NNN REIT Inc (NNN) 2013 Q2 法說會逐字稿

Greetings and welcome to the National Retail Properties second quarter 2013 earnings conference call.

At this time all participants are on a listen-only mode. A brief 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, Mr. Craig Macnab, Chief Executive Officer. Thank you, sir. You may begin.

Donna, thanks very much and good morning. Welcome to our second quarter 2013 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 strong quarter at National Retail Properties with continued FFO per share growth. Importantly, we are delighted to have raised our dividend for the twenty-fourth consecutive year which is a milestone that places us in an elite category of just over 100 large public companies that have this multiyear record of consistently raising our dividend.

By the way, our per share results were actually stronger than reported for two reasons. Firstly, we incurred over $0.01 of acquisition costs which we do not normally incur. Plus, perhaps secondly, more importantly, we measurably strengthened our already fortress-like balance sheet which Kevin will be further discussing.

In the second quarter, our acquisitions team was very active, acquiring 209 properties, investing $438 million at a very attractive initial cash yield of 7.7%. Our team is continuing to identify off-market transactions as well as lightly marketed net leased retail properties for us to acquire. These deals were completed in 23 separate closings this past quarter with an average purchase price per property of $2.1 million per asset which is right in our sweet spot.

The largest transaction was our acquisition of 139 southeastern bank branches leased to SunTrust Bank which, as most of you know, is a large investment grade financial institution with a leading presence in the southeast.

From an underwriting standpoint there were several positive features of this acquisition including the credit and overall quality of what is now one of our biggest tenants, SunTrust Bank. The amount of deposits held at each of the local branches is pretty solid as well as the fact that we paid just over $1.7 million per branch which we conservatively determined as being about 75% of replacement cost.

Our fully diversified portfolio continues to be in outstanding shape and we are now 98.1% leased. Given this very high level of occupancy and with long duration leases, we have modest internal growth.

By the way, leasing out previously occupied space has never struck me as an attractive business model. However, as we have evidenced quarter after quarter, we can source attractively priced, well underwritten acquisitions at an initial yield comfortably in excess of our cost of capital. Further, it gets better than this as the contractual rate on these properties then increases 1.5% to 2% over time. NNN is very well positioned with a terrific business model that endures all economic and interest rate cycles.

Finally, having raised plenty of attractively priced capital earlier this year, we look forward to investing our dry powder on additional carefully underwritten acquisition opportunities where we like the real estate.

Kevin?

Thanks, Craig. Let me start off with the usual customary statement that 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 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.

With that, we did this morning report second quarter FFO of $0.45 per share and AFFO of $0.47 per share. For the first half of 2013 we reported FFO of $0.92 per share and $0.93 per share of recurring FFO which represents a 9.4% increase over 2012's $0.85 per share.

As Craig alluded, these strong results allowed us to recently increase our common dividend, putting 2013 on track to be NNN's twenty-fourth consecutive year of increases in our annual dividend paid to shareholders as well as reduce our payout ratio.

Additionally, our increased 2013 FFO guidance is projected to result in 8% per share growth at the midpoint of our guidance range which I'll discuss more in a moment.

As usual, this quarter's strong results were a combination of maintaining high occupancy and making new accretive investments while keeping our balance sheet strong. Occupancy was 98.1% at quarter end. That's up 30 basis points from prior quarter and down 10 basis points from a year ago and as Craig mentioned, we completed $438 million of accretive acquisitions in the second quarter over half of which closed late in the quarter.

If you look back over the past two years, the last eight quarters we have acquired over $1.8 billion of properties while improving our balance sheet metrics and lowering our dividend payout. I'll spend a little more time on the balance sheet in a minute but first a few details about second quarter results.

Compared to 2012 second quarter, rental revenue increased $15 million or 19% primarily due to the acquisitions we made in 2012. In-place annual base rent as of June 30 was $391 million on an annual run rate. Property expenses net of tenant reimbursements for the second quarter totaled $1.2 million and that has been ticking down for several quarters.

G&A expense increased to $9.4 million in the second quarter. The increase in G&A expense, as Craig mentioned, was largely attributed to real estate transaction costs which totaled $1.6 million for the second quarter. Typically, we have a fairly modest real estate transaction cost that gets expensed meaning $400,000 to $500,000 annually and we have included a little bit more detail at the bottom of page seven in the press release to give you some comparable data for prior periods.

But the big picture bottom line on this quarter's results are that the core fundamentals -- occupancy, rental revenue, expenses -- are all performing well with no material surprises or variances.

As I mentioned this morning we also announced an increase in our 2013 guidance to a range of $1.86 to $1.90 per share for FFO. That translates into a range of $1.94 to $1.98 per share for AFFO. This is a $0.01 increase in the top and bottom end of the range and it follows $0.04 increases in each of the prior two quarters and is largely driven by an increase in our 2013 acquisition volume guidance to $550 million to $600 million, the timing of those acquisitions and the ability to execute capital market transactions at a very attractive rate.

Hitting the midpoint of our new 2013 guidance will represent growth of 8% over 2012's recurring FFO per share results but importantly, 2013 per share results are tempered with the continued strengthening of our balance sheet leverage metrics which provides additional safety today and more opportunity for growth tomorrow.

Looking at AFFO, $0.09 of non-cash adjustments bring estimated 2013 AFFO results to $1.94 to $1.98 per share with the primary AFFO adjustments being the non-cash interest expense on our convertible debt and the non-cash based stock compensation expense. We remain one of the few REITs that produce AFFO that is higher than our reported FFO.

Turning to the balance sheet and capital markets activity, we were fairly busy in the first half of 2013. We raised $877 million of very attractively priced long term capital and that included $255 million of common equity, $278 million of 5.7% perpetual preferred and $344 million of net proceeds of 3.3% fixed rate, ten-year debt and that had a 3.39% effective yield.

We were more aggressive on the capital front than we anticipated at the beginning of the year and while this obviously weighs on near term per share results, it made sense to us to capture more rather than less capital when it was priced so well and to remain focused on the long term rather than the near term. Having said that, our per share results continue to move higher despite this short term headwind.

Also, we called for redemption our five-and-one-eighth percent convertible notes. This effectively forced conversion of those notes which we'll settle in the third quarter. The $223 million principal amount of the notes will be paid off with cash and any premium over par will be paid in common shares. These shares, importantly, have been included in our diluted share count so there will be no meaningful impact on our results from this share issuance.

But just stepping back a bit, if you include paying off these convertible notes with our June 30 cash balance, so far this year in round numbers we have had a net $69 million decrease in debt and $480 million of acquisitions funded only using permanent capital, common and preferred equity so despite funding all of our acquisitions with permanent capital, we continue to post solid per share result growth for 2013 and we think it demonstrates our commitment to thinking about the long term which sometimes comes at the expense of the short term.

Looking at our June 30 leverage metrics total debt net of cash to total gross book assets was 33.7% and that compares with 39.0% at the beginning of the year and we have full availability of our $500 million bank credit facility. Debt net of cash to EBITDA was 4.4 times for the quarter. Interest coverage was 3.7 times and fixed charge coverage was 3.0 times.

Only six of our 1,838 properties, or well under 1%, are encumbered by mortgages. Despite the significant acquisition activity over the past two plus years, our balance sheet remains in very good shape.

We're pleased with how 2013 is shaping up and importantly, we have positioned ourselves to make 2014 another good year. We have not used this environment to push leverage metrics or payout ratios higher. To the contrary, we're using this favorable environment to grow current results while building capacity for future growth.

We continue to believe we're well positioned to deliver the consistency of results, dividend growth and balance sheet quality that has supported attractive absolute and relative total shareholder returns for many years.

With that, Donna, we will open it up for questions.

Ladies and gentlemen, we will now begin the question and answer session. (Operator Instructions)

Our first question is coming from Juan Sanabria of Bank of America. Please proceed with your question.

Just a couple quick questions, I think you mentioned it, Kevin, what was the acquisition guidance for the full year? I'm sorry, it was just a little quick for me to catch.

Yes, $550 million to $600 million for the full year.

Okay great and can you just speak a little bit about the pipeline, what you're seeing, how it has changed if at all, through the tapering fears in late May and what you're seeing in terms of cap rates? Have you pushed your price point, your cap rate assumptions up a bit and if sellers sort of reacted or is there a lag expected?

I'll take this question. As it relates to cap rates, Juan, I think it kind of -- the answer to that question depends on where you start from. There have been some portfolios out there that we have all seen trade that have traded at very low cap rates yet seemingly, at least in part, due to people having a very high stock price but that is not the world that we have been playing in. What we spend, as you know, what we spend is a lot of time individually underwriting properties and dealing directly with tenants and in that world, the cap rates remain lower albeit because of the effort that we put in in dealing with the tenants individually, we're achieving much higher rates than these portfolios are trading at so I think from our perspective, we see a good pipeline, a strong pipeline and while cap rates are remaining somewhat under compression or being pressed, what we're getting is in line with the guidance we're giving folks and we're very comfortable with the guidance. So all in, I think it's, from our perspective, it's going to be business as usual with cap rates and with the pipeline.

So Juan, let me just add one thing to that before your follow up question. There is a whole lot of discussion from people in the industry, etcetera, that the world is coming to an end because there is a slight uptick in the 10-Year Treasury Rate and I hate to rebut that, the conventional wisdom, but we're just not impacted by it one little bit. As Kevin pointed out in his comments, we have essentially financed $480 million of acquisitions this year with common equity or preferred at a very healthy spread against the initial yield and then that initial yield has healthy bumps on top of that so it's going to take a material change in the 10-Year -- material -- to move the needle in terms of cap rates.

And I guess I would lastly add that we have operated very successfully over many years at much higher interest rates so we don't think that's the end of the world.

Just another sort of follow up on acquisitions, can you just talk about sort of your appetite for shorter lease durations, sub-ten years, potentially with the view of an improving economy and what cap rate differential you would have to have versus your longer term, ten to 15 year leases, to make up for that presumably assumed risk?

I think that's a fair, a good question and we obviously look at all different types of deals both long duration leases and clearly, with our average duration, lease duration in our portfolio of 12 years, we are predominately doing long duration deals. We look at short duration deals. However, we have got to convince ourselves that we are being paid to take that risk and we have seen some deals in the marketplace earlier this year where cap rates were measurably lower, not higher -- lower -- than what we are getting for 15 year leases so there is a little bit of a logic gap in terms of pursuing those, number one.

Let me address a little technical point, number two, which is that in almost every lease, the tenant has options at fixed prices to extend the lease so in your lease, you are bound by the terms of it and while it would be great to just push rents higher, that doesn't happen in the real world, so interesting opportunity but not a very good economic strategy.

Just a quick follow up while you mention that. What would you say just theoretically your mark-to-market on leases would be if you could take them up all the way? I know you just said you can't but just to have in our mind, what is that spread?

Firstly, we don't spend a lot of time on theoretical stuff but let me point out -- I mean, it's just so wacky to think about the notion of it and being an investment merit but let me answer it this way, Juan. As I mentioned in my prepared remarks, we have just purchased a large SunTrust portfolio. On average, there was over an acre of land. The vast majority of these properties are well located, corner locations where, by the way, on most of them the branch deposits were in the top three for SunTrust in that county and we paid $1.7 million per branch so if you think about it out there in the real world, an acre of dirt on a good corner is generally $1 million but obviously that depends whether it's in Atlanta or whether it's in Charlotte or whether it's in a different community but if you just take $1 million, we paid essentially $700,000 for the building. We got, on average, 5,000 square feet at $200.00 a foot, before you know it you're up to $2 million so the mark to market on that would be well above the rent our tenant is paying -- above as much as 50%, Juan.

That's helpful. Thank you very much.

But it's only theoretical because our tenant has a multiyear lease.

Our next question is coming from Emmanuel Korchman of Citi. Please proceed with your question.

Jay, maybe this is a question for you. A deal like the SunTrust deal, how long does that sort of take from you walking in to them and saying yes, we have this portfolio that we want to sell, to actually closing it?

Manny, that deal was probably in the 45 days kind of category. What we find is that we can move as quickly as anyone. All of our due diligence components are in-house and so we quickly strike. We strike a deal and we're able to kind of quickly get through the due diligence and then close right after that given the cash we had and at the time, we had the cash in the bank to invest in it.

What we do is approach these things with the goal of looking at all of the components of due diligence that we want to look at but looking at them very quickly.

And then Manny, just to go to the other side of the extreme, in the most recent quarter we closed a convenience store deal where we purchased 58 properties. From the time we had a handshake, and I don't have the exact date, but it was about one year to closing.

That wasn't due to us, Manny.

Maybe that's more the gist of the question. If we look at your guidance for the back half which is $70 million to $120 million, roughly, if there was a big deal in there, I guess my question is would you kind of know about it or could it pop up in the next five months?

Deals could definitely pop up and we'd be able to get them closed. You could see that at the end of last year when we had that very busy December and a lot of those deals didn't come around until October, November.

So at this point in time, in our pipeline are a lot of our core relationship deals, one property at a time. There are a couple of deals, smaller deals, that we're working on that may or may not happen depending on whether or not the tenant pursues the opportunity but right now, we are not -- we have certainly in the last couple of years, we have generally stayed away from these large portfolio deals which seem to trade at prices that for us, we don't understand the value proposition.

And maybe this is an offshoot of Juan's questions earlier but we had heard in other sectors that are similar to yours that there has been sort of a pause, maybe not from the cap rate compression or expansion side but just sellers sort of saying, let me wait this out because you're telling me that cap rates should be going up and I'm telling you that I want what I want. Have you seen deals that were about to, whether it be handshake or due diligence or wherever you are, get paused as the sellers are sort of scared of the environment?

Manny, no, we have not seen that. There is still good deal flow out there in our world and people want to go ahead and move their businesses forward.

Manny, I think you've also just got to step back with respect to, and just think about what you just said which is that if you're a seller, you are presumably going to accelerate your transaction in the event you think pricing is going to move higher so if people are telling you that sellers are getting skittish, I think that tends to suggest cap rates are going lower and I find that hard to believe.

Our next question is coming from Dan Altscher of FBR. Please proceed with your question.

With the SunTrust acquisition, banks as a percentage of your overall portfolio has become a little bit larger. It now looks like number six. Is this a new strategy or a new preference for banks or is this just kind of a one-off and we'll just see portfolio reallocation as it comes or is this a definitive initiative to get more into financials?

Dan, I guess to step back, one of the things your question points out is that we've got a very diversified portfolio and we are always looking for, looking at bank deals when they are out there. This particular one was very compelling given the real estate metrics and the quality of the real estate and so we jumped on it. If others came along, we would do it but it's all part of just building a very diversified portfolio.

With the convert that needs to get paid down, I guess the question is, is there going to be a tranche or a drawdown in the credit facility to pay for that or do you think that's just going to be straight cash off the balance sheet?

That will come straight from cash. At quarter end I think we had about $237 million of cash on our balance sheet. That convert, the principal amount of that convert is $223 million so we used $223 million to pay that off and any premium above par due to converting shareholders will be paid in common shares and as I pointed out, those shares are already accounted for in our dilutive share count so really not much impact there but that will all settle in the coming days here in August.

Great, and then just one more, with the move up in the 10-Year and the world hopefully not coming to an end, how do you think about financing our capital structure on a go-forward basis? Have you looked at or considered what your new cost of debt would be today versus the great rate you got earlier in the quarter or is there a preference now towards using more preferred or equity or do you think the debt markets are still open and at attractive rates that make sense for new acquisitions?

I think generally, capital is still reasonably priced. We'll put it that way, I guess. If you drag out a 30 year interest rate chart I think it's hard to argue that rates are high now. Having said that, obviously rates were better two months ago than they are now and we fortunately, were able to capture a good bit of capital in that environment and frankly, more capital than we had anticipated at the beginning of the year and more capital than we frankly needed but felt like the pricing of it was compelling enough to take on that capital despite whatever short term headwind that creates for maybe per share results but yes, our 5.7% preferred that we issued two months ago might be 100 basis points more, cost more than that today but even in that environment, in the current environment, our cost of capital is sufficiently low enough to make very accretive acquisitions.

Our next question is coming from Dan Donlan of Ladenburg Thalmann. Please proceed with your question.

Just real quick on kind of the investment spread that you guys are seeing right now -- Craig or Jay, could you talk about how this looks relative to the past five or six years? Do you think this is one of the more attractive times that you've seen in quite some time and could you maybe put that against how you see the acquisition environment in terms of deal flow?

In terms of the spread, as I mentioned a moment ago, in the most recent quarter our 7.7% initial yield with bumps on top of that but if you just take that 7.7% and you think to yourself, well, maybe they financed some of it with our 5.7% preferreds or alternatively, we did issue a lot of equity in the past six months and if you take the nominal cost of that, the inverse of our multiple, it is at a very wide spread and we're not even taking advantage of our less expensive debt.

If you go back historically, that spread has generally remained fairly constant and it is clear, on a cap rate basis, that there has been some cap rate compression in the past 30 months -- not a lot, but we were doing deals in the mid 8% initial yield over a year ago and today we are a little lower than that but I guess the thing that I would try to focus in on is that regardless of what happens to the 10-Year, the spread is very wide and three consecutive years of 8% plus FFO per share growth while measurably strengthening our balance sheet points to the merit of the business model.

Yes, I don't disagree. I think what investors might have a problem with is how repeatable is this going forward, AFFO streaming and evidently space is very wide and deep but do you think these mid to high single digit increases in AFFO, can they continue?

The only thing I would suggest is if you take a look at our ten-year return or our five-year return or 24 consecutive years of dividend increases, it seems to me that we're in a pretty good space.

Understood. And then just lastly kind of on the dividend, I was expecting a little bit more growth in the dividend. It looks like your AFFO coverage is really just now kind of low 80% and is probably going to move south of 80% once you have all the capital that you have to work over the next couple quarters. Why didn't you raise it a little bit more than you did?

That is something we have been pursuing over the years, frankly, is continuing to make the current dividend more safe by letting the payout ratio drift lower. I think you're probably on point, as we get closer to 80% maybe on an AFFO basis and we feel comfortable, we'll let the dividend increase more in line with our AFFO growth but again, it may be somewhat consistent with our balance sheet strategy is our dividend strategy of having capacity for better times tomorrow so a little bit of conservatism on our part and we have good use for the proceeds. I guess that's the ultimate question is what are you doing with the AFFO you're not distributing and we think we've got good opportunity to use it so a combination of safety, capacity in the future and good use of those funds for current acquisitions led us to where we bumped it up $0.01 per share and continue to push our payout ratio lower.

Our next question is coming from Jonathan Pong of Robert W. Baird. Please proceed with your question.

Maybe just looking at the investment spread question a little bit, in a different way. If you look at your cap rate spread between relationship deals and marketed deals over the last three years I think you see about a 60 basis point spread there. What is your outlook going forward as to whether or not that is repeatable and sustainable?

Jonathan, this is Jay. One of the great benefits of these relationships that we work so hard to build with tenants is that there is a certain stickiness in those cap rates. We always need to be market with our good relationships and not take advantage of it but there is a bit of a benefit in there that we derive and we feel comfortable that that will continue and the spread over the relationship cap rates versus what we buy in the direct market is really just completely driven by what we decide to buy in those very efficient auctions that brokers and investment bankers run out there.

As you know, as we've talked with you about before, we look at all of those deals and compare them with what we are doing with our relationships and what is the quality of the real estate and the quality of the lease and then chase after the ones we want to pursue. I guess the short answer to your question is I think that spread will be consistent over time but it just depends on what we decide to stretch for in these open market deals.

Got it, that makes sense. And then maybe for Kevin, as we look at the ATM, what is your appetite for capping that going forward and what are your thoughts on it there?

We've been fairly active users of that over the last 12, 15 months. At this point we're probably not as aggressive on it but in part, that will continue to be driven by our visibility on acquisitions and our need for capital but we do have a fair amount of balance sheet capacity as we've said a few times now and so the need to push more shares out on the ATM, frankly, is not there but we'll let the acquisition and investment opportunity environment drive some of that.

(Operator Instructions)

Our next question is coming from Todd Stender of Wells Fargo. Please proceed with your question.

Can you provide more details on the SunTrust deal? Craig, I think you mentioned it was a 20-year lease. Did I get that right?

No, I didn't say that. What I did comment about was the fact that we purchased it at what we think is 75% of replacement cost. I talked about the very strong deposit attributes of this portfolio. Just to give you a little bit of a metric on that, the average deposit in our portfolio was $54 million and the, I believe if you go to SunTrust website, you will see that their median across their 1,500 or so branches is $48 million so clearly, this is in the better half of their branches.

And is this under one master lease?

It's actually under several master leases.

And are they various average lease terms?

No, all of the leases expire at the same time.

And can you share what the length of the lease is?

Yes, it's a shorter duration lease and it has about six years left today.

Todd, it's Jay. Just one thing to add to that though, we, in going through our underwriting, we looked at, did a very deep dive into the likelihood of lease renewals in these pools. The renewal period if for ten years and so our underwriting gave us a great deal of comfort that the vast majority of these sites, and it gets a little technical and I'm not going to get into all that, but the vast majority of these sites are, we think, very highly likely to be renewed so we took a land value kind of underwriting approach to it but we also recognized that it's really likely that these are 15 year leases predominately.

Okay and any rent bumps? What do the metrics look like? Is this flat or are there any fixed rent bumps?

The good news is when they renew, there are decent rent dumps.

It's kind of commensurate with what we did in the rest of our portfolio.

Okay so essentially, it sounds like they're flat for now and then up on renewal they'll bump up higher?

They're flat only because we've just taken a rent increase that we purchased the portfolio off, yes.

Okay, any vacancy that came along with this deal?

No, sir.

And then just looking at the mid-Atlantic convenience stores, are these largely Circle Ks? Is that their brand name?

That is correct, Todd.

And same idea? Several master leases or this is one deal?

That one is really one long duration lease deal.

Okay, and can you share what that length is?

It is at least 15 years.

Our next question is a follow up coming from Dan Donlan of Ladenburg Thalmann. Please proceed with your question.

What is the capitalized interest related to? What are you guys building right now?

We have always had a program, what we call slip-funded if you will, where we are, with a particular tenant we may buy the land. That tenant proceeds and builds the building and we may fund the construction of that building and upon completion obviously, we end up with land, building, and a long term lease so during that construction period we will essentially have some capitalized interest related to that but it's typically not a big number in the scheme of things but it's there.

Thank you. At this time I would like to turn the floor back over to Management for any additional or closing comments.

Donna, thanks very much. We appreciate all of your interest. We hope you enjoy the balance of the summer and we look forward to talking to you all in the weeks and months ahead. Thanks very much.

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.