NNN REIT Inc (NNN) 2010 Q3 法說會逐字稿

Greetings and welcome to the National Retail Properties third quarter 2010 earnings call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions). As a reminder, this call is being recorded.

It is now my pleasure to introduce your host, Craig Macnab, Chief Executive Officer for National Retail Properties. Thank you. Mr. Macnab, you may begin.

Thank you, Melissa, and good morning, and welcome to our third quarter 2010 earnings release call. On this call with me is Kevin Habicht, our Chief Financial Officer, who will review details of our quarterly financial results, plus provide more details about our 2011 guidance, following my brief opening comments. In the third quarter, we acquired 25 properties, investing $88.8 million at an initial cap rate of 9.47%. We were, of course, pleased to deploy the cash that had been sitting idle on our balance sheet.

These properties were acquired from nine different retailers, of which four of them were existing tenants of NNN. We're delighted to add five new retailers to our already fully diversified portfolio, but perhaps more importantly, it is our hope, and, frankly, my expectation that we will do more business with each of these ten nantds in the next 18 months. Thus far this year, we have remained true to our discipline of being selective in our acquisition process. As you would anticipate, we have taken a close look at the portfolio transactions that have been completed in the net-lease retail category. However, our pricing discipline has meant that we have been regularly outbid in any auctions. As a result our acquisition team continues to focus on smaller, off-market deals, where we have been able to obtain excellent initial yields, and in these off-market transactions, we're not encountering a feeding frenzy. We remain very comfortable with our guidance of acquiring $170 million of properties in 2010 and our initial yields will be above 9% for the calendar year.

Next year, we do expect cap rates to be lower than which we have achieved this year. There is plenty of capital-seeking yield, and the low interest rate environment is an influencing factor. I would expect that our initial cap rates next year will end up around 8.5%. Even at this reduced cap rate, there's still a widespread over our cost of capital. By the way, the initial yields that we are obtaining compares very favorably to cap rates that other REITs are acquiring real estate at.

In terms of volume for 2011, we're planning right now on $150 million of acquisitions, which, like this year, we expect to be back-end loaded. As you are aware, the $150 million is obviously only an estimate, and it is less than what we will acquire this year, and considerably less than our historical transaction volume. As Kevin will discuss in a moment, our balance sheet and liquidity are both very strong. Such that, if we identify additional acquisition opportunities in 2011, we'll be in good shape to execute on them.

As of the end of the third quarter, our portfolio is 97.1% leased, which we're very pleased with. To give you a flavor for what happens with expiring leases in a long-lease duration portfolio like ours, this year, we have renewed 27 out of 29 leases that were coming to the end of their lease term at almost 104% of the expiring rent. For your information, next year we only have 21 leases that will mature.

We currently own 1,037 investment properties, located throughout the United States, leased to about 250 different tenants, so our portfolio is more than fully diversified. One more data point that I think is not fully understood about our portfolio is the granularity and marketability of the portfolio, with each of our investment properties only averaging approximately $2.53 million per asset. This size is right in the sweet spot of what individual investors want to acquire if we choose to sell these assets. Kevin?

Thank you, Craig. Let me start with the usual cautionary statements. We will make certain statements that may be considered to be forward-looking statements under federal Securities law. The actual future results may differ significantly from the matters discussed in these forward looking statements and we may not release revisions to these 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 this morning's press release.

Quick summary to start with. First we did report third quarter FFO per share of $0.36 that was flat with prior-quarter results, we reported AFFO of $0.39 per share for the third quarter, as Craig indicated acquisition activity accelerated in the third quarter to $89 million at attractive cap rates bringing year to date acquisitions to $127 million. Our occupancy is holding up well, the balance sheet is in great shape, which positions us well to capture those additional opportunities.

The 2010 FFO per share guidance, excluding impairments was not changed from prior guidance of $1.42 to $1.47 per share and that translates to AFFO per share of $1.56 to $1.61. We did introduce 2011 FFO guidance of $1.47 to $1.52 per share, and that translates in to AFFO of $1.62 to $1.67 per share and represents about a 4% increase.

With that let me get to just a few details. As I mentioned third quarter FFO results were $0.36 per share, many of these income statement line items were very consistent, and with prior results as well as consistent with expectations, so I won't go through them in much detail. Property expenses net of tenant reimbursements fell slightly from the prior year and prior quarter results.

G&A expense increased about $1 million in the quarter and $1.3 million for the nine months, largely due to timing of incentive compensation accrual amounts. For the nine months FFO results totaled $1.02 per share for the nine-month period, that compares with $1.17 per share for the same period in 2009.

As we have noted in the past, 2010's comparisons with 2009 lacked the same level of transactional income, which obviously dampens results but produces higher-quality earnings streams. Specifically in the first nine months of 2009, we had $10.4 million of lease-termination fees and debt buyback gains that we did not replicate in 2010. In addition, we had a 4.3% higher share count, so the FFO from core operations, and AFFO in the first nine months was fairly flat with prior-year amount. Bottom line is the core fundamentals and the performance of the income statement and the portfolio are relatively steady. Occupancy at September 30th was 97.1%, which is down 20 basis points, but up 70 basis points from the beginning of 2010. Obviously acquisitions made in the second half of 2010 will support better results than 2011.

With that, let me talk a little bit about the 2011 guidance we put in this morning's release. We introduced 2011 FFO guidance of $1.47 to $1.52 per share. The primary assumptions in our guidance more notable ones being $150 million of acquisitions skewed to the second half of the year. G&A expense of $26 million, no real change in occupancy. $2.6 million of mortgage residual interest, which is about $900,000 lower than 2010 as those loans just continue to amortize off as scheduled. We are not estimating -- projecting any lease-termination fees in 2011 versus $1.2 million in 2010, and the $7.8 million we had in 2009, and lastly, 3.9% increase in the outstanding share count, partly through issuances in our DRIP plan. $0.15 of non-cash adjustments bring estimated 2011 AFFO results to $1.62 to $1.67 per share with the larger AFFO adjustments being the non-cash interest expense on our convertible debt, which is about $0.07, as well as non-cash stock-based compensation expense which is about $0.07 per share.

With that quick note on our balance sheet, it remains in very good shape with the next material debt maturity being $138.7 million of convertible notes due in September of 2011. We have $463 million of availability on our bank credit facility at quarter end. We continue to maintain very strong credit metrics in access to capital level that will allow us to handle the macroeconomic weakness as well as take advantage of the attractive acquisition opportunities that arise. 98% of our properties are unencumbered.

Looking at the metrics, total debt to total assets on a gross book basis is 37.7%. It's up 70 basis points from the prior quarter, and 90 basis points from a year ago. As of quarter end, debt to trailing 12-month EBITDA was right at 5.0, which was fairly flat with prior quarter levels. Interest coverage was 3.2 times for the third quarter as well as the nine months of 2010. Fixed charge coverage was 2.9 times for the third quarter, and the nine months of 2010 as well.

So we're very pleased with how the Company is positioned. We believe we're well situated to see improved results in 2011, and the opportunity to make additional accretive acquisitions. With that I think we'll open it up to any questions.

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Our first question is from Michael Bilerman with Citi Group. Please proceed with your question.

Good morning, guys, it's Greg Schwartzer here.

Hi, Greg.

Could the 8.5 cap rate you are expecting next year is that similar to the type of tenants that you acquired this year?

Similar to what, Greg?

Similar to the type of deals --

Absolutely.

Yeah.

Just straight down the middle, good national retailers. Obviously our third quarter yields were very, very good, just as a reminder, several of those transactions were cut earlier in the year, and we managed to keep the yields at those levels. Clearly, there's a whole lot of capital around right now. Interest rates are very low, and -- so cap rates are definitely lower, and I think you are seeing it in your coverage.

Okay. And then could you have provide a bit more detail on the bigger portfolio deals that you have seen out there, and subsequently walked away from. What sort of industry and tenants have been on offer?

Wow. You know, Greg, we're always looking at variety of deals. All of the big deals come to us and our primary competitors in this space at different points in time we all see them differently, and I'm sure we will acquire some of these where others might pause on them, but, you know, right now, I always applaud people that have had success in acquiring portfolios and building their businesses, and God bless them.

Okay. Great. Thank you.

Thank you. Our next question is from Tayo Okusanya with Jefferies & Company. Please proceed with your question.

Yes, good morning, gentlemen. Quick question, the $88 million of acquisition that was done in third quarter, could you give us a sense of around what time that was done in the quarter, just so we can get a sense of how much earnings is backed out in the quarter, how much could flow over in to fourth quarter?

Yeah, precisely. But the weighted average would have a September date attached it to, meaning it would be in the third month of the quarter, so late.

Very late. Okay. That's helpful. And then the 2011 guidance, weighted to the back half of 2011, just kind of curious what the logic of that would be, just given, one, your acquisition volumes (inaudible) pipeline and three, your competitor is also seeing a very strong acquisition pipeline right now.

Well, I think Tayo, it's a fair question, and right now there are a couple of deals in the market, and the sellers, the retailers are -- many of them are looking to close these before the end of this year, you know, with this clarity on taxes particularly if there are individuals involved, or companies involved. So there is some decent acquisition activity this year from our perspective on sort of the smaller, one-off transactions which we have had some success in. If anything we're -- it appears that some of the volume, which might otherwise take place in the first quarter of 2011 is being pushed in to calendar 2010.

Okay.

So with that being the case, we have been cautious in our projections. You know, I think just as a reminder, and I know you are aware of this, Tayo, but for everybody else on the call, the timing of when you take those acquisitions is so important. If you -- the acquisition activity which -- we're having right here, you know, in September quarter and then frankly in this fourth quarter which again is occurring at the end of the quarter, it does not move the needle in this current calendar year. So if we can accelerate the timing of some of our acquisitions or alternatively increase the volume in the first laugh of the year in 2011, it will have a nice impact, but we are no providing that guidance.

Uh-huh.

Quite frankly we're not looking at it either.

Uh-huh. That's helpful. Could you give us a sense of the overall ranked coverage ratio of the portfolio at this point, and generally what you are seeing with tenants in some of the stronger retail categories versus some of the softer ones?

Yeah, I mean, if you look at our largest top tenants, the range right now on the rent coverage is -- you know, from a 1.5 to a 5.1 with a weighted average of about 2.8 at the moment, and, you know, as we have talked in the past, you know, rent coverage is a metric. As we underwrite new investments, we don't think it's the be all , end all maybe or weighted quite as heavily as some others. Another metric that we consider is fixed-charge coverage, which not only layer in rent coverage, but add on top of that coverage of interest expense, because that really gets to whether the corporate tenant can survive. And that -- right now our weighted average on a fixed-charge coverage basis is about is 1.9. Really the tenants are performing very well, you know, across the board. We will monitor the credit, but we also understand that in this environment, transactions can take place with any given tenant that changes the credit overnight.

Okay.

And then, you know, Tayo just sort of qualitative comment, the convenience store category, which is our largest single exposure, continues to do very well. What you have seen is very strong comp-store sales numbers from our primary tenants, Pantry, Sussa, Sussa has pre-released very good numbers. You have seen more demand in this broad category from the consolidators. In the last quarter you saw the Canadian company which operates the Circle K this country trying to buy one of the big national operators KCs unsuccessfully. 7-Eleven took a swing at them and also was unsuccessful. Convenience stores are clearly doing well. On the restaurant side, you have seen a little bit more uptick in same-store sales. They have all had a good year, because food prices have been low in the first half, so margins have been pretty good. You know, if you followed the weakening dollar and commodity prices, next year you have probably got some head winds for some of these operators, commodity prices are much higher particularly in the food side. You are seeing in this mornings Journal, cotton prices -- I think you saw it in the earnings release of a big publicly traded apparel retailer a couple of weeks ago.

Right.

But retail is stable at this point in time, and the vast majority of our tenants, I think, are doing quite well.

Right. And on the last question could you give an update on the order services business that you took over a couple of months ago.

Well the good news is the September quarter was by far the best in the year. We would expect it, by the way, to be that way. That is seasonally a strong quarter. We're in a weaker quarter right now. The business is going the way we thought. There is still some room for improvement, and we look for a little bit of that in calendar year 2011. Just as a reminder, it is a very small part of FFO per share. Frankly, I would like it to be bigger.

All right. Thank you very much.

Thank you. Our next question is from Andrew DiZio with Janney Montgomery Scott. Please proceed with your question.

Thanks. Good morning, guys.

Good morning, Andrew.

Just a question on your acquisition side. I just a couple of things you mentioned in your comments. With your expectation for cap rates to be lower in 2011 and your cost of capital, we don't know what it will be in 2011, and your cost of capital today is probably at or near an all-time low. Would you think about paying up a little bit to make acquisitions and locking in that unknown spread versus waiting until next year?

Yeah, and obviously we took a hard look at some of these opportunities, it's -- the way the arithmetic works is that the incremental contribution from acquisitions is very keenly correlated with the cap rates, so at the very high cap rates that we had in the third quarter and what we're going to end up with this year, the arithmetic suggests we don't need quite the same amount of volume to move the needle the same amount. But, you know, at -- different transactions are more appealing and we're going to take a look at all of them. As you pointed out, we did not participate earlier this year in some of the bigger portfolio transactions.

Okay. Thanks, Craig. And then just my other question is on the dividend. When I look at your pro -- or your guided to AFFO for next year, and where your dividend currently, it looks like it works out to a low 90% payout ratio. Where do you want that payout ratio to be and where would it need to be for us to look for more substantial dividend increases?

Well, we need to make some progress in growing FFO per share, and on the dividend we're very proud of 21 consecutive years of growing it, and it's important that we grow it, and frankly the amount that we grew it this year, just allows that statistic to expand. It doesn't really move the needle, so as we grow FFO per share, we're going to have an opportunity to raise the dividend by larger amounts, and at this point, you know, we haven't discussed it in detail with our Board or are planning for 2011, so sorry for the vague answer.

So you don't really have a targeted payout ratio I guess is my question.

Not for this call.

Okay. Thank you. That's all for me.

Thank you. Our next question comes from Josh Barber with Stifel Nicolaus. Please proceed with your question.

Hi, good morning. I wanted to ask how presumptive you guys wanted to be in financing given where bond rates are today? Would you consider doing a larger bond offering to basically lock in your cost of capital today in advance of some acquisitions next year?

Yeah, that's clearly on our minds. There's a couple of ways of doing that, and frankly, we anticipate in 2011, that we'll have a little bit of headwind potentially from that grabbing capital earlier than may be exactly needed, but obviously, you can, pursue a capital transaction to raise debt sooner rather than later, and/or you can do some hedging that accomplishes a good chunk of that same effect. So we definitely are looking at that as an opportunity. It's not lost on us that the attractiveness of capital pricing right now.

Uh-huh. Okay. So we could actually assume some of that is in your guidance for next year.

There's some of that, yeah.

In light of some of your comments about how active individual market -- active on one-off transactions?

The one-off pricing, just like my comments about cap rates next year, it's got awfully thin. The risk premium seems to have reloaded very rapidly, and in the one-off market, cap rates are very low. Just to give you a sort of data point on that, flat lease Walgreen's are closing today in the 7.3% type range, depending on where it is located. That compares with earlier this year, we bought a couple of Walgreen's, almost 200 basis points higher than that.

Would you look to actually sell off some of your properties and take advantage of those cap rates today?

If our acquisition volume picks up, we'll have a nice opportunity to do some capital recycling, but we need to have that use of the capital right now.

Okay. One last question. There r there any other --

I think just to your point, Josh. One of the features which gets to my comments in the prepared remarks, they think not enough investors fully understand about the virtues of the net-lease retail category, which is we own lots and lots of small properties that are very marketable assets if we choose to sell them at cap rates that are frankly really low.

No, I think that was exactly what I was trying to get at, which is if you have the opportunity to do that, it would seem like it would be a good time to be doing things like to now, and taking advantage of some of those --

I think it's going to continue in to next year.

Okay. One last question in regard to tenant categories is there anything on your wash list or emerging wash list beside the usual book and video stores?

I -- you know, I don't really think so, but it's certainly on your mind, I know because we (inaudible) directly. But the book category is some risk. We own five Borders. Generally I think they are well located properties. Borders is a big question mark. So that's the one that's sort of on my mind.

Great. Thank you very much.

Thank you. (Operator instructions). Our next question is from Rich Moore with RBC Capital Markets. Please proceed with your question.

Hello, guys, good morning.

Good morning.

Question for you, again, on acquisitions for next year. I certainly had a higher number to be honest with you for what we were anticipating for next year, and what I'm hearing from you is it sounds like there's really nothing in the pipeline at the moment, so anything in the first quarter would be pretty unlikely; is that pretty accurate?

You know, right now we're -- got burned in the first half of this year. Our acquisition activity was very limited, and we know how quickly that gets down to the bottom line in terms of FFO per share. If we can acquire them and they are good real estate tenants that we feel comfortable with, I promise you, we'll be pulling that trigger.

Okay. Okay. And you mentioned you will do some this quarter, but as far as that 150 number that you came up with, what are you thinking is going to happen, Craig, in terms of the economy? It seems to me there is going to be a lot of opportunities out there, and that number should be higher.

I think there's a lot of opportunity to do big volume at very low cap rates. That is not our business model. Our business model is to get premium cap rates for good properties that have appropriate risk-adjusted return, and chasing deals to put numbers on the board is not part of our MO.

Okay. And so, again, for the first half, then, you would -- you were saying, I think, that the second half is where you would weight the 150, so the first half you would consider that to be, I take it, fairly light?

Yes, sir.

Very good. All right. Great. Thank you.

Thank you. Our next question is from RJ Milligan with Raymond James Financial. Please go ahead.

Good morning, guys.

Good morning, RJ.

Craig, on a broader sale, given the proposed lease accounting changes going forward for 2011, how is that going to affect the sale-lease back properties, and the potential to acquire those types of assets?

RJ right now I am not that worried about it. We have talked to a number of retailers, and I believe that share that view, that's it's not really a factor. Just to help you think about it, the only people that it will have a fair amount of impact on is a retailer that is very small that is very quickly expanding. The reason I say that is take a company like Walgreen's or Home Depot, or Target or Sussa. They already have a very big number of leased properties that are going to have balance sheet impacts for them. So given that growth rate is a much smaller percentage of the existing properties, the incremental accounting impact is not going to be that big, and I don't believe these types tenants make decisions based on the powers that be in Washington that define these accounting rules.

At the end of the day, I think cash economics will still drive the equation, and unfortunately, as we all do make adjustment to GAAP accounting financial statements to arrive at the metrics we deem to be relevant. So I think the tenants will be in that position. I think the rating agencies, at least the early indications are, they are not particularly worried about this, because they really already thought about this anyway.

And then RJ, you know, just to complete my answer, given that the proposed regulation, which, if all goes according to plan, will become effective in 2013, takes in to account, existing leases if the regulation was only going to apply to new leases, then I would have a different level of concern.

Okay. Great. Thanks, guys.

Thank you. Mr. Macnab there are no further questions at this time. I would like to turn the floor back over to you for closing comments.

Melissa, thanks very much. We appreciate all of you listening. We're going to see and visit with a number of you in two weeks at NAREIT, and we wish you all a very happy holiday season, and look forward to seeing you in the near future. Thanks very much.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.