Four Corners Property Trust Inc (FCPT) 2022 Q2 法說會逐字稿

Hello, everybody, and welcome to the FCPT Second Quarter 2022 Financial Results Conference Call. My name is Sam, and I will be coordinating your call today. (Operator Instructions)

I'll now hand you over to your host, Gerry to begin. Gerry, please go ahead.

Thank you, Sam. During the course of this call, we will make forward-looking statements, which are based on beliefs and assumptions made by us. Our actual results will be affected by known and unknown factors, including uncertainty related to the remaining scope, severity and duration of the COVID-19 pandemic that will be under control or ability to predict. Our assumptions are not a guarantee of future performance, and some will prove to be incorrect. For a more detailed description of potential risks, please refer to our SEC filings, which can be found at fcpt.com.

All the information presented on this call is current as of today, July 27, 2022. In addition, reconciliation to non-GAAP financial measures presented on this call, such as FFO and AFFO, can be found in the company's supplemental report also available on the website. And with that, I'll turn the call over to Bill.

Thank you, Gerry. Good morning. Thank you for joining us to discuss our second quarter results. I am going to make some introductory remarks. Patrick will review some details around acquisition and the pipeline, and then Gerry will discuss the financial results. The existing portfolio continues to perform exceptionally well with collections at 99.9% for the quarter and our occupancy remaining at 99.9%.

We reported second quarter AFFO of $0.41 per share, which represents an 8% increase year-over-year. We grew cash rental revenues over 12.5% on a year-over-year basis, including the benefit of rental increases and $274 million of acquisitions over the trailing 12 months.

This included the acquisition of 26 properties in the second quarter for $54 million at an initial cash yield of 6.4%, reflecting rent credit to closing and near-term rent increases or 6.1% of rents in place as of June 30.

100% of the acquired properties are corporate operated, and we remain highly confident we are aligning our portfolio with best-in-class operators at attractive rent levels. We built the portfolio since inception to be conservative and not stretch on credit underwriting. We believe we are well positioned even in this challenging macro environment to continue to execute on our strategy.

Patrick will discuss the investment environment in more detail, but we are seeing a structural change. Pricing has started to improve in response to higher cost of capital and more accounting sellers, which lead to a busy second half of the year. In the quarter, we also sold 3 properties for a combined sales price of $12.8 million, representing a 4.7% weighted average cash cap rate. The strong demand for our properties provides us an alternative source of capital and validation of our portfolio quality.

Moving on to our tenants' performance. Restaurant operators continue to have strong results in the most recent quarter. Quick service restaurants are operating at approximately 115% and casual dining is operating in line with 2019 weekly sales levels according to Baird's most recent weekly restaurant survey reported on July 18. Of course, all of our operators are experiencing the effects of inflation on food, labor and other input costs, which is pressuring margins.

Interesting, inflation in grocery and at-home food prices has outpaced inflation in restaurant for the past 9 months. We've added a slide from Baird Research to this quarter's investor presentation to highlight this trend. Baird estimates inflation in grocery stores of 11.6% in Q2 compared to 7.4% in restaurant.

Consumer behavior is difficult to predict, but generally, a faster rise in grocery prices should provide restaurant operators flexibility to increase prices as well. We note that June's 1% increase in consumer spend at restaurants, marks the fifth consecutive month of increased restaurant spending.

Turning to the balance sheet. We have raised over $186 million of capital year-to-date to support our investment program. This included the closing of a $125 million private note that funded in March but was priced last December at a 3.1% coupon and $61 million of equity via forward sale agreements. We settled $4.6 million of this forward in the second quarter and expect to settle the remaining $56 million over the next period of time to fund acquisitions.

Additionally, the $13 million of dispositions helped fund our pipeline in the quarter at accretive rates. Finally, a few important comments on the team. Over the last 3 months, we have hired 2 additional investment analysts to the acquisition team, a new associate General Counsel, an HR manager and an operations director and have added new roles in property management. Along with additional investments we are making in our financial and property systems that improve automation and efficiency, this staffing sets us up well to support continued portfolio growth. With that, I'll turn it over to Pat.

Thanks, Bill. I'd like to start by discussing the cap rate environment. and our acquisition mix for Q2. We spoke on the last call in April about the tightening cap risk we observed in 2021 and how that trend had helped steady in the first 4 months of '22. We also stated that we are seeing the initial signs of that momentum slowing and our expectation that cap rates would moderate as borrowing costs rise.

Over the past 3 months, we've witnessed upward movement in cap rates. We're seeing transactions come back to us where other potential buyers cannot secure accretive debt financing and the decrease in competition is allowing us to increase our pipeline for the coming quarters while also being more selective in our asset screening.

We're very pleased with the state of our pipeline, and in particular, how the opportunities that has grown for us over the past month. FCPT maintained price discipline over the past several years and avoided any real cap rate compression in the assets we acquired. As a result, our investment spreads continue to be positive. We will continue to exercise price discipline with what we introduced to the pipeline.

We've also seen increased engagement from mall and shopping center owners on outparcels transactions. A great example of this is the 11-property $33 million outparcel transaction that we announced in June with PREIT. The portfolio includes 8 restaurant properties. We also announced the 7 property outparcel portfolio in Texas earlier this month for $17 million, which includes 6 restaurant properties. We expect the [$15] million of combined outparcels will close mainly in the third quarter, and we are actively engaging other parties to continue building out the outparcel pipeline.

For the quarter, auto service accounted for 63% of our investments, medical retail for 23% and the remaining 13% consisted of casual dining and well-located investment-grade bank branches.

Turning to our pipeline for the rest of the year. We built out a stable of properties with high-quality tenants and well-located retail quarters. The pipeline sector and expo restaurants, auto service and medical will shift to green line with past years in the second quarter as deal timing led to a higher number of auto service transactions closing in Q2. On the disposition front, as Bill mentioned, we completed the sale of 3 properties in the quarter.

These were comprised of the Bob Evans and an Olive Garden, both at 4.5% cap rates as well as a franchisee operated outback at a 5% cap rate. Each of these store sales volumes underperformed the brand average and so removing them from the portfolio at such attractive pricing was particularly compelling.

Just 1 final reminder. Historically, Q1 and Q2 have been lower acquisition volume quarters in the second half of the year. For example, in 2019, '20 and '21, each year's first 6 months represented approximately 31% of total closings for that year. While we don't provide acquisition guidance, if we look to the pipeline, we do expect the dynamic of higher volume in the second half of the year to continue. Now turning to Gerry for a discussion of our portfolio and financial results.

Thanks, Pat. We generated $46.8 million of cash rental income in the second quarter after excluding $1.1 million of straight-line and other noncash rental adjustments. As Bill mentioned, we reported 99.9% collections for the second quarter with no material changes to collectibility or credit reserves or any balance sheet impairments. On a run rate basis, our current annual cash base rent for leases in place as of June 30 is $181.2 million, and our weighted average 5-year annual cash rent escalator is 1.45%.

Cash G&A expense, excluding stock-based compensation for the quarter was $3.7 million, representing 7.8% of cash rental income for the quarter. For the second quarter, we estimated tenant rent coverage was maintained at 4.6x for the 75% of our tenants who report financial results, which continues to highlight how low FCPT rents are. On the capital front, as Bill mentioned, we have entered into equity forward agreements in the first half of the year totaling $61 million based on the initial average forward price of $27.28 per share.

We settled the $44.6 million in the second quarter, and we'll expect to settle the remainder in the second half of this year to fund acquisitions. Net debt to EBITDA for the quarter was 5.7x. Pro forma for settling and deploying the remaining equity forwards, we estimate our leverage is 5.6x and well within our range of 5.5 to 6 for our leverage target.

In May, we received a second investment-grade rating of Baa3 from Moody's in addition to the upgrade in Q1 from Fitch to double -- to BBB flat. This second rating allows us to decrease the credit margin on our existing term loans and our revolver by 25 basis points. This will lead to at least $1 million in annual interest expense savings on the term loan, incremental savings when we use the revolver and will benefit future private note and bond offerings.

We ended the second quarter with over $267 million of liquidity, comprising $17 million of cash and full availability on our $250 million revolver. We remain focused on maintaining a conservative balance sheet, extending and layering our debt maturities and thinking thoughtfully about our repayment obligations. Our next debt maturity of $50 million is not due until November of 2023. And with that, I'll turn it back over to Sam for investor Q&A.

(Operator Instructions)

Our first question comes from Sheila McGrath of Evercore.

Bill, I was wondering if you could help us understand the differential on cap rates on acquisitions versus the assets sold. I see the acquisition lease term was like just under 6 years and the assets sold was 12 years. Would you say that a lot of the differential in cap rate is driven by the remaining lease term?

I think, Sheila, there's some of that. But what I would say is the assets that we sold, we are relatively reactive. We don't sell many assets. We get incoming inquiries, we only accept those at very strong pricing. And then what we've been purchasing have had moderate lease terms but we score the property holistically, and they score quite well because the rents are low. In many cases, their ground leases, and they have good corporate credit.

Great. And then on the PREIT and the other outparcel transaction that you mentioned, are most of those ground leases? Or are they improvements?

Yes, they're mostly ground leases.

Okay. Great. And then I guess last question for -- sorry, go ahead.

Sheila, so much about these outparcel transactions is the low rents and the corporate operating tenants. So we look on those very favorably.

Okay. Great. And then on this one is for Gerry. On the investment-grade rating, that helps the pricing of the line of credit, I believe, and maybe the term loan. Can you provide a little bit more detail on interest savings? And did you get any benefit of that in 2Q?

Great. Thanks, Sheila. Yes, we get -- with the second rating and with the BBB flat rating from Fitch, we qualify on a pricing grid that reduced our margin on our -- all of our term loans by 25 basis points and also the revolver. We've started to benefit from that roughly the middle of the second quarter on our term loans. We didn't have any usage on our revolver in the second quarter. And so you'll see that continued benefit on the $400 million of term loans for all of the third quarter and beyond.

Our next question comes from Anthony Paolone from JPMorgan.

I guess, Patrick, you mentioned some cap rate movement in the last few months. Would you be able to put maybe some brackets or numbers and maybe by product type, kind of what the order of magnitude has been? And -- and also maybe if you think that's -- we're done or there's more to go there?

Yes, sure. I think it's hard to place an exact amount because there are so many variables as Bill was alluding to earlier. Certainly, you could be comfortable saying 15 basis points, maybe 20 basis points. But I think there's more of a dynamic of -- what this allows us to do from a quality filtering perspective and making sure that we can be even more stringent in what we're introducing to the portfolio versus just taking incremental 10 or 15 basis points.

And then on your second question, yes, we -- our view would be that there's more to come, but we're waiting what the Fed does today, what the Fed does for the rest of the year and a lot of other factors in the macro environment.

The only thing I'd add is that there's a delay between identifying our property, doing due diligence, getting it under LOI, purchase and sale agreement, further due diligence and closing very easily takes several months. So we do as -- I would reiterate exactly what Patrick said that we're seeing higher cap rates that allows us to be a little bit more selective, but it will take months for that to filter into the announced results.

Okay. And then, Bill, you mentioned or talked to this a little bit to Sheila's question, but just want to revisit the shorter lease lengths that you did this past quarter and you've done some of that in the past. Any way to give us a sense as to what you kind of get in return, like either your IRRs, where you think yields go by doing some of the shorter duration deals versus if you were to do something like 10 years or something more down the fairway like that?

Well, I think it really -- there's something you can do when you finance at the corporate level. So we're not putting property mortgages on the individual properties, which lenders are very focused on having lease duration well past there mortgage maturity. So we don't finance that way. And then what I would say is you want to be very careful that you're selecting good credits with low rents.

So the renewal probability is very high. But we've had very good success in having high renewals and in the very, very unusual circumstance where a tenant hasn't renewed. We've backfilled with other tenants, in some cases, at much higher rents. But maybe more of that -- and these are 1 or 2 properties per annum, but we've had very good results so far.

Okay. But is it the sort of thing where as opposed to doing something with 1% or 2 bump every year, you feel confident that if it works out, a 6 yield goes to a 7? Or what's kind of -- like what are you kind of playing for there?

We wouldn't look at it that way. Most of the times, the tenants do have renewal options, not always, but very often they have 5-year renewal options. So it's not -- we're not doing this to get a big jump on renewal. It's that you can find better tenants with better located real estate with low length. But with shorter lease term, the pricing is still pretty reasonable. And so you have to be confident in your ability to underwrite the renewal probability.

Got it. I understand. And then -- last question, just any desire to increase dispositions just given the execution you showed relative to the stuff you're buying?

I think you'll see -- the last couple of years, we haven't sold anything. You've seen us do a couple of sales this year, you'll see that continue through the second half of the year and the theme will be very consistent, which is pruning the portfolio, but still getting very attractive cap rates.

Our next question comes from the line of R.J. Milligan from Raymond James.

We've been hearing from some of your peers, not just in the net lease space but maybe elsewhere in retail, that their expectation is that cap rates will continue to rise to the back half of the year. So the taking a little bit slower approach at least in the very near short term on acquisitions. And I'm just curious if that's something that you guys are considering or thinking about?

Yes, it's a great question. In the history of the company, we've always tried to have as large of a pipeline as we could, but being thoughtful about the quality. Going into this year, we felt like the second half of the year would be better and offer us fatter pitches to swing at. So we were a little conservative earlier in the spring. I think, and as Pat mentioned, we've seen cap rates go up 15, 20 basis points at least.

And then in the last month or so, we have become more aggressive on acquisitions. And so we do agree that maybe the last 7 months of the year will be better than the first handful. So that dynamic is definitely the case with us. And as Pat said, it's not just pricing, it's quality of the portfolio. Are we -- how difficult it is to source and because we're well capitalized with low leverage and a favorable stock price. We do think this is the time to be a bit more aggressive and build the pipeline and the acquisition cadence into the second half of the year.

Okay. That's helpful. And then -- maybe you guys can talk about the competition out there. Four Corners obviously has a slightly different sandbox big plan given the smaller price points, more of a restaurant focus, at least on the restaurant side. And I'm just curious what you're seeing out there, given the move in interest rates, does that impact the 1031 market at all? Or what does the competition look like out there for competing for assets?

Yes, I think I would highlight. On one hand, the one-off market, individual buyers are going to their banks and finding that mortgages on the properties are significantly more expensive than 6 months ago, given what's happened in rates. So folks whose business was to buy using a local bank mortgage that's less attractive.

And then on the other hand, we had a lot of concern in the fall with new entrants from the private equity arena. Again, they use more financing. So their business is not nearly as attractive when the 10-year is at 3% and their borrowing costs are in the mid- to high 5s.

So we feel like the competitive environment is meaningfully more favorable. And I would also say the sellers going into this year had extreme confidence, right? They felt like if they didn't get exactly the price they want, they would just hold out and another buyer would come the next week, and their financing was attractive. So they were cash flowing significantly.

Now financing has rerated to a higher rate. So the incremental cash flow is lower. They've had buyers who are relying on the mortgage market walk away. So we've actually are got a number of properties that we call rebounds, where they've fallen out of contract with someone else, and we've been able to acquire them at more favorable pricing.

Our next question comes from John Massocca from Ladenburg Thalmann.

Just a couple of quick detailed questions for me. I guess, first off, our cash G&A expectations still at around the [$50] million mark for full year '22.

I'm sorry, John, I missed the first part of that question?

Sorry. Cash G&A expectations for this year? Are they still at around [$50] million?

That's correct.

Okay. And then maybe just could you provide some color on the differential between the 6.1% cap rate kind of June 30 and the 6.4% when all the kind of credits and rent escalations are factored in. I mean, don't be the exact details, but just kind of broad strokes, what's going into that 30 basis points.

Yes. We just had an unusual result this quarter. This dynamic happens all the time, but it was -- the 30 basis points was a little higher, much higher than it's been in the past. It's essentially when you buy a property, let's say, in May, and there's a 10% rent bump that happens in August.

If you use the May rent, it's a 6.1%. If you use the August rent, it's a 6.4%. And we're very often getting credited at closing for the differential. So I think, John, most folks would talk about it locally as a 6.4% cap, but we wanted to make sure we were being conservative in pointing out the difference. But it's basically very near-term rent bumps and instances where we're credited for additional rent on the closing statement.

Okay. And then maybe in terms of kind of in-place tenant credit and even as you look at the acquisition environment, are you seeing any kind of conservatism, if you will, from tenants around some of these kind of recessionary concerns? I know obviously, it doesn't seem like it from some of the public names in the portfolio today, they reported pretty strong earnings. But just anything you're seeing out there about any kind of concerns about the health of the consumer and its impact and flow through to your tenants?

Yes. We're definitely seeing it in the marketplace just not in our portfolio. I mean if you look at inflation, fuel prices obviously has impact on dollar stores. Other retailers of goods. They also have supply chain issues. Obviously, gas stations with very significantly fluctuating gas prices, and the impact that has on demand and therefore, their C-store business. We're seeing it across the board, but our portfolio seems quite immune to it, and we feel like that's going to put us in a position where from a time management standpoint, we can be very focused on acquisitions and not working out problem credits.

(Operator Instructions) Our next question comes from Wes Golladay of Baird.

I want to look at the shorter-term lease deals that you're doing. Are there a lot of tenant options with those deals?

Yes. Typically, there's multiple tenant options usually 2- to 3-, 5-year options with rent growth continuing on the option periods.

Got you. And I guess, maybe, Bill, a quick question for you. To say we are in a little bit more inflationary environment sort of like can't get to 2. It's more of a 3% plus environment. I guess how are you going to approach the business if you get more conviction that, that may be the case.

It really doesn't have as much effect on us as you might think. We don't use much debt. If our stock price hangs in there where it is, it's still quite accretive for us to buy things. And it makes it -- what we found is it makes it easier to procure acquisitions as owners of assets who finance at the property level are challenged to finance accretively.

And if you think about it, I think one of the really interesting dynamics right now is at a very high level, net lease capital competes against capital in the high-yield market. It competes against mortgage capital. It competes against equity multiples. And historically, when old economy retailers were trading to private equity firms at 15 to 18x multiples net lease is less attractive because the private equity firm will pay for your business at a very high multiple when high yield was 4%.

And it was a very attractive source of capital versus doing a net lease sale leaseback. If you could get a mortgage on your property at 3%, again, very attractive compared to doing a sale leaseback at 6.5%. So I think we are quite excited that we're going into a period where net lease capital at a very high level is much more attractive on a relative basis than it has been in the last half decade post financial crisis.

There is no further questions, so I'd like to hand the call back to Bill for any closing remarks.

Thank you, Sam. I hope you can tell that we're quite excited about the second half of the year, and we'd be more than happy to do any investor outreach. Please reach out to [Greg]. And thank you, everyone, for their time.

Thank you, everybody. This concludes today's call. Thank you for joining. You may now disconnect your lines.

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