Realty Income Corp (O) 2016 Q4 法說會逐字稿

Good day and welcome to the Realty Income fourth-quarter 2016 earnings conference call.

Today's conference is being recorded.

At this time.

I'd like to turn the conference over to Ms. Janeen Bedard, Vice President.

Please go ahead, ma'am.

Thank you all for joining us today for Realty Income's fourth-quarter 2016 operating results conference call.

Discussing our results will be John Case, Chief Executive Officer; Paul Meurer, Chief Financial Officer and Treasurer; and Sumit Roy, President and Chief Operating Officer.

During this conference call, we will make certain statements that may be considered to be forward-looking statements under Federal Securities law.

The Company's actual future results may differ significantly from the matters discussed in any forward-looking statements.

We will disclose in greater detail the factors that may cause such differences in the Company's Form 10-K.

We will be observing a two-question limit during the Q&A portion of the call in order to give everyone the opportunity to participate.

I will now turn the call over to our CEO, John Case.

Thanks, Janeen, and welcome to our call today.

We are pleased to report an excellent fourth quarter which concluded a solid year for our Company across all areas of the business.

We completed a record-high volume of high-quality property acquisitions, accessed the capital markets at favorable pricing and terms, and actively managed the portfolio to maximize value.

As a result, AFFO per share during the fourth quarter increased 10.3%, to $0.75, which contributed to 2016 AFFO per share growth of 5.1%, to $2.88.

As announced in yesterday's press release, we are introducing our AFFO per share guidance for 2017 of $3 to $3.06 as we anticipate another attractive year of earnings growth.

Now, let me hand it over to Paul to provide additional detail on the financials.

Thanks, John.

I'll provide highlights for a few items in our financial results for the quarter and the year starting with the income statement.

Interest expense decreased in the quarter by $3 million, to $49 million, and decreased in 2016 by $13 million, to $220 million.

This decrease is partly due to a lower average outstanding debt balance over the past year as we have primarily sold common equity for our capital needs over the last two years to repay outstanding bonds and mortgages.

Our October bond offering of $600 million was the first large debt offering we had completed in over two years.

The decrease in interest expense was also driven by the recognition of noncash gains on interest rate swaps during the quarter and year, which caused a decrease in that liability and lowered our interest expense.

As a reminder, we do exclude the impact of noncash swap gains or losses to calculate our AFFO.

Our G&A as a percentage of total rental and other revenues was only 4.9% for the quarter and year as we continue to have the lowest G&A ratio in the net lease REIT sector.

We project G&A to remain approximately 5% in 2017.

Our non-reimbursable property expenses as a percentage of total rental and other revenues was 1.9% in 2016.

This was slightly higher than 2015 due to higher carrying costs associated with some vacant properties.

We expect non-reimbursable property expenses as a percentage of total rental and other revenues to remain in the 1.5% to 2% range for 2017.

Provisions for impairment were $20.7 million in 2016 on 32 sold properties, 6 properties held for sale, and 2 properties held for investment.

We have increased our property sales activity a little, with $90.5 million in sales in 2016 and $75 million to $100 million of sales expected in 2017.

Briefly turning to the balance sheet.

We've continued to maintain our conservative capital structure.

In 2016, we raised approximately $573 million of common equity capital.

In fact, over the last two years, approximately 70% of the capital we have raised has been common equity, and our balance sheet remains very flexible.

Our senior unsecured bonds have a weighted-average remaining maturity of 6.6 years, and we have approximately $900 million available under our $2 billion revolving credit facility.

Other than our credit facility, the only variable-rate debt exposure we have is on just $38 million of mortgage debt.

Our overall debt maturity schedule remains in very good shape, with only $278 million of debt coming due in 2017, and our maturity schedule is well laddered thereafter.

Finally, our overall leverage remains modest, with our debt-to-EBITDA ratio standing at approximately 5.7 times.

In summary, we have low leverage, excellent liquidity, and continued access to attractively priced equity and debt capital, both of which remain well-priced financing options today.

Let me turn the call now back over to John.

Thanks, Paul.

I'll begin with an overview of the portfolio, which continues to perform well.

Occupancy based on the number of properties was 98.3%, unchanged from last quarter.

We expect our occupancy to remain at approximately 98% in 2017.

During the year, we released 186 properties to existing and new tenants, recapturing 105% of the expiring rent, which is well above our long-term average.

Since our listing in 1994, we have re-leased or sold more than 2,300 properties with leases expiring, recapturing approximately 98% of rent on those properties that were re-leased.

This compares favorably to the handful of net lease companies who also report this metric.

We remain active in our asset and management efforts as we look to enhance the returns on our existing properties as well.

Our same-store rent increased 0.9% during the quarter and 1.2% in 2016, which is generally consistent with the run rate we expect for our portfolio in 2017.

90% of our leases continue to have contractual rent increases, so we remain pleased with the growth we were able to achieve from our properties.

Approximately 75% of our investment-grade leases had rental rate growth that averages about 1.3%.

Our portfolio continues to be diversified by tenant, industry, geography, and to a certain extent, property type, all of which contributes to the stability of our cash flow.

At the end of the quarter, our properties were leased to 248 commercial tenants in 47 different industries located in 49 states and Puerto Rico.

79% of our rental revenue is from our traditional retail properties.

The largest component outside of retail is industrial properties, at about 13% of rental revenue.

Walgreens remains our largest tenant, at 7% of rental revenues, and drug stores remain our largest industry, at 11.4% of rental revenue.

During the fourth quarter, we added two new tenants to our top 20, including 7-Eleven, which represents 1.8% of our annualized rental revenue, and Home Depot, which represents 1.1% of our annualized revenue.

We are pleased with these additions as both of these tenants are investment-grade rated, best-in-class operators in their respective industries, with excellent real estate locations and strong store-level metrics.

We continue to have excellent credit quality in the portfolio, with 47% of our annualized rental revenue generated from investment-grade rated tenants.

The store-level performance of our retail tenants also remains sound.

Our weighted-average rent coverage ratio for our retail properties remains 2.8 times on a four-wall basis, and the median remains 2.7 times.

Moving on to acquisitions.

We completed $1.86 billion in property-level acquisitions in 2016, of which $786 million was completed during the fourth quarter.

Both of these amounts were record-high volumes for our Company and were completed at investment spreads relative to our nominal first-year weighted-average cost of capital that well exceed our historical average.

We continue to see a steady flow of opportunities that meet our investment parameters.

In 2016, we sourced $28.5 billion in acquisition opportunities.

We remain disciplined in our investment strategy, acquiring less than 7% of the amount sourced, which is consistent with our average since 2010.

Our selectivity reflects our focus on quality.

Our distinct cost-of-capital advantage allows us to consistently grow earnings while adding the highest quality investment opportunities to our portfolio.

Given the pipeline we are seeing today, we are introducing 2017 acquisitions guidance of approximately $1 billion.

As a reminder, this estimate reflects our typical flow business and does not account for any unidentified large-scale transactions.

I'll hand it over to Sumit to further discuss our acquisitions and dispositions.

Thank you, John.

During the fourth quarter of 2016, we invested $786 million in 279 properties located in 27 states, at an average initial cash cap rate of 6.1% and with a weighted-average lease term of 14.3 years.

On a revenue basis, approximately 84% of total acquisitions are from investment-grade tenants.

94% of the revenues are generated from retail, and 6% are from industrial.

These assets are leased to 27 different tenants in 21 industries.

Some of the most significant industries represented are convenience stores, financial services, and discount grocery stores.

We closed 24 discrete transactions in the fourth quarter, and the average investment per property was approximately $2.8 million.

During 2016, we invested $1.86 billion in 505 properties located in 40 states, at an average initial cash cap rate of 6.3% and with a weighted-average lease term of 14.7 years.

On a revenue basis, approximately 64% of total acquisitions are from investment-grade tenants.

86% of the revenues are generated from retail, and 14% are from industrial.

These assets are leased to 51 different tenants in 28 industries.

Some of the most significant industries represented are convenience stores, drug stores, and financial services.

Of the 85 discrete transactions closed during 2016, 5 transactions were above $50 million.

Transaction flow continues to remain healthy.

We sourced more than $5 billion in the fourth quarter.

During 2016, we sourced $28.5 billion in potential transaction opportunities.

Of these opportunities, 61% of the volume sourced were portfolios, and 39%, or approximately $12 billion, were one-off assets.

Investment-grade opportunities represented 26% for the fourth quarter.

Of the $786 million in acquisitions closed in the fourth quarter, 30% were one-off transactions.

As to pricing, cap rates remained flat in the fourth quarter with investment-grade properties trading around 5% to high-6% cap-rate range, and non-investment-grade properties trading from high-5% to low 8% cap-rate range.

Our investment spreads relative to our weighted-average cost of capital were healthy, averaging 214 basis points in the fourth quarter, which were well above our historical average spreads.

We define investment spreads as initial cash yield less our nominal first-year weighted-average cost of capital.

Our disposition program remained active.

During the quarter, we sold 26 properties for net proceeds of $34.4 million, at a net cash cap rate of 7%, and realized an unlevered IRR of 8.5%.

This brings us to 75 properties sold during 2016 for $87.6 million, at a net cash cap rate of 7.3% and an unlevered IRR of 8.5%.

In conclusion, we had an exceptional year in 2016 regarding acquisitions as well as dispositions.

We look forward to achieving our 2017 acquisition target of approximately $1 billion and disposition volume between $75 million and $100 million.

With that, I'd like to hand it back to John.

Thanks, Sumit.

As Paul mentioned, 2016 was an active year for our capital markets activities.

We issued $573 million in common equity, at an average price of approximately $61 per share, reflecting the lowest cost of equity raised in any year in our Company's history.

Additionally, with the highest credit rating in the net lease sector, we issued $600 million in 10-year, fixed-rate, unsecured debt at a yield of 3.15%, the lowest yield for debt we have issued with this term in our Company's history.

Our 10-year credit spread, which has narrowed by over 20 basis points since the offering, is now among the lowest in the entire REIT industry.

Our leverage remains low, with debt-to-total-market cap of approximately 28% and debt to EBITDA of 5.7 times.

We currently have approximately $1.1 billion outstanding on our $2 billion line of credit, which can be expanded to $3 billion at our option.

This provides us with ample liquidity and flexibility as we continue to grow our Company.

Last month, we increased the dividend for the 90th time in the Company's history.

The current annualized dividend represents a 6% increase over the prior year.

We have increased our dividend every year since the Company's listing in 1994, growing the dividend at a compound average annual rate of just under 5%.

Our AFFO payout ratio is 83.5%, which is a level we are quite comfortable with.

To wrap it up, we are pleased with our performance in 2016 and remain quite optimistic for 2017.

As demonstrated by our sector-leading EBITDA margins of approximately 93%, we continue to realize the efficiencies associated with our size and the economies of scale in the net lease business.

Our portfolio remains healthy, and we continue to see an ample volume of acquisition opportunities that allows us to consistently grow earnings.

The net lease acquisition environment remains a very efficient marketplace, and we believe we are best positioned to capitalize on the highest quality opportunities given our sector-leading cost of capital, access to capital, and balance sheet flexibility.

At this time, I would now like to open it up for questions.

Operator?

(Operator Instructions)

We will take our first question from Vineet Khanna with Capital One Securities.

And, also, please be sure to limit your question to one and one follow-up.

Yes.

Hi, folks.

Thanks for taking my questions.

Just regarding the credit facility and understanding that you can expand it by $1 billion, what are your plans for the $1.1 billion that's sitting on it now?

Would you consider tapping the preferred market versus pricing significantly better in the 10-year or 30-year bond market?

Vineet, we have a tremendous amount of financial flexibility right now, as I said in the opening comments.

And, at the appropriate time.

We'll take a look at all forms of capital that are available to us, and that would include unsecured debt, equity, as well as hybrid capital and make a decision as to what makes the most sense at that time to term out some of the line.

But, in terms of leverage right now, with a debt-to-EBITDA of 5.7 times, we're well within our targeted ranges and feel very comfortable about where the balance sheet is.

Okay, great.

And then, looking at the transaction market, have you seen any changes in portfolio premiums or discounts?

And, it sounds like there were a handful of portfolios in the fourth quarter including the large convenience store one.

So, maybe you could talk about the trends there?

Sure, the premiums right now are for one-off assets.

On the portfolio side, especially when you get to the higher quality product and large investment dollars, there's substantially less competition because there aren't very many players who can execute, if any, in the public sector who can execute on that type of transaction.

So, what we are experiencing right now are cap rates on one-off transactions that are 25 to 75 basis points lower than where they are on the larger portfolio transactions.

Great, thank you.

Thank you.

We'll take our next question from Joshua Dennerlein with Bank of America Merrill Lynch.

Hi.

Question, in guidance, what are you budgeting for CapEx in 2017?

For recurring CapEx in 2017, we're budgeting $5.5 million.

Is that the standard run rate going forward, or is that an uptick?

It hops around.

In 2016, it was $1.5 million.

In 2015, it was $8.5 million.

So, really it's driven by timing on those recurring CapEx and the requirements fluctuate year to year so there's not really a smooth run rate.

But, I'd say, in general, it's somewhere between $2 million to $8 million over the next few years, and this year, we're projecting $5.5 million.

Okay, thanks.

And then, where are you seeing the best opportunities across asset types and tenant types in the market right now?

I'd say it's pretty broad right now.

It's consistent with what we were seeing last year where some of our larger, more attractive industries, we're seeing product from tenants in those industries.

And, whether it be C-stores, QSRs, some theatre opportunities, some fitness opportunities -- it really is quite broad.

And, I can't say there's one particular industry that's driving the opportunities on the investment side that we're seeing currently.

But, we do have a good flow of opportunities as we mentioned in the opening remarks.

We will take our next question from Michael Knott with Green Street Advisors.

Hi.

Obviously, you're blessed with a very attractive cost of capital, particularly on the equity side.

Debt side also, but on the equity side.

I'm just curious, given your record level of acquisitions you reported last night at one of the lower yields combined with the market's pretty favorable reaction this morning -- curious if that has any bearing on your thoughts on where you go and where you position yourself on the quality spectrum in terms of acquisitions.

It seems like you're focused more on the higher quality side here lately with better cost of capital.

Just curious, if today's reaction gives you any pause on that?

Well, I think, given our distinct cost of capital advantage, we're able to focus on the highest quality net lease properties and investments out there.

This is a very efficient market, and as you go out on the risk in yield spectrum, you're going to be taking on issues that you don't take on on the higher quality.

And, with our unique position, we're certainly able to achieve IRRs that exceed our hurdle rates and spreads -- initial spreads relative to our first-year nominal weighted average cost of capital that are much wider than what they have been historically.

So, we plan to maintain that quality focus, and we think it's paying off.

And, we think the market is respecting that.

Okay, thanks.

And then, other question for me would just be, curious if you can talk about the occupancy -- tiny reduction you expect in 2017?

Is there any particular credit issues that you're seeing generally across a couple different types of industries?

Or, is it just pretty normal course of business?

Just normal.

We have been in this 98%-plus-or-minus range, and it's hard to get it down to 0.1 of a percentage point in terms of prediction.

So, in our model, we modeled approximately 98%.

The portfolio -- there are no material issues in the portfolio right now.

We feel quite good about its health, and 98% is not indicative of any downturn on the portfolio front.

We'll take our next question from Nick Joseph with Citigroup.

Thanks.

John, you mentioned the premiums on the one-off assets and not portfolios, so is it fair to assume that if you do exceed your 2017 acquisition guidance that it could be more meaningful because it would be driven by those portfolio deals?

Yes, I think that's fair to say, Nick.

And then, I guess along that line, in terms of potential M&A in the space, just wondering if you have any updated thoughts?

Just given multiple disparity among the group?

No I don't.

I don't like to speculate on any potential or theoretical M&A activity, so I don't really have any thoughts to share publicly on that front.

We will take our next question from Vikram Malhotra with Morgan Stanley.

Hi, this is Landon Park on for Vikram.

Just to start off, I was wondering if you could touch base on the 7-Eleven portfolio you purchased?

Just the process there as well as the underlying lease characteristics?

Well, we're subject to CA, so I can't get into specific details on that portfolio, but what I could do is talk about what we look for when we do a C-store transaction.

So, again, we're focused on quality, really a best-in-class operator with high-quality real estate.

Store sizes that are at least 3,000 square feet because that's where these C-stores drive their profits, and that's where their margins are.

We want to be in properties that are reflective of market rents and replacement costs, and we want good coverages.

And, having a great credit is icing on the cake, and we prefer to be with best-in-class operators.

Couche-Tard -- Circle K is another one of our Top 20 tenants.

That's what we like.

We're actually selling some C-stores right now, and the ones we're selling are a contrast of what I just described.

We don't have a lot of them, but they are non-strategic in that the store sizes are 500 square feet or less.

They are more kiosk, regional.

The locations are inferior, and certainly, the credits are inferior to someone like a 7-Eleven.

We don't really experience a lot of competition certainly from the public sector on those types of transactions because, again, going back to our cost-of-capital advantage and our ability to execute and clear our hurdles and drive earnings through these types of investments.

Could you give any sense of pricing relative to what you did on average for the quarter?

Or, where the coverage levels are on average compared to your existing portfolio?

The coverage levels on those types of transactions exceed our average for our overall portfolio.

I can't release specifics on that front given the fact that we're subject to a CA.

Thank you very much.

We'll take our next question from Michael Carroll with RBC Capital.

Thanks.

John, how would you characterize the competitive landscape today, and has that changed over the past few quarters?

Not materially.

When we are looking at the higher quality investments that we've been talking about some on today's call, we don't see as many public companies, if any, there.

We see institutional capital being run by institutional investment managers that are familiar and experts in the net lease sector.

So, when we go out a bit on the yield and a little bit out on the risk spectrum, we start to bump into some of the other public and private REITs out there in the net lease space.

Pus we see some mortgage REITs and sometimes private equity capital.

That's been consistent for the last few quarters, if not the last 1.5 years, so no real discernible changes on that front.

Can you give us some color on the planned dispositions that you have in your guidance?

What's the main reason for these sales?

And, are they vacant or stabilized assets?

It's a mix.

So, we're guiding to $75 million to $100 million in dispositions this year.

That's really comprised of the kiosk, lower quality, legacy C-stores and some casual dining opportunities, as well as some daycare properties that are no longer consistent with our investment strategy that we're moving now.

Some are vacant, and some are leased.

It's probably 50/50 somewhere in that neighborhood.

With the $90 million we did last year, those were also non-strategic sales.

And, on the leased assets which were about 50% of what we sold, we achieved cap rate in the low 7%s, so that gives you an idea of the market where we can sell non-strategic assets in the low 7%s.

Our overall unlevered IRR on all of our sales including our vacant properties was 8.5%, and again, these are our non-strategic investments that we're selling.

Thanks.

Thank you.

We'll take our next question from Daniel Donlan with Ladenburg.

Thank you.

Good afternoon.

Just had a quick question on, you used to talk about a metric called the DARTH score, and just curious if you still use that?

And, what's that showing in terms of tenant health now versus maybe what it did at this time last year, given the weakness seen with many bricks-and-mortars retailers in the fourth quarter.

I'm curious if that has picked up, or what's going on there?

We've converted from a DARTH to an S&P approach in terms of credit, so the DARTH days are behind us.

But, I can talk about the categories from a credit perspective.

We have really four categories from a tenant credit, and it's excellent, above average, average and below average.

And, below average are the weaker credits, and they represent about 6% of our revenues.

But, our watch list -- the list from which we sell is in the low 1%s, and that watch list combines both the credit and the quality of the real estate.

So, there's some very high quality real estate in that 6% below average credit bucket that we wouldn't mind getting back and selling or re-leasing.

And so, we're fine holding on to that.

The trends have been pretty consistent there.

The watch list is hovering in the low 1%, and the below average credit has been in the 7%.

I'll tell you, you've been following us for a long time.

If you go back eight years ago, and you looked at our Top 20 tenants the average rating would be double B minus.

You flash forward to today and at the end of 2016, the average rating of our top 20 tenants is a solid triple B. So, we've made real good progress over the years in upgrading the credit profile, and we feel good about where the portfolio stands, Dan.

Appreciate it.

And then, curious on the lower cap rates.

If you could comment on what percentage of acquisitions maybe in the fourth quarter or even 2016 were direct sale lease backs?

I'm wondering if the low cap rates is more or less a function of you trying to engineer higher rent coverage ratios versus just simply paying a low cap rate?

So, any commentary on that would be helpful.

Yes, well on the sale lease back, 75% of the activity in the fourth quarter was sale lease back.

For the year, it was about 60%.

We don't financially engineer transactions so we want to underwrite market rents.

We could juice those rents and show higher cap rates, but that gives you risk on the residual and long-term risk so we've always avoided that.

And, we don't mind announcing an initial yield of 6.1% like we did in the fourth quarter when we're buying the quality assets that we're buying.

We're still making, as I said, great spreads, well above our historical average.

And, on our IRRs, we're exceeding notably our hurdles there.

So, what we see done in the industry is some players dressing up their yields by buying assets that have rents that are well above market, and in the long run, it's our opinion that's just not a value-creating exercise.

Okay, thanks.

Thank you.

We'll take our next question from Jeremy Metz with UBS.

Hi, just one quick one.

You have the $409 million of preferred with a coupon of a little over 6.6%.

I believe it just became callable last week.

So, given the coupon versus where you are buying assets and call it the low 6% range, it would seem like redeeming this would clearly seem to make sense.

Can you give us your thoughts around this?

And what, if anything, is baked into guidance?

We're going to take a look at this coming out of the call in the next few weeks and determine what's appropriate for the Company and the shareholders.

We've made no definitive decisions on that.

Okay, so nothing in guidance then?

No.

Okay.

Thanks.

This concludes the question-and-answer portion of Realty Income's conference call.

I would now turn the call over to John Case for concluding remarks.

Okay, thank you, Kyle.

Thanks to everyone for joining us today, and I know we'll be visiting a number of our investors who were on the call today in less than two weeks at the Citi conference.

We look forward to that.

And, again, thanks for your participation and have a good afternoon.

This does conclude today's conference call.

Thank you all for your participation.

You may now disconnect.