Spirit Realty Capital Inc (SRC) 2018 Q3 法說會逐字稿

Greetings, and welcome to the Spirit Realty Capital Third Quarter Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Pierre Revol, Vice President of Strategic Planning and Investor Relations. Thank you. You may begin.

Thank you, operator, and thank you, everyone, for joining us today. Presenting on today's call will be President and Chief Executive Officer, Mr. Jackson Hsieh; Chief Financial Officer, Mr. Michael Hughes; and Head of Asset Management Mr. Ken Heimlich.

Before we get started, I would like to remind everyone that this presentation contains forward-looking statements. Although the company believes these forward-looking statements are based upon reasonable assumptions, they are subject to known and unknown risks and uncertainties that can cause actual results to differ materially from those currently anticipated due to a number of factors. I'd refer you to the safe harbor statement in today's earnings release and supplemental information as well as our most recent filings with the SEC for a detailed discussion of the risk factors relating to these forward-looking statements.

This presentation also contains certain non-GAAP measures. Reconciliation of non-GAAP financial measures to most directly comparable GAAP measures are included in today's release and supplemental information furnished to the SEC under Form 8-K.

Both today's earning release and supplement information are available on the Investor Relations page of the company's website.

For our prepared remarks, I'm now pleased to introduce Mr. Jackson Hsieh. Jackson?

Thank you. Good morning, everyone, and thanks for joining our third quarter 2018 earnings call. My prepared remarks for today's call will be significantly shorter than in previous earnings calls.

Given our success of simplifying our business over the past year, our portfolio is ideally positioned. Balance sheet flexibility and capacity are strong, and the entire Spirit staff and board are all very excited to take advantage of the opportunities we see as we move forward.

From the time the board made the management change on May 7, 2017, our stock price, dividends and SMTA dividend has resulted in positive returns. We believe we're in a great place. Our plan is working, and as always, we appreciate your interest and support in Spirit.

On the portfolio front, we recently completed our annual property review and ranking process, and we're extremely pleased with the quality and positioning of our assets, especially from a tenant and industry weighting point of view. Over 50% of Spirit's rent is derived from public listed companies, and the remaining balance is split equally between private equity and entrepreneurial-owned businesses.

In addition to completing the property rankings for a third year, I'm pleased to report we have developed our in-house business analytic tools. These cloud-based tools connect to our underlying MRI database, allowing asset management to dynamically update our property list and property rankings with the latest data. We're currently using these tools for our financial planning and analysis, for monitoring credit metrics and to help make strategic decisions on both acquisitions and dispositions. We believe these tools will continue to improve our asset management and investment decision-making, which will ultimately lead to improved cost of capital.

One of our highest priorities has been to derisk the concentration exposure that Shopko poses within the SMTA portfolio, and I'm pleased to report that we've made major progress on this. Specifically, earlier this morning, SMTA filed an 8-K announcing the closing of 2 important financings. The one of particular note was the $165 million nonrecourse loan on all of the 85 assets outside of the master trust leased to Shopko. The details are contained in the 8-K, but this loan represents a strategic win for SMTA with associated benefits to Spirit. It derisks Shopko tenant exposure by locking in a cash value floor while preserving the opportunity for SMTA to realize additional upside through the incremental proceeds from future sales of Shopko Stores.

Now turning to the third quarter results. Our operations remain sound and consistent as we continue to focus on strong portfolio management and tenant communication. Our portfolio is 99.6% occupied, and our weighted average unit rent coverage is 2.7x. Annualized contractual rent was $31.8 million, and our annualized cash rent received was $380.9 million. Our same-store contractual rent rose 1.7% year-over-year. We saw especially strong performance from our casual dining and movie theater industry tenants. In addition, we continue to show improved results on property cost leakage, which was $1.7 million this quarter versus $1.9 million in the prior year period.

As you will recall, we highlighted our third quarter acquisition effort in last quarter's earnings call. We invested $229 million in 26 assets. They were a balanced mix of direct deals with tenants, broker transactions and take-out construction transactions. Alaska's gyms was a $61 million transaction done direct and took us almost 1 year to complete, while the Life Time transaction closed 39 days after we had a handshake agreement on price and terms. With the Life Time transaction, we committed $224 million for the entire portfolio and subsequently brought in a partner to acquire one of the national lease portfolios.

As we look forward ahead to the end of 2018 and beyond, we believe the transaction market remains healthy, and we continue to uncover attractive opportunities as we add to our pipeline. Dispositions in Q3 were de minimis. However, we are expecting more activity in Q4 given we have numerous assets and portfolios being currently marketed.

As I mentioned, this quarter was very simple, but our results were strong. We were able to increase our base rent by $90 million while keeping leverage at 5.2x. Our same-store sales, occupancy, lost rent percentage and very low property cost leakage are result of the many process improvements we have made at Spirit over the past 2 years. We're excited about our completed acquisitions and the deeper relationships we're building with our existing and new tenant base.

As a reminder, similar to last quarter, SMTA will report earnings on Friday, November 9, and we will have recorded comments in order to help investors. Go to the webcast link on SMTA's IR site and do the dial-in provided in their press release.

I'm now going to turn it over to Mike Hughes.

Thanks, Jackson, and good morning, everyone.

We are pleased to be reporting on Spirit's first clean post-spin quarter. While we did recognize $966,000 in discontinued operations for transaction expenses related to the spin-off, there was no other impact from the financial position of SMTA for the 3 months ending September 30, 2018.

As I noted on the last call, all prior year comparison periods in the income statement and balance sheet have been adjusted to reclassify the operations and financial position of SMTA from Spirit's consolidated results to income or loss from discontinued operations in the income statement and assets and liabilities related to SMTA's spin-off in the balance sheet.

Please also note that the statement of cash flows, footnotes to Spirit's consolidated financial statements and non-GAAP metrics, such as adjusted EBITDA and adjusted AFFO, are not adjusted for discontinued operations. Additional disclosure related to the discontinued operation's line items can be found in Note 8 of our 10-Q, which will be issued premarket on Friday.

Now turning to third quarter results.

We have been a net acquirer over the last 12 months. However, as the majority of our acquisitions took place toward the end of this quarter, rental revenues declined $6.2 million compared to the same period last year and grew $1.7 million compared to second quarter. Annualized contractual rent, which annualizes the rents in place at quarter-end, grew $19 million compared to last quarter, of which $15 million came from acquisitions. Interest income grew by $827,000 compared to last quarter as second quarter's interest income was reduced by $600,000 related to the acceleration of noncash amortization that resulted from the early prepayment of a $7.5 million mortgage note receivable in April. Third quarter interest income also included interest from Spirit's $34 million investment in SMTA's Master Trust Notes for the full 3-month period. Other income was relatively flat compared to the same period last year but decreased $764,000 compared to last quarter. The second quarter included a $1 million prepayment penalty related to the previously mentioned mortgage note receivable.

Unreimbursed property costs or leakage declined by $513,000 from last quarter as we recaptured 68% versus 55% of property costs. This improvement was driven by successful property tax appeals and the renegotiation of a professional fees contract at one of our multi-tenant properties. Reducing leakage remains a key focus for our team, and we are very pleased with the results this quarter.

Reserves for lost rent decreased from 0.3% of contractual rents last quarter to only 0.2% this quarter, which is a historic low for Spirit.

General and administrative expense was $11 million compared to $13.5 million last quarter. As I mentioned on the last call, normalized second quarter G&A was approximately $12.1 million after you net out the $1.4 million in accelerated stock grant amortization resulting from the early vesting of SMTA shares. Now this quarter, G&A was low primarily due to the timing of accruals for professional fees, and I expect our quarterly run rate G&A to be closer to $12 million.

Related party fee income, which was a new line item last quarter, was $6.75 million, representing a full quarter of SMTA asset management fees and MTA property management fees. We also recognized preferred dividend income of $3.75 million for the quarter from our investment in SMTA's preferred equity.

AFFO per share was $0.17, which was in line with our previous AFFO per share guidance for Spirit as a stand-alone entity.

Now for the balance sheet. During the third quarter, we borrowed $420 million on our delayed-draw term loan facility, and the proceeds were used to repay our line of credit. Subsequent to quarter-end, we exercised our first extension option to extend the term loan maturity to November of next year.

Our leverage and liquidity remain strong. Our adjusted debt-to-annualized adjusted EBITDAR was 5.2x at quarter-end. And as of November 2, we maintained $636.5 million in available liquidity. We're also pleased to report that in mid-August, S&P upgraded their credit outlook for Spirit from neutral to positive, representing the third credit outlook upgrade that we have received since the spin-off of SMTA.

Now for guidance, we are reaffirming the guidance that we provided last quarter. As it relates to our capital deployment guidance, year-to-date we have repurchased 168 million of our common stock, deployed or committed $80.1 million for redevelopment and forward takeouts, acquired 14 properties for $226.5 million and invested $22.8 million in revenue-producing capital expenditures across 42 properties. As it relates to our disposition guidance, year-to-date we have sold 12 properties for $24.1 million and transferred 6 properties with gross investment values for $28.5 million to special servicers in satisfaction of $56 million in CMBS loans.

With respect to Spirit's common dividend, the Board of Directors declared a quarterly cash dividend of $0.125 per share for the third quarter, consistent with our previously stated target equal to approximately 75% of AFFO.

Overall, we are very pleased with our third quarter results, which met all of our expectations, and we look forward to a strong finish this year.

Operator, I'll now open up the call for questions.

(Operator Instructions) Our first question comes from the line of Vikram Malhotra with Morgan Stanley.

Just 2 quick ones. Just first on the Shopko assets. Certainly a positive, and I agree with the derisking. There's some commentary in the article on sort of establishing a floor. I'm wondering if you can share a sense of what the LTV was on the loan.

Without getting into specifics on a loan, I wanted to let Ricardo and team go through their discussion points because as you know, that's a separate company. But the proceeds are basically $3.40 a share for SMTA. So it's a great addition of liquidity for them.

Okay. Okay, that's -- and then just a second question on the watch list. Any changes or any notable tenants that went on or off the watch list? And any specific commentary you can provide around Taco Bueno, please?

Well, first of all, on -- without getting into specific names, Taco Bueno is a QSR tenant within our portfolio. It's in our top 50. We have been in discussions with those -- with that tenant. We're pretty confident that its QSR assets and really good real estate and good markets in a master lease. And our expectation is, it's less than 1% of rents. It's not going to have a major impact to Spirit. And beyond that, this is a really stable portfolio.

Our next question comes from the line of Derek Johnston with Deutsche Bank.

This is Shivani Sood on for Derek Johnston. I'd like to start to contemplate dispositions as a source of capital. Can you just share some thoughts on what would be an acceptable sort of spread between acquisitions and dispositions given a rising rate environment? Was it like about 30 basis points year-to-date?

Yes. I mean, and so when we look at dispositions versus acquisitions, I mean, we're not really targeting a spread. I'll tell you that I think if you know the story, we do take these real estate rankings seriously. We do property rankings on every single asset that includes asset management, acquisitions, credit and lease administration. And part of the reason why we go through that effort is we identify assets that can be sold accretively, assets that we love and we want to re-extend leases or assets that we need to sell. And so it's really more a function of trying to be more offensive with our portfolio than trying to match up with a spread. So you might see a superwide spread one quarter and maybe not as much in the next quarter. But like I said, we're trying to construct a fortress portfolio here. So you do that by looking at your assets, discussing it, making sure everybody's on the right page, doesn't line up with our heat map. And that's why we think it's such a critical part of what we're doing.

And I mentioned in my prepared comments now those BI tools. That's something we've been working on for over a year now. And I'm so happy that, that's in place now because that's giving our entire organization leverage across different cross functions on how to attack these issues. So one of these days, we'll have an Investor Day and really allow you guys -- I said, "Well, we'll show you how this stuff works."

Our next question comes from the line of Haendel St. Juste with Mizuho Securities.

Jackson, what more can you possibly tell us about the assets in the portfolios that you're marketing here in the fourth quarter? Any particular industry tenant that you're looking to pare back from? And any sense of cap rate or pricing?

I mean, I don't want to get too far ahead because I can tell you that it's a real cross-section. I mean, we have some QSRs, we have some c-stores. We're looking at a distribution center. We've got some casual dining situations that we're looking at. We've got some drugstores as well. So I think for us to give you a one-size-fits-all kind of strategy on why we're selling certain things, like, hey, we're selling flat leases, it's not really exactly that way. Organizationally, I can tell you we have a really, really strong sense of our 2,500 assets within both SMTA and Spirit. And we have a very good sense as to what needs to be sold and what doesn't need to be sold. And like I said in my earlier comment, having these tools now connected with our BI capability is something that's giving us a lot of leverage right now. So -- but to answer your question, it's a cross-section across all of those categories.

Got it. And the pricing should be fairly consistent with what you said?

I think the pricing -- I mean for -- some of the pricing is assuming very low cap rate. There might be a couple with higher cap rate. And so like I said, we're not targeting a cap rate target. It's not just about a -- look, we have some very low cap rate opportunities out there right now that we expect to sell. Also, a supermarket area is another area that we're focused on in the fourth quarter. So rather than try to give you an exact number, I can just tell you it's going to be a cross-section of all those categories I just talked about.

Fair enough, fair enough. Michael, I guess for you. Just curious on thoughts on, I guess, floating-rate debt here heading into the what appears to be higher rate environment into '19. And then more specifically, so you extended your term loan from this November to next November. Curious if you have any more options at your disposal there. And then how you're thinking about the 2 pieces of floating-rate debt maturing next year, the convertibles and then the term loan in November.

Yes. I mean, definitely, something that I'm very focused on during the fourth quarter. We definitely have a plan and a path that we're going to look at our near-term maturities and deal with those, and we'll be able to talk more about that in February. As far as the floating-rate/fixed exposure, granted, obviously, our leases are mainly fixed and -- with bonds, but I do think that there's a place for a certain amount of floating-rate exposure within this portfolio mainly because it's hard to guess where rates are going to go. The forward curve can often get overstated. So I think it's good to have a piece. And I'm comfortable with the sliver, where it is. I don't think I would expand that out anymore that I think we'll be past that 80:20 split. However, we are looking at potentially fixing some of the floating-rate debt going forward. Swaps are looking pretty attractive, and that is something that's on the table. And we'll make that decision over the probably next couple of months. So it could come down a little bit.

And just to confirm, I think I read in one of the footnotes that you have one more extension option for the term loan in November? Is that right?

That's right. Right.

So...

Yes. So we -- there's a -- the first extension states November 19. We have another -- one more extension after that. And the line of credit also has a 1-year extension.

At your disposal? Or is it with the bank?

Yes, No, no, that's at our disposal. Of course, certainly, you have to meet certain covenant tests, which, of course, we're meeting. So yes, it's at our option.

Our next question comes from the line of Wes Golladay with RBC Capital Markets.

Congrats on a much cleaner quarter with all the noise behind now. When you -- looking at deal flow, where are you seeing the best risk-adjusted returns?

Well, for us, well, since it's specific to our heat map, if you kind of look on our website, I mean, we do take that seriously. So we are focused on sectors that have -- that are a little bit more Amazon resistant, sort of score well on Porter's Five, the way we weighed, which is -- have strong competition dynamics and barriers to entry. So we sure look at categories like that for us. A lot of the service industries kind of really fit in that box. So the gyms, the entertainment assets, even carwashes. To some degree, we sort of score well in that. Auto service scores well. So we're focused on those kind of verticals right now, and obviously keeping an eye on sort of where we are from a -- from just an allocation of capital standpoint given our existing exposure to the industries.

Are you still finding, I guess, a good deal flow there as far as not a whole lot of competition? I imagine some of those categories a lot of people like. But are you still finding your niches in there?

Yes, I think what's interesting from what I can tell, it's -- we're just getting back into the acquisition front. And so I kind of mentioned in my prepared commentary just those 2 gym opportunities. The reason I did it was one was just a deal where we were working with this group for one year. It was just us. Took a long time to nail that transaction down. That was the Alaska gyms deal. And then the Life Time portfolio was a little bit more competitive. It wasn't really being shopped by a book or anything like that. There were some brief discussions, but we were able to move more aggressively on that. I would sort of characterize the market as a lot of the companies, at least that we're competing with, sort of had different areas of interest or focus in any given particular time period. And so I don't think that all -- not all of us are chasing the same things. And so I think that's a big positive in terms of trying to control pricing. And you didn't ask us, but I do think that you're starting to see a little bit of cap rate movement up for assets that are not the prime-prime 1031-eligible kinds of assets. So larger portfolios, properties in more rural markets, properties with more complex tenant issues around them. We're starting to see widening in that area. But if you're talking about core c-store or core QSR or a well-located gym, those are still pretty aggressive.

Our next question comes from the line of Spenser Allaway with Green Street Advisors.

Based on your full year external growth guidance, it looks like you guys are anticipating around $200 million in that growth in 4Q. Can you maybe break out how much of that you expect to be attributable to revenue enhancing CapEx even though I'm sure it's marginal?

Yes, Spenser. This is Mike. So when you look at our capital deployment guidance, it's $450 million to $550 million. As I kind of walked through, again, in my prepared remarks, we're pushing close to -- we're in the high $400s million right now through Q3 for capital deployment. I think it's around $490 million. So that would imply $50 million, $60 million of additional acquisition in the fourth quarter, which we feel comfortable. Now we could be a little higher than that. We could be little lower. We have lots of sites for the fourth quarter. Timing can be tricky, especially coming to year-end. But I think we still feel very comfortable in that $450 million to $550 million range. And again, we're kind of pushing in the $400s million right now through Q3.

Okay. And then when you look at cap rates and what you guys are acquiring in 3Q, obviously much lower than where you're buying prior to the spin, which makes sense given, obviously, the improved portfolio composition. But is it safe to assume, without giving too many details, that any near-term acquisitions will be done at similar cap rates as you guys continue to enhance the portfolio?

Well, just one thing. I think when you look at our 3Q portfolio, I think we had mentioned in some of the meetings life Time was an interesting portfolio because there's a 10% rent bump in June of 2020, which will drive our acquisition cap rates to 7% cap based on that rent bump, which is not actually too far away. But I'd say generally like low 7s is kind of an area that we're sort of focused on. But you'll see that we do a lot higher in some cases. It's sometimes lower as a blend, but I think if you think about a low 7% type of yield, that's sort of where we're -- that's kind of where the blended average is churn out for us.

Our next question comes from the line of Collin Mings with Raymond James.

I just want to go back to Haendel's question real quickly regarding the debt maturity profile. Maybe can you just remind us on how comfortable you feel taking debt-to-EBITDA going forward? Again, obviously, the guidance is for 5.2 to 5.4 kind of for this year, but just remind us of parameters there. And as you look at options to address the near-term maturities, can you give us any sense on where you'd like to push that average maturity out to? Again, right now, it's about years.

Yes. So on the first question, on leverage, we do feel comfortable with this year kind of being at 5.2 to 5.4 range. I've said previously I don't really -- I want to stay at or below 5.5x in the medium term. Over the very long term, I'd actually like to take leverage down below that. But that's not a hard and fast ceiling. We can certainly fluctuate above that and come back down at later quarters. And some of that depends on the timing of dispositions. But generally, I would think about that 5.5x as getting to a point where I want to go much higher. But for closing an acquisition in a quarter that takes us above, we have dispositions following on, that's fine. We've have got free cash flow that we're using to redeploy as well. We have about $30 million a quarter. So we do have some capacity there to continue to incrementally bring leverage down. But that's the goal there. As far as the near-term maturities, I would like to push my weighted average maturities out as far as I can. Obviously, the yield curve is a little up, and we have to balance interest rates with that duration. But as we go into this fourth quarter, we are looking to find that right financing or group of financings that would give us the best duration for the best price. And so certainly, our long-term goal would be to push that duration out. And we're definitely too short right now. We're going to deal with that in the fourth quarter.

Okay. And then just switching gears to the comments around the widening of cap rates versus some assets or opportunities. Jackson, can you just -- does that change any of the banking around the heat map? Again, you've extensively highlighted as far as opportunities. Just how does what you're seeing in terms of the transaction market impact maybe, again, the kind of that heat map discussion?

Look, the heat map is just one tool we use. Obviously, we spend a lot of time on credit. Obviously, tenant credit is critical, right. If you don't get the tenant right. So really, you need heat map, you need good real estate, you need really strong credit underwriting on tenants. I think that the issue on the widening is just -- like -- people like ourselves and our competitors, I think we're just being more selective about what we're trying to do. And obviously, with rates going up, that's scaring some people that might, on a margin, be incremental buyers. That being said, the 1031 market, for what I'll call the traditional down-the-runway, $3 million-to-$5 million-size unit per sale, that thing has -- that hasn't changed at all, and we're seeing that in the dispositions that we're trying to pursue as well as things like that come up on the radar screen. So I would just say it's really more of, I would call it, buyer selectivity given rates are rising as sort of an overall comment. But not necessarily tied to our heat map because it's really all 3 of the things: heat map, property rankings and credit that we focus on.

Our next question comes from the line of John Massocca with Ladenburg Thalmann.

Maybe touching on acquisitions again and kind of a near-term focus. How -- has your pipeline changed at all since the September presentation? I know you closed about $6 million more on acquisitions in 3Q versus kind of what was disclosed in that presentation. So that gives you around $68 million more in transactions. Sounds like that's kind of a bow we should expect for the rest of 4Q. But is there anything else that's kind of in that pipeline kind of just dated for 2019?

Well, I mean, well, just one thing that's been different since the September presentation, we had a -- we had our first tenant appreciation of that here at Spirit. There was a couple of days we invited down kind of a lot of tenants and other vendors that we do business with. And that was really a first for the company, and that event is only going to grow. And so as you've heard us talk in the past, with over 400 tenants in both companies that we operate, there is no shortage of tenants that we really want to do repeat business with. So one of the things that is a high priority here is really continue to focus on that effort to really dig deep with our existing tenants. And you'll see that, I think, in 2019 and beyond. You're always going to have the normal kind of broker transactions that you look at, and you might win 1 of 5 -- 1 out of 5 times in those situations, but we really like the idea of once you get to know someone and their business and what they do, it just makes dual-constructing business better. They like our -- at least we're able to construct acquisitions off of our existing tenant lease agreement. We've got much better handle on their operational capabilities, so there's no surprises. And more importantly, my experience so far, I've seen that tenants like that would generally allow us to have a more attractive return because we're predictable as a counterparty for them versus just trying to buy assets that have existing leases on them.

Understood. So it sounds maybe more of a shift to a relationship based -- I mean, kind of talk about a -- or relationship based. Kind of yours is something similar to the Life Time transaction you did this quarter.

Yes, those -- I mean, the Life Time was unique. That was -- I would call that more of a -- look, I hope to deal more with Life Time, so -- in the future. That's not to say it's the case, but that was one where, as you all know, that asset was being sold from a REIT that was going through a tech-lab transaction. So -- and that (inaudible) asset was something that we had kind of an interest in, in the last couple of years actually, that particular portfolio.

Understood. And then kind of sitting at the low end right now of the year-end leverage target, and it kind of sounds like, from your comments on the call, that maybe long-term leverage target is about 5.5. I mean, how you look at kind of balancing equity today versus maybe where you're trading and kind of stimulating external growth and maybe other methods to kind of stimulate external growth if the equity markets aren't kind of accommodative?

Yes. So, I mean, when we think about the leverage here in the fourth quarter, there's some -- I mean, it really depends on the timing of asset sales and acquisitions that actually close depending on where we end up with at the end of the year. So we have a lot of dispositions and acquisitions in the pipeline, and they can have big impacts. So we could end up on the low end of leverage. We could end up on the higher end of leverage. So when we think about going forward, we did have free cash flow. It was about $30 million -- I mentioned $30 million in a quarter which we can deploy. We do have more dispositions, cap recycling. But when you think about the long term, yes, we -- to really run this business effectively and to do what we want to do, we will be issuers of equity. And when I think you don't have a specific price target in mind that I can articulate, I think for the right group of transactions with the right returns, we could issue equity. So it just really depends on what things look like at the time that we need to raise capital. But we definitely plan to come back and be an issuer of equity at the right time.

There are no further questions at this time. I would like to turn the call back over to Mr. Hsieh for any closing remarks.

Great, thank you. Well, thank you, everyone, for joining us today.

We're pleased with our results this quarter. Our portfolio remains healthy with low vacancy and positive same-store growth. Our balance sheet is robust, and we're continuing to source and close acquisitions to create a path for long-term growth with shareholder value. We look forward to seeing many of you at NAREIT this week. Thank you.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation. Have a wonderful day.