Essential Properties Realty Trust Inc (EPRT) 2020 Q2 法說會逐字稿

Good day, and welcome to the Essential Properties Realty Trust Second Quarter 2020 Earnings Call. (Operator Instructions)

It is now my pleasure to turn the program over to Mr. Dan Donlan, you may begin.

Thank you, operator, and good morning, everyone. We appreciate you joining us today for Essential Properties Second Quarter 2020 Conference Call. Here with me today to discuss our second quarter results are Pete Mavoides, our President and CEO; Gregg Seibert, our COO; and Anthony Dobkin, our Interim CFO.

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

With that, Pete, please go ahead.

Thanks, Dan. And thank you to everyone who has joined us today for your interest in Essential Properties. The second quarter presented an extremely challenging operating environment in the wake of the COVID-19 pandemic; however, the obstacles we face paled in comparison to those of our tenants. While we worried about whether or not to grant rent deferral requests and where our collections may land at quarter end, our tenants were managing through mandatory shutdowns and stay-at-home orders. They confronted the threat of losing multi-generational businesses and the pain of laying off employees in large numbers, only to face the new challenge of quickly and profitably restarting operations without endangering themselves, their employees and their customers and those complications do not even compare to those faced by the frontline workers and emergency responders who have selflessly combatted this pandemic and all of the individuals and families, whose health had been directly affected by it. So overall, we feel fortunate to be where we are, how the portfolio has performed, and our prospects going forward.

Starting with the operating status of our properties and rent collections, as of today, approximately 93% of our portfolio as a percentage of our portfolio as percentage of ABR is open or operating, albeit some on a limited basis. This compares to just 66% back on April 15 when we first reported this statistic. We have found operating status to be the fact most correlated to a tenant's ability to meet his rent obligations, so we feel optimistic about this trend and continue to monitor closely. In terms of rent collections, we collected approximately 69% of contractual rent in the second quarter including 68% in April, 67% in May, and 72% in June. More importantly, we saw collections materially improved to 87% in July with the majority of our tenants operating without deferrals. As you can see in our disclosure, the vast majorities of our deferrals in July are concentrated in industries that continue to face closures and utilization or capacity constraints including theaters, fitness centers, and casual and family dining. The operators in these industries have proven incredibly resilient in adapting to this new operating environment and we expect collections to continue to improve in the coming months. Assuming we do not revert back to widespread shutdowns.

Moving on to rent deferrals, we deferred 29% of the contractual rent due to us in the second quarter or approximately $11.5 million. We view these modest tenanted accommodations as entirely reasonable and appropriate given the impact of the pandemic. That said, approximately $1.7 million of that deferred rent was not recognized in revenue giving our view on the probability of collection.

Turning to the portfolio, we ended the quarter with investments in 1,060 properties that were 99.6% leased to 215 tenants operating in 16 different industries. The weighted average lease term stood at 14.6 years, which is 1.1% of our ABR expiring over the next 3.5 years. A weighted average unit level coverage was 3 times at quarter end, but we would note that this coverage ratio lags are reporting by a quarter. So this, the impact from the pandemic is not flowing through our tenants financials. Ultimately, the value of our company does not reside in our leases, it resides in our properties and our ability to keep them consistently leased and we see high and stable occupancy as a key indicator of that value.

Turning to investment activity in the quarter. As discussed on our first quarter's earnings call and throughout the quarter, we intended to take a conservative investment posture, given the volatility of the pandemic caused, both in our portfolio and our cost of capital. During the quarter, we invested $42 million at a weighted average cash cap rate of 7.4% and the majority of these investments were committed to prior to the onset of the pandemic in mid-March. All of our second quarter investments were directly originated sale leasebacks, 68% contained master lease provisions, and 100% are required to provide us with corporate and unit level financial reporting on a regular basis.

Turning to the balance sheet. We finished the quarter with low leverage of 4.9 times net debt to Annualized Adjusted EBITDA RE and excellent liquidity of over $500 million. Looking forward, our investment team and relationships continue to drive an attractive opportunity set, but as we have indicated in the past, we would need to see stability in both our portfolio and our weighted average cost of capital prior to becoming more aggressive on the external growth front. We are very pleased with the operating collection trends demonstrated by the portfolio but one month is a small subset and unfortunately, the pandemic does not appear to be entirely controlled in many states. In terms of our weighted average cost of capital, it has continued to improve since March, as our share price has rebounded. The debt markets appear to be open and efficient and nominal interest rates have moved lower still. So we are cautiously optimistic about our ability to become more offensive on the investment front and we will closely monitor our key metrics going forward.

With that, I'd like to turn it over to Anthony, our Interim CFO, who will take you through the balance sheet and the financials for the second quarter. Anthony?

Thanks a lot, Pete. It's been a pleasure to work with you and the team over the last 5 months. As reported in our earnings press release, FFO was $0.26 per share in the quarter and Core FFO and AFFO in the second quarter were each $0.27 per share. Before going into the quarterly results and discussing the balance sheet, I would like to focus on two areas that have been topical. The first is rent deferrals and how we are accounting for them and the second is a decision to account for certain tenants on non-accrual or a cash basis. As noted on Page 15 of our supplemental, we entered into deferral agreements totaling $18.1 million. Of that $18.1 million, $11.5 million represented deferrals of second quarter rents and $6.6 million are associated with future period rents. Of the $11.5 million of second quarter rent deferrals granted, we recognized $9.8 million during the quarter. The $1.7 million variance that we did not recognize is a result of non-accrual accounting for certain tenants, which I'll get into shortly. Note that the $1.7 million equates to the 4% label -- 4% number labeled non-recognized deferred rent for Q2 on Page 15 of our supplemental.

During the quarter, we moved 15 tenants to non-accrual status. That resulted in a $4.8 million reduction to GAAP revenue during the quarter with $2.5 million being a reduction in cash revenue and $2.3 million being reduction in straight-line rent. These numbers are disclosed at the bottom of Page 3 of our supplemental. Of the aforementioned $4.8 million reduction to GAAP revenues, $2.8 million represented a write-off of receivables for prior periods and $2 million represents a reduction in revenue from the current period. Of that $2 million reduction in current quarter revenues due to cash accounting, I previously noted that $1.7 million relates to nonrecognized deferred rent, so the remainder is in the unresolved rent row on Page 15 of the supplemental. I would like to emphasize that while we believe that full rent collection from the tenants on non-accrual status is not probable, going forward the value to the company of these assets resides in the real estate and not the leases.

With that said, let's move on to the balance sheet. From a capital markets perspective during the quarter, we repaid the $65 million that was outstanding on our line of credit and ended the quarter with a zero balance. In June, we established a new $250 million ATM program and during the quarter we sold just over 1 million shares at an average price of $16 and 86 cents, generating $17.3 million of gross proceeds.

We continue to believe that our low levered balance sheet and significant liquidity position are among our greatest strengths in this uncertain environment we ended the quarter at 4.9 times net debt to adjusted annualized EBITDAre. As of June 30, we had $110 million of cash in our balance sheet and the full $400 million available under our line of credit, equating to approximately $510 million of liquidity.

Lastly, consistent with last quarter, we are not providing 2020 guidance due to general economic uncertainty.

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

Thanks, Anthony. I want to start with the impact of COVID-19 on our portfolio, which we have summarized on Page 15 and 16 of our supplemental. As of the last week in July, 80% of our portfolio ABR was open, 13% was open on a limited operating basis, and 7% was closed.

In terms of rent deferrals, we granted deferral request to 85 tenants across 299 properties, representing $18.1 million in rents. As of quarter end, we had $6.6 million of deferred rent remaining for future periods. Those remaining deferrals are concentrated in our theater, health and fitness, entertainment, and casual and family dining industries.

The average deferral period was just under 5 months with an average payback period of 14 months. Additionally, we had just 11 tenants that remained in a deferral period as of August 1 and all but one of those tenants are paying a portion of their contractual rents. Moving onto our unresolved rent, less than 1% of second quarter rent was from unresolved tenant situations.

However, this increased to 3% in July as a handful of tenants that were subject to a deferral the second quarter came off their deferral period. Approximately 65% of this bucket is related to three fitness centers that are master leased to one tenant.

We are aggressively enforcing our lease on these properties and we are confident that we will find a resolution. The remaining portion of unresolved rent is spread out across various operators in some of the most severely impacted industries.

Moving on to investments, during the second quarter, we invested $42 million into 11 and 13 properties at a weighted average cash cap of 7.4%. These investments were made within six different industries with equipment rental, quick service restaurants, and auto service, representing over 75% of our investment activity in the quarter.

The weighted average lease term of these properties was 16.7 years. The weighted average rent escalation was 1.8%. The weighted average unit level of coverage was 4.3 times and our average investment per property was $2.9 million. Consistent with our investment strategy, 100% of our second quarter investments were originated through direct sale leasebacks, which are subject to our lease form with ongoing financial reporting requirements. From an industry perspective, quick service restaurants remain our largest industry at 14.3% of ABR, followed by early childhood education at 13.5%, car (inaudible) medical dental at 11.3%, and convenience stores at 10.2%. From a tenant concentration perspective, no tenant represented more than 3.2% of our ABR at quarter-end, with our top 10 representing 23% of our ABR. In addition, we had equipment share and apparels enter our top 10 as incremental investment activity with both tenants this quarter pushed their concentrations higher.

In terms of dispositions this quarter, we sold three properties for $3.4 million net of transaction cost. Despite having 1.3 times unit level of coverage, we achieved a 6.8% weighted average cash cap rate for these assets, which equated to a 28% realized gain versus our allocated purchase rights.

With that, I will turn it back to Pete for his concluding remarks.

Thanks, Gregg. In conclusion, I would like to say that I am proud of how the team at Essential came together and managed the portfolio through this unprecedented time. I would also like to thank Anthony for agreeing to take the role of Interim CFO and more importantly, doing a tremendous job. I would like to welcome Mark Patten, who starts as our permanent CFO on Monday. He's an excellent addition to our team and I look forward to working with him as we continue to execute the business plan that we laid out during our IPO.

With that, operator, please open the call for questions.

(Operator Instructions) And we can take our first question from Christy McElroy with Citi.

This is actually Parker Decraene for Christy. My first question that I just wanted to ask is about, if there's been any change in your appetite for adding certain tenants or exposures, maybe even for some of the more riskier areas such as health and fitness or theaters or something. And do you see any market dislocation in pricing for those riskier tenants that you would feel comfortable buying?

Yes, I think in general, if you look at the trends of our industry exposures, you will see that we have been -- we have been bearish on some of those industries for a period of time and a lot of those industries of concentrations have come down over time. So certainly, we've taken the current performance of our tenants and the impacts of the pandemic and tried to incorporate that into our go-forward investment strategy. I would say we're not solely basing it upon the performance of 3, 6, or 9 months, we were taking a longer-term view and trying to understand how customers behaviors may change and how that might impact our operators in these sectors and trying to be thoughtful about how we deploy new capital.

So in terms of dislocation in the market, there is certainly dislocation and I would say we're not, as you can see by our investment activity, concentrated away from those sectors and in QSRs. Our investment stance is not to chase opportunistic deals and get outside yield, but really get good returns -- good risk-adjusted returns for investments in industries that we think will be durable for the duration of our lease term, which is 20 years plus.

Yes. Okay. And then just can you guys touch on the $4.8 million of rents that you moved just to cash, specifically providing some detail on just the exact category exposures that they're sort of in potentially.

Yes, I would say we -- the decision to move tenant to cash accounting really it goes to the collectability of those tenants and the deferred rent and really looking on a go-forward basis and I think it's safe to assume that those categories are reflective of the categories where we continue to see heightened risk that we laid out earlier in our comments, movie theaters, fitness centers, restaurants.

And we will move next to Sam Choe with Credit Suisse.

I guess this is a follow-up to the prior question. I'm just kind of wondering how you determine the categorization of the recognized deferrals versus non-recognized. I may understand the non-accrual treatment, but it just so -- I mean, you're talking about some probability of some tenants not being able to pay, just kind of walking through life, what was the commonality that led you to classify something as non-accrual versus recognized.

Yes. It's a judgment we make about the collectability of that receivable and there is accounting guidance surrounding that, but at the end of the day, it's a management judgment call about the collectability of that receivable, taking into account the tenant credit, the industry fundamentals, and just the probability that that tenant will be able to pay us the money that he owes us.

Okay. Now there also has been a lot of headlines, I guess about some -- I mean throughout the industry that, let's say like AMC, they were able to secure some rent abatements, but you guys have been pretty good at keeping that number fairly low. So I was just wondering what you guys have done to achieve that.

Ultimately, our ability to defer and not abate rent and quite frankly if you think about a non-recognized deferral, that -- it's an option that effectively we are saying is in essence abating rent, right and that we don't think we'll get it, but ultimately our leverage in the negotiation surrounding the tenants obligation to pay us rent goes to the value of our assets and our properties to that tenant and his desire to operate in those sites because they generate profit for his organization.

And we can move next to Brian Hawthorne with RBC Capital Markets.

First question is, can you talk about what drove the rent and home furnishing to drop from 1420 last quarter to 580 this quarter.

Yes, really our home furnishing exposure is largely concentrated in the properties that were formerly leased to Art Van. We released those sites to Love Furniture as we've previously disclosed during the quarter and as part of that re-led, there was a free rent period and so that's flowing through. And so those numbers aren't a run rate, they are really for the period, and so they are standing out as somewhat artificially low and we would expect those to normalize over time.

Okay. How many periods of free rent are there?

I'm not going to comment specifically on an individual tenant, but it was a reasonable accommodation recognizing that many of the sites were closed and give them the opportunity to get those sites opened and operating and it was less than a year.

Okay, sounds good. And then on the risk calc for your tenant credit levels, I just -- how does that system work, is that rule based -- I mean, like, so if you go to put those -- the updated financials in the next quarter, are they going to -- are you look at the financials in and is it not going to be able to account for the fact that a bunch of your tenants were closed during 2Q.

No, I think -- it's a program that we lease from Moody's and it's formulaic and it's not going to be pretty and you plug them in and the numbers come out.

(Operator Instructions) We will go next to John Massocca with Ladenburg Thalmann.

Digging in maybe a little bit on the portfolio, one kind of tenant industry stood out a little bit as having fairly broad openings, but decently high deferrals and kind of non-cash collection was the early childhood education center, what are you kind of hearing from your tenants there that may be driving that and potential for that to reverse here in the next couple of months.

Yes. As we kind of indicated, we thought the early childhood education was going to come back a little slower. There's really two things that are driving that, one is mandatory capacity constraints imposed across those operators that limit the number of children they can -- they can have in their buildings and then secondly, really the demand for that service giving this -- given the stay-at-home orders and if people aren't working, there is not a -- generally, a need for childcare and so we saw deferrals go into past the first quarter and recognize that some of our operators would need deferral support beyond the second quarter. I would say most of them are partial pay and they are open and operating albeit at diminished capacities, but we would expect, particularly as we get back to schools opening and people getting back to work at those sites would come back online and be full payers.

Okay. And then, maybe if you look at slide 11 in this, how much, kind of COVID or pandemic-related impact do you think is in the changes between last quarter stuff in this quarter stuff, just trying to think if it was maybe a fuller pandemic impact there already or if because it's kind of a bit of a lag in the reporting numbers, it was something more organic or something not really related to pandemic activity.

Yes, listen, John, I would say this disclosure is very much a forward indicator of risk and the pandemic and what we've seen in the short term is a much different level of risk and which is why you've seen us more focus our disclosure around COVID related disclosure, open close status and collectability status and that given the lag and financials, I would imagine not a ton of COVID related impacts are flowing through, particularly when you think this pandemic and shutdowns really set in kind of mid-March and these were likely looking at for most of our tenants, the first quarter sort of numbers, and so this disclosure is going to evolve and change as the full impacts of these shutdowns flow through our tenants results and -- but clearly it's a forward indicator of risk and we're going to have to work through that in the coming quarters.

As I kind of think about the change quarter-over-quarter, I mean was there something else driving that, maybe Art Van obviously occurring in 1Q, would it cause those numbers to shift a little bit more negatively in terms of coverage and credit versus kind of coverage.

Yes, it's all the tenants, right, and Art Van at 2% is not going to move it materially, but there's ins and outs in all of the buckets and all this gradation and it's -- there is a lot of guys moving around both up and down.

Okay, and then one last quick one. Were any tenants moved to either kind of percentage rent to replace kind of future fixed rent or percentage rent to kind of pay off any kind of deferred rents going forward.

We haven't agreed to any situation where our deferred rent is coming back to us on a percentage basis, but in a handful of situations, less than a handful, I would say, we have gone to a more percentage rent based payment for a short period of time while these guys return to normalized operations, but in those instances, the delta between the contractual rent and any rents paid to us becomes a deferred amount that's due to us in later periods.

(Operator Instructions) At this time, there are no additional questions. This does conclude our Q&A session. I'd like to turn the program back over to Pete for any closing remarks.

Great. Well, again, thank you all for joining. We appreciate your interest in Essential Properties. Clearly, it's an interesting time, we're happy to get this report behind us and look forward. So thanks again and have a great summer.

Thank you for your participation. This does conclude today's program. You may disconnect at any time.