NNN REIT Inc (NNN) 2012 Q2 法說會逐字稿

Greetings, and welcome to the National Retail Properties Second Quarter 2012 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

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

Claudia, thanks very much. Good morning and welcome to our second quarter 2012 earnings release call. On this call with me are Jay Whitehurst, our President; and Kevin Habicht, our Chief Financial Officer, who will review details of our second quarter financial results following my brief opening comments.

We are pleased to have produced another consistent and predictable quarterly results with continued improvement in our business. Importantly, we're delighted to have raised our dividend for the 23rd consecutive year, which is a milestone that places us in an elite category of just over 100 large public companies that have this multi-year record of consistently raising our dividend.

In the second quarter we acquired 27 properties, investing $115 million at a very attractive initial yield of 8.5%. Our team is continuing to identify off-market transactions as well as lightly marketed net leased retail properties for us to acquire.

The first six months of the year have been productive for NNN, as we've now invested $313 million in carefully underwritten net lease properties.

We continue to have attractive deal flow, allowing us to be selective and disciplined, and we have a couple of attractive opportunities that we are working on that we expect to acquire in the months ahead.

Consistent with last quarter's guidance, we are projecting a slightly slower second half of the year than we've experienced thus far this year, as we are choosing not to chase some of the highly marketed deals that are currently being offered for sale.

Our fully diversified portfolio continues to be very well leased, with occupancy continuing to improve, and we are now 98.2% leased.

Nationally, there has been little new retail development and our generally small, well-located retail properties are attracting solid tenant interest and are being leased up by our in-house team.

Our high portfolio occupancy is an effective scorecard on how we have done with our real estate analysis on the front end when we acquire properties. We have a terrific underwriting group that primarily focuses on real estate fundamentals when we make our initial acquisitions.

Credit is obviously important to us as well. But our track record shows that if we focus on key real estate metrics such as location, acquiring properties with market rents, and evaluating alternative uses for the space, good things happen for our shareholders over time.

Kevin will be providing more details about our noncash impairments, but let me quickly say that, like you, I am frustrated with this accounting charge, especially as we fully expect to recover the economic value that is being impaired over the years ahead.

Finally, despite the vagaries of the accounting for this investment, it is (A) small and (B) has been a very profitable, successful investment for NNN.

National Retail Properties continues to be extremely well positioned. Our access to attractively priced capital continues to be outstanding. And with our strong balance sheet, we have plenty of dry powder to deploy as we identify carefully underwritten acquisition opportunities. Kevin?

Thanks, Craig. Let me start by saying we will make certain statements that may be considered to be 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 these 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 this morning's press release.

With that out of the way, this morning we reported second quarter FFO of $0.41 per share and AFFO of $0.46 per share. The FFO results included a $2.7 million noncash impairment charge in connection with our mortgage residual valuation. Excluding this item, it brings FFO to $0.43 per share, which results in a 13.2% increase over prior-year levels.

On the same basis, first half FFO per share also increased 13.2%, from $0.76 per share to $0.86 per share. So 2012 continues to be on track to generate 8% growth in FFO per share, which is consistent with our prior guidance.

As usual, the strong results were a combination of maintaining high occupancy and making new accretive investments while keeping our balance sheet strong. Occupancy was 98.2% at quarter end -- that's up 70 basis points from the prior quarter and 130 basis points from a year ago. And as Craig mentioned, we completed $115 million of accretive acquisitions in the second quarter.

First, just a few details on second quarter results. Compared to 2011 second quarter, rental revenue increased $20.4 million, or 34.9%. That's primarily due to the significant acquisitions we made in 2011 and 2012. In-place annual base rent as of June 30, 2012, was $326 million for an annual run rate.

Property expenses net of tenant reimbursements for the second quarter totaled $1.6 million, and that's down sequentially from $1.8 million in the first quarter.

G&A expense increased to $7 million, which was a 7% increase over prior year amounts.

As I noted, we took a $2.7 million impairment charge in connection with the valuation of our small investment in commercial mortgage residuals. The valuation pushes out the timing of some expected cash flows, and when they get discounted back at 25% discount rate, it has a real impact on the net present value, which is used for the valuation.

But as a reminder, this investment came about by investing $9 million in 2005, from which we received, to date, over $38 million in cash distributions. So I have to remind myself and everyone else that we've been more than well paid for the accounting noise associated with this investment.

And lastly, I will note that we issued our Series D preferred stock this past February. When we did that, we elected to pay long first dividend at June 15 to account for the sub period from the issuance date to March 15. So during the second quarter, we paid $5,926,000 of preferred dividends, and that included $1,164,000 of above-normal quarterly dividend of $4,762,000 to account for that sub period in the first quarter, just to be clear.

But the big picture bottom line is that the core fundamentals -- occupancy, rental revenue, expenses -- are all performing well, with no real surprises or variances.

We've not changed our prior FFO guidance, which was previously set at $1.67 to $1.72 per share, and that guidance excludes impairments as well as the first quarter's preferred stock redemption charge of $3.9 million.

While acquisitions will likely exceed our prior guidance of $300 million to $350 million, it will not likely have a material impact on 2012 results, given the timing.

The only other change, which has little bottom-line impact, is that effective in May of 2012, we ceased our California retail operations and now have leased those properties. The operating income from the retail operations, which was around $2 million in 2011, is now effectively replaced with an equivalent amount of rent. While little incremental change in the bottom line, it's a notable qualitative improvement there.

Turning to the balance sheet, not a lot of activity during the quarter. On June 1, we did pay off $50 million of maturing unsecured notes that carried a 7.75% coupon.

As of quarter end, June 30, total debt to total gross book assets was 36.7%. That's fairly flat with recent quarters. Notably, debt to EBITDA was 4.7 times for the second quarter, and interest coverage was 3.5 times and fixed charge coverage was 2.9 times.

Only 11 of our properties, less than 1%, are encumbered by mortgages, and so despite having acquired just under $1.1 billion of acquisitions over the past six quarters, our balance sheet remains in very good shape and modestly less leveraged than when we began six quarters ago.

So we're very pleased with how 2012 is shaping up, and our guidance for this year results in 8% FFO per share growth, and based on what we believe are very achievable assumptions and continuing our moderate leverage capital structure. Notably, 2011's FFO grew 8% as well. So 2012's growth is not coming as a result of easy comparisons.

So we believe we're well positioned to continue to deliver the consistency of results, dividend growth, and balance sheet quality that have supported attractive absolute and relative total shareholder returns for a long number of years. And with that, Claudia, we'll open it up to any questions.

Thank you. (Operator Instructions) Joshua Barber, Stifel Nicolaus.

Good morning. Can you remind us what the orange mortgage portfolio consists of today, just given the impairments?

It is a pool of commercial mortgages that typically have personal guarantees on top of that from the owner-occupant of that particular property. When they were originally underwritten in 2001, '02, and '03, they were approximately 70% to 75% loan-to-value kind of commercial mortgage loans. They're all single-tenant business kinds of properties and the pool has performed fairly well.

It was an unusual investment for us but by virtue of an option to invest a small amount of money in 2005, we saw there was significant up side relative to the price, meaning the $9 million we paid in 2005. And so as I noted, that $9 million investment has produced $38 million in cash distributions so far.

It shows up as a line item as interest income in our revenue section on an ongoing basis over time. It will continue to drift lower as those loans amortize off, but it's been a big home run investment -- not one that we will duplicate, but has worked out very well.

And those loans are fully amortizing, correct?

Correct. But if they pre-pay, obviously then it shortens the life, which therefore shortens the value. I mean, to be clear and candid, this is residual interest. We're at the bottom of the waterfall so we understand what we've got here, but it's worked out more than well.

Okay. Can you talk a little bit more about the asset classes that you guys own today, and I guess what classes are on your watch list -- what is getting better today and what seem to be getting a little bit worse?

Josh, I think that's a good question. And as evidenced by our occupancy, which has steadily ticked up in each of the last six quarters, we're in pretty good shape. We're not exposed to some of the fashion categories, so we have almost -- I don't believe we have any apparel tenants at all in our portfolio. Most of our mix is value, necessity, small box retail.

For sure, retail is not exactly the sweet spot. I don't think too many people on this conference call are about to go home to their family and say, let's get into the retail business. But what you are seeing is a market share shift that continued to occur, and the better-managed companies are continuing to take market share.

In the restaurant space, for example -- there are clearly too many restaurants in our country. But the single units, the mom-and-pop owned restaurant operators, are slowly withering at the vine as the big, better-managed companies take advantage of supply chain efficiencies and so forth.

We're seeing exactly the same thing in the convenience store space, which obviously is a big sector for us. The better-managed companies such as Susser, which is our second-biggest tenant, is recently announcing its 23rd consecutive year of same-store sales increases. So our convenience store portfolio is doing well.

And to be honest, Josh, we don't see a lot of turmoil in our portfolio in the near term.

Great; thank you very much.

Immanuel Korchman, Citi.

Hey, good morning, guys. If you could just tell us -- the acquisitions you completed in the first quarter, kind of what the asset types were. And it looks like the average size of each location was smaller than the last couple of quarters. If you can just talk about -- or bigger, rather. Sorry.

Manny, good morning. Welcome to NNN's coverage list. I think every quarter you're going to see a little bit of mix shifts. I think in the most recent quarter, the average was skewed just a little bit. We did purchase a LA Fitness property, for example, in northern New Jersey. That was almost a $10 million asset so it slightly moves the averages.

I think in this current quarter we are looking at a couple of bigger-box type transactions, so slightly more than our normal average of around $2.5 million. But give or take, how that works quarter by quarter is sort of noise at the end of the day. We're sticking to our knitting of retail.

And then, other than that large gym there, the rest is -- obviously, you talked about what types of retail they were?

I think, Manny, if you take a look down our biggest tenants, it's across the board. I don't think we -- well, I know that we didn't purchase any convenience stores in this most recent quarter; a couple of restaurants, a couple of box retailers.

Thank you very much.

Paula Poskon, Robert W. Baird.

Thank you. Good morning, everyone.

Hey, Paula.

I have a question on margin trends. So year over year, your margin was up this quarter and it was up sequentially as well. Likewise, on G&A as a percentage of revenue, it was down a couple hundred basis points year over year.

What do you attribute that to? I mean, I know you're obviously very focused on cost controls and efficiencies, but are there particular line items where you're seeing much-improved operating leverage?

I think over time we've experienced pretty significant operating leverage. I mean, it will bounce around a little bit quarter to quarter, but if you step back and look more maybe on an annual basis, you'll see that G&A as a percent of revenues has continued to drift lower over the last few years as we've been just more efficient in terms of people as well as systems in place to leverage and handle a larger asset base and property count.

So I think -- there's nothing in particular, I guess, but something we do work on continually and we think there will continue to benefits in that arena.

All right. And then, just more housekeeping. How should we be thinking about the straight-lining of rents going forward, just it's been bouncing around a little bit?

And it will a little bit. I think in general, it will continue to -- we're on the bulk of our portfolio, reaching -- I should say, the bulk of the portfolio that has straight-line rents, which is the older portion of our property base, reaching the midpoint of the lease term on a lot of those properties.

And so you'll start to see straight-line rents starting to be a more positive number in terms of the reconciliation with AFFO, meaning we'll be collecting more cash than we're reporting in revenue. But that will, over time, start to drift in that direction. We're kind of, like I say, at the crest of the hill, if you will, of that -- midpoint in the lease term.

Okay. That's all I have; thank you very much.

Thank you, Paula.

Wes Golladay, RBC Capital Markets.

Good morning, guys. Craig, you mentioned getting aggressive in your work on case (ph) deals. Is this more for larger deals or for the typical one-off, all the one deals you guys do?

Wes, that's a fair question, and I think the answer is yes to both points. One thing that has clearly changed this year is that people -- the demand to deploy capital in a low-yield environment continues to be very high. And the risk-adjusted return attributes of net lease retail continue to attract attention. So it's a strange thing, but there is effectively a portfolio of premium out there.

Which is to say that when assets are aggregated in conjunction with a financial transaction such as a buyout or something like that, there's a lot of interest in those types of opportunities, and some of the cap rates on the deals that we are seeing are getting what we think are pretty skinny.

I think by the same token, there's continued turmoil in the financial markets -- even in the one-off space there's excellent demand for properties.

Okay. And sticking with that, I know the cap rates are coming in but you guys have cost of capital even with the equity having a nice move this quarter. Does that help you guys at all? I mean, if you've got some permanent cap financing with -- permanent capital structure preferred in equities, and would you guys be willing to move down the yield?

Wes, thanks for observing. Our spreads right now are arguably as attractive as they've ever been. And I think -- what we try to do -- 98.2% occupancy comes from doing a good job on underwriting on the front end. So it's not so much a yield question as it's a qualitative decision.

Just for example, internally we are meeting a couple of properties that in some respects, after a Google search, etc., they seem pretty attractive. Once we got into it, we said thanks very much and we will not be submitting an offer. So we're going to continue to be selective, but you're absolutely right -- the spreads, given our cost of capital, are very attractive right now.

Okay, so it's more of a combination of the spread and the actual quality you guys are seeing, then?

Yes, sir.

Okay, and last quick question. On the auto services business -- did I hear you right, you're completely out of that?

That's correct.

Okay. Thanks a lot, guys.

(Operator Instructions) Todd Stender, Wells Fargo.

Hi guys, thanks. I think this was your first foray into the medical space this quarter. Could you just speak of how you initiated this type of acquisition, and how were these stand-alone buildings located?

Todd, you are correct that we have purchased a small number of what we consider retail medical-type properties, which are properties that the consumer is visiting every day. They're freestanding net lease properties. We've spent several -- I mean, firstly, let me say it is small and at the margin.

But we have purchased a couple from a really well, well-capitalized I think category killer in the urgent care sector. We purchased some properties here in the recent quarter on top of a couple that we have already had in the portfolio. They're freestanding, well-located, quite profitable units from a well-capitalized company.

Now, they are net leased, so you don't have direct exposure. But do you have now to keep an eye on any regulatory issues as far as reimbursement, whether it's Medicare or Doc Fix or anything, from a higher level?

Todd, obviously you cover the sector and so we might have to call you to get some information. But yes, we do pay attention to it. The payment mix in this particular category is primarily private pay. What this is is just part of the continuum of care, with the emergency room being a very expensive way to deliver care and the freestanding box that this care is delivered in is a very, very efficient way to do it. So as it so happens, where the payment comes from is a little less relevant given the value proposition is quite powerful.

Sure; thanks for that. And just kind of going back to the acquisitions. With the size of them -- again, we kind of focused on this already early in the call, but what were some of those large properties? If my math is right, you're getting up into the 30,000-square-foot properties. Is that correct?

We did purchase this LA Fitness, which was the single biggest property, almost a $10 million asset. We also purchased a couple of opportunistic deals where somebody that we know well wanted to reallocate, or reposition, their portfolio and three of the properties were in the bigger-box retail area. We did not purchase those directly from the retailer, which is our normal practice. Those ones, plus that LA Fitness, were just opportunistic, and each of those was a bigger retail footprint.

How about the lease terms -- are they longer lease terms or are they on the shorter side?

They are less than 15 years but they are still not short.

Okay, thank you. And just looking at the held for sale bucket, if you can just explain what's going in there? And now the pricing still continues so robust, can you kind of consider that you might be selling more than you thought at the beginning of 2012?

We're always looking at selling properties and we do have a couple that we're offering right now. We're a very price-sensitive seller. We work this extremely hard.

Let me give you an example -- we had a well-located property in the greater Dallas metroplex. Our in-house team identified somebody who really wanted to buy this. It only had a shorter lease duration here in the second quarter. We went back to the tenants and negotiated a longer lease term and went back and sold it at $700,000 more than what the offer price previously was by extending the lease term.

So we're constantly working these and there are a couple of properties that we are offering for sale right now and they currently are under contract. They haven't closed yet, otherwise I'd be delighted to tell you about them.

Okay; thanks, guys.

R. J. Milligan, Raymond James.

Hey, good morning. The yields in the quarter were pretty high at 8.5 and I was just wondering -- has the market moved that much since you got those under contract, or was there something specific that enables you to get such high yields? I guess where (inaudible cross-talk)

I guess what we should do is take that as a compliment, and I'll say thanks very much. Really, our acquisition team, which I know some of them are listening to this call -- they should take an extra bow and acknowledge the applause from the crowd.

Just strong execution. We've been saying for a while that these 8.5% yields are not going to hold up and lo and behold, I think you'll probably see some of that come to happen here in the third quarter.

But we're out there slugging it away every day. If we stay away from the widely marketed deals where there's a lot of interest and the sellers are getting really strong cap rates, we'll be able to maintain very, very good risk-adjusted returns.

We are not a volume shop. If you're pushing for volume, you have got to truly get down and dirty in the cap rate arena. That's not the space we are currently playing in.

Okay; thanks, guys.

(Operator Instructions) Dan Donlan, Janney Capital Markets.

Good morning. Beth Bland here with Dan Donlan. Just a quick question -- what was the timing of the acquisitions? Were they weighted towards either end of the quarter or pretty spread evenly?

They were fairly ravelly. If I had to pick a date, I'd call it June 1 as a number. One of the metrics that we include in our press release is on the last page, and I mentioned in my comments, was that we note what the annual in-place lease base rent is as of quarter end. So at June 30, we had $326 million of annual base rent in place with in-place leases. And so that gives you a great starting point to project forward off of, and you don't have to do as much guessing as to kind of the timing around prior-period acquisitions, etc.

Okay, thanks.

It appears we have no further questions. I will turn the floor back over to management for closing remarks.

Claudia, thanks very much. We really appreciate all of your interest. We know this is a busy time of year for you. Equally importantly, we hope you get to spend some time with your families over the summer. Thanks very much; we'll be talking to you all again in just three months. Cheers.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and we thank you for your participation.