Spirit Realty Capital Inc (SRC) 2014 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Spirit Realty Capital third-quarter 2014 earnings conference call.

(Operator Instructions)

Please note that this conference call is being recorded. An audio replay will be available for one week beginning at 6 PM Eastern Time today, and the webcast will be available for the next 30 days. The dial-in details for the replay can be found in today's press release and can be obtained from the Investor Relations section of Spirit Realty's website at www.SpiritRealty.com.

(Operator Instructions)

I will now turn the call over to Ms. Mary Jensen, Vice President of Investor Relations for Spirit Realty Capital. Please proceed.

Thank you.

Joining us today on the call are Tom Nolan, our Chairman and CEO; Pete Mavoides, our President and COO; and Mike Bender, our CFO. Tom will give a brief overview of the quarter and update you on how we are progressing on our stated business plans. Pete will then bring you up to speed on the current transaction activity and portfolio activity. And before taking your questions, Mike will provide additional color on the financial results that were issued earlier today, as well as a summary of our 2015 guidance.

Please note that during the conference call, we will make certain statements that may be considered to be forward-looking statements under federal securities law. These statements are based on Management's current expectations and the Company's actual future results may differ significantly. In our periodic reports on file with the SEC, we set forth certain factors that could cause our future results to vary from Management's forward-looking statements.

All information presented on this call is current as of today, November 3, 2014. Spirit does not intend and undertakes no duty to update forward-looking statements unless required by law. In addition, reconciliations of non-GAAP financial measures presented on this call, such as FFO, AFFO, and FAD, can be found in the Company's earnings release, which was issued earlier today and available on the Investor Relations section of this website.

With that, I would like to turn the call over to Chairman and CEO, Mr. Tom Nolan.

Thank you, Mary, and thank you, everyone, for joining us today.

Our third-quarter earnings call signifies another milestone, as we continue to establish our track record as one of the premier net lease REITs in the industry. It has been two years since we made our public debut and a year since we completed the significant acquisition of the Cole II portfolio. Today, we are one of the leading net lease REITs, with an Enterprise value of over $8 billion.

Our Corporate philosophy has not changed since we took the Company public two years ago. We continue to make our shareholders our number one priority, and as such, we are focused on maintaining and growing a high-quality portfolio that supports sustainable earnings growth and predictable dividends for our shareholders. We have also recapitalized our balance sheet with flexible, attractively priced, well laddered capital. These transactions have reduced our leverage since the IPO and improved our cost of capital to fuel future growth through acquisitions.

Our portfolio strategy is as important as our capital plan. We continue to benefit from the current market conditions, seeking real estate investments and sales opportunities using our consistent and disciplined underwriting. We are seeing solid, risk-adjusted opportunities that are consistent with our core strategy to invest in, and prudently grow the portfolio. Current market conditions are also allowing us to capitalize on opportunities to sell selected assets, so that we can proactively manage risk within the portfolio.

An integral part of our portfolio management strategy involves the active management of tenant diversity. Two years ago our largest tenant represented more than 30% of our revenues. Today it is less than half of that. We've taken significant steps to provide ourselves with the flexibility to reduce that concentration further. And while we continue to evaluate options in that regard, it is our policy not to speculate on prospective transactions or to discuss transactions in process.

Moving on to operations, our investment and asset management teams have been doing an excellent job. Since the IPO, in addition to the Cole II portfolio, we have invested in over $1 billion of real estate and real estate-related assets, primarily through sale leaseback transactions.

In addition, we have proactively disposed of more than $500 million in non-core real estate assets. These activities continue to strengthen the portfolio with credit-worthy tenants, which allow us to have the predictable income streams that support our dividend and future growth.

In summary, the results of this quarter reflect that our team is focused on creating value for our shareholders through proactive asset management, accretive investing, and prudent balance sheet management.

Now I will turn things over to Pete, who will provide a detailed review of our operations during the quarter and our expectations for 2015. Pete?

Thanks, Tom.

Our internal growth drivers remained strong during the quarter, supported by our investment and asset management initiatives, which continue to generate consistent cash flow. We ended the third quarter with a $7.8 billion gross investment in real estate and related loans, with substantially all of it invested in 2,408 properties.

As of September 30, 2014, approximately 2 million square feet was available for lease, representing 40 properties with a total gross investment of $161.5 million. This represents an occupancy of 98%, which we consider essentially full. Our leases are generally long-term, with a single tenant on a triple net lease terms and a weighted-average maturity remaining of approximately 10.2 years.

As of September 30, 2014, approximately 44% of our annual rent, defined as annualized third-quarter rental revenue, is contributed from properties under master leases, and approximately 87% of our single-tenant properties provide for periodic rent increases. As part of our asset management strategy, we review our tenants' financial statements and analyze unit-level rent coverage, which was again healthy in the third quarter.

Our portfolio represents strong income-producing profit centers, which are operationally essential to our tenants. For the trailing 12 months, our unit-level rent coverage was 2.8 times for our reporting tenants. This compares favorably to 2.7 times for the same period a year ago. As you know, we view this as a valuable indicator of how essential our properties are to our tenants' operations and their ability to pay rent.

We continue to increase our tenant and geographic diversification through acquisitions and dispositions. We also look to continue to assess our current tenant concentration. During the quarter, our largest tenant, ShopKo, a $3 billion, large, well-established pharmacy and general merchandise retailer located in the Midwest, represented 14.3% of total revenues. We continue the process of right-sizing this concentration. We are currently in negotiations with multiple parties on a variety of transactions. Given the ongoing nature of these discussions, we cannot comment further at this point.

Our real estate portfolio, as of September 30, 2014, was diversified geographically across 49 states and among various industry types. Our largest states, Texas, Illinois, and Wisconsin, accounted for 12%, 6.7%, and 4.8% of the annual rent contribution of the real estate portfolio, respectively. Our top three industry types as of September 30, were general merchandising, accounting for 16.3%; followed by casual dining at 9.3%; and quick-serve restaurants, at 7.3%.

Moving to new investments. The market for real estate transactions remain active and the creditworthiness of our tenants continue to improve at a steady pace, with the overall economic landscape. As a result, we had a good third quarter of transactions and our investment team continues to execute on a solid investment pipeline going into the fourth quarter and into early 2015.

During the quarter, we acquired 51 property totaling $206 million. These investments had initial cash yield of 7.5% and have a remaining term of approximately 14.3 years. More than 33% of our transactions consisted of direct sale leasebacks, while 67% of that amount was invested with existing tenants.

Through the first nine months of the year, we have invested more than $572 million in 251 new properties at initial cash yield of 7.7%. More than 57% of these investments represented direct sale leasebacks, and 43% represented transactions with our existing tenants. These investments demonstrate our ability to source and close small portfolio acquisitions where we believe we are able to exercise meaningful pricing power with less competition from large investors.

The slight decline in cap rate from our prior quarter is more a function of the specific deals that closed in the quarter and is not indicative of a shift in our underwriting for the overall market. We remain optimistic in our ability to source and close new investments with attractive pricing and lease terms, while proactively selling properties.

During the third quarter 2014, we sold 12 properties, generating gross sales proceeds of $29.5 million. We believe that actively managing our real estate portfolio is an essential component to creating overall long-term asset value. As market conditions cooperate, we will continue to seize opportunities as they present themselves in order to create the scale and capital structure necessary to deliver sustainable shareholder value.

With that, I will turn things over to Mike.

Thank you, Pete.

Our financial results for the quarter and year to date are in line with our expectations. Those results are outlined in our press release and accessible through the Investor Relations section of our website. Consequently, I would like to review the more salient parts of quarter and how they tie in with our stated business strategy and the guidance we provided on our last call.

AFFO for the third quarter totaled $83.1 million, or $0.21 per diluted share, which was in line with the increased guidance range we provided last quarter. Total revenue for the third quarter ended September 30, 2014, totaled $152.6 million, representing a 9% increase from the comparable quarter in 2013. The increase was driven by significant acquisition volume and continued rent growth throughout the quarter and the year.

Total operating expenses were in line with expectations. General and administrative expenses in the third quarter totaled $12 million, which included a $1.7 million one-time [CAM] adjustment. This was booked to bad debt expense and was part of a set of uncollected receivables from the Cole II portfolio. Absent this expense, G&A would have totaled $10.4 million, or 6.8% of revenues.

At September 30, 2014, our cash and cash equivalents totaled $50.1 million. During the quarter, on July 15, 2014, we paid our second-quarter cash dividend of $0.16625 per common share. During the quarter, the Board also declared a third-quarter cash dividend of the same amount, which was paid on October 15. On an annualized basis, our dividend represents $0.665 per common share, representing a yield of approximately 6.1%, based on our September 30 closing price, and a payout ratio of approximately 80%.

Moving on to guidance. We narrowed our previously stated 2014 AFFO guidance range of $0.80 to $0.83 per common share to $0.81 to $0.83 per common share.

I will now provide our 2015 AFFO guidance. We are establishing an AFFO guidance range of $0.84 to $0.86 per common share, which assumes net income of $0.22 to $0.24 per share and excludes any non-recurring items that are not reflective of our ongoing operations and includes $0.61 per share of expected real estate depreciation and amortization, plus $0.01 per share related to non-cash items and real estate transaction costs.

As in the past, we do not provide guidance on acquisition or disposition activity; however, our estimates do include assumptions related to those activities.

With that, Tom, Pete, and I will be happy to take your questions.

(Operator Instructions)

Vikram Malhotra.

Thank you. Guys, I wanted to just clarify -- I know you are not giving any details or talking about ShopKo, but you did list a few properties, a few weeks ago. I'm just trying to get a sense of, have you -- do you have now flexibility to list assets on an individual basis or is that something that you are still looking to get or was this more of a one-off listing?

We've believe we have the -- we've listened those assets because we believe we have the ability to transact on those assets and we're hopeful that through our marketing process, we will find buyers of those assets.

Because I was under the impression, and maybe this was wrong, but I was under the impression that there were obviously three master leases on the ShopKo assets and in order to sell them individually, you would have to renegotiate or get flexibility in order to sell those assets. Is that correct?

We have a lease with ShopKo, which is public document. The lease speaks for itself in terms of the ability that we have, and clearly we're operating under the full [walls at] the lease, as you would expect. Where, as Pete alluded to, there are a number of conversations and negotiations that are occurring. But it really -- we are really left with just stating that at this time because, again, we simply don't want to speculate on what may occur and what negotiations may occur and what transactions may occur. But clearly, what we are moving forward on is within our ability as the lease is currently constructed.

Okay. And then just the last one -- just to clarify. Given that you're -- it's in process, can you just update us as to how you're thinking about the exposure in general? Are you thinking you'd like some exposure or how are you thinking about, at this point? I understand that, that might change going forward, but how are you thinking about ShopKo as a whole?

Vikram, as we said in the past, we are completely comfortable with that tenant credit risk. What we are uncomfortable with is having a 14% tenant and have committed to work that down over time. It's not a paring of the exposure because of riskiness inherent in the exposure; it's just purely due to the size. We'll right-size that as market conditions permit.

Okay. Thanks, guys.

You're welcome.

Alexander Goldfarb.

Good evening. On the ShopKo part, and maybe it's just the way the portfolio has changed, but this quarter it was listed as 14.3% exposure and last quarter was 13.8%. Is this because you've scaled back some of the other assets or were there some additional assets that suddenly came into the pool that are part of exiting the pool?

No, Alex. That is really simply a function of ShopKo having a rent bump that occurred actually into the second quarter, so you only had a portion of that increase reflected in that period, and then the total run rate amount in Q3.

Okay.

Obviously, we have tenants that rents go up, contractually, every year. We have other tenants where it goes up on different time frames. The ShopKo tenant, which again, this lease is a disclosed document, the ShopKo lease rent only goes up once every three years. So you get that bump in the third year. That bump happened in this particular quarter. Of course, the irony is we made more money from them, which caused the concentration to go up, but of course, from my standpoint, that's a good problem to have. We got more money from them, as the lease bump was executed.

That is true. Rent paying tenants usually are good thing.

I agree. Thanks.

Now, I'm sure that you are expecting it to be asked, so the big question. Obviously, we've had a little accounting hiccup over at ARCP. Just your take -- two-part question on this. One, how many of the sellers of assets were you competing with against ARCP, such that maybe there's more opportunity for you, or maybe is was a totally different seller set, in which case there is no impact?

And then two, if ARCP had to prune assets or sell or divest or anything, is there opportunity -- are there assets that are in there that are desirable to you guys or they were totally a different animal, at which point it's just not really anything that would be interested for you guys in a material way?

I am going to let Pete answer that question, Alex. Obviously, it's an excellent question. I do want to preface it just by saying that we want to be very cautious about discussing what has occurred there, and obviously, it's a very dynamic situation. We will keep our comments quite general, relative to the impacts of the market, but I will turn it over to Pete to discuss those specifics.

Where we compete on the buy side, Alex, it's not a complete overlap of opportunity sets, but as you can imagine, they were a pretty veracious acquirer and so certainly we ran into them on a number of occasions and we would see them frequently as a large aspirer of net lease properties in the space. So to the extent that they were to pull back from the market and buy less, we would anticipate some benefit from that.

On the potential for them to prune assets, we saw a lot of the assets that they acquired in the market and competed and lost. There are certainly a lot of assets in that portfolio that fit our investment model of being operationally essential, being granular, being well-leased to high-quality tenants. To the extent that some of those properties were offered to sale or reoffered to sale to the market, we would be interested if the pricing were right and the underwriting was right.

Okay. And then just finally, Mike, you mentioned a comment about 2015 guidance, that there is some level of acquisitions or dispositions baked in there. Can you just quantify that?

No, but I appreciate that you asked, Alex. I know you've heard this speech before. We make that statement because we're obviously putting out guidance. It's a business plan; it's a business plan we're confident in achieving. It has portfolio activity in it. But we simply have a philosophy that to put out a number of proposed acquisitions is inconsistent with the way that we run the Business.

The Business is, for us, we acquire assets to create shareholder value. What we try to do is to give our current outlook of the acquisition environment and that outlook could be current, you could think of it as looking out over the next quarter, because that is how we see the market. We have given indications, we think that is an attractive market and we are continuing to acquire.

The position that we simply do not want to be in is to have an acquisition target as if that is the objective, as opposed to ultimately creating accretive investments. We all know markets can change and they can change quickly. They can change dynamically and the reality is, if we decide that the acquisition market is not as favorable as it currently is, then we would expect that our behavior would change appropriately and therefore we don't want to have a target out there that we would then be needing to amend.

As far as the guidance is concerned, clearly, we believe that, depending on almost any set of circumstances, depending on how aggressive we were on acquisitions, dispositions that are not aggressive, we are comfortable that we can meet the guidance, regardless of, again, how that acquisition dynamic changes over the next calendar year.

Okay. That is fine. I appreciate it. Thank you.

You are welcome.

Juan Sanabria.

Good afternoon. Just to follow up on the guidance question, maybe just to ask it a different way, what would be your guidance if you stripped out all acquisition assumptions?

No. Again, that would suggest what our acquisition number is and therefore we would be providing acquisition guidance. So it's just -- we're providing a range. It has acquisition, disposition, portfolio management activity in it. We are confident we could hit that range, depending on whatever level of activity we believe the market determines. But by providing a non-acquisition number, we would be in essence providing guidance on acquisitions, which again is against our philosophy of portfolio management.

Okay. Does the low end include activity as well?

Again, it's a range and it's a range that we are comfortable we can hit within the levels of a band of activity.

Okay. Fair enough. On ShopKo, have you had to negotiate with the tenant to restructure any of the leases, to a prior question, in any form? And if so, what was the give-and-take in that negotiation with the tenant?

Juan, as we said, we're in a number of negotiations on a variety of transactions. If we had amended the mass release, that is a material document that is public and so you could imagine we would have disclosed that.

Okay. Then just last one for me on the dispositions, what were the cap rates on those. And I'm not sure what the vacancy -- if the buildings were vacant or if there was an NOI that could derive a cap rate from?

Our disposition activity represents a lot of variety of activity, including vacant properties, including risk mitigation sales and including accretive sales and even assets that were purchased via purchase options, so we have a range of cap rate from 5% up to 10%, representing various transactions. So the average really wouldn't be meaningful.

So no weighted average?

No.

Okay. Thank you.

(Operator Instructions)

Chris Lucas.

If I could just ask another question related to guidance, but I was really looking for the organic growth you are expecting, the same-store NOI growth for next year?

As we've said before, we tend to originate in the 1% to 2% bump range and that's on 85%, 87% of the portfolio, something like that.

Okay. And then you mentioned in your prepared remarks, related to the rent coverage currently versus a year ago. I was trying to understand how much of the portfolio that represents?

That's roughly about half of the portfolio, Chris.

Okay. Then maybe, Tom, let me ask this question as it relates to the acquisition environment. A year ago, given where your cost of capital was and the flexibility was, how do you feel about your opportunity set today versus a year ago?

Speaking for myself, speaking for the team, and the acquisition group, we feel that the Company is very well-positioned. We have seen a tightening of cap rates over the last 12 months, but it's been modest. The corresponding capital, the cost of capital, both on the debt and equity side, our cost of capital has improved, and the debt markets have been very, very robust. And so the spread, and this is a spread investing -- this is what these companies, such as ourselves, are doing, which is to accretively add to the portfolio.

We're looking today, and we're looking at a spread that remains high by historical standards. When we look at the -- even though cap rates have tightened somewhat, the cost of capital has tightened further. It remains a very large space. There are a lot of -- naturally, we have competitors, we come across the usual group of competitors, but there is a lot of product available to buy, so we don't feel as though we're challenged. As a matter of fact, we think we have got a very good [staple] of opportunities to look at, and again, if these conditions continue, we would expect that we would continue to be an active acquirer of real estate, consistent with what we've been doing over the last couple of quarters.

Then the last question for me just relates to the portfolio level, which has been in this drift down. Is there anything specific going on there or is it just simply non-renewals of leases that are coming up or is there a specific -- one specific deal? Is there something there that you could maybe offer some guidance as to what is going on there?

I'm not sure, in going on -- we may have missed your specific question.

Just the occupancy change has been drifting down -- just trying to a --

During the quarter, we had some credit situations that came to maturity during the quarter, where we took back properties from tenants that we had been wrestling with for a long period of time. That just happened in the quarter. That spiked it up and we will continue to work that down. As we've said in the past, operating between 98% and 99%, where we think it's stabilized for the portfolio.

How do you expect to resolve those specific vacancies? Are you looking at just selling those assets or is there an opportunity to release that you think you've got a good chance on?

We have vacant 40 properties against our 2,400-plus and we list those properties with various brokers and try to maximize value. Some of those will be re-let, some of them will be sold [dark], and it really, at the end of the day, it will the most sufficient execution that generates the best return for us and it tends to be a 50/50 mix.

Okay. Great. Thank you.

Ross Nussbaum.

Can you give us a sense of what leverage levels that you've put into your business plan for next year specifically related to the guidance you put out?

We have said consistently that we are comfortable at the leverage levels that we're at. We have brought it down from the time of the IPO, which was a commitment that we made at that time. We have been bringing it down. Then it tends to fluctuate within the zone that we are currently in. We're in the low 7s and that is going to continue to tick up a little bit in between potential equity transactions and then flow down.

So we're certainly not intending a dramatic shift in capitalization strategy. We're very comfortable with where we are and we continue to look at leverage as -- we are as focused on is it matched, is it laddered, do we have the right type of leverage on our books? And then when -- to make sure that, that level does not get outside of the zones that we are operating under, but there really isn't a dramatic shift from what we've had over the last year.

Sure. I see you did not elect to issue any equity under the ATM in the third quarter. I'm just curious, why? Did you not like the stock price in the $11.50 to $12 range or were you comfortable that following the second-quarter issuance, that you were okay for a while?

First of all, following the issuance, we were locked out, and I don't remember the exact dates that the lock-out expired, but -- so we were not in the market, for the 60 days following the equity issuance. After that, it becomes a facts and circumstances situation, as we're getting near the end of the quarter. It didn't necessarily happen. But clearly we have the ATM. It's a tool. I would expect that it's a tool that ultimately the Company will call upon. But the beginning of the quarter, again, the lock-out was --

And we came out of that capital transaction pretty (multiple speakers).

Right. Because that particular transaction was oversubscribed and we did upsize it, there was, as Pete suggested, substantial liquidity through the quarter.

Tom, you had mentioned in answer to a prior question that your guidance for next year included portfolio management activity. I'm wondering does that statement include anything related to ShopKo or is that a whole separate strategic ball of wax that has not been included in the guidance?

No, ShopKo is, when we discuss portfolio management, ShopKo is an integral component of that.

I appreciate it. Last question I have, your guidance midpoint-to-midpoint from 2014 to 2015 implies 3.5% growth, which I would qualify as not being sexy, perhaps, but not horrible. I'm just curious how you think about that growth rate relative to, ultimately, what you would consider to be, perhaps, a longer-run growth rate for the Company? Is that what you think we should expect out of Spirit over some longer period of time?

First of all, our view on guidance is to point out a prudent number that we are confident that can be hit, so as a Management team, we spend every day looking at opportunities that could create additional shareholder growth. There is a difference between putting out a guidance number, again, from your basic business, and looking at those opportunities.

I do think that the triple-net space has a lower overall growth rate. We are an income-oriented product with long-term leases. We believe the value that we are bringing to the equation is predictable cash flow that is growing, and that a growth rate much higher as a status quo or an underwriteable growth rate, I am not sure is really appropriate for the triple-net lease industry, which again, which is the longest, it is the most stable cash flow that has the longest term leases, it has the most laddered debt in the industry.

I don't -- obviously, facts and circumstances can change in the capital markets and that can change our outlook going forward. But I think right now, that sort of growth with the current dividend that we are paying and an ability to create further value from transactions not contemplated this [spot] of the guidance is something we are very comfortable with.

Thanks. I appreciate it.

That concludes the Q&A portion of today's call. I will turn the call over back to Mr. Tom Nolan.

Thank you very much. We are pleased with our quarterly results and believe that value for our shareholders is supported by our operating discipline, which is systemic to Spirit Realty Capital. We have a quality portfolio with credit-worthy tenants, which creates predictable and solid cash flows. We strive for the highest level of integrity, transparency, and discipline at all levels of the Organization and we have a professional seasoned management team with decades of experience in the triple-net industry.

At the time of the IPO, we made a commitment to our then new shareholders to strive towards becoming one of the premier companies in the triple-net industry. We look forward to another year of delivering on those commitments. For those of you that will be at this week's NAREIT Conference, we look forward to seeing you all in Atlanta. Thank you very much.

Ladies and gentlemen, that concludes today's call. You may now disconnect.