NNN REIT Inc (NNN) 2016 Q2 法說會逐字稿

Greetings and welcome to National Retail Properties' Second 2016 Earnings 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.

I'd now like to turn the conference over to your host, Mr. Craig MacNab, Chairman and CEO. Thank you, you may begin.

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

We are pleased to have produced another consistent strong quarter at National Retail Properties, with continued predictable per share growth. Also, we are delighted to be raising our dividend, which will make this our 27th consecutive year of increased dividends. I would like to point out that our dividend remains very well covered by portfolio of cash flow, as Kevin will further describe. In the second quarter, we were very active growing our retail portfolio by investing $344 billion at an initial cash yield of 6.9%. These acquisitions were all within our primary retail lines of trade with noticeable activity taking place within the restaurant sector.

We continue to remain highly selective in making acquisitions with our due diligence colleagues keenly focused on real estate metrics as they visit each and every property that we acquire. Deal flow for quality acquisitions continues to be solid. And of course, our access to capital and the cost of that capital has seldom been more attractive.

The average lease duration for properties acquired in the second quarter is just over 18 years. Based on our current visibility, acquisitions in the second half of the year look good. Although, not as robust as in the past six months. As a result, we are raising our acquisition guidance for 2016 to a range of $650 million to $750 million. As a reminder, acquisitions in the first half of the year have more impact on calendar year results than acquisitions that close in the months ahead. Our fully diversified portfolio is in outstanding shape and we remain 99.1% leased. In general, our tenants continue to perform to our expectations.

The convenience store sector has recently had the wind in their sales, with lower gasoline prices, which has led to wider-than-normal margins at the pump. After many years of positive same-store sales growth, restaurants are all competing for market share in an environment of slightly growing sales. However, their ability to pay our rent remains very good. At a higher level, we are encouraged about the outlook for consumer spending. If jobs keep getting created at almost 200,000 per months and wages slowly creep higher, consumers will have more disposable income, which results in modestly higher consumer spending, which benefits all of our tenants.

This year we've utilized our ATM consistent with our capital market strategy, which includes tapping the markets when capital is available and well-priced. The amount of our equity issuance has occurred slightly earlier in the calendar year than we had budgeted. However, maintaining a strong balance sheet is integral to our goal of generating attractive per share growth rates over a multi-year time frame. Kevin?

Thanks, Craig . As usual I'll start with our usual cautionary statements that we will be making 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 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, headlines from this morning's press release announcing second quarter results include reporting a 7.3% increase in core operating result per share, completing $344 million of new investments, while maintaining a low leverage profile and strong balance sheet liquidity. We believe these metrics and results compare favorably within the REIT industry and they're an important part of supporting our strong total shareholder return over the years.

Getting into some of the results, we reported second quarter core FFO $0.57 per share and that represents a 7.3% increase over prior-year results. Just to let you know, what we previously labeled recurring FFO is now being called core FFO, which we think better describes the term, but our definition and use the metric is unchanged. Our AFFO per share increased 7.1% to $0.60 per share and our AFFO dividend payout ratio continues to drift slightly lower to 72.5% in the second quarter, but we'll pick up slightly going forward given our recently announced 4.6% increase in our third quarter dividend, which puts us on a path to make 2016 the 27th consecutive year of increases in our annual dividend per share.

Occupancy continues to hold up well as Craig noted, ending the quarter at 99.1%. And as of June 30, 2016, the annual base rent for all leases in place at quarter-end was $517 million. We had a strong acquisition pace of $469 million in the first half of 2016 with $344 million of that coming in the second quarter.

We have maintained our FFO guidance of $2.31 to $2.36 per share, which suggests 5% growth to the mid-point compared to 2015 results. We did increase our guidance last quarter. Our current guidance is based on the assumptions, which are included in our press release and they include $650 million to $750 million of acquisitions in the high six cap range, G&A expense of $35.5 million to $36 million plus $700,000 of acquisition transaction costs, $1.8 million of mortgage residual interest income, property expenses net of tenant reimbursements of about $5.5 million and lastly, property dispositions of $85 million to $100 million.

As usual, we don't give guidance on our capital markets plans, but you should expect our behavior will remain consistent with the past 20 years, meaning we're going to maintain a conservative balance sheet, conservative leverage profile and we're going to get capital on it's available and well-priced, and all of this based on a multi-year view, not a quarterly view, of managing the Company and our balance sheet.

Turning to the balance sheet; during the second quarter, we raised $128 million of common equity, primarily through our ATM. And for the first half, we raised $216 million of common equity. So, if you take that $216 million of common equity, we also added $72 million of property disposition proceeds and $45 million of, what I'd call, retained AFFO, after all dividends. That provides $333 million of total capital equity equivalent proceeds to fund 71% of our $469 million of first half acquisitions.

We just want to remind investors we're not generating per-share growth by using more leverage. At quarter-end, we had $147.3 million outstanding on our $650 million bank credit facility, which is our only floating rate debt. So, we remain very well positioned from a liquidity perspective. Excluding our bank line, our weighted average debt maturity is 6.5 years with a weighted average interest rate of 4.5%. Our next debt maturity is $250 million of 6.875% notes that come due in October of 2017.

The balance sheet remains in great position to fund future acquisitions and weather potential economic and capital markets turmoil.

Looking at the June 30, 2016 leverage metrics, debt-to-gross book assets was 33.3%, flat with where we started the year. Debt-to-EBITDA was 4.6 times at June 30, interest coverage was 4.7 times for the second quarter and the first half. Fixed charge coverage was 3.4 times for the second quarter and the first half. Only six of our 2,452 properties are encumbered by mortgages totaling $17 million. So, 2016 operating results look like they'll continue the trend of recent years. We've been reminding investors of some of our distinctives, which largely come from maintaining a consistent strategy for 20 plus years.

We remain focused on a single property type. We believe retail properties offer better risk adjusted returns over the long-term, compared to other single-tenant net leased property sectors. Additionally our core competency and long-track record is in retail properties. We've always maintained a conservative balance sheet profile and don't plan to change that. We like the optionality a flexible balance sheet creates, especially if the capital markets become less friendly.

And we've chosen not to use meaningful amount of short-term debt and/or variable rate debt. Using meaningful amount of that type of capital surely helps per-share results in the short run, but creates risks over a multi-year horizon and that doesn't seem prudent to us especially when long-term capital is so well-priced.

Our strategy is that we've been consistent for many years. Our overriding goal remains the grow per-share results and manage our balance sheet on a multi-year basis and we think if we do this, we're optimistic, we'll be able to perpetuate our 27 consecutive year track record of raising our dividend, which has been an important part of consistently outperforming REIT equity indices and general equity market indices for many years.

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

Thank you. At this time we will be conducting a question and answer session. (Operator Instructions). Landon Park, Morgan Stanley.

Just had a few questions on some of your top tenants. I was wondering if you can give us an update on what's happening on the SunTrust portfolio. We also saw there are few Gander Mountains that we're potentially being marketed for sale, if you could comment on those?

Landon, good morning. It's Jay. I will take this take this question. On SunTrust, just as a reminder, we own 121 SunTrust Bank branches that are in seven different master lease pools. And those leases don't expire until April 2018. And under the lease documents the talent is to give a landlord 18 months' notice of renewal, which would then be -- we'll be getting our notice in September of this year, September 2016. One other reminder, the renewal rights under those leases are 10 year -- if the tenant renews, it's a 10-year renewal and there is a minimum threshold requirement under each lease that properties comprising 75% of the rent in each pool must be renewed or not at all.

All of that said, Landon, we are under a comprehensive confidentiality agreement with SunTrust that doesn't let us talk about what negotiations might going on or where things might fall out. So, by September, once we've received the notice and we are able to talk about that, we certainly will. I do want to point out that we bought these properties, right. When we acquired this portfolio four plus years ago, we paid $1.75 million per property and these are very good bank branch corner locations at lower rent, at $140,000 per property annual rent. So, while we can't talk about what the outcome might be, we are very confident that it's going to be a favorable outcome with SunTrust as we get to the renewals. And we will have a year and a half to market any of the properties that are coming back to us, so that gives us plenty of time to address whatever vacancies occur.

I think your other question was on Gander Mountain and we are not marketing any of the Ganders at this time. So, I'm not sure what you saw, but those are not -- I don't believe we have any on the market. We're happy with the locations we've got with Gander and certainly the sports category is under some duress, but we're happy with those locations and everything is fine so far.

And then just one last one, just we'll go a bit broader on the acquisition front. Can you just talk about what you're expecting in terms of cadence for the back half of the year-end and maybe any larger portfolios in certain categories that you're looking at, I know C stores was one in particular that you guys have your eyes on.

Yes. The pipeline looks very good for the second half of the year. Remember, a lot of our acquisition efforts are focused on building relationships with retailers and doing off-market deals. Early in the second quarter, we acquired the Bob Evans portfolio, that was $161 million there. We have not classified that as a relationship deal, because it was marketed before we came in and kind of the pre-empted the process. But separate from that, we have done deals with 30 different relationship retailers so far this year and 85% of the dollars that we've invested, excluding Bob Evans has been with relationship retailers.

So we are continuing to have very good success dealing with the portfolio of regional and national retailers that we do business with. We still see all of the portfolios that are out there. We're selectively underwriting those and making a run at the properties that are in the portfolios that are most appealing to us. And you are right, there is convenience store deal flow out there. We do love that real estate, we love that industry. It's done very well in our portfolio and we're excited to be able to look at portfolios there going forward. All in all, it looks very similar, the pipeline and the deal flow out there looks very similar to what's been the case for the last six months or a year.

And that includes pricing?

Pricing -- whether the cap rates are coming down or going up kind depends on where you start from. The premium for investment-grade portfolio has disappeared and you're not seeing a portfolio of premium and/or investment-grade properties, but we were not acquiring properties in that market anyway. As Craig mentioned, our average cap rate for the quarter was 6.9%. I think one thing to remember there is that our leases contain rent bumps that are average 1.5% per year. And on a 15-year to 20-year lease that adds 80 basis points to 100 basis points of anticipated growth. We don't straight line that, but it is built into the cash flow coming from the leases. So, if you start from a high-6s cap rate basis with rent growth, what we're seeing is, is cap rates remaining flat or trending down a little bit.

Nick Joseph, Citigroup.

I'm wondering if you can touch on tenant health, maybe specifically Bob Evans and then just across the portfolio. Any changes in the rent coverage ratio and the watch list please.

Not a lot of change to be quite on it. We continue to see -- we think we're in a muddle-through economy and so retailers are generally stealing in share from each other and some respect, from the bigger teams, but we've not seen lot of movement in that. Our weighted average rent coverage is still a very solid number. We're averaging in the mid-3s and so for our largest tenant, as usual -- and we've talked about this before, there's always tenants who are moving up the credit ladder and down the credit ladder, if you will. And so, we've talked about, Gander Mountain in the past, we're comfortable there. We think they're in solid footing in terms of results. The one we talked about is Logan's that we do have concerns about. And so, we're monitoring that, but generally I think we feel like we're in pretty good shape.

And then, maybe just specifically on Bob Evans and what was attractive of that portfolio?

Nick, it's Jay Whitehurst. We talked about this on the previous call, I think we mentioned, the highlight of the Bob Evans transaction is the spectacular pricing that we got for a property there. We paid $1.35 million per property for those 117 Bob Evans properties that we acquired. That's works out to $91,000 per property in annual rent. So it's very safe, very secure rent for both the landlord and the tenant. The four-wall rent coverage on that deal was around 3 times. Our peers often report kind of four-wall coverage, so maybe that's an apples-to-apples number with others folks. When we underwrite it and look at these things, we look at a coverage with overhead loaded in. And that was even -- that's a mid-2s kind of rent coverage number. And I think one other thing to point out on the Bob Evans transaction was the 117 units that we bought result selected by Bob Evans for sale leaseback, we visited with their CFO before the transaction and asked him why they chose these properties and their answer was, because these are ones that they were committed to do a 20-year a lease with.

And that is some of the best due diligence that you can have. Low rent, high coverage units selected by the retailer for sale leaseback, is why we focus our efforts on calling directly on retailers.

And from a corporate perspective there you can see that they are pretty moderately leveraged. They're public company so the data was out there. Company's been in business along many decades and has performed well over a long period in time, they seem to be continuing that trend.

Just and then just pardon me Kevin, what were the impairments in the quarter related to?

We had some impairments, we added back as it relates to FFO which are just standard kind of real paid impairments for properties, that we've had in the process is selling. The other impairments are the adjustment down in the reconciliation from FFO to core FFO, really primarily relates to just for a little context a relatively small and declining amount of mortgage receivables on our books.

We have about $15 million in total at quarter end. They've been there for some period of time and has been declining as those loans amortized off and that consists kind of two parts, one was a more traditional notes receivable, mortgage notes receivable I should say, as well as what we call residual interest in a pool of mortgage notes, which we've always acknowledged, it's not the lowest risk investment out there, but it is small and declining part of our portfolio.

So, during the second quarter, we took an impairment charge on the mortgage receivables of about $3.6 million. We don't anticipate any future such charges, but obviously can't rule that out. But for those that have followed the Company for some time, you'll know that we've also taken periodic impairments on our commercial mortgage residual interest since we're required to mark those to market every quarter. And we took a $632,000 impairment on net investment in the second quarter. Since these valuation impairments are not related to depreciable property, they can't be added back in calculating FFO like other real estate impairments, losses and charges. And since these mortgage investments have never been a part of our core business and it's been a pretty small number in total in our balance sheet, we've adjusted for these items in our core FFO calculation.

Lastly, I guess I'll say just for some added context as it relates to the commercial mortgage residual interests, we made a $9 million investment in that asset about 10, 12 years ago. And over that time period, that $9 million has returned over $60 million of cash to NNN. So despite the economic noise, which comes from mark-to-market accounting, it's been a very successful investment, but again these mortgage receivable investments on our balance sheet will likely continue to decline over time as those loans are paid off.

Robert Stevenson, Janney Montgomery Scott.

Just a couple of quick ones. It looks like you've got nearly 6% of the leases expiring in 2018. Are there any big concentrations other than the SunTrust portfolio that's in there?

Rob, hey, it's Jay Whitehurst. No, the SunTrust makes up two-thirds of that. I think there's 50 to 60 leases other than the SunTrust leases and its spread across the entire portfolio.

And then you -- the disposition guidance is staying at $85 million to $100 million, you guys have done $73 million in the first half of the year. Is there a potential to go beyond that? I mean are you only marketing essentially another $10 million to $25 million over the remainder of the year?

Rob, if it changes, it's not going to be a big delta either way. So, we are always looking at selling some properties, the possibility of selling one at a cap rates (inaudible). But we've got a long way to go to sell at, I mean it's got to close, the buyers is got to come through, but we're always out there crawling if you will from within our portfolio. But in the context of 2,432 properties it's a small delta.

And as a reminder, there's bit of a chunkiness to it in the first quarter, we had one asset that's sold for $42 million and so that influences that number significantly.

I guess the other question was that, do you not really see too much of a sort of deltas you get towards December 31 and people having to execute [1031s] etcetera, where you can get better pricing on assets in the last quarter of the year, last month of the year as long as you're willing to take -- from you guys perspective, I mean, I'm not sure selling assets in December versus if it were to slip into January makes any real difference given the size of the Company, but seems like that there is always high demand at year-end for a sort of 1031 -- for quality 1031 assets.

Yes. It won't move the needle much as you pointed out and we don't see a whole lot of seasonality I guess to that disposition opportunity, let's put it that way,

Vineet Khanna, Capital One Securities.

In the past you guys have sort of tapped the capital market well ahead of maturities and redemptions and just given sort of current market pricing, would you consider tapping the capital markets Sonner rather than later maybe to fund the redemption of the preferred that come available in February?

Yes, I think it's an accurate observation in terms of our general interest over the years of obtaining capital when it's available and well-priced even to the extent it may seem early and/or cause some short-term disruption to per-share results. We think it's the right thing to do over the long-term. So, we've been very active on the ATM given where equity pricing has been today. 10-year debt is very attractive, probably in the low 3% for 10-year fixed rate, and preferred as you noted, is cheap as well today for us probably in the low 5%. And so, we're looking at all of those opportunities and sorting through which one makes the most sense.

The preferred you referenced doesn't become redeemable until February of 2017. You really can't call it early, we could prefund it I guess, if you will, but won't be able to redeem until next year some time. And as I mentioned earlier, we have some debt that comes due late next year, but your point is well taken and it's not (inaudible) capital is well-priced and available and we do have a history that taking advantage of that.

And then just, Kevin, were there any one-time items that contributed to sort of the improved operating margins?

Improved operating margin in terms of property expenses or what -- I'm not --

Correct property expenses [over ABR?]

Yes. I guess, the way we think about that is we think about net property expenses. And so for the quarter, net property expense was $1.3 million. We've always had a high percentage of our income drop to the bottom line in terms of revenues over time. But I don't know that it's changed dramatically I guess for my read of the numbers. This quarter 2Q 2016 versus 2Q 2015.

And then just lastly maybe, can you guys provide an update on sort of Sports Authority that you guys have in your portfolio?

Vineet, hey, it's Jay Whitehurst. Just as a reminder, we own Sports Authority properties that really comprise 0.5% of our rent. So, not material at all. Two of those properties have already been re-leased to existing sub-tenants that were on the properties and the other two are in Florida. I believe as we speak right now, one of those two has been rejected by Sports Authority, the other technically hasn't been rejected yet but will be. And our leasing team is on the case for those two remaining properties to get those re-leased. They're in good locations. One of them is in a very good location, both in good locations. And what I anticipate, to get those leased up in the ordinary course.

Joshua Dennerlein, Bank of America Merrill Lynch.

Just curious on how you feel about your restaurant exposure. It's over 20% now of the rents, is there a kind of a target you want that to be over the long term and if so, how along would you expect it to take to get there?

And our approach is always bottom up property-by-property. We are not making capital allocation decisions based on percentages to any category or sector. So, at points in time, it certainly goes up and then it tends to moderate over time. But as Kevin mentioned earlier, if you take our Top 20 tenants, the rent coverage ratio is nicely over 3 times. So anytime we have an opportunity to purchase a well-covered, good real estate location, we are going to be doing that, whether it's in the convenience store category, which is a single biggest sector or the casual dining or the fast food restaurant sector or in any others. So, for us it's property-by-property and carefully underwritten as the number one rule.

Just one more question from me. Funding cost, if you recall the treasuries have fallen since the Brexit vote. Was there any move in the market on cap rates, do you expect any move to happen?

So, if you think about it on average, we are buying properties certainly this year at less than $2.5 million per property. And the alternative purchaser maybe somebody who is investing $2.5 million is funding it in a market that is not led to the 10-year treasury. As a result, we don't see any delta despite the perception. We see zero change in cap rates, driven by a movement in the 10-year treasury. We do see movements in cap rates based on supply demand that drive for yield, returns for alternative assets, et cetera. So, as Jay Whitehurst pointed out, we see for us, for National Retail Properties, the type of assets we've buying, cap rates are essentially flat and maybe trending small basis points lower and that is not driven by the 10-year treasury.

(Operator Instructions) Tyler Grant, Green Street Advisors.

Just to piggyback on the last question there. You talked about the structure of cap rates. So for example, have you seen any change in terms of the spread between primary, tertiary-type markets, investment-grade tenancy versus non-investment grade tenancy. And then have you seen any change in demand for certain types of categories?

Tyler, let's see if we take a swing at that and thank you for your question. I think that there is -- so let's go geographically. For whatever reason people in California think that the cap rate should be lower than it should be in Florida or in Texas. And that trend has applied for years and years and years, that trend has sort of migrated into the Nevada and some Arizona properties. So cap rates geographically have tended to be slightly lower. As you observed well with your question, investment grade tenants command a lower cap rate.

Bank branches, as it so happens, command really low cap rates, especially when there's an investment grade tenant. When I say really low, I'm talking at high-4s or around 5%. Just as a reminder some of those leases even at that type of cap rate had no rent growth over the duration. So, non-investment grade tenants for us are trading in the high six type cap rate range which has been trended down slightly over the last several years. And depending on the mix of what the tenant characteristics and the market location, there is right now a fairly small delta, pick a number 25 to 35 basis points which we are seeing based on the type of properties that we like to focus on.

So, I think if you are buying a very small franchisee or a tenant that has, as we call it, internally very little (technical difficulty) you could capture an 8% type cash cap rate, but that is not the type of asset we choose to own.

Earlier in the call, I believe that you had mentioned that there is not as robust of an opportunity set in terms of acquisitions for the remainder of the year, what caused you to say that?

We purchased one large portfolio, which Jay referenced, which is the Bob Evans. So, if you backed that out, the portfolio activity is generally the same in the second half as it is in the first half. In the first half, we just had one lumpy transaction where we purchased a large portfolio, Bob Evans.

In terms of one-off transactions, the opportunity set there is still pretty stable?

The business opportunity is very, very good. We're always looking at portfolio deals in addition to our regular course of business. And frankly right now, we are looking at a portfolio that we will put a lot of time and effort into it. My guess is somebody is going to be a little less sensitive about the quality of the lease than real. Other than that, it looks like an exciting deal, but if somebody else is a little more flexible, they will win it. We are not flexible about lease terms.

Mr. MacNab, I'm showing no further questions at this time. So, I will turn it back to you for closing remarks.

Thanks very much. We appreciate all of your interest in National Retail Properties. Business continues to be very good and we hope that you enjoy the summer just as much as we will here in Florida. Thanks very much.

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