cap rates have not moved upward at all for the types of properties that we are pursuing. So it's still what we think of is a low cap rate environment out there for large regional and national non-investment grade operators with good you know good business and good real estate. That said, the low cap rate environment is also working on the positive side for us with our dispositions. So it allows us to sell into that low cap rate market and redeploy the assets into our acquisitions which are primarily driven from our relationships as opposed to being the lowest bidder, that the highest bidder, lowest tax rate bidder in a competitive marketed environment.
Thanks. Appreciate the color.
Thanks Nick.
Our next question comes from the line of Brian Hawthorne with RBC Capital Markets. Please proceed with your question.
Hi. When you guys are selling a property, have you seen any change in the number of potential buyers?
Brian, no is the short answer to that question. Our properties are on average $2 million to $3 million. We hit that one very big sale but typically we're selling $2 million, $3 million, $4 million, $5 million properties and the universe of buyers for those small single tenet retail properties is huge and very aggressive. So right, now we think that one off market is still very hot.
And then are there any specific lines of trade that you're trying or you would like to buy more into?
We've got a broadly diversified portfolio right now and our primary focus on our acquisitions is through building these recurring relationships with growing retailers. So our focus is less on line of trade and more on good real estate regardless of the line of trade has been operated on it and then a good operator in that business.
So if you take the other end of your question, the convenience store industry is a very good strong industry. We've got great relationships with good operators in that business. And we think that real estate is the some of the best and safest in our portfolio. It's very fungible and it's well located at a good price. So we like the real estate that underlies convenience stores, we like the industry and then we build relationships with good operators. And that kind of the way we focus on our acquisitions as opposed to kind of red lining any particular line of trade.
Okay, thank you.
Our next question comes from the line of RJ Milligan with Robert W. Baird. Please proceed with your question.
Hey good morning, guys. Jay, can you give a little bit more color on that $40 disposition, what was the industry type and sort of the background behind that?
Sure. I can give some amount of color. We had a property that was leased to one of our tenants that has adjacent land as part of the overall trend, as part of the overall lease. And that adjacent land was encumbered with a variety of restrictions. And so the money that we spent in the previous quarter that we talked about on the last quarter's call was to get that property, the adjacent vacant property unencumbered. And then we sold the entire parcel the leased property and a vacant property to one buyer. There are a bunch of confidentiality agreements involving all that RJ, so I can't go into a whole lot more detail than that. But we got this vacant property cleaned up and then sold the whole piece to one buyer.
Okay. That's helpful. And so with that $40 million disposition, you guys were able to sell assets at a lower cap rate than where you were buying. Do you think that that's still a possibility going forward even removing that that one-off opportunity?
Yes, very much so. There's 100s if not 1,000s of properties in our portfolio that would trade for cap rates lower than our average acquisition yields. The two particular tenants and properties, property types to talk about in that vein are our SunTrust Bank branches that have been renewed. We have around 80 SunTrust branches that were renewed for 12 years terms, not too long ago with SunTrust. And those trades in the 5% and call it around a 6% cap rate in the one-off market. So they're great fodder for recycling capital. Also in my opening comments, I talked about 7-Eleven acquiring the Sunoco properties and becoming a bigger tenant for us.
7-Eleven convenience store properties also trade for very low cap rates and so we've got opportunities there as well. But beyond those two, we've got a lot of other opportunities in the portfolio to sell properties at lower cap rates and recycle into the business that we're doing with our relationship, retailers and other properties that we find to buyout in the market.
That's helpful. I guess my last question, Jay is a more general question on net lease. We've been hearing some tenants in the net lease space are looking to sign shorter lease duration leases and I don't know if that's anything that you've noticed out there. Obviously, your acquisition average lease term this quarter was significantly longer 20 years, just curious, if in sale leaseback negotiations if you're seeing a push for shorter lease durations?
Yeah. RJ I would say we're not seeing a significantly greater push than we always have. It is important to us when we are negotiating with our relationship retailers to try to get as longer lease term as we can and we will trade some other things too to get a longer term, a longer lease term is important to have. It is why we like the relationship business, it allows us to have that kind of broad range discussion with the retailer when you're negotiating the overall lease. But I think what you're hearing in the market is not inconsistent with what I think a lot of other people are seeing, which is that there are more tenants are trying to keep their leases limited to 10 years or so when possible.
That's helpful. Thanks guys.
Okay.
Our next question comes from line of Collin Mings from Raymond James. Please proceed with your question.
Hey, good morning, guys.
Good morning.
Just going back to RJ's questions as part dispositions. Just curious are there any other hidden opportunities kind of embedded in the portfolio or things that you think about some of the count but unique when you achieved on 1Q?
Collin, good morning. That to be too facetious but with 2,800 properties, I'm sure we've got some other hidden opportunities, I just think there are hidden. We have great, our focus is on buying good well located real estate and so that improves our odds of having good things like this happen occasionally.
Okay. Fair enough. So that's kind of in the pipeline currently, but again if you think about your strategy think it will lend itself to have other opportunities like this as you look at that disposition in the future, is that fair?
You should definitely expect us to continue to be marketing and selling some of our lower cap rate properties to recycle back into acquisition.
Okay. And then just recognizing your comments again about how broadly you look at acquisition opportunities, but again looking at automotive service as an example here I mean that's up sequentially and year-over-year as far as the exposure there. Can you just maybe talk a little bit more about the opportunity you've been sourcing there and just maybe the competition in that package just given that category just generally viewed as being less exposed to e-commerce?
Correct. And that this competition in all the lines of trade where we're trying to grow our business and we're just trying to build relationships with good operators in some of those more e-commerce resistant lines of trade. In this case, a lot of the auto service uptick has been with higher stores and we've got some good relationships in those areas that have generated good risk adjusted returns for us.
Okay. And then…
Go ahead.
Oh, no. I just as it relates just the acquisition strategy just curious recognizing again a lot of relationship based deals, but just certainty of close. How important is that as you whether it be relationships or potentially new sources of acquisition did that in the current environment are, why you haven't seen a change in cap rates in terms of the acquisition environment, have you seen kind of the sellers being drawn more to the certainty of course you guys offer?
Well, I can't say that we've seen, the sellers be more drawn to it, but it is part of the certainly the value proposition for dealing with National Retail Properties, is that we have this great line of credit that allows us to close on things at any given time and we don't have financing contingencies in our term sheets, we don't have any partners in our ownership of the property. And all of those components do often resonate well with those operators and with some operators and those are the folks that we end up forming long term relationships with certainty of close. In choppy markets, certainty of being able to close is very valuable to the retailer, absolutely.
Okay. I appreciate the color. Thanks.
Our next question comes from the line of Vikram Malhotra with Morgan Stanley. Please proceed with your questions. Vikram, your line is lost. You have us on mute. Our next question comes from the line of Joshua Dennerlein with Bank of America Merrill Lynch. Please proceed with your question.
Hey, good morning, guys. I am just looking at your line of credit, any thoughts on timing that out yet or at what level would you start to think about that?
Yeah. Hey, Josh, it's Kevin. Yeah I mean that's definitely on our radar and we signaled that to some degree in our disclosures in the last quarter's 10-K or in fourth quarter of 2017 where we noted that we've put in place two forward starting swaps which is in connection with potential issuance of long term debt later in 2018. So that's definitely on our radar. We've prided ourselves over a lack of usage of that line and still are using less than 20% of our line compared to others I think been more reliant on that as a form of somewhat permanent capital.
But my benchmark is when the first digit starts with a two in the bank line balance, Kevin starts to get a little nervous. So I don't think that will change much in 2018. And most importantly, our goal is to continue to drive for a share result on a leverage neutral basis. And so we're working to dispositions et cetera to make that happen. But yeah at someone will pay down the bank line.
For the last six years, consecutive years, we've operated with the weighted average back line balance of $100 million and so we're just to underline my point that we've not been big users of that credit facility to drive results despite the fact that's available and very cheap.
Got it. And maybe on the opposite end of the spectrum on equity there, how do you think about potentially reactivating the ATM using out of the source of bonds?
Yeah I mean it's a great program, we've used it for a long, for many years. We don't give guidance as it relates to specific capital market activity. So I don't have a lot to tell you there. I will say last year, when we issued equity on the ATM, it was at average price of $0.42 a share, we did not issue any in the first quarter of 2018. We understand, we could issue equity at this right and still be creative, our issues has over the years and we've had many discussions with many of you on this call, investors is that we just think our capital decisions need to be sufficiently accretive, not just a creative, but sufficiently accretive to make sense to do that.
And so the good news is we were able to issue equity, I'm sorry to make dispositions in the fourth quarter about 4% cap rate which if you pencil through the math creates an equivalent of selling stock at $0.70 a share in round numbers. And so we've attacked it at a slightly different angle in this environment and we think will be able to continue to do that for a period of time.
Got it. Thank you.
Our next question comes from the line of John Massocca from Ladenburg Thalmann. Please proceed with your question.
Good morning, Julian.
Good morning, John.
So if you look at your Sunoco plus 7-Eleven exposure at the end of last quarter it was 201, properties, that 7-Eleven exposures now 152 properties. What happened to the balance and how many of them ended up in that commission agent structure that Sunoco ended up forming in West Texas?
Yeah, the balance of the properties remained Sunoco, so we've got 49 give or take Sunoco stores that are about a little under 2% of our rent, 1.9 or something like that percent of our rent. And I think John, it's around a dozen of our stores out in West Texas became part of that commission market or acquisition of a bunch of stores from Sunoco. The rest are since the Sunoco operated stores.
Okay.
And John, let me just say also, we're really agnostic as to how all that comes out. There are both good operators, they're both, they are good credit and we own those properties that what we think are good prices and reasonable rents. And so we feel good about it no matter how it came out.
Okay. Any with those, doesn't that are or so that are in that commission agent structure, is Sunoco is still the last I guess line of credit there or is that transferred to whoever ended up taking over those properties?
No, Sunoco remained on the lease, liability for all of those.
Okay. Makes sense. And then you had of a decline quarter-over-quarter in the amount of Camping World, you had and it went from 46 to 40, what kind of drove that?
We just sold a small portfolio of existing Camping World stores. We thought perhaps someone might ask about that these were not, we did not sell any of the Gander outdoor stores that Camping World has taken over from our former Gander Mountain location. Those stores are still kind of getting ramped up and - but we had the opportunity to just sell a small portfolio of our existing Camping World.
Okay. And then maybe the other side of the coin, you guys completed about 30% of the top end of your acquisition volume guidance in 1Q, 2018. Understanding there's always kind of limited visibility in your business once you get more than a couple quarters out. Is there some reason you would expect the next three quarters to be less robust in terms of acquisitions versus what you did this quarter?
Well, John. Just like Kevin said, he always worries when the line of credit starts with two. We're always concerned that the acquisition volume in the unforeseeable future might dry up. But there's nothing in particular in the environment that would kind of raise that concern for us. You just can't see very far ahead on your acquisition volume. Notwithstanding, the high level of acquisitions that we do with our relationship tenants, even there we still don't know –don't have a great feel for what their volume will be in any particular year.
But there's nothing specific to this quarter in terms of like a portfolio closing or some think like that that would have made this particularly robust quarter?
No, nothing particular, it's just timing.
That's it for me. Thank you guys, very much.
Thanks, John.
Our next question comes from the line of Todd Stender with Wells Fargo. Please proceed with your question.
Thanks. Just a quick one for Kevin. You spoke about the retained cash flow and disposition proceeds from Q1. Do you have a free cash flow estimate for the full-year just as we model out potential for maybe no equity to be raised from the ATM just looking at your free cash flow?
Yeah. It'll be around $110 million to $120 million for the year as their estimate and so that's an important source and plus dispositions.
And then from the dispositions, are there any mortgages on those assets that you could potentially could sell or that's really clear?
Yeah, now everything's free and clear. We really barely have any mortgages at all, only five properties in our 2,800 portfolio at mortgage is going himself. So it's all your pure proceeds whatever we sell.
Okay. Thank you.
Thanks Todd.
Our next question comes from the line of Michael Knott with Green Street Advisors. Please proceed with your question.
Hey, guys. I just want to ask you about how you're thinking about your cost of capital, I mean it looks like you trade and kind of mid-6 type and quite cap rate range. Just curious, are you thinking about allocating the degree of capital that's in your guidance today and are you looking at that for the rest of the year?
Yeah. Thanks, Michael. It's an important question we think and we don't - our thought process and the deploying capital hasn't changed materially because we really despite the fact where our share price may be trading. And I think you said mid-6s or low-6s for equity, we tend to what a burden our cost of equity at a higher cost in that regardless of that 6% kind of trading employee cap rate today. And so we tend to think of our cost of equity is really causing us something closer to 8 plus percent and making those decisions. And then we layer in long term, the cost of long term debt as well they preferred it's in our capital stack and we end up getting to a weighted average cost of capital for purposes of making investment decisions in kind of the low 6% range. And so you've not seen us do any transactions sub 6%.
And frankly, I'm not sure we've done much below 6.5%, but so we view that as an important part of our philosophy and getting back to where I alluded to earlier is driving sufficient accretion in capital that we deploy. We could make sub 6 cap acquisitions and still be accretive. I understand how the math works. But we just don't think it sufficiently accretive and we think shareholders are expecting more than that and so are we. And so I think in terms of how we view our cost of capital today, we think of it is being in kind of low 6% range for weighted average cost of capital including debt and preferred.
Right. Thanks. Certainly I always appreciate the way you guys think about that and so it's sounds like you're still seeing a sufficient spread over your cost of capital to make value accretive investments today.
Absolutely.
And then Kevin, can you just comment maybe a little bit more specifically on what cause you to increase the guidance for it a little bit, was it the low cap rate sale, was it something else, it looked like the depreciation per share was going up and the net income contribution was going down, just curious on sort of what drove that?
Yeah. Nothing, the disposition, the low cap rate dispositions in the first quarter, so $72 million at a four pack clearly was the piece of the probable for increasing the guidance as well just a little more visibility into 2018, three months more visibility versus where we were in a quarter ago. So really not being notable in terms of the assumptions changes to drive that but just felt better about the assumptions behind all that, so felt comfortable fairly modest increase in the guidance.
Right, okay, thanks. And last one for me would just be just a little bit more color on the answer you gave earlier to lease duration question. Does that have to do with sort of a pending accounting changes on the lease accounting side that I think are taking effect next year, what are you seeing there, maybe a little bit more color?
Yeah, we don't think so adventurously in our conversation and then our execution of transactions. That topic despite the fact you think it would be on the mind of number of it would come up and it really does not. And so I don't - we have not seen pending the accounting change next year for leases change any conversation or change any behavior of our customers at this point. And to be honest I doubt it will most of the retailers in the United States including all the ones we do business with many properties and lease many assets beyond real estate. And so they're going to have to deal with this accounting change and it will make notable differences to their balance sheet.
So even if they all decided to change their behavior, the balance sheet change is already baked in and so I think it's unlikely you're going to see them change their structure of leases going forward. I don't think, in the rules I don't think they're going to allow a material loophole to allow them to do that to scape some of the accounting changes. So at the moment, we don't see any change from that lease accounting change.
Okay. Thank you.
[Operator Instructions] Our next question comes from the line of Chris Lucas with Capital One Securities. Please proceed with your questions.
Hi, good morning, guys. Most of the questions have been asked already, but I do want to follow-up on the on the Gander Mountain dispositions with you Jay, just kind of curious as to what characteristics were present in those particular assets that what made you think about selling those and are there others in that pool that you would look to sort of look to sell over the next year?
Sure. Chris, good morning. Just to clarify what we saw were some Camping World dealership, we did not sell any of the Gander outdoor property. So I apologize if I have…
No. I'm my mistake.
And that has considered - was just an opportunity to sell this small portfolio that felt like the right thing for us to do. So there wasn't - nothing really strategic or trend worthy to talk about in that disposition.
Okay. Thanks. And then Kevin, on your - as you think about you're potentially issuing a long term debt later this year, any thoughts about what to do with the 2021 debt, I know it's out there as it relates to sort of the only what I would call interest savings opportunity on your debt stack, just curious to how do you think about I know that the costs are there related to make hole but just kind of curious how you think about that?
Yeah, today and we've seen a number companies write very large checks for the May calls and I understand that you're an essence just paying the interest early effectively in kind of pulling forward with that expense. But yesterday we've opted not to do anything on the 2021, that is a bit of expensive make hole and so we been on the sidelines on that regard. I think as the year-end unfolds, we continue to think about that, but today we just felt like a little too expensive to pull the trigger on that.
Great. Thank you. That's all I had this morning.
Yeah, thanks, Chris.
There are no further questions in queue. I like to hand the call back to management for closing comments.
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