Essential Properties Realty Trust Inc (EPRT) 2021 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Essential Properties Realty Trust First Quarter 2021 Earnings Conference Call. (Operator Instructions)

This conference is being recorded, and a replay of the call will be available 2 hours after completion of the call for the next 2 weeks. The dial-in details for the replay can be found in today's press release. Additionally, there will be an audio webcast available on Essential Properties' website at www.essentialproperties.com, an archive of which will be available for 90 days.

It is now my pleasure to turn the call over to Dan Donlan, Senior Vice President and Head of Capital Markets at Essential Properties. Thank you, you may begin.

Thank you, operator, and good morning, everyone. We appreciate you joining us today for Essential Properties First Quarter 2021 Conference Call. Here with me today to discuss our first quarter are Pete Mavoides, our President and CEO; Gregg Seibert, our COO; and Mark Patten, our CFO.

During this conference call, we will make certain statements that may be considered forward-looking statements under federal securities law. The company's actual future results might differ significantly from the matters discussed in these forward-looking statements. And we may not release revisions to those 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 yesterday's earnings press release. With that, Pete, please go ahead.

Thank you, Dan. And thank you to everyone who is joining us today for your interest in Essential Properties. The first quarter was solid for us on all fronts. In terms of the portfolio, our portfolio demonstrated great stability and durability as our tenants largely put the impacts of COVID-19 behind them and emerged from the pandemic as stronger operators. While the pandemic continues to affect businesses, these burdens are now more manageable with the vast majority of our tenants no longer needing support from us in the form of deferred rents. Additionally, the fourth quarter and into the first quarter, we largely completed the repositioning of properties formerly leased to tenants that needed to restructure as a result of the pandemic.

In terms of investments, our industry relationships, which were strengthened during the pandemic, are driving investment activity as tenants continue to turn to us as a capital partner of choice for their real estate capital needs. As a result, the record level of activity that we experienced in the fourth quarter continued into the first quarter with another strong performance on the investment front. During the quarter, we invested $198 million into 74 properties at a 7.0% initial cash yield with over 16 years of lease term. More importantly, 81% of these deals were repeat/relationship transactions and 85% were direct sale leasebacks on our lease form.

In terms of the capital markets, the capital markets remained attractive for us, and we continued to operate well within our desired leverage range. Specifically, we finished the quarter with net debt to annualize the adjusted EBITDAre of 5.1x. However, when taking into account our follow-on equity offerings subsequent to quarter's end, our pro forma leverage declines to 4.1x, which provides ample capacity to continue our external growth strategy.

Looking out to the balance of the year, we anticipate our new vintage portfolio to remain highly occupied, our focused and robust pipeline to generate a creative and attractive investment opportunities and the capital markets to offer multiple sources of well-priced capital. Based on these assumptions, we are reiterating our 2021 AFFO per share guidance of $1.22 to $1.26. We believe our projected double-digit increase in AFFO per share, combined with our well-covered dividend and our commitment to prudently managing our balance sheet and portfolio risks offer an investor a compelling total return opportunity.

To dig in with more specificity, we ended the quarter with investments in 1,240 properties that were 99.1% leased to 259 tenants operating in 17 industries. Our weighted average lease term stood at 14.3 years at quarter end with only 4.2% of our ABR expiring over the next 5 years. Our weighted average unit level coverage ratio was 3x, which was a slight improvement over last quarters. 2.9x. As we have previously mentioned, our traditional credit statistics, which focuses on implied credit rating and unit level coverage, remain skewed as these metrics have been negatively impacted by the pandemic-related shutdowns last year, yet they do not pick up the benefits of forgivable loan programs and rent deferrals. Nonetheless, it is encouraging to see this upward trend.

Our pipeline remains strong and we look forward to continuing to add properties and tenants to our portfolio predominantly through direct sale leasebacks with growing middle market operators in our targeted industries. While our balance sheet remains fully supportive of our external growth strategy, we will continue to stay way ahead of our capital needs in order to maintain optimal financial flexibility.

With that, I'll turn the call over to Gregg, our COO.

Thanks, Pete. During the first quarter, we invested $198 million in the 74 properties through '22 separate transactions at a weighted average cash yield of 7%. These investments were made within 9 different industries with over 95% of our activity coming from 4 industries: quick service restaurants, auto service, medical/dental and early childhood education. The weighted average lease term of our quarterly investments was 16.1 years. The weighted average annual rent escalation was 1.8%. The weighted average unit level coverage was 3x and our investment per property was $2.7 million. Consistent with our investment strategy, 85% of our first quarter investments were originated through direct sale leasebacks, which are subject to our lease form with ongoing financial reporting requirements and 79% contained master lease provisions.

From an industry perspective, carwash has remained our largest industry at 14.9% of cash ABR, followed by quick service restaurants at 13.6%, early childhood education at 13.4% and medical/dental at 12.4%. We view these 4 business segments as Tier 1 industries for Essential Properties. As we have noted in the past, we view our industry focus as a distinct competitive advantage as it allows us to remain diverse while retaining deep and specific industry relationships and proprietary data sets.

Going forward, we continue to see concentration increases occurring in the more pandemic-resistant industries like auto service, equipment rental and sales, pet care services, building materials and grocery. However, we are pursuing attractive investment opportunities in both the entertainment and casual dining industries, which have begun to experience strong rebounds in revenues and profits as more states relaxed indoor capacity restrictions and vaccinations increase. Conversely, we expect further reductions to the movie theaters and home furnishings. Of note, our combined exposure to both industries is now just 3.4% of ABR, which is down 75% versus 3 years ago.

From a tenant concentration perspective, no tenant represented more than 2.6% of our ABR at quarter end and our top 10 accounts for just 20.2% of ABR, which compares to our 41.8% concentration just 3 years ago, increasing our tenant diversity as an important risk mitigation tool and a differentiator for Essential Properties. This is also a direct benefit of our middle market focus, which offers a significantly more expansive opportunity set than investment strategy concentrated on publicly traded companies and investment grade rated credits.

On the occupancy front, we did see a 60 basis point pull back this quarter, which mostly relates to our decision in late March to terminate a 7-property master lease with an auto service tenant in the Southeast. Given our basis in the real estate and the strength of our operator relationships, we determined this was the best course of action for the long term. We have either relet or identified replacement tenants for all of these sites, and we expect a recovery that is consistent or better than our historical performance on lease terminations, which speaks to the quality of our underwriting and desirability of our properties. As of today, our occupancy stands at 99.5% with only 6 vacant properties.

In terms of dispositions this quarter, we sold 16 properties, including 1 vacant property for $25 million in net proceeds. When excluding vacant properties and transaction costs, we achieved a 7.1% weighted average cash yield on those dispositions. As we have mentioned in the past, owning liquid properties is an important aspect of our investment discipline as it allows us to proactively manage industries, tenants and unit level risk within the portfolio. That said, future disposition activities should moderate to levels more consistent with our historical average, as much of COVID-related restructuring is behind us.

With that, I'd like to turn the call over to Mark Patten, our CFO, who will take you through the balance sheet and financials for the fourth quarter. Mark?

Thanks, Gregg. As both Pete and Gregg noted in their remarks and was evident in our release last night, we had a great first quarter highlighted by strong revenue growth and our FFO and AFFO results, which on a per share basis were $0.30. Some of the notable elements in our reported operating results for the first quarter of 2021 include the following: total revenue reached $48.6 million for Q1, an increase of $7.1 million or 17% over last year, which reflects the full quarter impact of our record level of investments of $244 million in Q4 2020, and more broadly, our total 2020 investment activity of $603 million at a weighted average cash yield of a 7.1% (inaudible).

For the first time since the onset of the pandemic, our results did not have notable adjustments directly related to COVID. That said, we did incur approximately $300,000 of property level expenses associated with property taxes and maintenance for a vacant property that was sold in April 2020 as well as a few properties that were relet in the third quarter. So those should be nonrecurring going forward.

We recognized approximately $5.7 million in impairment charges during the quarter, $3.8 million of this charge related to a single furniture property. We also recognized $3.8 million in gains on asset dispositions that Gregg mentioned during the quarter.

Total GAAP G&A was $6.4 million in Q1 2021 versus $7.5 million in the same period last year. That's a 15% improvement, which reflected reduced costs for professional services, such as audit and legal, as well as certain outsource services. We expect that these particular cost elements in our G&A will continue to trend favorably during 2021. We saw our recurring cash basis G&A for Q1 2021 decreased to approximately $4.8 million versus $5.6 million in Q1 last year. And notably as a percentage of total revenue, our Q1 2021 cash G&A was just over 10%, a favorable level compared to Q1 2020, which was nearly 13% of revenue.

Net income with $15.3 million in the quarter, which was up 9.5% from first quarter last year. Our FFO totaled $32.9 million for the quarter, it's an increase of $7.4 million or 29% over the same period in 2020. Our FFO per share on a fully diluted basis was $0.30, as I mentioned, a 7.1% increase over the same period in 2020. Our core FFO on a nominal basis was 21.4% higher than Q1 2020 and on a per share fully diluted basis, core FFO for the quarter was $0.30 per share. Our AFFO was up $5.9 million. That's a 22% increase versus Q1 last year, totaling approximately $32.5 million for the quarter. On a fully diluted per share basis, AFFO for Q1 2021 was $0.30 per share, that's up 3.4% from Q1 2020.

With regard to our balance sheet at quarter end, the notable elements are largely the following. With another strong quarter achieved by our team, particularly investing $198 million in 74 properties, our total gross assets stood at $2.8 billion at quarter end. Our unrestricted cash totaled nearly $43 million with an additional $2 million in restricted cash available for deployment into new investments. This cash balance was slightly elevated in support of our robust investment pipeline. The increase in our long-term debt is as of quarter end on a gross basis was essentially the result of the $120 million we drew on our credit facility to fund our first quarter of 2021 investment activity.

From an equity perspective, we generated $65 million of gross proceeds from our ATM during the quarter selling approximately 2.8 million shares at an attractive weighted average price of $23.22 per share. As Pete referenced, subsequent to the quarter end, we executed an upsized overnight equity offering generating total gross proceeds of $193 million at a price of $23.50 per share before the underwriter's discount. Our total liquidity at quarter end stood at $307 million. As we pointed out in our release on a pro forma basis, the overnight offering moved our leverage to 4.1x net debt to annualize adjusted EBITDAre and our liquidity increased to $492 million. We appreciated the support from both new and existing investors as we now have ample runway to continue to pursue our strong pipeline of potential investments.

With the net proceeds of the offering, we paid down the outstanding balance on the credit facility. As we've noted in our past quarters, our current $492 million of total liquidity does not include the $200 million accordion feature that we could access on our credit facility and an additional $70 million of borrowing capacity available through an accordion feature that we have on our term loan due in 2026. We continue to hold the view that our low levered balance sheet and significant liquidity is a strategic advantage for us and provides not just a platform for growth, but a position of stability to weather a challenging macroeconomic environment, such as we've seen during the height of the pandemic and these intervening quarters.

With that, I'll turn it back over to Pete.

Great. Thanks, Gregg and Mark. With that operator, please open the call for questions.

(Operator Instructions) Our first question comes from the line of Sam Choe with Crédit Suisse.

I was just kind of looking at your investment activity and just seeing that March was especially strong. So just wanted a reminder of when investments are under like the PSAs or LOI, how long does those generally take for you to complete? And I know that a lot of it is relationship-based, and that helps with the timing standpoint, but just curious if there has been any changes since the pandemic on how expedient you can be on that front.

Yes, thanks, Sam. Generally, as we said in the past, we have about a 60- to 90-day transaction cycle, 30 days to negotiate a contract and then 30 days to perform diligence and that may vary. We've closed deals as quick as 3 weeks and we've had deals that lag for many months. Given that we're predominantly sale leasebacks, a lot of our deals are driven by an underlying M&A transaction, that often becomes the gating item for closing where another operator is buying a competitor and doing diligence and that business deal drives the timing. But generally, you should assume we have about a 60- to 90-day cycle on our pipeline.

Got it. And are you able to disclose how much investments are under the PSA, LOI subsequent to the quarter?

Generally, we don't. In the context of our overnight offering that we did in April, we disclosed our forward pipeline in the context of that offering, which was about $250 million. And so I guess my broad commentary would be we have a full pipeline and we're working hard to close the quality opportunities that we see and drive investments.

Our next question comes from the line of Sheila McGrath with Evercore ISI.

Pete, in the supplemental, on the leasing page, the retail line item looks to have some lease restructurings with a lower recovery rate. I was just wondering if you could give us a little bit of detail on that.

Yes, sure. The -- I would first start off by saying we generally don't have a lot of generic retail and certainly the numbers in that had [1.1 million to 5 69] would support that. What you're seeing there is largely the impact of some of our [van] restructuring leases.

Okay. Great. And then I think, Gregg -- go ahead.

Just tie that together. If you go back to Mark's commentary on the impairment that we had during the quarter, it was related to a furniture property.

Okay. And then Gregg I think mentioned that in the pipeline, there's more entertainment assets, but you're not focusing on cinemas. So what would that -- what kind of tenants would that include? And are cap rates any higher on entertainment assets now since the pandemic?

Yes. So I think what Gregg said is we're seeing some in our pipeline and we're open to investing in both entertainment assets as well as casual dining, as those sectors have rebounded and certainly selectively. That can -- includes family entertainment center, bowling alleys. We also have some trampoline parks and other miscellaneous type uses in that, keeping -- really keeping disciplined to having our granular and fungible properties. So it wouldn't encompass some special use assets. And generally, those -- that industry is going to be at the wider end of our cap rate range. But for the high quality operators and fungible assets we're looking at, it's not going to be super wide to our average. And so I would think that, that sector would be in the low 7 range, Sheila.

Our next question comes from the line of Nate Crossett with Berenberg.

So maybe just to follow up on Sheila's question a bit. So the pipeline that's in place now, the pricing that you're kind of anticipating to [act] on, you're saying is in the low 7s, is that correct? And then just maybe your comments on competition and pricing overall, the last 3 months as we've seen kind of rates back up.

Yes, I would say you should certainly expect to see us continue transact in that low 7 range. And the current pipeline is supportive of that. We've seen kind of in the first half of the year here increased competition. As you know competitors have restarted their investment activities and new competitors have come to the space, and that competition has not really abated as a result of rates sort of spiking up. But we think we have a great set of relationships and people choose to transact with us and we certainly have a full pipeline, and you should, despite that count competition, expect to continue to see us invest in that kind of low 7 range.

Okay. That's helpful. And then just one on the funding side, I think you have one investment grade with Fitch and I think last quarter, you mentioned you may pursue another this year. And so I'm just curious where that stands.

Yes. If there were an update on that, we would have provided it. We're in dialogue with the agencies. And when we get somewhere, we'll let you know, but that's an ongoing discussion that we're having.

Okay. I mean is it a material difference if you were to price, I don't know, if say 10-year money today if you had 2 investment grades versus what you have right now?

It can give you more granularity on it, but it certainly depends on which market you're pricing into. And I think the more validation of your credit that you have, the more expansive the universe of investors that you can approach. But I think given where the markets are today and what we're hearing is that there wouldn't be a material difference. And I would say, Nate, that with the recent equity raise and paying down our revolver and sitting on cash, we're not in a position where we need any debt capital, but certainly preparing ourselves for the time when we do.

(Operator Instructions) Our next question comes from the line of Haendel St. Juste with Mizuho.

So I guess starting first on the auto service tenant issue in first quarter that drove the occupancy dip, it seems like there was some prior concerns. I think the tenant was already on cash-based accounting. So what changed in the first quarter? And is there any reason for us to be concerned about this subsector at all, given this tenant issue? Or is this more of a one-off in your perspective?

Yes, listen, I would say it shouldn't certainly give you any concern. The automotive service sector is doing fine and is one of the least impacted industries that we invest in from a COVID-related perspective. The occupancy dip is really not terribly material at all. If you think, we're not certainly not going to get defensive about occupancy over 99% and we gave some commentary on the call where we've worked through those assets.

I would say, broadly, given the COVID backdrop and we gave tenants more leeway than we normally would, really gave them the benefit of the doubt. And as the pandemic played out and impacted their business and really trying to discern whether the operator was impacted truly from the pandemic or was just a bad operator. And so it took us a little long longer to come to the conclusion this guy was just a bad operator and we needed to put better operators in place. And that's what we decided to do.

Got it. Got it. And can you talk a bit more about maybe the time line for reletting those 7 assets and how we should think about the new rents versus old and recoveries you're underwriting?

Yes, separate from this specific tenant, generally, the mandate to our asset management team is find the market for the asset and then finding the market means running an organized, processed and disciplined process to find whether it's a replacement tenant or it's a sale to find the market, right? And that process should not be any longer than 90 days, really, an orderly marketing and negotiation and the closing. You may have deals fall out, which prolong that, but it shouldn't go on for 6 months. And to the extent that we have a vacant asset longer than 6 months is because we're just not meeting the market. And so that would be my expectation around timing. And we provide, in my view, a really good disclosure on our relet history. And as we said on the call, we would expect the outcome on this specific situation to be consistent with our past experience.

Okay. Fair enough. Any tenants begin paying rent in first quarter? Or did you recognize any prior period rents? And what are you thinking here about the prospects for how some of the tenants on cash-based accounting as well as the potential for reversing and potentially recognizing some of the accruals?

There's a lot going in that question, Haendel. We repositioned a lot of tenants throughout the fourth and into the first, a lot of assets that'll come back online. And so there's a lot of puts and takes in our revenue and our tenant base. And I would say all of those puts and takes are baked into our guidance. And generally, we're feeling good about our tenants and what they're paying us. But Dan, you or Mark add anything to that?

Yes. I think what I'd add is, on the deferral front, we had set along on the deferrals really burned off the year. Payback was anywhere from 12 to 18 months. So we're probably 35% of our way into the deferral payments and we're collecting basically, substantially all of them. So we're in pretty good shape on the deferral front in terms of getting paid, what we agreed to defer.

Okay. On the nonaccrual...

Yes. I mean, Haendel, I think you should expect the nonaccrual bucket to continue to increase in terms of their collections throughout the year. And then in terms of the nonrecognized deferrals, which we did not recognize in revenues, there's opportunity for that to come into the earning stream, but that wouldn't be later until 2022 or beyond.

Yes. Whenever they pay us either the cash or we somehow catch up, which would probably -- be mostly when they've caught up.

Got you. No, I appreciate this and I'll probably follow up with you guys offline to get a bit more color.

Our next question comes from the line of John Masato (sic) [Massocca] with Ladenburg Thalmann.

As you start looking at investments in the entertainment sector, in particular, has there been any change to how you are structuring leases with potential new tenants kind of post pandemic. Just thinking insurance requirements, deposits, any kind of force majeure language, et cetera.

I mean not really. Listen, we have a very durable lease. Generally, we're doing a lot of repeat business. So in fact, some of the tenants in that sector that we're dealing with, the lease is already in place, and we're just adding new properties to it. And we have not, more broadly, seen change in terms of our leases as a result of the pandemic. I think both investors and operators recognize that this is a sort of hopefully once in a lifetime sort of event and shouldn't change the nature of an underlying 20- to 40-year agreement.

Okay. And then the other side of the -- things are of coming back on the investment radar. How are you thinking about underwriting in the casual dining space? Is it tough to get a feel for this segment, given maybe balancing some of the reopening euphoria versus some of the headwinds that existed prepandemic and maybe some operating pricing pressures? Just how are you kind of thinking about investing in that segment holistically?

Yes. I think as we typically do through sale leasebacks, we're looking at 3 or 4 years of operating history and performance and understanding how that site has performed both in a stabilized and challenged environment, how that site has recovered. We're certainly digging into P&Ls and understanding the sources of revenue, both on-premises, off-premises and the like. And then also kind of back testing the real estate value and understanding the rent per square foot we're charging and our basis. And so I guess on a broad basis, our discipline in terms of underwriting assets really hasn't changed. We certainly have more data to look at, but making sure we're getting in at the right basis and buying units that are healthy and stabilized is what we're looking to do.

Our next question comes from the line of Chris Lucas with Capital One Securities.

Just a quick one on the early childhood education line of business. Just kind of curious as to how that business performed over the last several quarters. And then curious as to whether you guys have any thoughts in terms of what the President's proposal on pre-K funding may do either as a tailwind or a headwind to that business.

Yes, so the early childhood education space was severely impacted by the COVID pandemic as we disclosed, and our collections in that sector, kind of lagged in terms of recovery as we've also disclosed. But as we sit today, those guys are open and operating and paying and operating profitably. With occupancy, I think occupancies were shut in the second quarter, rebounded to maybe 40% to 60% in the third quarter, and call it 60% to 80%, almost full occupancy here in the fourth and into the first. So those guys are doing well and open and operating.

In terms of the government initiative for subsidized early childhood education, most of our operators are for-profit and not really businesses that are driven or majorly supported by subsidies. But more globally to the extent that there's more demand for childcare and -- I think it would only be a benefit for operators and the ability to fill up the real estate that they own -- that we own and they operate. So we think it would be a plus. But clearly, I don't think we need it or our operators need it. I think it'd be a nice tailwind.

Thank you. That does conclude today's question and answer session. I'd like to turn the floor back over to management for closing comments.

Great. Well, thank you all very much. We look forward to engaging with you guys over the next several weeks as we have a couple of non-deal roadshows coming up and we're excited to continue to execute here in the second quarter. Thank you all.

This concludes today's teleconference. You may disconnect your lines now. Thank you for your participation and have a wonderful day.