NNN REIT Inc (NNN) 2017 Q4 法說會逐字稿

Greetings, and welcome to National Retail Properties' Fourth Quarter 2017 Operating Results. (Operator Instructions) And as a reminder, this conference is being recorded.

I would now like to turn the call over to Jay Whitehurst, CEO. Please go ahead.

Thank you, Brenda. Good morning, and welcome to the National Retail Properties' Fourth Quarter 2017 Earnings Release Call.

Joining me on this call is our Chief Financial Officer, Kevin Habicht. After some opening remarks, I'll turn the call over to Kevin to discuss our financial results in more detail. 2017 was another very strong year for National Retail Properties in every aspect of our business. We ended the year with core FFO per share growth of 7.2% over 2016 results. As we've said many times, our focus is on long-term consistent results, and I'm pleased to report that through year-end 2017, National Retail Properties produced total shareholder returns that exceeded the REIT averages and many major equity indices over the past 3, 5, 10, 15, 20 and 25-year periods, respectively.

Our broadly diversified portfolio of almost 2,800 single-tenant retail properties remained healthy with an occupancy rate of over 99%. Our high lease renewal rate continued in 2017. Over 87% of our expiring leases were renewed by the current tenants at 103% of the expiring rent. Our efforts to release vacant properties was also successful in 2017 as we released 27 properties, including all of our former Gander Mountain stores. The rent recovery rate for our 2017 releasing was below our long-term average of approximately 70% of prior rent due to the lower recovery rate on the Gander Mountain properties, but we remained very pleased to have quickly leased all of those vacant properties to a strong national tenant for a 20-year term.

On the acquisition front, in 2017, we invested $755 million in 276 single-tenant retail properties at an initial cash cap rate of slightly over 6.9%, and with an average lease duration of almost 19 years. Roughly 75% of our dollars invested in 2017 were with our portfolio of relationship tenants. We did business with about 3 dozen relationship tenants in 2017, including 14 relationship tenants, with which we did no business in the prior year.

As we look ahead to 2018, there are a few key takeaways that I'd like to highlight. First, per share results are what really matter. You'll never meet a management team more concerned with per share results and less concerned with growth for the sake of growth than the management team at National Retail Properties. REIT headlines are often devoted to the volume of acquisitions in any quarter or year. To us, what matters is consistent multiyear growth in per share results while maintaining a conservative balance sheet, not headline growth in our asset base. This approach to creating shareholder value allows us to be highly selective in our acquisitions and positions us to perpetuate our long-term track record of consistent core FFO per share growth with less execution risk and more focus on quality real estate.

Second, not all retail is toxic. Our tenants typically operate large regional and national businesses that focus on customer services, customer experiences and e-commerce resistant consumer necessities. We have very little exposure to a payroll or other retail concepts that are struggling with e-commerce and getting negative headlines. The primary lines of trade that make up our tenant mix are expanding and adding stores, and our major tenants are playing offense in their respective businesses.

Third, not all portfolios are created equal. Our focus is on good real estate locations at reasonable rents. By concentrating our underwriting on these factors, we create an enduring margin of safety that better withstands any turmoil on the general economy or in any tenants' individual business. During the depth of the recession in 2008 and 2009, our occupancy rate never dipped below 96.4%. And for the last 5 years, our occupancy rate has averaged 98.8%.

Lastly and most importantly, our associates make all the difference. The senior management at National Retail Properties averages over 18 years’ experience, and over half of our associates have been with the company for at least 10 years. The deep experience and real estate expertise of our associates and our culture of putting the shareholders' interest first positions us to seize the opportunities and address the challenges that face us daily. Even after 25 years of working with this team, I continue to be impressed and humbled by the talent, hard work and dedication of the associates who give their all for the company shareholders every day. Their high level of professional excellence, commitment to culture and institutional memory is invaluable.

Before turning the call over to Kevin, I would like to comment briefly on today's challenging capital markets environment. While all REITs are currently being affected, very few companies are better positioned than National Retail Properties to confront this more challenging environment. Our strong, low leverage balance sheet gives us great flexibility to issue equity only when we feel the price is right. Moreover, we maintained tremendous capacity on our $900 million line of credit. In addition to our balance sheet strength, we have a deep pool of single-tenant properties that can be sold one-off at attractive cap rates to raise capital for accretive reinvestment. And with our conservative dividend payout ratio, we generate significant retained earnings that are also available to be deployed where needed.

Our initial cash yield on acquisitions is in the upper 6% range, which is significantly higher than for the most property types. And our long-term leases typically include rent increases of around 1.5% annually. History tells us that cap rates will adjust upward if interest rates continue to rise. And in the meantime, our relatively high initial yields provide a meaningful cushion. In sum, National Retail Properties is well positioned to weather the current market turmoil with our healthy portfolio, our pipeline of selectively underwritten acquisitions and our conservative fortress-like balance sheet.

Let me now turn the call over to Kevin for more color on our results.

Thanks, Jay, and let me start with the usual cautionary statement that 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.

With that out of the way, headlines from this morning's press release include announcing fourth quarter results of $0.63 per share of core FFO operating results, which represent a 5% growth over fourth quarter 2016 results. For the full year, we announced core FFO results of $2.52 per share, and that represents a 7.2% increase over 2016 results and was in line with our prior guidance, which we had increased throughout 2017. So we finished 2017 on the high side of our mid-single-digit per share multiyear growth range while maintaining a strong and liquid balance sheet and not relying on large amounts of short-term and/or variable floating rate debt.

We increased our dividend 4.3% in 2017, which marks the 28th consecutive year of increased dividends, a record held by fewer than 90 public companies in the U.S. and only 3 REITs in the United States. We maintained our AFFO dividend payout ratio at 73.2% during 2017. Occupancy ticked up 30 basis points in the fourth quarter to 99.1% at December 31. We continue to drive additional operating efficiencies with G&A expense decreasing to 5.8% of revenues for the year, and that's compared to 6.8% for 2016.

For purposes of modeling 2018 results, the annual base rent for all leases in place as of December 31, 2017, was $585.3 million. One item I want to note in the fourth quarter was a $4 million charge that we took that is included in the impairment loss and other charges line item on the income statement. In connection with getting full unencumbered access to a parcel of land adjacent to one of our retail properties, we needed to settle a dispute that cost us $4 million. We are optimistic this will pave the way for unlocking significant value for this property, which we hope to realize in 2018. So stay tuned. But we're not getting into a lot of details and particulars around this property until then. But we're optimistic it's going to turn out very well.

We maintained our previous 2018 guidance. The details of which are on Page 6 of our press release, and that guidance implies 4% to 5% growth in core FFO and AFFO per share results for 2018. During the fourth quarter of 2017, we issued $81 million of common equity via our ATM. Equity raised for the year totaled $253 million. And if you combine this with the 2017 retained AFFO of $102 million, that's after all dividend payments, plus our disposition proceeds of $97 million, we've raised $452 million of equity-like capital in 2017. And that represents 60% of the $755 million of total acquisition investments we made during the year.

During the fourth quarter, we previously announced that we had recast our bank credit facility, increasing availability from $650 million to $900 million, and extending the term to January 2022. Additionally, the borrowing cost base on our current debt rating was reduced modestly to LIBOR plus 87.5 basis points, which I believe is the lowest in our sector. We ended 2017 with $120 million drawn on our bank line. But one very important point to note is that for each of the past 6 years, the weighted average outstanding balance on our bank line for the year was less than $100 million. So we've not been a particular heavy user of that short-term variable rate capital despite its availability and attractive pricing. We remain very well-positioned from a liquidity perspective and a leverage position. With the exception of our bank line, all of our outstanding debt is fixed rate. Our balance sheet remains in good position to fund future acquisitions and to weather potential economic and capital market turmoil.

Looking briefly at our year-end leverage metrics. Net debt to gross book assets was 35.3%. That's up 80 basis points from year ago 2016 levels. As you know, we've never managed our balance sheet around market-based cap leverage metrics. More notable, net debt-to-EBITDA was 4.9x at December 31 for the fourth quarter. Interest coverage was 4.7x for the fourth quarter of 2017 and the full year 2017. Fixed charge coverage was 3.6x for the fourth quarter of 2017 and 3.5x for the full year. Only 5 of our 2,764 properties are encumbered by mortgages totaling only $13 million.

In closing, I'll note 2017 7.2% increase in core FFO results follow 2016's 6% growth. And we believe 2018 will be another year of solid growth in operating results per share. On sourcing capital and making capital allocation investment decisions, driving per share results on a multiyear basis is at the forefront of our mind, not volume or size, growing per share results is job 1. Our investment strategy in terms of property type and tenant type and our balance sheet strategy have been very consistent for many years. We're optimistic we're going to be able to perpetuate our 28th consecutive year track record of raising our dividend, which is an important part of outperforming REIT equity indices and general equity market indices over the long term.

With that, Brenda, we will open it up to any questions.

(Operator Instructions) Our first question is coming from the line of Nick Joseph with Citigroup.

Jay, you mentioned that historically cap rates will adjust to higher rates. Have you seen that in the market yet, particularly cap rates adjusting up or deal volume pausing?

Nick, good morning. We have not seen any change in deal volume. The pipeline still feels very good out there across all the different lines of trade that make up our portfolio. As it relates to cap rates, from our vantage point, we are not seeing them tip upward yet. If -- we, as I noted in the comments, start in the high 6s kind of range. And for -- at that level of cap rate, with the large, regional and national operators that we do business with and seek to acquire their properties, we're just not seeing those cap rates move higher. I think if you were a buyer of lower cap rate properties, you're going to start to see those trend up sooner. But at the high 6s rate, we're not seeing any movement yet.

Given the movement of rates that have already occurred, do you think that cap rates will adjust up from here? Do you need to see rates move up even further before they'll adjust?

No. We -- Kevin and I have been doing this for 25 years so we've kind of seen it all before. And it does feel, Nick, like they ought to start moving up soon. But we're not -- I'm not completely surprised that they remain flat. There's just a lot of demand out there for our kind of assets.

I mean, if you look at the 10-year treasury as some level of benchmark for these movements, it's really only been about 2 months. So I think it's going to take a little bit higher rates and persist at those higher rates before cap rates start to move.

And then just maybe on source of capital. Do you need to issue equity to acquire the net $450 million of assets? Or would you be comfortable funding it with debt and free cash flow?

We have debt, free cash flow and dispositions are options given where our share prices today. We -- if you kind of pencil through our numbers for the fourth quarter as well, throughout 2017, you could see we were issuing equity around $42 a share. We're not sellers here today. And the good news is we don't need to be. And that's kind of a critical factor, not only managing the leverage, but also managing liquidity in terms of lack of usage of the bank line, which I've tried to highlight in my comments. So we feel very comfortable we can achieve our 4% to 5% per share growth this year without needing to lean on the equity market.

Our next question is coming from the line of Kevin Egan with Morgan Stanley.

I just had a quick question. In terms of the same-store rental income, it looks like on Page 13 of the '17 supp, you now have the properties and the leases basis. I was just curious, in terms of do you know what the property basis would have been last year? Had you provided it?

Yes. I don't have that number to give to you, so I cannot answer that. But yes, we -- as you noted, we've added to our disclosure there. We have the same-store rents for all leases that were not vacant during the year, which showed 1.5% increase in the same-store rent from all properties owned during both periods showed same-store rents of 0.4%, which the primary delta between those 2 numbers being the Gander Mountain bankruptcy. So if backing out the Gander Mountain bankruptcy, same-store rents for all properties owned for both periods would have been 1.2%. Just for some context.

Okay. And then, I guess just a quick question in terms of the sort of dispositions. It looks like the vacant property dispositions ticked up a little bit this quarter. And I know just historically you guys have been pretty reluctant to sell vacancy. So I'm just curious if you have any color around that?

Yes, we do. I mean, if you look back at our history, we have been reluctant to sell vacancies. So in 2015, we sold 6 vacant properties. In 2016, we sold 3. This year, that ticked up. Half of what we sold this year -- half of the vacant properties, I should say, we sold this year were related to the SunTrust. We've gone ahead and classified those as vacant. We -- you could maybe debate this because the reality is, we -- they weren't -- we got rent right up to the day we sold them as well as through March 31. So SunTrust paid us rent through March 31, 2018, even if we sold it in December of 2017. We call that vacant. So about half of those vacancies, these vacant dispositions you're seeing are those SunTrust properties that we're selling -- that were really still leased that -- just the second before we sold the property. But that's driving that result. I think over time, you'll see that moderate a bit once we kind of plow through the SunTrust vacant properties.

Kevin, from a strategic level, there is no trend here that you should concern yourself with. Job 1 remains leasing vacant properties. But once we've concluded that the best way to create shareholder value is not through leasing it, then we're going to look to sell the properties. But the philosophy here is still very much committed to getting those properties back into income-producing status through releasing.

Our next questions come from the line of David Corak with B. Riley.

Just starting with the Gander, Camping World, TI. I understand that TI is associated with the new rents achieved. But so is this TI just an option that they have for additional rent? Maybe just some color on that piece. And then were there any changes made to the deals since we were all last together?

Yes. David, hey, there are no changes to the arrangement with Gander Mountain since our last call or since we've talked about it. And in your analysis, it's correct. The -- our basic -- we took the big rent haircut for an as is lease with Camping World, and that was the deal that we disclosed before. That's the deal that's baked into our numbers. We -- Camping World also has an option to draw down some additional proceeds at a very accretive cap rate. We were very happy to provide that option to them, but that adds on to additional rent. It was not part of the as is deal for the original rent haircut. And so we -- I'm hopeful that they'll take the money. They're very -- it would be a good return for us.

I think importantly, too, the rent was cut sufficiently low on the first round that the incremental rent on any TI dollars they put in won't put us in a high risk position, we believe, of having burdened the property with too much rent. So I think it's -- it'll come out well for both parties.

Okay, that's great. On that topic, I guess, in the $585 million ABR number, I guess the question is, what's in there related to the 12 former Gander stores? Did that reflect the full 12 stores on a run rate basis? Is that just a portion? Or is there none in there at all?

They were all leased at year-end, so it is -- it reflects all the base rent that was in there. It does not reflect any -- obviously any rent -- incremental rent from TI funding that may come.

All right. Okay, that makes sense. All right, and then, Kevin, last one for me. You mentioned on the last call, things I'm quoting here, go precisely as planned to be able to get to the high end of '17 guidance. Obviously, you're still -- you still ended within the range and well above the initial range given. But was that impairment charge the only thing not to go to plan in 4Q? Or is there any other noise in there that's noteworthy?

No. Yes, thank you. That $4 million charge that I mentioned in my comment -- my prepared comments was the only unusual item in fourth quarter. And that's 2-plus cents a share. So if that had not occurred, we would have been well into that high end of the range if not above. And we would've hit or exceeded everyone's estimates. So that $4 million charge was really the delta. And the way I think about that, and frankly, we contemplated it from an accounting standpoint is we view that $4 million as an investment that we were going to not only recoup but create real value off of. So in our minds, we view that as a capital investment. The accounting for it, unfortunately, didn't allow us to capitalize it and we had the expenses. But we very much view that as a very good investment. And we'll be able to talk about that more hopefully in the coming quarters.

Our next questions come from the line of Michael Knott with Green Street Advisors.

Just curious. Kevin, it looked like your tenant coverage metrics that you showed were down a little bit versus last year, I think maybe just 0.2x. Any thoughts on reasons for that? Or anything related to that?

No, there's nothing really notable on that besides the general malaise within retailing. So we're not surprised by that. I think one of the lower covered tenants on the list last year was Gander Mountain. So that's obviously gone, and so it was helpful to the net uptick to the averages, if you will. But nothing of note in the coverage arena.

Michael, I would just add, we are -- we feel very comfortable and confident with the retailers -- the tenants that we're -- that are making up the portfolio right now. In the past, we've given folks heads ups about Gander Mountain and other tenants. And right now, there are no major tenants that we want to give folks a heads up about that we're losing sleep over.

Okay. And then sort of related to that. Any thoughts on the impact of tax reform to help your tenants' financial condition or liquidity?

Yes. Just generally, I mean, we think it's going to be helpful. Most -- a lot of retailers pay a pretty reasonably high tax rate, so I think they'll benefit from that theoretically, their customers, consumers have a few more dollars in their pocket. And so some of that may end up in the retailer stores. And so definitely, a positive to the retailing environment from tax reform. I mean, we're not putting a lot of stock on how much it will be. But it's the right direction anyway.

We've talked to a lot of our relationship -- the CEOs of our relationship tenants and they would echo what Kevin just said. They're happy to have the slight positive. It's not causing anyone to change their mindset on how to structure their capital stack particularly or cause them to do really more or less sale leaseback, but it's just giving them a slight lift otherwise.

Okay. And then just a couple of quick ones for me. Just on the releasing spreads, obviously, the Gander situation you had to take a pretty big haircut there with a lot of distress, I guess, I would say in the big box category nationally. But then it looked like if you excluded that, your releasing to new tenants was otherwise pretty high. I think it's at 94%. So just curious if you could comment on sort of the dichotomy in those numbers?

I don't think there's much of a trend to pull out either. Our long-term average is around 70% recovery. And it's why we only do our supplement once a year, Michael, really. Any -- there's -- we think we need a large sample size in order to really come to a conclusion. And we just had a good year other than Gander Mountain last year on releasing.

To Jay's point on sample size, there's 27 properties in that leased to new tenants. And 12 of those were the Gander being released to Camping World. So there's really only 15 others in that bucket. So you can have an outlier or 2, good or bad. This past year, good, that will drive that number higher. But to Jay's point, we think about 70% is the long-term average.

I talked about our -- both our people in my opening comments. And we handle -- we have leasing folks on staff that are charged with doing this. And that is their day job every day. To do the best they can in that arena. And like I said, 2017, they did a good job. They did a great job.

Yes. And I -- we do want to underline that we, too, work with these assets one at a time. And it's a lot of work. And even for the example, we were talking about the $4 million charge in that 1 property that we think we can create a meaningful value on. I don't want to know how many hundreds of hours of people on the floor have worked on that. But it will be worth it, we believe. And we're willing to do to roll the sleeves up and plow through and push and -- to hopefully create value at least maintain value and sometimes on deals just to salvage some value. And so we're willing to do the work at the real estate level to accomplish that.

And then just last quick one for me would be just on the cap rate comment. Do you feel like with possibly higher interest rates that there might be even less of a sort of push for competing capital from sophisticated, large capital providers in the private side of things in your industry?

Yes. I think at the end of the day, we will benefit from a more disciplined market, which will result from higher rates. And so we can withstand rates drifting higher better than a number of our other competitors, particularly in the private world. And so yes, this -- the margin should be helpful to us over time.

Our next questions come from the line of John Massocca with Ladenburg Thalmann.

So kind of first question, can you give us some more color maybe on the composition of the 4Q '17 disposition? What do you think drove that 5% to 7% cap rate? And is that something you think is sustainable over the course of 2018? Or is that more of an outlier?

Yes, the -- John, it was a mixed bag of dispositions other than the vacant dispositions that Kevin mentioned. And it kind of came from different places in our portfolio. We had a number of properties that were in there that were very highly sought after. So we had some trade in the very low 4% cap rates. And our disposition philosophy is kind of a barbell. So we're happy to sell some of the really sought after properties at low cap rates and then to also prune back on properties that we think are noncore or are more likely to -- for the tenant not to renew down the road at the end of the lease and happy to sell those at a higher cap rate. And it blended to the high-5s number that you mentioned. I think that's worth noting that in our portfolio, we have a great deal, a great number of properties that are very good fodder for capital recycling, for selling in the 5% cap rate range, in the 5s, and being able to recycle that capital very accretively into new acquisitions. But there wasn't anything otherwise particularly notable about the other dispositions there.

Okay. Does that 5% to 7% include the effects of the vacant assets? Or is that just the 5%, 7% on occupied properties you sold?

Just on the occupied properties there.

Makes sense. And then if equity markets kind of remain depressed and you don't feel your cost of equity capital is attractive, could you kind of maybe ramp up your disposition volume over the course of the year in order to fund the acquisitions? Or is that something where you just think the market is best at 800 -- sort of that $80 million to $120 million level?

No, no. We could most definitely ramp it up if we feel like that's the best source of capital to continue our growth.

Makes sense. And then kind of outside of that. Your leverage sitting here on the high 4s, if equity markets still remained depressed, I mean, where do you think -- where do you feel comfortable taking that leverage over the long term?

Yes. At the moment, we don't think we need to move it much at all. I think in the low 5s is probably -- we would be comfortable with that. But that's not our plan today to get there anytime soon.

(Operator Instructions) Our next questions come from the line of Todd Stender with Wells Fargo.

A lot of my cap rate questions have been answered. But I guess just industry concentration, when we look at your valuation relative to the peers, how are you thinking about anything above 10%, I guess, industry concentration? You've got convenience stores and full-service restaurants. How do you think about that and maybe its impact on the overall company?

Todd, the -- yes, let's work our way kind of down the list a little bit. The convenience store line of trade, I think it's important to remember that we've got almost 600 different convenience store properties in there leased to dozens of tenants in almost all over the country. So it is a very diversified portfolio of small, well-located assets. The convenience store industry is doing very well. Our convenience store tenants are doing very well, and we love the real estate attributes of convenience store real estate. So how we watch that concentration and pay attention to it and think about it, it is some of the best and safest real estate in our portfolio. And when you're thinking about concentration, in the phrase I've used with you and others before is, you want to make sure you're not guarding the wrong person. The -- you would not want to dilute your best and safest real estate with something with higher risk, but we do keep an eye on it. As it relates to restaurants, full-service and limited service are the next 2 lines of trade. And again, those are very diversified portfolios. We -- on our full-service restaurant portfolio, we look very closely at keeping our cost per property down and our rent per property as low as possible so that we build in a high margin of safety there for the operator. The lower the rent, the easier it is for the operator to succeed and stay at the property and be easier it is for us to release it if something goes wrong. So we still like the opportunities in all of those top categories, but we're just going to be very thoughtful about the dollars per property and the real estate attributes in our underwriting for those and for every other line of trade in the portfolio.

Jay, it's helpful. I think what happens is that the group is so hypersensitive to headlines. And while Amazon, it's probably not a good example with convenience stores or restaurants, but when people start talking about self-driving cars, you get the headlines, I think, anybody with that kind of concentration can get hit. So I think it's -- you're right. Like your initial comments that not all retail is bad, I just think we're more sensitive -- or investors are more sensitive with knee-jerk reactions to sell stocks even if it's triple net leased.

Yes. The ultimate security for our portfolio is that we have a whole lot of small, well-located corners at reasonable prices with reasonable rents and with good operators. What I think -- Todd, what I think it's lost a little bit in that overreaction that you just described is that people assume that good operators aren't out there every day figuring out how to meet their customers' needs of the future and to compete with Amazon or whomever comes after Amazon. That's one of the real benefits of our relationship-oriented focus is we get to spend time with lots of CEOs and CFOs and management teams of really good operators who are out there competing all day long every day in all these different lines of trade. And none of them are just saying, "Oh gosh, the future is going to be different than the past. We should just roll over and give up." They are all out there fighting and figuring out how to provide a customer experience, how to get the customer in the door, how to have their business succeed. And convenient corners are very often an important component of how they want to compete.

Just I guess switching gears towards our modeling for acquisitions. Your guidance calls for volumes that are less than what you required last year and disruptions to the capital market. So maybe cost of capital has gone up a little bit. Should we model maybe a little more conservatively and back-end-weight your volumes?

Yes, our volumes and our guidance were somewhat back-end-weighted anyway meaning like 40% first half, 60% second half of the year. But at the moment, we didn't feel compelled to change our initial guidance as where we see things. And you're correct that compared to recent years, the guidance that we've come out with is less than what we've acquired in each of the last, probably, 5 years by a fairly meaningful amount. And so we think at the moment, that feels -- our 2018 guidance feels good. And most importantly, we feel comfortable with our per share guidance, which is really, at the end of the day, what we're trying to achieve. And so we don't feel like we need to change that. But a little bit second half of the year weighted in terms of timing.

Thank you. This concludes our question-and-answer session. I'd like to turn the floor back to management for closing comments.

Thank you very much, and we look forward to seeing many of you at the upcoming conferences this spring. Good day.

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