NNN REIT Inc (NNN) 2015 Q2 法說會逐字稿

Greetings, and welcome to the National Retail Properties' Second Quarter 2015 Earnings Conference 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 conference is being recorded.

It is now my pleasure to introduce your host, Mr. Craig Macnab, Chairman and CEO for National Retail Properties. Thank you, Mr. Macnab. You may begin.

Linda, thank you very much. Good morning, and welcome to our second quarter 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 strong quarter at National Retail Properties, with continued predictable FFO per share growth. Also, we are happy to be raising guidance for 2015 after two quarters of strong per share results.

In addition, we are pleased to have raised our dividend for the 26th consecutive year. As Kevin will describe in further detail, our strategy is focused on generating a competitive total return for our shareholders, while taking what we think is less risk. In an environment of greater capital markets volatility and perhaps even uncertainty, I have a suspicion that a well-covered growing dividend may become more attractive to investors. Of course, we also strive to grow per share Recurring FFO as well, which is what we have done over the last several years.

In the second quarter, we acquired 37 retail properties, investing $148 million at an initial cash yield of 7.1%. For what it's worth, our sense is that cap rates have stabilized at these current low levels.

Our second quarter acquisitions substantially came from within our existing tenant base and relationship tenants. The average lease duration for properties acquired in the second quarter is just under 17 years, and for all the acquisitions we've completed thus far in 2015, it is just over 14 years.

We continue to be selective and disciplined on our acquisitions. We are, however, in the final stages of underwriting a couple of attractive opportunities. So we are raising our acquisition guidance for 2015 to a range of $500 million to $550 million. Our fully diversified portfolio is in outstanding shape, and we remain 98.8% leased.

As you can see in the detail of our press release, we have a modest amount of leases expiring in the next 30 months. Our tenants continued to perform well, and thus far, we have had zero exposure to some of the retail bankruptcies that have incurred. Many of the retailers that have recently experienced challenges have been in the apparel category, which is a segment to which we have extremely limited exposure.

Finally, as Kevin will describe, our balance sheet is very strong, which means we have plenty of optionality to finance our continued growth.

As a comment on the angst around rising interest rates and the impact on NNN, we use almost exclusively fixed-rate tenure debt to finance our business, and we have carefully staggered debt maturities. We do have a debt maturity coming due in December, but we are substantially confident that we will refinance this debt maturity at a lower total cost.

Perhaps more importantly, our deployment of capital continues to be at very attractive spreads, especially versus several other property types. As a result, we continue to believe that the net lease retail segment is a very good business, and we like the way that we are positioned to continue to build shareholder value. Kevin? Audio at 8:23

Craig, thank you. Let me start with our usual cautionary statement that we will make certain statements that may be considered to be forward-looking statements under Federal Securities laws. 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.

So with that, this morning we reported second quarter FFO and Recurring FFO of $0.55 per share, which represents a 10% increase over prior year results and was largely in line with our expectations. We also reported AFFO of $0.56 per share, which represents a 9.8% increase over prior year results.

For the first half of 2015, we reported $1.09 per share of Recurring FFO and that represents a 7.9% increase over the prior year and an 8.8% increase in AFFO to $1.11 per share for the first half. So this is a good start to 2015, and the increased acquisition guidance that Craig mentioned has allowed us to also increase our FFO and AFFO guidance for the full year, which I'll talk more about in a moment.

So 2015 is on track to perpetuate growing per-share results on a multi-year basis, while we continue to maintain a strong balance sheet.

Now, I want to look at a couple of details on the past quarters that the strong results were a combination of maintaining high occupancy as well as income from acquisitions we made over the past four quarters.

Occupancy was 98.8% at quarter-end, and that was flat with the prior quarter and up 30 basis points from a year ago. And as Craig mentioned, we completed $148 million of accretive acquisitions in the second quarter. Our dividend payout ratio decreased to 75.7% of AFFO in the first half.

Now, compared to 2014's second quarter, rental revenue increased $11.8 million or 11.7%, and that's primarily due to the acquisitions we made over the past four quarters. In-place annual base rent as of June 30 was $458.6 million on an annual run rate. Property expenses, net of tenant reimbursements, for the second quarter totaled $1.3 million, and that compares with $1.5 million for the second quarter of 2014.

G&A decreased modestly for both the second quarter and the first half of 2015 compared to last year. We continue to generate positive operating leverage as we grow, with G&A declining from 7.6% of revenues in the second quarter of 2014 to 6.7% in the second quarter of 2015.

To underline these efficiencies a little more broadly, you'll note that compared to the first half of 2014, our total revenue for the first half of 2015 increased $23.6 million, and AFFO increased $21.9 million first half 2015 versus 2014. So all that means is that 92.7% of our incremental revenue is finding its way to the bottom line, even after accounting for interest on an increased debt load of approximately $160 million. So in total, at NNN, we've started 2015 well. Occupancy, rental revenue, expenses, all are performing well with no material surprises of variances.

As I mentioned this morning, we also increased the low end and high end of our prior FFO guidance by $0.02, increasing it to $2.16 to $2.19 per share for FFO. Similarly, AFFO guidance is now $2.21 to $2.24 per share. Primary assumption change is the increase in the acquisition guidance to $500 million to $550 million as Craig mentioned earlier. The other assumptions are largely the same. Still see G&A expense around $33 million to $34 million, real estate acquisition transaction cost of about $1 million, and net property expenses, net of tenant reimbursements, of $5.4 million.

Turning to the balance sheet. We reported -- we've raised $39 million of common equity primarily through our ATM program during the second quarter, and for the first half of the year, we've raised $87.4 million. And as you can calculate from our disclosure, our average selling price for the quarter and the half was very close to $40 per share.

Additionally, $25 million of property dispositions and $36 million of retained earnings, which I'm defining as AFFO minus dividends, adds another $61 million of equity-like capital during the first half of 2015. So we've raised more equity than needed in recent years and that's moved our leverage levels lower. At quarter-end, we had $127.5 million outstanding on our bank credit facility, leaving over $500 million of availability.

The average debt maturity for all of our debt, including the bank line and any mortgages is six years, and the weighted average interest rate on that debt is 4.5%. So less than 7% of our total debt is floating rate and only 2% of our assets are financed with floating rate debt. The next debt maturity, as Craig mentioned, is $150 million of 6.15% notes due in December of this year 2015. But our balance sheet remains in great position to fund future acquisitions as well as where there are potential economic and capital markets turned on.

Looking at our quarter-end leverage metrics, debt-to-gross book assets was 33.4%, debt-to-EBITDA was 4.5 times for the quarter. Interest coverage was 4.7 times for both the second quarter and the first half. Fixed charge coverage was 3.3 times for both the second quarter and the first half.

Only nine of our 2,138 properties well under 1% are encumbered by mortgages totaling $25.9 million. Despite the significant acquisition activity over the past four years, our balance sheet remains in very good shape. So 2015 looks to be another good year for NNN. Our strategy has been very consistent for years.

Our overriding goal remains to grow per-share results on a multi-year basis. And as we do this, we are optimistic we'll be able to perpetuate our 26th consecutive year track record of raising our dividend, which has been an important part of consistently outperforming the REIT equity indices as well as the general equity market indices over the short, intermediate and long term.

As we build NNN, we've not made multi-billion dollar acquisitions and/or deployed capital at marginally accretive cap rates. We've stuck to our retail property core competency, and we've not utilized more leverage or employed shorter-term debt. Instead, we've deleveraged an already strong balance sheet with additional long duration capital, while still delivering 7% plus per-share growth over the last several years. As Craig said, we like the optionality that we've created, especially if the capital markets are less friendly than they have been recently.

With that, we'll open it up to any questions, Linda.

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) One moment please, while we poll for questions. Vikram Malhotra, Morgan Stanley.

Thank you. First, just a couple of quick numbers question. Can you maybe just talk a bit about some of the impairments that we saw? And I think there was a tax benefit this quarter. Could you maybe just give us a bit more color?

Yes, good question. I probably should have pointed that out in my comments. Yes, we did take a couple of impairments primarily related to vacant properties that are either have been sold or will be sold, but you're correct in pointing out that there was a tax benefit connected to those property set in our TRS. So the impairment was $2.686 million as you see on the front of the income statement, but there was a tax benefit associated with that of $982,000. So the net of those two numbers is $1.704 million.

And so that's what we used in calculating our FFO. So when we backed out the impairment loss, we offset the income tax benefit connected to that impairment loss. So we didn't think it would be fair for us to pick up $982,000 of FFO just because we booked income tax benefit related to that impairment. So in that reconciliation, you'll see the impairment loss, net of income tax, totaling $1.704 million.

Okay, thanks. And then, you referenced several times kind of obviously the balance sheet where you've taken leverage, the future potential for maybe some dislocation. Where are you willing to kind of take up leverage if you decide to use the balance sheet, and could we see sort of the next $500 million worth of deals done more so with debt than what you've done in the past?

You have the numbers where we've been historically. At the moment, it doesn't feel like we need to move our leverage to generate the, kind of, per-share growth that we are targeting. So we don't have any bright line drawn, but we like where we are. We think it allows us to perpetuate per-share growth on a multi-year basis, but at the moment, don't feel like we need to use any of that dry powder.

Okay. And then just last one, just on the disposition front. So maybe some of the, call it -- if you can call it smaller portfolios or deals with multiple assets, for example, Chuck E. Cheese, would you be -- are there some assets that you could prune out?

Vikram, that's a good question. And I think the way to think about it is on the front end of that transaction and several others, we pruned out properties that we did not think fit in our long-term portfolio. The good news is, Chuck E. Cheese is performing extremely well. It's got a good balance sheet. As we review their quarterly numbers, they are making good progress, and frankly our rate coverage is improving.

In terms of dispositions at a higher level rather than with regard to one portfolio, we are embarking on a very small initiative to simplify our business and that's my term, and that means getting rid of some smaller assets that frankly take quite a lot of time, sometimes cost us a little bit of money in terms of recoveries, tax and things like that even though we are triple net.

And one of the things that's important to us is that statistic that Kevin mentioned, which is incremental rent dropping down to the bottom line, which includes amongst other things leveraging our existing workforce. So you're going to see us over the next couple of quarters selling, if markets allow, a number of smaller assets that frankly just don't move the needle in terms of our portfolio, yet take a disproportionate amount of time.

Juan Sanabria, Bank of America.

Hi, good morning. Just I'm curious on the guidance, what is assumed at the bottom end? It seems like it'd be flat to slightly down on your current second quarter run rate from an FFO perspective?

Yes. As usual, we don't give guidance on our capital markets activities. And so -- and that can be meaningful. For example, we have this debt that comes due and we've got at the end of the year $150 million. We've got a line of credit balance. And if we did that debt deal tomorrow versus December 1, it makes a pretty material difference actually in how the numbers play out. So that just gives us the wiggle room to again retain optionality to move in the capital markets when we think it's best.

And what's the current feedback on what you guys think you could issue to repay that December balance?

I think right now we'd be around 4% in terms of a coupon on a ten-year debt. And again we're going to be focused on issuing long duration capital at fixed rates. We're not looking at shorter-term capital at the moment.

Great. And then just to Craig's previous point about select dispositions, any sort of dollar amount that we could think of maybe on an annual run rate basis?

It's not really an annual run rate. It's just getting rid of some very small properties. I don't want to overemphasize it, because the dollar impact on is so small, it's immaterial to your model or to our business. It's just a simplification effort around here.

Okay.

In the most recent quarter, there were, I think, four properties, a small number of million dollars. We sold $2.2 million at four assets. That's just symptomatic of what we are talking about.

Okay. And then there is -- just lastly, there has been increased activities particularly on some of the restaurant chains. Do you guys see yourself likely to participate given what you see in terms of pricing with some of the opportunities whether they're Bob Evans or some of the Darden chains, et cetera?

Juan, good morning. This is Jay. We will -- as we've mentioned before, we see all of those things, and we will very thoroughly deeply underwrite each one of those opportunities when they come up. And to the extent they make sense to us, we will go forward aggressively.

That said, our relationship pipeline looks great. We have as many relationship tenants right now as we've ever had and they are performing well. They are growing. They are adding stores. And that's a wonderful baseline for us to work off of when we look at portfolios that are out there.

Did you guys do any transaction with Taco Bell? I saw that they were now in the top tenant roster?

We had a longstanding relationship with a few Taco Bell franchisees around the country, some of the stronger ones. And there has been some consolidation in that space, and our relationship tenants have looked to us for capital in those instances. And so what you see there now is really kind of a consolidation of a few different relationships that we've had with some strong retailers and strong Taco Bell operators in that business.

So Juan, as it so happened, we did not buy any Taco Bells in the most recent quarter. That reflects just the merger of some entities.

Got you.

Which is always a good thing. If our tenants get bigger and stronger, we like that.

Dan Altscher, FBR Capital Markets.

Thanks, and good morning, everyone. Maybe expanding a little bit on Juan's last question. Can you just talk about for the roughly $147 million, $148 million of acquisitions that you completed in the quarter, kind of just broadly what those comprised, whether it's tenant type or if there is any sort of geographic concentration there?

Dan, thank you very much. As it so happens, I think it was just over 20 different tenants with 15 different closings. So it's just a very typical quarter for National Retail Properties, lots of small little deals with as Jay mentioned, almost always in the second quarter anyway, existing tenants and relationship tenants. That's just a bread-and-butter quarter for us.

Just to stay with it a little bit longer, I cannot emphasize enough that we have been very disciplined in deploying capital. We've seen lots of these bigger deals and it just so happens that a bunch of people have wanted them more than we have. And we don't think we grow per-share results by deploying a lot of capital at very thin yields. If there are attractive deals, and quite frankly we hope to find them, especially with a little bit more capital markets volatility, we'll take advantage of them.

That's great. Craig, you often made a comment earlier in the script and maybe there is a little bit tongue-in-cheek around a well-covered dividend being even more attractive going forward. Was that just a tongue-in-cheek kind of comment, or is that maybe a broader, maybe, statement about the group or the net lease side or the retail side in maybe the near future?

Yes. So we're very focused as Kevin described in producing total returns, which are competitive to all of the indices, including the NAREIT index, but also S&P, et cetera. We get a total return from two different places, dividend and per-share growth. And in the last couple of years, it's been clean sailing and people have ignored the value of a dividend.

I guess I'm suggesting that maybe in the next couple of years, a well-covered dividend that grows every year like us may be a core value. Having said that, just like you did, you and I hope that the S&P and various indices keep hitting highs every day, it'd be good for all of us.

You're right. You're exactly right about the last part. Quick question on the model. Kevin, it looks like just in the quarter in terms of the AFFO, the straight line rents seemed to maybe have reached a little bit of an inflection point, maybe being a positive add back. Is that accurate to say we've kind of hit maybe a little bit of an inflection point here with the seasoning of the whole portfolio that now we're gaining some additives to the AFFO from a straight line basis?

That's correct. So yes, a lot of our older leases have contractual base rent increases which require them to be straight-lined. We're getting close to the midpoint in those lease terms, meaning around 10 years or so. And so yes, as you know, as you get to the second half of the lease, the straight line rent numbers start to reverse and they don't detract from cash flow calculations. They are additive. And so yes, we've kind of reached that neutral point at the moment. And over the next year or two, you'll see I think positive numbers hit on that line item.

Okay, that's perfect. And then just one other quickie on the guidance, and I appreciate the comment that not giving guidance on capital markets activity, that's fine, but does your guidance include capital markets activity?

Absolutely. It always does, yes. We have something in mind. What's interesting though is that we always put something down. We make an assumption. We try to be reasonable and we lean to maybe the conservative side on that. But we try to maintain a balance sheet that allows us to pivot and deviate from what we put down in our budget or reforecast to whatever the capital markets are providing the best alternative for at the moment.

And so we can move notably away from what we assumed four months ago in terms of our capital markets activity. A great example of that was in 2013 when we did a big preferred offering that wasn't in our 2013 budget; five months before we did it and it wasn't even in our sight, two months before we did it. It's just -- and rates got very attractive on preferred.

We've got a great perpetual capital. It was a good transaction, but that wasn't in our budget. And so we just -- we like to be able to move towards the capital, that's best-priced at the moment. But yes, we have assumed that we would be issuing capital to fund these acquisitions.

Yes, okay. Perfect. We got -- we have that in the model too. So we're good there.

Good.

Nick Joseph, Citigroup.

Thanks. Craig, you mentioned greater capital markets volatility twice. What impact does that greater volatility have on the conversations you're having with sellers and the transaction market overall?

Nick, firstly congratulations on getting married. In terms of our retail relationships, the good news is they're paying attention to same-store sales growth and margin in their business and opening new locations. And while they are all financially sophisticated, the good news is they are not watching a ticker every day. And to be honest, the pricing of real estate is more dependent on demand and supply than it is on the tenure.

And so, it's really not as closely linked as investors seem to think it is. Right now there is terrific demand for properties. And I think Darden gave a number that they are seeing their restaurant -- their Olive Garden restaurant properties selling at and it's well below 6% initial yield. So that's in the one-off market.

So cap rates, I mentioned are -- we think are probably stabilized at these types of levels. If banks are willing to provide interest-only loans, people think they are getting a leveraged return. That's quite attractive, if they buy a net lease retail property and finance it with a short-term bank loan that's interest-only; so cap rates are low.

Thanks. And then you mentioned being in the final stages of underwriting for some acquisitions. Can you give us some details on the potential transactions in terms of the tenant type and the timing?

Yes. So, Jay Whitehurst always reminds our Board that we're one phone call away from a transaction not happening. We've always got deals in the hopper, Nick, and they've -- you are not going to see us straying from retail and as you take a look at our portfolio mix, that's exactly where we are going to be doing deals.

So it starts all the way down from convenience stores to restaurants, to auto parts, to all of the service industries in retail. And we are looking at deals in all of those categories. What we do is we let these deals bubble up to the surface and then, we determine which we think are most attractive and we will selectively close those deals.

Rich Moore, RBC Capital Markets.

Good morning, guys. This is [Jimmy] on for Rich. We are wondering if you take a look at the Life Time Fitness sale leaseback and if you had any commentary on the operator or the portfolio?

Jimmy, we look at all of the deals in the market. And that's a company we've tracked for a long period of time. We know the management team well. We think they are extremely good operators. We definitely looked at the deal as you would expect, and I think Life Time is a very good operator.

I think one of the characteristics of National Retail Properties is that we're, one, selective on our acquisitions, and two, in terms of our go-to assets, we generally prefer smaller ticket items, which is on average asset is $2.8 million, if you take a look at Life Time Fitness they're big, big boxes. Having said that, at the right price and the right yield, the right location, we will also do a Life Time Fitness deal, but we chose not to do those big deals.

All right, great. Thank you. And then just following up on the balance sheet, what do you think about the viability of a preferred at current pricing?

It's something we always look at. I think today our preferred bucket is pretty full and I don't think it would be any better priced than our last preferred issuance. So at the moment, it probably doesn't feel like that's the direction to head. We look at preferred at relative to where 30-year debt might be issued and 10-year debt. And at the moment, I'm not sure preferred is winning that race at the moment.

Amit Nihalani, Oppenheimer.

Hi, good morning. Are you able to comment on the trending cap rates right now in the market?

Amit, this is Jay Whitehurst. We would really say that cap rates to us right now feel like they have just kind of flattened out. They are not going down any further, but they are not trending back up either. So right now, we feel like it's just kind of a flat market out there for the retail properties that we are looking for.

And I think just one more point on that is that net lease retail pricing continues to be nicely higher than what you're experiencing in most other property types. So while cap rates have stabilized at what we consider low levels, they are still nicely higher than what other property sectors are paying for their assets.

(Operator Instructions) Vineet Khanna, Capital One Securities.

Yes. Hi, good morning. Just given the recent stock and interest rate volatility and the expected rate hike as well as yields coming in, can you remind us of the low end of your targeted investment spread over your long-term debt or weighted average cost of capital?

Yes, we really don't -- we have a page in our presentation that speaks to cost of capital because we do -- we probably view that differently than many other companies in the REIT industry. And so we don't publish spreads over debt because we don't think that's a good way to think about it, because debt is only a third of our capital stack, and we also have a different view on what our cost of equity is than other companies might have. And so we'll not really comment on that.

Having said all of that, we can still make accretive acquisitions at today's pricing of capital and at today's cap rates for acquisitions. And so while that -- yes, it's narrowed somewhat in recent months. It's still a very good spread and good return on our investments.

Okay. And then, can you just provide some color on the competition for small one-off retail deals versus larger portfolio deals now versus six months ago and maybe what the cap rate differential is?

In terms of competition, it's a wide open marketplace. The total size of the market that we play in is vast. And I was recently talking to one of my colleagues who pays attention -- who is very active in our disposition effort. The way he tracked the market last year, and this is just anecdotal, is that for identified competitors, he came up with more than $35 billion of purchases, and that is just an identified list of companies.

So the first thing is it's a huge marketplace, and of course there's competition. There are lots of good public companies that play in our space and then there are thousands of individuals that are buying one property at a time, some of which are in 1031 exchanges. So that's -- I think one of the things to remember is that even though there is lots of competition from individuals, an individual by definition doesn't have the competitive advantages that we have.

Firstly we have access to capital. Secondly, we have a large and deep pool of relationship tenants that come to us consistently for more deals. And then thirdly, we have a group of professionals that are out there in the marketplace every day.

So when you cut through it at the end of the day, there are a small number of competitors that focus on generally on the bigger deals; many of those types of players are quite reactive, they are responding to brokers coming in. We are not reactive at all. If you look at somebody like Jay Whitehurst's travel schedule, you would like to have his miles.

There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

Linda, thanks very much. We appreciate all of you listening today. We understand there are plenty of other earnings calls. We hope you have a great summer. We will be talking to you next quarter. Thank you very much.

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