Agree Realty Corp (ADC) 2013 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Agree Realty Corporation's third quarter 2013 earnings conference call. During today's presentation, all parties will be in a listen-only mode. Following the formal presentation, the conference will be open for questions. As a reminder, this conference is being recorded.

It is now my pleasure to introduce Joey Agree, President and Chief Executive Officer of Agree Realty Corporation. Mr. Agree, you may begin.

Good morning, everyone, and thank you for joining us for Agree Realty Corporation's third-quarter earnings conference call. With me here this morning is Al Maximiuk, our Chief Financial Officer.

As everyone is aware, Agree Realty Corporation is a fully integrated, self-administered and self-managed real estate investment trust focused on the acquisition and development of net leased properties throughout the continental United States. During this call, we will make certain statements that may be considered forward-looking under federal securities laws. The Company's actual results may differ significantly from the matters discussed in any forward-looking statements.

Let's get started with our real estate operations for the third quarter. On the acquisition front, we closed on six properties during the quarter for an aggregate purchase price of approximately $27 million. The properties are leased to six tenants located in six states representing five different retail sectors. The properties acquired during the third quarter are net leased to Tractor Supply in Madisonville, Texas and Forrest, Mississippi; Mattress Firm in Baton Rouge, Louisiana; AutoZone in Sun Valley, Nevada; Bally Fitness in Rochester, New York; as well as BJ's Wholesale Club and Waffle House in Allentown, Pennsylvania.

The seven properties acquired during the quarter had an average cap rate of approximately 8.6%. Since the start of our acquisition program in 2010 on our $230 million of acquisitions, the average cap rate has been approximately 8.25%. For the nine months, our acquisition activity totaled approximately $70 million. Year to date we have acquired 16 net leased properties located in 13 different states representing nine different retail sectors. Approximately 43% of the annual rentals acquired year-to-date is derived from investment-grade retailers.

During the quarter, we delivered our third Wawa development, located in Casselberry, Florida. The store held its grand opening on July 24. Total project costs were approximately $2.8 million.

Exclusive of our joint venture activity, we currently have two development projects underway. This includes our previously announced Wawa project in St. Petersburg, Florida, as well as our newest Walgreens on the University of Michigan campus in Ann Arbor, Michigan. These projects are 20-year turnkey and ground leases, respectively. We expect to deliver both projects during the first half of 2014.

In September we delivered the redevelopment of our Monroeville, Pennsylvania property to HomeGoods. As you may be aware, HomeGoods, a subsidiary of the TJX Companies, is an industry-leading home furnishings retailer with over 400 stores across the United States. This is the first TJX in the Company's portfolio.

During the second quarter of this year, we had announced our first joint venture capital solutions project in Grand Forks, North Dakota. We closed on a 4.2-acre parcel of land for the development of a 55,000 square-foot Hobby Lobby store. Hobby Lobby executed a 15-year lease for the project. I am pleased to announce that construction is now complete and Hobby Lobby is open for business on October 11. Agree provided the necessary capital and is the sole owner of the project.

Subsequent to quarter end, we announced our second joint venture capital solutions project in New Lenox, Illinois. T.J. Maxx, Ross Dress for Less and Petco have all executed 10-year net leases. The total project cost is estimated at $8 million. We expect this project to be complete in late 2014.

Moving on to our current portfolio metrics, our occupancy at September 30, 2013 was approximately 98%. As of September 30, our portfolio consisted of 128 properties. It spanned 33 states and contained an aggregate of approximately 3.8 million square feet of gross leasable area. The portfolio is comprised of 119 net leased properties as well as nine community shopping centers. The Company developed approximately half of these properties including 49 of the 119 net lease properties in all nine of the shopping centers.

As of September 30, 2013, approximately 97% of our annualized base rent was from national and regional tenants. Approximately 61% of total rental income is derived from retailers that are investment-grade. 72% of net lease rental income is from investment-grade retailers. Additionally, the portfolio also contains a number of unrated credits that we believe would qualify for investment-grade status if they pursue a rating in the future.

Due to the delivery of the Wawa in Casselberry, our top five tenants are now Walgreens, Kmart, CVS, Wawa and Walmart. Portfolio wide, the weighted average base term remaining is approximately 12 years. This increases to over 13 years specifically for our net leased properties.

I think that about covers our retail operations. At this point Al Maximiuk, our Chief Financial Officer, will provide a financial update. Al?

Thank you, Joey. Good morning, everyone. I will be providing a few highlights of the results for the quarter. Please note that we will be discussing non-GAAP financial measures, including funds from operations and adjusted funds from operations. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures can be found in the Company's earnings press release issued yesterday. This release is available on our website at agreerealty.com.

The Company is pleased to announce that our revenues for the third quarter of 2013 increased 26% year-over-year from $9.2 million to $11.6 million. This strong increase in revenues is due to the execution of our acquisition and development programs while continuing to maintain high occupancy levels. Funds from operations, or FFO, for the quarter increased by 20% to $7,255,000 from FFO of $6,052,000 for the third quarter of 2012. FFO per share for the third quarter of 2013 was $0.54 per share compared to $0.52 per share a year ago. Excluding the impact of expensing acquisition costs included in general and administrative expense, FFO would have been $0.56 per share for the quarter ended September 30, 2013.

Adjusted funds from operations, or AFFO, for the third quarter of 2013 was $0.55 per share compared with AFFO of $0.54 per share for third quarter 2012. Excluding the impact of expensing acquisition costs included in general and administrative expense, AFFO would have been $0.57 per share for the quarter ended September 30, 2013. The Company's revenues for the nine months of 2013 increased 25% year-over-year from $26.2 million to $32.7 million. For the nine months, FFO increased 18% to $20,442,000 compared to FFO of $17,283,000 for the year prior. This equates to $1.54 per share for the nine months in 2013 compared to -- with FFO of $1.51 per share for the prior year. Excluding the impact of expensing acquisition costs, FFO would have been $1.56 per share for the nine months ended September 30, 2013.

Adjusted funds from operations for the nine months of 2013 was $1.56 per share compared with AFFO of $1.56 per share for the prior year. Excluding the impact of expensing acquisition costs, AFFO would have been $1.58 per share for the nine months ended September 30, 2013.

For the third quarter, the Company paid its 78th consecutive cash dividend. The dividend for the third quarter amounted to $0.41 per share or $1.64 on an annual basis. Our current FFO payout ratio is 76% and the AFFO payout ratio is 75%.

Moving to the balance sheet, the Company's balance sheet continues to be in a very strong position. At quarter end, the Company's net debt to enterprise value was approximately 32%. The portfolio currently has 77 unencumbered assets.

The Company's interest coverage is healthy at 4.1 times and our debt to EBITDA ratio is at 5.3 times. On September 30, the Company entered into a new seven-year, $35 million unsecured term loan with PNC Bank, the Bank of Montreal as well as SunTrust Bank. This loan includes an accordion feature to increase capacity to $70 million, subject to customary terms and conditions. The interest rate will be LIBOR plus 165 to 225 basis points, depending on the Company's leverage. The Company also entered into an interest rate swap to fix LIBOR at 2.2% until maturity. Based on the Company's current leverage ratio, it anticipates the margin will be 165 basis points over LIBOR for an initial interest rate of 3.85% including the impact of the interest rate swaps.

Our $85 million unsecured revolving credit facility had $40 million outstanding at September 30 with additional capacity of $45 million available for borrowings. Approximately $22.8 million or 20% of total mortgage indebtedness is self-amortizing nonrecourse loans that are secured by 13 Walgreens assets. These loans will be completely paid off between 2017 and 2026.

Principal amortization for the third quarter was $878,000 and $2,586,000 year to date. The principal is amortized at an average of $3.5 million to $3.8 million a year over the next few years. In total, approximately $27.4 million of amortizing debt will be paid down between 2013 and 2026.

Between now and 2017, the Company's mortgage debt maturities are well staggered, with only $18 million maturing in the next few years.

That concludes the highlights of the Company's financial and operating results for the third quarter of 2013. I would like to turn the call back to Joey to bring to a close.

Thank you for the update, Al. At this time, we would like to open it up for questions.

(Operator Instructions) R.J. Milligan, Raymond James and Associates.

Joey, I was wondering if you could talk about the acquisition environment. You guys did a lot in the quarter. Sort of where you are seeing cap rates trend since we have seen the volatility in the 10-year of the past couple months and what you are seeing in terms of volumes, the number of deals you guys are looking at.

We are seeing significant deal flow, nothing interrupted from the first or first/second quarter of the year. In terms of cap rates, we really haven't seen much cap rate expansion across the board. Obviously there's significant dollars entering the space. The 10-year has pulled back recently. But we haven't seen that cap rate expansion. We are focused on truly sourcing opportunities where we can add value, off-market opportunities or opportunities that, frankly, aren't correlated, necessarily, to market cap rates.

Okay. And your switching over to the occupancy in the quarter just ticked up 100 basis points. I was wondering, given some of the weakness we've seen in retail sales, is there anybody in the portfolio that you guys are concerned about on your watchlist?

No new entrants on our watchlist. We have continued to watch Rite Aid same-store sales improve. At the same time, we closely monitor anybody, any tenants in the portfolio, including the shopping center portfolio, including same-store sales trends or balance sheet issues that might arise. But we are pretty comfortable with the portfolio to date.

Okay. And I guess along those lines, do you have any update on -- I know you were looking to strategically dispose of some of your assets that had Kmart exposure. And I was wondering -- and you guys certainly got rid of some of the lower-tier properties. Any more updates there? Are you in discussions with people, or is it something that you have put on hold right now?

By no means are we on hold. We continue to enter into discussions and we hope to have an announcement by year end there, both potentially on the disposition front as well as strategic transactions, which I talked about in prior quarters.

Okay, thank you, guys.

Craig Kucera, Wunderlich Securities.

I had a question. Just as you look at your underwriting this quarter and into the fourth quarter, as the overall retail environment decelerated, were there any sectors that you took a look at and you thought really we are looking as if they were going in the wrong direction and that you might want to steer away, whereas a quarter or two ago they might have looked more appealing?

Yes, that's a good question, Craig. I don't think that we steered away from any sectors due to any macroeconomic conditions or any trends within any sectors. We are more focused on strategically adding to the portfolio assets that we feel that we have an imbalance in terms of sectors, or we are underweight. And we continue to execute. I think you've seen us complement our portfolio of auto parts retailers as well as wholesale clubs with the BJ's acquisition. We feel that we have a significant number of retail sectors where we still remain underweight and we have an opportunity to increase exposure, frankly.

Okay, great. And R.J. hit on this, but I would like to go back to the Kmart issue. You've got a number of leases coming due for renewal in the next couple of years, particularly at some of your shopping centers. Are they giving you any feedback, or is that something that you are just going to address later as you approach your strategic plan and dispositions?

We are in constant and consistent dialogue with Sears Holding. In 2014 I believe we have three Kmart's maturing. Two of those are actually the freestanding stores, which are well performing stores. So near term, we are focused on continuing to strategically divest or reposition assets, or even possibly monetize out lots as well. But at the same time, we are constantly in dialogue with Sears Holdings on store performance and opportunities to create value in the portfolio.

Okay. And then finally, you've done a lot of build-to-suit in the past. I think it's, I don't know, maybe it's 40%-50% of the portfolio, quite a bit. Now you've transitioned into the joint venture capital solutions program. What does that give you relative to what you used to do more in the build-to-suit plan?

We really view our joint venture capital solutions program as an inorganic development pipeline. It's an opportunity for us to leverage our balance sheet and our development expertise and partner with private developers who have relationships as well as projects that they are looking to partner with a stronger balance sheet to bring to fruition.

So we've had two projects thus far that we've announced this year, the Hobby Lobby in Grand Forks, which is open and paying rent; and then our recently announced project subsequent to quarter end in New Lenox, Illinois, where we will be constructing a T.J. Maxx, Petco as well as Ross Dress for Less. So the joint venture capital solutions platform for us is really the third leg to the stool. We have our acquisition platform, which obviously originated in April of 2010, our 40 years of development history, and now the joint venture platform which seems to be firing on all cylinders.

If you were just supposed to compare on an apples-to-apples basis the development yields versus doing it on balance sheet yourself versus doing the joint venture, how do they really stack up?

I think -- but you have really got to look at individual transactions to look at yields and comparable yields to our, quote-unquote, organic development pipeline. That said, the yields are very strong. We won't give specific yields on the call today, but they are substantially above market cap rates where we could acquire. But I think it's fair to say that they typically do not reach our hurdle for an organic development where we are going through a 2 or 2 1/2-year development process.

Okay, thanks.

Michael Gorman, Janney Capital Markets.

Just wanted to go back to the acquisition environment for a minute. I was wondering if you could talk about maybe the competition that you are seeing in the marketplace or if there has been any reduction buyers because of some of the volatility in the financing markets or just any drop-off overall because of interest rate sensitivity.

We really haven't seen a drop off in terms of competition. As everyone is aware, there is non-traded capital in this space, obviously traded capital in this space. We see 10 $31 participating in the acquisition market, private capital, foreign capital. It's really across the board. In our typical wheelhouse where we play in the acquisition realm is a price point of approximately a few million dollars.

And in that wheelhouse, you see a significant amount of competition along with a significant amount of capital-chasing yield. I don't think -- obviously, spreads have contracted in terms of the 10-year on an overall basis, ticking upward. And as I mentioned, obviously we've seen that pull back a little bit in recent weeks. We haven't seen a significant drop-off in competition, nothing material.

That said, we are acquiring $27 million in the third quarter, a little bit over $70 million year-to-date. We really are surgical and strategic in the assets that we chase and the assets that we put paper out on. And we are not entering into a bidding war or an auction-like environment. We are aware of our cost of capital and we are aware of the spreads that we need to create to be accretive to our shareholders.

Sure. Okay, great. And keeping in the lines of being surgical, I'm interested if you could talk a little bit more about the second joint venture development that you are working on, or the one that you just announced in Illinois, how you approached it, how it came about. It seems like a little bit more of a hybrid between a traditional triple-net and a shopping center, and just maybe some of the economics of the leases in terms of bumps or just how that came about.

Sure, and it's a great question because it kind of dovetails with how we work on a repeat basis with partners.

Our partner in the New Lenox project is actually a former seller of actually two assets that we acquired, an LA Fitness as well as an Aldi. They had developed the power center where this project is located, which is anchored by Walmart and Menard's, as well as a number of out lots. They were looking for a partner to come in and complete the project, wrap up the leases, complete entitlements and then pull a permit and start construction, which we did last week. So that project is three essentially triple-net leases. So it's Ross, T.J. Maxx as well as Petco, all three brands new entrants into the portfolio.

So I think that project is really symbolic of the types of opportunities that we are capitalizing on. We love the real estate; we are extremely fond of those three tenants. They are all 10-year leases with traditional bumps at the five-year point.

Okay, great. And then they be just one last one -- Al mentioned the payout ratio at about 76%. That's trending towards the low end for the sector. I'm just kind of curious how you guys are thinking about the dividend here versus some free cash flow to continue the development pipeline and the expansion pipeline, just how you are approaching that decision with the Board.

Yes; we are obviously trending toward the low end of that bracket. Typically, on an FFO basis, we are on 75% to 85%. Our AFFO and FFO are pretty tight currently. The Board is consistently and constantly looking at our payout ratio, looking at the free cash flow on an absolute basis and what the use of that capital is. And the Board reviews it quarterly. And they are obviously aware of the downward trend in our payout ratio and the possibility or the potential to increase the dividend in the future.

Sure, great, thanks, guys.

(Operator Instructions) Wilkes Graham, Compass Point Research & Trading.

A couple quick questions -- one, can you talk at all about the spread or targeted spread you might have between acquisitions and dispositions?

I don't think there's necessarily a targeted spread, a correlating targeted spread between acquisitions and dispositions, only because when we dispose of an asset, typically we deemed it non-core for a reason. It could be on credit watch, as R.J. asked earlier in the call. It could be that we are looking to rebalance either a geographic sector or tenant concentration.

So while we are obviously trying to minimize that spread, at the same time we are looking at the underlying real estate and we are taking a bottom-up approach as well as a top-down approach from a credit perspective. And we are determining if it's a fit within our portfolio for the long-term. We are obviously long-term holders, and that's the nature of this business. So there's a number of different motivations on the disposition front that necessarily don't tie directly to the acquisition front.

That's fair. And maybe along the longer-term front, I'm curious if, as you get larger and you continue to face competition not only from some of the public guys, but certainly from the private capital that's out there; and given that you do place a big emphasis on the underlying real estate in these acquisitions, as you grow, as you grow into the future, would you consider other property types like industrial or single-tenant office or something like that? Or, do you think you will stick just to retail?

I don't have a crystal ball, but I will tell you that we have no plans anywhere in the near-term to venture into other property types. The net lease retail sector is a wide and disparate sector. I don't have a crystal ball going years or a decade in the future. But I will tell you that I personally am not a fan of the industrial or office net lease sector.

That said, if we found the right opportunity, which happened to have one or two or a couple of assets or a minimal amount of NOI tied to it in a portfolio, I think we would have to deal with it. We are highly and keenly focused on continuing to execute in the continental United States on the net lease retail sector.

Great, thanks, Joey.

(Operator Instructions) Daniel Donlan, Ladenburg Thalman.

Joey, there's been a lot of talk in the triple-net space about scale. I was just curious; how big do you think you could grow this Company before you would have to really start looking at an increase in G&A? Do you think it would be double the size of the asset base, that the G&A could stay roughly the same or just slightly pick up? What's your thoughts there?

Well, I think, as demonstrated previously by participants in the sector, by our peers, this business is highly scalable. That said, as the portfolio grows, there's accounting/administrative assets that we think we will need to bring on board. But we are comfortable today at 130 assets with our G&A. But the very nature of the leases, the very nature of the portfolio today is well-suited to run with the G&A that we have currently.

In addition to that, as we have divested of shopping center assets over the course of the last couple years, we continue to eliminate CAM and administrative burden that comes with that in terms of accounting as well as property management. So I think we are increasing our efficiencies. We are looking at our systems. We are looking at our processes. We are constantly improving those processes to create efficiencies to continue to scale this portfolio.

Okay. And obviously, being located in Detroit probably helps out a lot from that site as well, relative to like, say, New York or San Francisco, I would imagine?

We are all frequent flyers on Delta here in Detroit.

And just on the term loan, I'm sorry if I missed it. Did you guys give the length of the term loan?

Yes, that's a seven-year unsecured term loan. So we are very pleased to enter the seven-year unsecured space. As Al mentioned, that's a $35 million term loan with a $35 million accordion fully swapped out for those seven years at 385 today. And we are very pleased to have our banking partners allow that deal to come to fruition.

Okay. And then on the Hobby Lobby, what was the total cost of the project?

Total cost of Hobby Lobby was approximately $5.7 million, $5.8 million.

Okay. And then just lastly, going back to Michael's question, the dividend policy, is there going to be something where you are going to look to raise it like every first quarter? Or, could it be that you have one raise one year and maybe another year you have two raises, kind of dependent on acquisition growth? Is there going to be any type of -- some of your peers, they raise it like every fourth quarter, they raise it every first quarter. How should we be looking at that modeling going forward?

It's a good question, and obviously a very pertinent question. The Board doesn't have a policy in terms of when dividends -- obviously, first and foremost, they are reviewing our payout ratios on a consistent basis. But the Board doesn't have any policy on when any dividend raise is appropriate or applicable. I think, and I've stressed this to the Board and the Board fully appreciates that a level of consistency and predictability is important in this space. Obviously, it's a yield-oriented space, and so that's significant.

So I think what you will see, what I anticipate you'll see, is a level of predictability, stability and consistency that gives a level of awareness to our shareholders. That said, there are transactions, there are always things moving in and out of the portfolio as well as a pipeline of opportunities that the Board considers.

Okay, that's it for me, thank you.

And showing no additional questions in the queue, this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Joey Agree for his closing remarks.

Well, that about wraps it up. I would like to thank everybody for joining us this morning and we look forward to hearing from everybody next quarter.

Thank you. Ladies and gentlemen, the conference is now concluded. We thank you for attending today's presentation. You may now disconnect your lines.