Agree Realty Corp (ADC) 2017 Q1 法說會逐字稿

Good morning, and welcome to the Agree Realty First Quarter 2017 Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Joey Agree, President and CEO. Please go ahead.

Thank you, operator. Good morning, everyone, and thank you for joining us for Agree Realty's first quarter 2017 earnings call. Joining me this morning is Matt Partridge, our Chief Financial Officer.

We are pleased to report a strong start to 2017 as we continued executing in all phases of our business across our unique operating strategy. Investment volume across our 3 external growth platforms and active portfolio management further strengthened our best-in-class portfolio and drove solid year-over-year earnings growth.

Let's begin with our 3 external growth platforms, where total investment volume for the quarter was approximately $62.1 million. We invested in 13 high-quality retail net lease properties with 11 of the 13 properties sourced through our acquisition platform. Total acquisition volume in the quarter was approximately $52.9 million.

The acquired properties are located across 9 states and are leased to leading national and superregional tenants. These tenants operate in 8 retail sectors, including the discount apparel, auto parts, health and fitness, farm and rural supply, home furnishings and pet supply sectors. The properties were acquired at a weighted average cap rate of 7.6% and had a weighted average lease term of 11 -- 10.6 years.

Turning to our development in Partner Capital Solutions programs, we completed and brought online 2 projects during the quarter with total cost of approximately $9.2 million. Our previously announced Camping World in Tyler, Texas, which is the first in the company's portfolio, was completed ahead of schedule in January. The project, which had total costs of approximately $7.5 million, is subject to a new 20-year net lease.

The company also completed in the quarter its previously announced Burger King in Heber, Utah. This project represents the fifth Burger King in the company's partnership with Meridian Restaurants and is subject to a new 20-year net lease. Total project costs were approximately $1.7 million.

In addition to our completed projects, the company also has 2 previously announced projects currently under construction, representing approximately $12.3 million in total costs. In Georgetown, Kentucky, construction continues on the company's first ground-up development for Camping World. The project will be the second Camping World in the company's portfolio and is subject to a new 20-year net lease with rent anticipated to commence in the third quarter of 2017.

Construction is also ongoing in Boynton Beach, Florida for Orchard Supply Hardware, where we are redeveloping and expanding an existing property. The property is subject to a new 15-year net lease guaranteed by Lowe's Companies, which carries an A- credit rating from S&P. We anticipate rents will commence in the third quarter later this year.

In total, our announced development in Partner Capital Solutions projects completed or under construction during the quarter represent total capital committed of approximately $21.5 million. We continue to see more opportunities to leverage our distinct capabilities for national and superregional retailers and are excited about our pipeline.

As we execute across our 3 external growth platforms, we remain disciplined in our underwriting, emphasizing retail real estate fundamentals, including retail synergy, visibility, demographics, traffic patterns and access. We combine that approach with a top-down focus on leading retailers that operate with a well-defined omnichannel strategy, whereas brick-and-mortar operations provide a compelling customer experience or value proposition.

Our sector-leading portfolio represents an increasingly well-diversified mix of tenants, retail sectors and geography. We remain encouraged about our pipeline as our origination team continues to produce high-quality opportunities across all 3 platforms. It's interesting to note that the longest tenured member of our acquisition team has been with our growing company for just over 2 years. Today, this 5-person team continues to develop relationships in their respective markets while our company's reputation in the net lease space continues to advance.

For context, in 2015, our 2-person acquisition team presented approximately $1.25 billion in qualified opportunities to our investment committee. That number grew to approximately $2.5 billion last year in 2016. Year-to-date, our current team has brought in just over $1.2 billion in high-quality opportunities. We remain confident in our ability to achieve our guidance of $200 million to $225 million acquired this year.

While we have significantly enhanced portfolio-to-portfolio diversity through our 3 external growth platforms, our disposition in capital recycling effort has improved our portfolio and reduced exposures. During the first quarter, these efforts continued as we've sold 1 property net leased to Walgreens located on Jackson Road in Ann Arbor, Michigan. The sale generated gross proceeds of $10.5 million, representing a 5.86% cap rate on net operating income. We developed this Walgreens in 2010 for a total investment of $6 million and have realized a gain on sale of approximately $4.5 million, demonstrating the significant value creation our development program can create.

As the result of this disposition as well as the company's disciplined growth, our Walgreens exposure has decreased approximately 600 basis points in just the past year to 10.5% at quarter end, down from 16.5% at 3/31 of 2016. We remain committed and on track to bring our Walgreens exposure to below 10% by year-end.

Similarly, we have seen a significant reduction in our pharmacy exposure, which has decreased more than 700 basis points year-over-year to 15%. And lastly, from a geographic perspective, our Michigan exposure now stands at approximately 14.2%, representing a decrease of approximately 500 basis points year-over-year. From all aspects, our progress is tangible and our expectation is that it will continue.

As of March 31, our growing retail portfolio consisted of 377 properties net leased to leading retailers in over 25 distinct sectors. Our portfolio, which derives 45% of annualized base rents from investment-grade tenants, spanned 43 states and totaled 7.3 million square feet of gross leasable space. The portfolio remains effectively fully occupied at 99.6% and has a healthy weighted average lease term of 10.6 years.

To maintain high occupancy rates and portfolio stability, our asset management team has remained proactive in addressing our future lease maturities. During the quarter, we executed new leases, extensions or options on approximately 346,000 square feet of gross leasable area. The new leases extensions or options included 7 Tractor Supply stores, totaling approximately 154,000 square feet, as well as our 32,000 square foot T.J.Maxx in Aurora, Colorado. As a result of our asset management team's efforts, our 2017 lease maturities now represent only 0.4% of our portfolio's annualized base rents.

And finally, I want to once again highlight our ground lease portfolio, where nearly 90% of our ground lease rental income is derived from tenants with an investment-grade credit rating. This portfolio continues to represent more than 7% of our annualized base rents and presents an extremely attractive risk-adjusted investment for our shareholders as the company owns a fee simple interest in the property, yet the tenant has invested their own capital to construct the building improvements.

With that, I'd like to thank our many loyal shareholders for their continued support. And I'll turn it over to Matt to discuss our first quarter financial results.

Matt?

Thanks, Joey. Good morning, everyone. Let me begin quickly by running through the cautionary language. As a reminder, please note that during this call, we will make certain statements that may be considered forward-looking under federal securities law. Our actual results may differ significantly from the matters discussed in any forward-looking statement. In addition, we discuss non-GAAP financial measures, including funds from operations or FFO and adjusted funds from operations or AFFO. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures can be found in our earnings release.

As we announced in yesterday's press release, total rental revenue, including percentage rents for the first quarter of 2017, was $24.2 million, an increase of 29.7% over the first quarter of 2016. General and administrative expenses were approximately 9.8% of total revenue, representing a decrease of roughly 30 basis points year-over-year as compared to 10.1% of total revenue in the first quarter of 2016. G&A was elevated during the quarter due to timing considerations of certain expenses, and we anticipate G&A as a percentage of total revenue to be below 8.5% for the full year as we continue to reduce corporate operating leverage through increased scale.

Funds from operations for the first quarter was $17 million, representing an increase of 34.5% over the comparable period of 2016. On a per share basis, FFO increased to $0.65 per share, a 6.3% increase as compared to the first quarter of 2016. Adjusted funds from operations for the first quarter was $17.1 million, representing an increase of 34% over the comparable period of 2016. On a per share basis, AFFO increased to $0.65 per share, a 5.9% increase as compared to the first quarter of 2016.

Turning to the balance sheet. We continue to maintain one of the most conservative credit profiles in the industry with no debt maturities in 2017 and limited maturity exposure over the next 5 years. As of March 31, 2017, total debt-to-enterprise value was approximately 24.7%, and our fixed charge coverage ratio, which includes principal amortization, was a healthy 4x. Furthermore, net debt to recurring EBITDA was approximately 4.9x, below the low end of our stated leverage range of 5 to 6x. We elected not to utilize our at-the-market equity program during the quarter. However, we continue to view the at-the-market equity program as an efficient tool for us to reduce our overall cost of capital, improve the timing and efficiency of raising capital and increase liquidity of the stock.

The company paid a dividend of $0.495 per share on April 14 to share -- stockholders of record on March 31, 2017. The quarterly dividend represents a 6.5% increase over the $0.465 per share quarterly dividend declared in the first quarter of 2016. Since the company's IPO in 1994, we've paid 92 consecutive cash dividends.

Our quarterly payout ratios for the first quarter of 2017 were 77% of FFO and 76% of AFFO, both of which are in the lower half of the company's targeted ranges and reflects a very well-covered dividend.

With that, I'd like to turn the call back over to Joey. Joey?

Thank you, Matt. To conclude, we are very pleased with our results for the quarter and are confident that our balance sheet and investment pipeline are well positioned to execute incoming quarters.

At this time, we'll open it up for questions.

(Operator Instructions) Our first question comes from Nick Joseph from Citi.

Joey, you mentioned the diversification across the external growth channels. But just specifically, for the PCS and development, with the 2 being completed this quarter, there's only 2 still in progress. What's the opportunity to grow that pipeline? And where does it stand today?

So we're focused on -- to continue to scale both, both our Partner Capital Solutions program as well as our organic development platform. Of note, winter months, typically in northern climates, aren't a great time to commence projects. But we're excited about some of the opportunities in there and both our partners, our PCS as well our development platform, some new tenants as well as existing tenants in our portfolio. Different sectors, but sectors that we're focused on growing our exposure in context of e-commerce and recession resistance.

Would you expect to add a few projects to this disclosure during this quarter? Or is it more of later in 2017?

No. I think there's the opportunity for us to add at least a couple of projects this quarter, in Q2. If not Q2, early in Q3. So we look forward to getting some shovels in the ground. And commensurate with that, we will announce those projects.

And then just more probably on tenant health. I wonder if you could talk about any changes to the watch list or anything else that you're keeping an eye on.

Yes. We -- really no material changes to our watch list. We continue to monitor the Walgreens-Rite Aid transaction; don't have any information that isn't publicly available. Rite Aid, the largest tenant, really the material tenant on our watch list. At the same time, we're watching the evolution of retail. Our mission is to stay in front of that evolution of retail. We see the opportunity to continue to improve the portfolio through our 3 external growth platforms, as well as the opportunity to divest of assets, opportunistically take advantage of cap rates and valuations throughout the remainder of 2017. So that's really -- our focus is to maintain what we believe is the highest quality net leased retail portfolio out there today.

Our next question comes from Rob Stevenson of Janney.

Joey, in terms of -- you talked about driving the Walgreens down below 10%. Is that basically, at this point in the year, what you're seeing for the dispositions in the guidance? Or is there odds and ends elsewhere in the portfolio that you'll be looking to either take advantage of robust pricing or get out before things deteriorate type of thing on other tenants as well?

No. I'd refer back to my answer versus Nick. We think if there's an opportunity for us to continue to improve portfolio of quality on the asset level, specifically take advantage of cap rate, monetize and recycle some proceeds given the cap rate environment out there today. And I think it's incumbent upon us to be proactive asset managers. And so given our disposition guidance of $20 million to $50 million, we think we really telegraph that to the street and we're going to execute on that. Specific to Walgreens, the Ann Arbor sale was really akin to selling 2 Walgreens assets. It was a $10 million deal. I think everybody noted in the prepared remarks over a $4.5 million gain. That asset specifically was over $600,000 in rental income. Frankly, it was not a strong performer, it wasn't a wrap, so it was off the hard corner. And we still own the 2 dominant Walgreens in the Ann Arbor MSA. So I would look forward to us continuing to divest of Walgreens assets, reduce that exposure below that 10% threshold that we've been very clearly -- that we very clearly communicated to investors but also look to continuously improve portfolio quality.

Okay. And then just lastly, what -- on the leasing that you did during the quarter, how does new leases look stacked up versus expiring on those -- on that 346,000 square feet?

Yes, a de minimis increase, I would tell you. So there was a number of early lease extensions in that leasing activity. We're talking about 2% to 2.5%, typically increases from a base rental perspective. So really, it was proactive asset management as we noted in the prepared remarks. We really have de minimis expirations remaining through this year, and we're really focused on 2018 at this time.

Our next question comes from Collin Mings of Raymond James.

Just one question for me. You said you look ahead to 2018 lease expirations. Just curious if you see any opportunities or need for redevelopment projects, like the Orchard Supply project here in Florida?

I would tell you that there's the potential for 1 or 2 redevelopments in 2018, either densifying existing sites or potentially some opportunities to increase rental rates as well as credit quality in those assets. And we're focused on 2018 as I mentioned now.

Got you. Any sort of idea what sort of capital commitment that might look like?

Not at this time, it's early. I would tell you that there could be potential opportunity on an asset basis on the ground lease all the way to turnkey. So we're early to really announce anything there. But like I said, we're focused on '18 and any embedded opportunities within the portfolio, both from an [ outlaw ] perspective as well as the primary piece.

Our next question comes from David Corak from FBR.

Just looking at the acquisitions environment this year. When you gave the guidance 4 months ago that there was certainly a ton of uncertainty in the political environment, the interest rate environment, et cetera, and I guess, there's still some uncertainty. But since then, your cost, your stock cost, the equity has improved. So I guess, I'm trying to figure out what the governor on acquisition volume is at this point other than just kind of sourcing quality deals? I guess, in other words, what's changed since January? And what sort of environment do we need to be in to kind of hit or exceed the top end of that guidance range?

It's a good question. I'll tell you that the first quarter may be boring to some. But I think we see a continued and a consistent pattern of execution. In terms of our acquisition guidance, the governor really is opportunity dependent. And as we talked about in the prepared remarks, we have an acquisition team, which is now 5 people, which is growing and experiencing capabilities on a quarterly basis, we're excited with the growth of the team on the individual as well as the group level. I'll tell you that our pipeline, as we discussed in the prepared remarks, is strong. The number of opportunities that we're seeing, the qualified number of opportunities that we're seeing, continues to ramp up and increase. And frankly, our ability and the knowledge of Agree in the net lease market has increased by a factor of a multiple there. So in terms of the existing guidance for $200 million to $255 million, we're confident we're going to strike within that guidance. We're clearly on pace and we clearly see the ability to execute to that throughout the course of the remainder of the year. And if we -- at the top end or the -- if we increase that guidance or at the top end of that guidance it's because we find a number of qualified opportunities that frankly hit within our wheelhouse.

Okay, great. And I guess, just to quantify that a little bit. I think you mentioned $1.2 billion year-to-date that you brought through investment committee. But maybe how does that compare to this time last year? And then, is there some sort of kind of selectivity metric that you can share with us that you guys follow or something to help us get some color there?

Sure. I don't have the quarterly numbers from 2016. But the investment committee saw $2.5 billion of activity again. So we're at $1.2 billion effectively year-to-date, $2.5 billion over the course of the full year in 2016. I'll tell you, our ability to be disciplined and selective only improves as our cost of capital improves. And so we're out there looking for opportunities across all 3 external growth platforms that fit within the continued execution that we've laid out to investors with a top-down perspective of that e-commerce and recession-resistant retail sectors and then securing opportunities with the industry leaders in those respective sectors.

Okay. So you feel like you can be more selective with where you are today versus maybe this time last year?

Well, I think we could be more selective because we're seeing more opportunities frankly. I wouldn't tell you that it's cost of capital dependent -- I would didn't tell you it's cost of capital dependent. There's no doubt our cost of capital has improved both from the debt and the equity side our cost of capital has improved. But we're able to be more selective because of the opportunities that frankly enter into the funnel. And so I think first quarter was a quarter of consistent execution for us, both on the acquisition as well as disposition side. In Q2, Q3 and Q4, we think there's a pipeline of opportunities that are of higher quality or at least of the quality that we've seen consistently since the launch of the acquisition platform in 2010.

(Operator Instructions) Our next question comes from R.J. Milligan from Baird.

Just curious, you guys specifically called out in terms of leasing of the Tractor Supply assets, and I think you guys have just acquired them in the fourth quarter. So curious how that lease renegotiation went.

We're big fans of the company Tractor Supply. Specifically, it's a great company, it's got a fantastic balance sheet. It's publicly available for everybody to see, and we have a great relationship and respect for them. So again, it's just an example of us creating value across our acquisition platform, leveraging our relationships, our capabilities on the diligence front to understand stores, to understand markets, how they perform relative to their district and then triangulate the execution.

Okay. And so those leases were renegotiated for additional term?

So those leases were -- they were advantageous extensions, I'll leave it at that. But there are advantageous extensions where we could create some value and potentially save some occupancy costs for our tenant there.

Okay. And last year, you guys were successful in acquiring a larger portfolio. I'm just curious in terms of portfolios that are out there, obviously, you said you guys are seeing a lot more in terms of your pipeline, but just wondering if there's any chunkier deals out there.

Well, we're always looking at opportunities of different sizes and shapes. The portfolio in 2016 was very unique. We've talked about earlier, we have yet to see anything, prior to that or since that, of the quality or nature of that portfolio and also the relationships with the existing tenants that we had in that portfolio to really understand the asset level quality. We're looking at diversified portfolios, we're looking at single credit portfolios. But again, our true nature, our DNA is finding one-off of real estate opportunities across all 3 platforms. Portfolio opportunities were not included in our guidance of $200 million to $225 million acquired. We don't anticipate them, we don't rely upon them. Our team here is really tasked with finding those -- with those [ diamonds. ] And so we want to continue to execute on that front in any portfolio that we find and execute on -- are really bonus to us.

Our next question comes from Craig Kucera from Wunderlich.

Appreciate the color on the acquisition pipeline and the amount of opportunities you're looking at. But as we look through the next year, are we -- should we expect to see somewhere in the closer to the mid-7% cap rates over the next couple of quarters? Or was that a little bit lower than kind of what you're seeing in the backlog and pipeline?

I think it's really opportunity dependent. When you have 11 acquisitions effectively in the quarter, any single transaction can bring that yield down incrementally. Our targets remain the same, our discipline remains intact. So I can't tell you how Q2, Q3 and Q4 will -- I don't have that ability today to tell you how those quarters will stack up relative to Q1. But we're going to be effectively in the same range. I wouldn't anticipate anything materially deviating from Q4 of '16, Q1 of '17.

Got it. And one more for me. Obviously, there's been a lot of pressure on the apparel segment year-to-date. Can you talk how you see discount apparel functioning and performing better, frankly, as we continue to go down a path as it relates to e-commerce resistance?

Sure. We love the discount apparel sector. The T.J.Maxx in Aurora was a fantastic transaction for us. This quarter, we closed on a Ross in the West-Southwest part of Chicago with fantastic demographics, nearly 400,000 people in a 3-mile radius. We also closed on a Burlington. And so those 3 are really the industry leaders in the discount apparel sector. That sector continues to gain traction, same-store sales continue. If you really look at them, even on a stacked basis, they're fantastic. And so the same-store sales trends are fantastic. And the consumer preferences, we believe the consumer preferences are now cemented, that consumers with the ability to price check within a matter of seconds with mobile e-commerce and Google and Amazon no longer have to get in their cars and travel to multiple stores or traverse the mall to price check and comparison check. They have the ability within 15 or 20 seconds to see every competitive retailer and their pricing on any specific goods. And so we believe discount apparel is right in consumer preferences in an omnichannel, as well as a recession-resistant -- from a recession-resistant sector perspective. And so we're going to continue to execute, continue to look for opportunities in the discount apparel sector. And we anticipate those -- specifically those 3 continuing to see positive trends.

(Operator Instructions) Our next question comes from Dan Donlan of Ladenburg Thalmann.

So I missed the earlier part of the call. But just wanted to go back to the Rite Aid question. So with the merger kind of being renegotiated or the terms renegotiated with Walgreens, is there any update to kind of how you're looking at your footprint? Is it -- the new transaction terms more or less favorable to you than the prior terms?

No, really -- really no change. We look at our overall pharmacy footprint, we look at our Walgreens exposure specifically. Pharmacy's down nearly 750 basis points year-over-year. So obviously, we've made a significant improvement from a sectoral perspective. And so we understand all -- every store in the portfolio, how they perform, where they're positioned relative in their markets. And we're going to continue to execute in Q2 and beyond on our stated goal of reducing some exposures there.

Okay. And then just kind of lastly, for me. Just kind of curious, given all the retail malaise and several store closings, is there anything that's kind of happened to maybe a retailer that has a good business strategy, but maybe they just have too many locations? Is there any opportunity that you see with retailers that maybe have been closing stores and maybe some other investors are afraid to do that leaseback transactions or acquisitions of their properties? Is there anything that kind of sticks out to you? I mean, not just specifically name tenants, but is there any area that you're looking at where you think there's opportunity?

There's lots of areas that we're looking at where we think there's opportunities. I would encourage investors to follow our trends in the stated intentions. If you just look at our sector exposures in context of our stated investment strategy, again, pharmacy down nearly 750 basis points. Auto service is up 325 basis points. These are year-over-year. Grocery, specifically discount grocery, up over 160 basis points. Home improvement, up over 140 basis points. I would encourage investors to believe that these trends are going to continue, that we are going to consistently and persistently execute on our investment strategy, again with that top-down 30,000-foot [ lend ], and then pairing that with a disciplined approach from a bottoms-up perspective. We don't believe in investing in tertiary operators in those respective retail sectors. We believe in investing in industry leaders. In today's day and age, not only with e-commerce and Amazon and all the headlines that we read about in terms of retail store closures and bankruptcy. The unspoken competitive threat to all of these retailers today really emerged early in the millennium here with the advent of the supercenters and the expansion of Walmart and Target and the wholesale clubs, such as Costco and Sam's Club. So there's competitive pressures to category [ killers ] today. They have to have a value proposition for their consumers. They have to provide a compelling reason for consumers to shop in a brick-and-mortar environment rather than pick up their phone. So our focus again is those industry leaders who present that value proposition who we think are going to be here in context of those sectors for a long time.

Okay. So I guess, that's a long-winded way of saying, "No, we're not interested."

We are not interested in a lot retail operators in the space. We are picky, we are disciplined and we want to maintain it.

Okay, okay. Just kidding. But -- so and then just maybe more narrowly. Given your development and redevelopment expertise, as some of these big boxes come back and are vacant, are you seeing, are you maybe working with potential tenants to redevelop these properties and maybe do some type of transaction? Is that even on the radar? Have you guys been approached? Just kind of curious how you're looking at that. Or do you want to stay more smaller box as much as you can?

Our preference is smaller footprint retail. Have we been approached? Yes. We've been approached many times both from a redevelopment as well as a development perspective. The most important thing is, one, we aren't going to speculate on buildings or GLA or land. We're nonspeculative developers. We're working hand-in-hand with our retail partners. And two, they have to fit our investment criteria as I talked about a couple of minutes ago. And so our approach to development or redevelopment, we have -- we know we have those capabilities, the market's aware of those capabilities, our retail partners are aware, of course. We want to deploy them on a selective basis and we want to be efficient when we do deploy them.

This concludes our question-and-answer session. I would like to turn the conference back over to management for closing remarks.

With that, we'd love to thank everybody here for joining us today. We look forward to speaking to you again when we report our second quarter earnings. And good luck with the earnings season. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.