Realty Income Corp (O) 2017 Q4 法說會逐字稿

Good day, and welcome to the Realty Income Fourth Quarter and Year-End 2017 Operating Results Conference Call.

Today's conference is being recorded.

At this time, I'd like to turn the conference over to Janeen Bedard, Senior Vice President.

Please go ahead.

Thank you, all, for joining us today for Realty Income's Fourth Quarter 2017 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're pleased to complete another successful year for our company, with healthy AFFO per share growth of 6.3%.

We achieved this growth while completing just over $1.5 billion in high-quality acquisitions generating favorable rent recapture rates and continuing to strengthen our balance sheet, becoming one of only a handful of REITs with at least 1 single A credit rating.

We are introducing 2018 AFFO per share guidance of $3.14 to $3.20, which represents annual growth of approximately 3% to 5%.

Let me hand it over to Paul now to provide additional detail on our financial results.

Paul?

Thanks, John.

I'm going to provide highlights for a few items and our financial results for the quarter and year, starting with the income statement.

Interest expense increased in the quarter by $12.5 million to $61.5 million.

This increase was due to the $2 billion of long-term bonds we issued during 2017, as well as lower interest rate swap gain versus the comparative quarter a year ago.

Our G&A, as a percentage of total rental and other revenues, was 5.1% for the quarter and 5% for the year, which was in line with our full year projection.

We continue to have the lowest G&A ratio in the net lease REIT sector, and we project G&A to remain approximately 5% in 2018.

Our nonreimbursable property expenses, as a percentage of total rental and other revenues, was 1.8% for the quarter and 2% for the year, which also was in line with our full year projection.

We expect nonreimbursable property expenses to remain in that 1.5% to 2% range in 2018.

Funds from operations, or FFO, per share was $0.61 for the quarter and $2.82 for the year.

In the fourth quarter, we recognized a one-time charge of $42.4 million or $0.15 per share as a result of the early redemption of our 6.75% 2019 bonds, which we replaced with longer term and lower coupon bonds.

As a reminder, our reported FFO does follow the NAREIT defined FFO definition, which includes various nonrecurring and noncash items such as: interest rate swaps, gains or losses; amortization of lease intangibles; the $0.05 charge we incurred in connection with our preferred stock redemption back in April; and this $0.15 bond redemption charge we incurred in December.

These 2 redemption charges from liability management this year, totaling $0.20 cents, were the primary driver of the difference in FFO and AFFO in 2017.

Adjusted funds from operations, or AFFO or the actual cash we have available for distribution as dividends, was $0.76 per share for the quarter and $3.06 for the year, representing a 6.3% increase over 2016.

Briefly turning to the balance sheet.

We've continued to maintain our conservative capital structure.

During the quarter, we raised $136 million in equity, primarily through our ATM program.

For the full year, we raised over $1.4 billion in equity at approximately $60 per share.

Additionally, we issued $1.3 billion in long-term fixed-rate unsecured bonds during the quarter, at a weighted average yield of 3.48% and a weighted average term of 11.8 years.

Last year, we extended the weighted average maturity of our bonds from 6.6 years at the start of the year to 9.3 years at the end of 2017.

Additionally, our fixed charge coverage ratio is now 4.8x, which is the highest coverage in our company's history.

Our overall debt maturity schedule remains in very good shape, with less than $100 million of debt coming due the remainder of 2018, and our maturity schedule is well laddered thereafter.

Our overall leverage remains modest.

Our pro forma debt to EBITDA, assuming the annualized impact of our fourth quarter acquisitions, is now 5.4x.

In summary, we continue to have low leverage, excellent liquidity and strong coverage metrics.

And now let me call back over to John.

Thanks, Paul.

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

Our occupancy, based on the number of properties, was 98.4%, an increase of 10 basis points versus the year-ago period and matching our 10-year high for year-end occupancy.

We expect occupancy to be approximately 98% for 2018.

During the year, we released 259 properties, recapturing approximately 106% of the expiring rent, which is significantly above our long-term average.

This was our sixth consecutive quarter of leasing recapture rates above 100%.

Our recapture rates reflect net effective rents, as we saw them incur tenant improvements and leasing commissions.

This compares favorably to those companies in our sector who also report this metric.

Additionally, our recapture rates have continued to improve as we have increased our active asset management efforts.

Since 2013, our recapture rates have been 102%, an improvement over our previous run rate of 96%.

This is a testament to the talent and experience of our portfolio and asset management teams, which we view as one of our competitive advantages in the net lease industry.

Moving on to dispositions.

We also continue to selectively sell properties that no longer meet our investment criteria.

In 2017, we sold $166 million of nonstrategic assets, achieving an unlevered IRR of approximately 10% and a cap rate on leased property sales of approximately 7%.

20% of the disposition proceeds were from vacant assets that we were pleased to dispose of, given the associated carrying costs.

These negative cash flowing properties were sold at an attractive unlevered IRR of approximately 9%.

This allowed us to recycle the proceeds into properties that better fit our investment criteria, generating earnings growth and incremental shareholder value.

Our same-store rental revenue increased 1% during the year, which is consistent with our projected run rate for 2018.

The methodology for our same-store pool excludes properties that were vacant, under development or redevelopment or involved in eminent domain actions during any point of the comparable periods.

Our methodology is consistent with how we manage our portfolio, isolating our rental rate trends on leased assets.

However, we recognized that some in the investment community prefer to analyze this metric without excluding any properties.

As a result, we have decided to add an additional disclosure, which we will present on an annual basis at year-end to reflect our same-store rental revenue growth, inclusive of all properties owned for the entirety of the comparable periods.

In 2017, our same-store rental revenue growth for all properties owned in both comparable years was also 1% of rent.

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

At the end of the year, our properties were leased to 249 commercial tenants in 47 different industries located in 49 states in Puerto Rico.

81% of our rental revenue is from our traditional retail properties.

The largest component outside of retail is industrial properties at about 12% of rental revenue.

Walgreens remains our largest tenant at 6.5% of rental revenue, and drugstores remained our largest industry at 10.6% of rental revenue.

Within our retail portfolio, over 90% of our rent come from tenants with a service, nondiscretionary and/or low price point component to their business.

We believe these characteristics allow our tenants to compete more effectively with e-commerce and operate in a variety of economic environments.

These factors have been particularly relevant in today's retail climate, where the vast majority of U.S. retailer bankruptcies in 2017 were in industries that do not possess these characteristics.

We continue to have excellent credit quality in the portfolio, with 46% of our annualized rental revenue generated from investment-grade rated tenants.

The store level performance of our retail tenants also remained sound.

The weighted average rent coverage for our retail properties is 2.8x on a 4-wall basis, while the median remains 2.7x.

This metric is currently at the upper end of our historical range.

Our watch list remains in the low 1% range as a percentage of rent, which is also consistent with our levels of the last few years.

Moving on to acquisitions.

We completed just over $1.5 billion in acquisitions in 2017, of which $563 million was completed during the fourth quarter.

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

During the quarter, we sourced $6.2 billion in acquisition opportunities, bringing us to $30.4 billion sourced in 2017.

We remained selective in our investment strategy, acquiring approximately 5% of the amount sourced.

Our capital costs have increased recently.

We continue to invest at accretive investment spreads over our short-term cost of capital that are consistent with our historical average of approximately 150 basis points.

As a reminder, our nominal first year weighted average cost of capital reflects both our current AFFO yield as well as our cost of 10-year unsecured fixed rate debt, which has experienced considerable spread compression following our upgrade to A3 by Moody's in November.

Our continued low cost of capital allows us to acquire the highest-quality properties that provide favorable long-term returns, while also creating meaningful near-term earnings growth.

Given the continued strength in our investment pipeline and the current market environment, we're estimating 2018 acquisitions to be $1 billion to $1.5 billion.

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

I'll hand it over to Sumit now to discuss acquisitions and dispositions in more detail.

Thank you, John.

During the fourth quarter of 2017, we invested $563 million in 130 properties located in 27 states at an average initial cash cap rate of 6.25% and with a weighted average lease term of 13.6 years.

On a revenue basis, approximately 65% of total acquisitions are from investment-grade tenants.

91% of the revenues are generated from retail and 9% are from industrial assets.

These assets are leased to 28 different tenants in 16 industries.

We closed 30 discrete transactions in the fourth quarter and the average investment per property was approximately $4.3 million.

During 2017, we invested $1.52 billion in 303 properties located in 40 states at an average initial cash cap rate of 6.4% and with a weighted average lease term of 14.4 years.

On a revenue basis, approximately 48% of total acquisitions are from investment-grade tenants, 95% of the revenues are generated from retail and 5% are from industrial.

These assets are leased to 61 different tenants in 23 industries.

Of the 80 discrete transactions closed during 2017, 4 transactions were above $50 million.

Transaction flow continues to remain healthy.

Of the opportunities sourced during the year, 49% were portfolios and 51% were one-off assets.

Investment-grade opportunities represented 23% for the fourth quarter.

Of the acquisitions closed in the fourth quarter, 57% were one-off transactions.

As to pricing, cap rates remained steady in the fourth quarter.

Our investment spreads relative to our weighted average cost of capital were healthy, averaging 175 basis points in the fourth quarter, which were 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 13 properties for net proceeds of $97.2 million, at a net cash cap rate of 6.9% and realized an unlevered IRR of 8.7%.

This brings us to 58 properties sold during 2017 or $166.2 million at a net cash cap rate of 7.1% and an unlevered IRR of 9.9%.

We had an exceptional year in 2017 regarding acquisitions as well as dispositions.

We look forward to achieving our 2018 acquisition target and disposition volume between 75 million and 100 million.

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

Thanks, Sumit.

As Paul said, 2017 was a very active year for our capital markets activities.

We issued just under $1.5 billion in common equity, at an average price to investors of $60 per share.

Additionally, we issued $2 billion in fixed-rate unsecured bonds at a weighted average yield of 3.7%, with a term of over 14 years.

A nearly $3.5 billion of permanent and long-term capital was used to term out our line balance, fund our acquisitions activity and redeem high coupon bonds.

As a result of these capital markets activities, we reduced our leverage and extended the average term on our debt by almost 3 years.

We currently have approximately $1.5 billion available on our $2 billion line of credit.

We have ample liquidity and flexibility as we grow our company.

Last month, we increased the dividend for the 95th time in our company's history.

Our current annualized dividend represents a 4% increase over the year-ago period.

We have increased our dividend every year since the company's listing in 1994, growing the dividend at a compound average annual rate of 4.7%.

We are proud to be 1 of only 5 REITs in the S&P High Yield Dividend Aristocrats Index.

Our 2017 AFFO payout ratio of 82.6% was our lowest payout ratio since 2007.

To wrap it up, we are pleased with our company's performance in 2017 and remained optimistic for 2018.

Our real estate portfolio, acquisitions pipeline and balance sheet all remain healthy, contributing to favorable risk-adjusted earnings growth for our shareholders.

At this time, I'd like to open it up for questions.

Operator?

(Operator Instructions) And we'll take our first question from Joshua Dennerlein with Bank of America Merrill Lynch.

My question is on lease renewals.

What was the nature of lease renewals in '17?

Did you renew anything early that might have been expiring in '18 or beyond?

And what's up for renewal this year that you haven't renewed yet?

Yes.

That's a great question, Josh.

We have consistently proactively got in front of our future year's lease rollover.

So last year, we were able to address more than 30% of the 2018 leases rolling during 2017.

So we had good activity on the properties re-leased in 2017, achieving above average recapture rates.

We didn't really have a lot of significant re-leasing activity amongst our top 20 tenants, but we did have some fairly sizable portfolios that we were able to address in 2017 that were set to expire in 2018.

One of those was our PNC Bank portfolio.

We owned 49 assets leased to PNC Bank and we were able to release 47 of the 49 assets to PNC during 2017 and extending the maturities from 2018 to -- ranging from 2023 to 2029, and we were able to add a substantial term to those leases and also recapture rental rates that were well above our average for the year.

So that's something we've always done.

As we sit here today, we're working on 2019 and 2020 lease rollovers, including the remaining lease rollovers for 2018.

And next we'll go to Vikram Malhotra with Morgan Stanley.

It seems like your acquisition guidance for the year was a little bit above expectations.

You've mentioned there's no unidentified portfolio in there, but is there something large that you may have identified?

And just related to that, can you give us a sense of where you could take leverage if say the equity markets don't cooperate?

Sure.

The acquisitions estimate we came up with for this year is the highest that we've come up with at this juncture of the year.

Last year, as you may recall, at this point, we were predicting $1 billion in acquisitions and we executed $1.52 billion in acquisitions.

So we're optimistic we're seeing good transaction flow on the acquisition side.

And we think the right range in the current market conditions is $1 billion to $1.5 billion.

We have a number of sources of capital to fund our acquisitions growth, including -- we have a conservatively capitalized balance sheet today, so we do have some debt capacity.

We do have $1.5 billion available on the line of credit, but we also have retained cash flow proceeds, and then proceeds from asset sales as well to help us fund our acquisitions growth.

While we could find growth at today's share price and have it be accretive, it's something we'd prefer not to do.

I think we're one of the few REITs in the sector that actually could say that.

But it was -- it would be something we'd prefer not to do at this juncture.

And then, just, a second question.

The same-store NOI calculation that you provided, including all properties, just curious, have you done that calculation for say '15 and '16, just so we get a sense of how that number is trended?

Yes, we have.

And it's been relatively consistent.

So let me look at these, yes, so it's, in 2016, it was right at about 1%.

And in 2015, it was right at about 1.8%.

So we've looked at this and it's remained pretty consistent.

So I think it will continue to remain more or less in this range.

And going back to your first question, I think something I failed to answer was, where are we comfortable in terms of leverage?

We're very much committed to our current ratings from Moody's of single A3 and S&P BBB+ with a positive outlook and Fitch at BBB+.

So we want to preserve those ratings, because along with those ratings comes a very attractive cost of debt capital that helps our business.

And next, we'll go to Nick Joseph with Citi.

John, just going back to your comments on equity issuance.

How do you think about balancing issuing equity conceivably below either consensus NAV or your view of where NAV is versus an attractive investment spread relative to investment opportunities?

Yes, well, we would like to issue equity at higher prices than lower prices.

Obviously, due to macroeconomic factors that sector has been under some pressure in terms of values.

But again, I'll go back to what I said a moment ago, that we have multiple sources of capital to fund our growth.

And while we could fund some growth accretively at these equity prices, we prefer not to issue with these equity prices.

So -- and don't believe we necessarily will have to do that.

And just maybe more broadly on the transaction market.

Have you seen any adjustment of cap rates or deal volume given the rise in interest rates?

And then maybe secondly, if rates just stabilize around 3%, if cap rates haven't moved already, do you think they would move just given the kind of past movement of rates already?

Yes.

So we've always seen over our careers and lifetime cap rates following the cost of capital, albeit with a lag.

They're not like the 10-year treasury or securities that on a minute by minute basis have relatively significant changes in their yields.

So cap rates tend to follow the cost of capital over the longer run.

So it may take a quarter or 2 or even 3 for cap rates to catch up to where capital costs are.

I will say, however, that while our cap rates were pretty much unchanged in the fourth quarter of last year, and the discussions we're having with the sellers today, there's more of a willingness to entertain negotiations and transactions at cap rates that are higher than where they would have been in 2017.

So perhaps, we're seeing the beginning of that movement, and we would expect to see it occur throughout the year if capital costs were to remain elevated.

And next we'll go to Karin Ford with MUFG Securities.

Just to follow-up on the capital discussion we're having here.

John, just want to be clear, so do you think you have enough debt capacity, excess cash flow and/or disposition proceeds that you could fully fund your acquisition guidance today with no ATM issuance?

Well, I think, it all depends on the level of asset sales.

The routine cash flow after CapEx is pretty fixed around $150 million.

But on the asset sales front, that something we could tweak.

We're guiding to $75 million to $100 million.

But last year, we did almost $175 million.

So then, we have some additional leverage capacity given the conservative nature of the balance sheet today.

And could that get us to within the range?

I think it could.

I think it could.

I mean we'll have to look at that and see.

But again, we're fortunate, in that at today's price we could invest accretively at today's share price, but we would prefer not to, given the current levels.

My second question is just on the -- your core expectations for 2018.

Now performance has been really steady, credit has been great in your portfolio up to this point.

But given the continuing evolution of what's going on in your tenant base, both with consolidation, disintermediation and the like, did you consider taking a more conservative approach about your occupancy expectations for example, maybe considering potential store closures for this year?

Well, we've looked at the entire portfolio and our portfolio has been more resilient to the impact of e-commerce, given its nature with having a service nondiscretionary or deep low-price point orientation to it.

But as we did our analysis and preparing our plan for this year, we accounted for what we believe would be tenant credit issues that would occur in 2018 and those are baked into our guidance.

And at this point, we're not expecting and we're not hearing of any material tenant credit issues within the portfolio.

And next we'll go to Collin Mings with Raymond James.

First question for me, just going back to the flexibility you just highlighted on the disposition front, depending upon the capital markets.

Any specific thing driving initial guidance here [would -- just] suggesting like a material deceleration from last year?

Well, last year was a bit of an outperformance.

We were able to sell 2 office buildings accounting for about $73 million in proceeds.

We -- your office is not strategic to our investment philosophy, so we have been trimming that down, and you can see that in our numbers.

So it was a bit higher than normal.

But that's a program we can flex on the disposition side, if we needed to.

So if the capital we could access through dispositions was more appealing from a valuation and price perspective and issuing shares, we could certainly do that and increase the levels through our asset management team on the disposition side.

But as of right now, we're still guiding to $75 million to $100 million in dispositions.

As you all know, typically we've exceeded those numbers.

And then, maybe, I just -- as far as acquisition activity during the quarter.

Can you maybe just expand upon the industrial acquisitions during the quarter as well as the increased exposure to Walmart?

Yes.

Yes, we had a high-quality group of acquisitions that closed in the fourth quarter.

And that was reflected, I think, in the pricing.

We also had a high percentage of investment-grade.

And in terms of the types of -- the types of investments we made in the fourth quarter, we did have about 10% of the acquisitions were industrial properties and leased to existing tenants.

These were relationship transactions leased to large-cap investment-grade rated tenants that we were very pleased to work into the portfolio.

And next we'll go to Todd Stender with Wells Fargo.

Just to stick on that Walmart theme.

You guys acquired a couple of Walmart Sam's clubs.

What were the lease terms?

And are there any rent escalators?

It's an investment-grade rated tenant, but like CVS, I wondered if they're flat?

Yes.

Well, on our Walmarts we have lease escalators on about 30% of that portfolio.

So the primary Walmart exposure that we picked up in the fourth quarter was in the neighborhood markets.

And obviously, they're -- you have a 25% national market share in the neighborhood markets and those have been operating very well, and they're incorporating their e-commerce strategy, omnichannel platforms and associating that -- those initiatives with their brick-and-mortar buildings.

So they've been performing quite well and we are pleased with that.

And how much is left on the lease of that stuff?

I think they are somewhere around 15 to 17 years on that particular segment.

Overall, the average weighted lease term for our entire Walmart exposure is 12 years.

And then just you also acquired some Dollar stores, any updated thoughts there?

It's long been thought of as an internet resistant space, but then you see headlines of Amazon willing to ship Dollar level items.

Any comments there?

Well, the Dollar stores have just been a home run for us here over the last 6, 7 years, as you know, Todd.

Dollar General has experienced 27 consecutive years of same store growth.

And then Dollar Tree and Family Dollar have experienced 9 consecutive years of same store growth.

So they continue to do quite well despite any internet pressures.

They're largely insulated from internet pressures because their customers use cash.

Often, they're in small towns or rural areas.

Their customers are less likely to shop online.

The average basket size is $10 to $15.

And they're typically buying products that are immediately needed, maybe a quart of milk or butter or some produce for dinner that night.

So -- and given the challenges of a large national player trying to efficiently and cost-effectively deliver in some of these more rural and smaller locations, at this juncture, we're just not seeing any impact from e-commerce on their businesses.

So we're pleased with making some additional investments there.

I don't think we'll raise our exposure overall to that industry on a relevant basis in a material way, but it might creep up a little bit because it's performed so well for us.

And next we'll go to John Massocca with Ladenburg Thalmann.

So I think you kind of talked about it with regards to Walmart, but what percent of your portfolio today has no rent escalators?

And what percent has escalators based on CPI?

Yes.

So I'd say 88%, 89% have rent escalators and CPI escalators are somewhere around, Paul, 15%...

That's 15% of the leases...

About 15% of the leases.

That make sense.

And then with regards to the Albertson's/Rite Aid merger, how do you think that affects the tenant credit there?

Any thoughts that, that might be an opportunity for additional acquisitions?

Yes, well, I think we really don't have any exposure -- any material exposure to Albertson's, but as you know, Rite Aid has been in our top 20 for a while now.

Rite Aid is selling properties to Walgreens and we've seen 7 of our Rite Aids go to Walgreens and we would expect another 7 to 10 more going to Walgreens.

But we view the announcement of those plans and discussions positively.

It's going to create cost savings and synergies throughout the business.

Rite Aid will be able to expand its PBM business by rolling it out in the 4,000 stores that Albertson's owns and accessing their customers and making it more competitive with the PBM businesses of companies such as CVS.

So in addition, Rite Aid will be able to improve their food service offerings and having access to the private label prepared foods that Albertson's has been very successful at selling.

So really, just gives some size, scale, significant synergies to compete better against existing peers in their sector and also potential new entrants.

And we're seeing a lot of consolidation both horizontal and vertical consolidation within the drugstore industry, and we think that, that makes that industry a stronger industry as it creates more efficient companies and gives drug stores players like Walgreens and CVS and Rite Aid additional captive customers.

So that's the key.

So we view that quite positively.

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

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

Okay.

Well, thanks, David, and we appreciate everyone for joining us today.

I look forward to seeing everyone over the next few weeks at various conferences.

And thank you for participating in the call and have a good afternoon.

And that does conclude today's conference.

We thank you for your participation.

You may now disconnect.