STORE Capital Corp (STOR) 2018 Q2 法說會逐字稿

Good day, and welcome to the STORE Capital's Second Quarter 2018 Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Moira Conlon, Investor Relations for STORE Capital. Please go ahead.

Thank you, Nicole, and thank you all for joining us today to discuss STORE Capital's second quarter 2018 financial results. This morning, we issued our earnings release and quarterly investor presentation, which include supplemental information for today's call. These documents are available in the Investor Relations section of our website at ir.storecapital.com under News and Results, Quarterly Results.

I'm here today with Chris Volk, President and Chief Executive Officer of STORE; Mary Fedewa, Chief Operating Officer; and Cathy Long, Chief Financial Officer. On today's call, management will provide prepared remarks, and then we will open the call up for your questions. (Operator Instructions)

Before we begin, I would like to remind you that comments on today's call will include forward-looking statements under the federal securities laws. Forward-looking statements are identified by words such as will be, intend, believe, expect, anticipate or other comparable words and phrases. Statements that are not historical facts such as statements about our expected acquisitions or our AFFO and AFFO per share guidance for 2018 and 2019, are also forward-looking statements.

Our actual financial condition and results of operations may vary materially from those contemplated by such forward-looking statements. Discussion of the factors that could cause our results to differ materially from these forward-looking statements are contained in our SEC filings, including our reports on Form 10-K and 10-Q.

With that, I would now like to turn the call over to Chris Volk. Chris, please go ahead.

Thanks, Moira. Good morning, everyone, and welcome to STORE Capital's second quarter 2018 earnings call. With me today are Mary Fedewa, our Chief Operating Officer; and Cathy Long, our Chief Financial Officer.

We continue to be active on the acquisition front. Our investment activity for the quarter totaled just over $335 million. And we profitably divested approximately $115 million in real estate investments. Our investments and property sales reflect our ability to consistently invest in and recycle cash in ways that are accretive to our shareholders. At the same time, our portfolio remains healthy with an occupancy rate of 99.7% and about 73% of our net-lease contracts rated investment grade in quality based upon our STORE Score methodology. You'll hear more about our property investment and sales activity and portfolio health from Mary.

Our dividend payout ratio for the quarter approximated 69% of our adjusted funds from our operations, serving to provide our shareholders with a well-protected dividend and a company that's well positioned for long-term internal growth based upon anticipated tenant rent increases and the reinvestment of our surplus cash flows.

Our balance sheet remains well positioned. Our funded debt to EBITDA on a run-rate basis improved slightly to approximately 5.6x for the quarter, which includes the impact of the gradual new equity issued through our ATM program. Moreover, substantially, all of our investments made during the quarter added to our pool of unencumbered assets, which stood at $3.8 billion or about 56% of our gross investments, providing us with flexibility in our financing options.

Now as I do each quarter, here are some statistics relevant to our second quarter investment activity. Our weighted average lease rate during the quarter was approximately 7.96%, which is slightly above where we were last quarter. The average annual contractual lease escalation for investments made during the quarter approximated 1.8%, providing us with a gross rate of return, which you get by adding the lease escalations to the initial lease rate, of almost 9.8%.

Including average corporate borrowings at about 42% of investment cost and at an interest rate of 40 -- 4.5%, you're going to arrive at a gross levered return of better than 13%. The majority of our outperforming investor returns from STORE and predecessor successful public companies have always been driven by having favorable property level rates of return from the outset, which is why we take the time to disclose major return components.

The weighted average primary lease term for our new investments continues to be long at approximately 17 years. The median new tenant Moody's risk calculating credit profile was solid at Ba3. The median post-overhead unit level fixed charge coverage ratio for assets purchased during the quarter was in line with our overall portfolio at 2.1:1. The median new investment contract rating or STORE Score for investments was also favorable at Baa1.

Our average new investment was made at approximately 75% of replacement cost. 96% of the multiunit net-lease investments made during the quarter were subject to master leases. And all 111 of the new assets acquired during the quarter are required to deliver us unit-level financial statements, giving us required unit-level financial reporting from 97% of the properties within our portfolio. Our investment activity this quarter was exceptionally granular, with 53 separate transactions completed at an average transaction size of just under $6.5 million.

At the end of the quarter, the proportion of revenues realized from our top 10 customers is 19.2% of annualized rents and interests, which is up slightly from 18.8% at the end of the first quarter. However, our top 10 customers continue to be highly diverse, and the largest single customer represented just 3.3% of our annualized rents and interest, down from 3.5% last quarter, with a long-term target of having no tenant exceed 3% of our annual revenues.

During the quarter, we sold 26 properties, which represented an original acquisition cost of approximately $115 million and we netted a gain over our original cost of $10.4 million. Our ability to generate profits from asset sales and to accretively recycle the sales proceeds owes itself to our direct origination strategy. And as I have long stated, portfolio management activities like this, which produce real economic gains, serve to offset sporadic vacancies or asset underperformance, which is a customary part of the net-lease business.

And with that, I'm going to return the call over to Mary, who will discuss this activity in more detail

Thank you, Chris, and good morning, everyone. We had a strong second quarter with acquisition volume of $335 million at a cap rate of nearly 8%, bringing year-to-date acquisitions to over $655 million. This puts our growth acquisition pace at slightly over $100 million per month.

In the second quarter, our investments were made through 53 separate transactions, the most transactions in a single quarter by 46%, based on our quarterly average since our IPO. We are excited to achieve this level of transaction activity in a quarter, and I'm encouraged by the opportunity to further increase this level of volume with just a handful of additional larger transactions, which is customary to see in our market.

We continue to actively manage our portfolio, taking advantage of opportunities to sell properties. During the quarter, we sold 26 properties, which had an acquisition cost of $115 million. We generated net gains over the original cost of approximately $10.4 million. Based on acquisition costs, 38% were opportunistic sales and delivered the bulk of the gain, which averaged 16% profit over cost. 48% were sold for strategic reasons to reposition the portfolio at a 4% gain over cost. And the remaining property sales were from our ongoing property management activities and resulted in gains in the quarter of nearly 8% over our original cost.

Now turning to our portfolio performance highlights as of June 30, 2018. Our portfolio mix remains consistent with the majority of our portfolio in the service sector at 66%, 18% in experiential retail, and the remaining 16% in manufacturing. Customer ranking within our top 10 remains extremely diverse by design with our largest tenant, Art Van Furniture, representing just 3.3% of rent and interest.

We are excited to have added Dufresne Spencer Group to our top 10. Dufresne Spencer Group is the largest Ashley Furniture HomeStore licensee. With over 800 locations worldwide, Ashley is the world's largest furniture manufacturer and the #1 furniture store brand in the world. Dufresne Spencer Group is backed by a seasoned management team with a strong operating history and garnered an investment from Ashley corporate in December of 2017. They joined our top 10 as a result of their ownership in Hill Country Holdings, an existing customer of ours and another top licensee in the Ashley system.

Our portfolio health continues to be strong, as delinquencies and vacancies remained very low due to our active portfolio management and strong tenant partnerships, with only 6 out of our more than 2,000 properties vacant. Our customer focus on the middle market, which creates most of the revenue and employment growth in this country, continues to play out. Our customers grew their revenues by 15% on average in 2017.

Now turning to the overall market and our pipeline. Cap rates remain stable, and this allows us to continue our pattern of generating strong spreads over our cost of long-term capital. Our target market of middle-market and larger companies is extremely deep. And while the market penetration we've achieved is exceptional, we have plenty of runway ahead. Our pipeline remains robust and diverse with an emphasis on service, manufacturing and select retail sectors having high potential for long-term relevance.

With that, I'll turn the call to Cathy to talk about financial results.

Thank you, Mary. I'll start by discussing our capital markets activity and balance sheet, followed by our financial performance for the second quarter. Then I'll review our 2018 guidance. All comparisons are year-over-year unless otherwise noted.

Beginning with our capital structure. Our financing flexibility reflects an ability to access both the equity and debt markets in a variety of ways. Our ATM program has been a very effective way to raise equity. It also makes a lot of sense for us, given the flow of our business and the granular size of our transactions. During the second quarter, we sold an aggregate of 7.1 million common shares under our ATM at an average price of $26.64 per share. We raised net equity proceeds of just over $187 million, which we put to work through our real estate investment activity. Year-to-date, we sold an aggregate of 11.3 million shares at an average price of $25.86 per share. This equity gives us significant liquidity going into the third quarter.

At June 30, our long-term debt stood at $2.6 billion, with a weighted average interest rate of just under 4.4% and a weighted average maturity of about 6 years. In an environment focused on interest rates, it's important to note that all our long-term borrowings are fixed rate. Our debt maturities are intentionally well-laddered. Our goal is to grow our free cash flow after dividends, such that the amount of our annual debt maturities that wouldn't be covered by free cash flow is only about 1.5% of our total assets. Our median annual debt maturity is just under $260 million, and we have no meaningful debt maturities until the year 2020. Our leverage ratio at June 30 remained low at 5.6x net debt to EBITDA on a run-rate basis. This equates to around 40% on a net debt-to-cost basis.

At the end of the second quarter, we had borrowing capacity on our credit facility of nearly $500 million in addition to the $44 million of cash on our balance sheet. The accordion feature of our expanded credit facility provides access to even more liquidity. In summary, we're well positioned with substantial financing flexibility, conservative leverage and access to a variety of attractive equity and debt options to fund a large pipeline of investment opportunities.

Now turning to our financial performance. Acquisition activity during the second quarter was funded by strong cash flows from operations, proceeds from asset dispositions and proceeds from the ATM activities I noted earlier. As of June 30, our real estate portfolio stood at $6.7 billion, representing 2,084 properties. This compares to $5.5 billion, representing 1,770 properties at June 30, 2017. The annualized base rent and interest generated by our portfolio in place at June 30 increased 19% to $538 million as compared to $453 million a year ago.

Of our $6.7 billion gross real estate portfolio, approximately $2.9 billion was pledged as collateral for our secured debt, and the remaining $3.8 billion of real estate assets are unencumbered, giving us substantial financing flexibility. We expect that by year-end, the portion of our portfolio remaining unencumbered will approximate 60%.

Portfolio growth drives revenue growth. And in the second quarter, revenues increased 15% year-over-year to $131 million. Our second quarter acquisition volume was weighted towards the end of the quarter, therefore, the full impact of that volume won't be realized until the third quarter. Our consistently strong revenue growth reflects the broad-based demand for our real estate capital solutions.

For the second quarter, total expenses increased 13% to $89 million compared to $79 million a year ago. Nearly 70% of this increase can be attributed to higher depreciation and amortization, reflecting the growth of the portfolio.

Interest expense was up slightly compared to a year ago, primarily due to higher average balances outstanding on our credit facility. Interest expense on our long-term debt was also up slightly, as we used debt to partially fund our real estate acquisition activity. That impact was almost fully offset by a decrease in the weighted average interest rate on our long-term borrowings.

Property costs were $741,000 for the second quarter as compared to $1.1 million a year ago. Since 98% of our real estate investments are subject to triple net leases, property level costs such as property taxes, insurance and maintenance are the responsibility of our tenants and not a significant portion of our annual expenses. Property costs can vary quarter to quarter based on the timing of property vacancies and the level of underperforming properties. Over the past 4 quarters, property costs have averaged about 8 basis points of our average portfolio investment. During the second quarter of this year, property costs were lower at about 4 basis points of our average investments.

G&A expenses in the second quarter were $10.9 million compared to $9.3 million a year ago, primarily due to the growth of our portfolio and related staff additions. For the second quarter, G&A as a percentage of average portfolio assets decreased slightly to 66 basis points from 67 basis points a year ago.

Net income before gain on property sales increased to $42 million compared to $35 million a year ago. This increase was due to the growth in the size of our real estate investment portfolio, which generated additional rental revenues and interest income. This increase was offset by a decrease in net gains on property sales.

The second quarter of 2018 included a net book gain of $19.9 million from the sale of 26 properties as compared to a net book gain of $25.7 million from the sale of 23 properties in the second quarter of last year. Including these gains, net income increased to $62 million for the quarter or $0.31 per basic and diluted share compared to $61 million or $0.35 per basic and diluted share a year ago.

We delivered another strong quarter of AFFO and AFFO per share growth. AFFO for the quarter increased 19% to $91 million or $0.46 per basic and $0.45 per diluted share, from $76 million or $0.44 per basic and diluted share last year.

As you know, the Berkshire Hathaway investment last June meaningfully accelerated the timing of equity issuances, and we expected a dilutive impact to per-share amounts beginning in the back half of last year. This dilutive effect is reflected in the year-over-year net income and AFFO per share comparisons.

Our dividend is an important component of our stockholder return. Since our IPO in 2014, we've increased our dividend per share by 24%, while maintaining a low dividend payout ratio and at the same time, reducing leverage. For the second quarter, we declared a quarterly cash dividend of $0.31 per common share, representing around 69% of our AFFO per share. As you know, our board evaluates our dividend policy at each board meeting and considers raising it at least annually as our results permit. As we've maintained our quarterly dividend at the $0.31 level for 4 quarters now, and our dividend payout ratio is currently among the lowest in the net-lease sector, we would anticipate that our AFFO per share growth could translate into dividend growth.

Now turning to our guidance. Today, we're affirming our 2018 guidance first announced last November. Year-to-date, we're on track with our projected 2018 net acquisition volume guidance of approximately $900 million.

We expect AFFO per share to be in the range of $1.78 to $1.84. AFFO per share in any period is sensitive to the timing of acquisitions during that period as well as the amount and timing of dispositions and capital markets activities. In 2018, we expect acquisitions to be spread throughout the remainder of the year, though acquisitions are often weighted towards the end of each quarter. The midpoint of our AFFO guidance is based on a weighted average cap rate on new acquisitions of 7.75% and targeted leverage in the range of 5.5 to 6x run rate net debt to EBITDA.

Our AFFO per share guidance for 2018 equates to anticipated net income, excluding gains or losses on property sales, of $0.83 to $0.88 per share, plus $0.88 to $0.89 per share of expected real estate depreciation and amortization, plus $0.07 per share related to items such as straight-line rents, equity compensation and deferred financing costs.

As we move through the second half of the year, we'll continue to assess our outlook and update guidance as needed. And now, I'll turn the call back to Chris.

Thank you, Cathy. Before turning the call over to the operator, I'd like to make a few comments just regarding some of our achievements over the past year.

STORE has, by design, the most highly diversified net-lease investment portfolio we know of, and certainly the most diverse in our own long history of running successful net-lease companies. Taken alone, investment diversity can be expected to deliver investment-grade performance, which is a long proven cornerstone of the structured finance universe. But we hold not just a diversified portfolio of real estate leases, but a diversified portfolio of senior contracts. That's the beauty of our strategy to exclusively hold profits in our real estate. Contracts are senior when the properties we own deliver properties -- deliver profits to our tenants after our rent is paid. Contract seniority is yet another long proven cornerstone of the structured finance universe, standing at the core of many investment-grade note issuances. So pairing sector leading portfolio diversity with contract seniority alone should yield a high level of investment-grade portfolio performance.

Our long-run average STORE Score suggests that roughly 75% of our contracts are investment grade in quality, which is based upon tenant credit and location profitability. But adding in portfolio diversity, investing real estate at discounts to net asset value and replacement cost and then highly active property and portfolio management and you get performance that actually well exceeds the STORE Score. Since we started STORE, our aggregate portfolio performance has been more like an A-rated credit. And we've realized this while achieving industry-leading equity returns.

The results of our organic growth has been an impressive AFFO per share growth of 9.8% since the end of the third quarter of last year, which is the last time that we raised our dividend and includes the first full quarter of the 9.8% Berkshire Hathaway investment in STORE. So our dividend has become more protected in the interim, and our payout ratio at the end of the second quarter stands at just 69% of AFFO. As Cathy alluded, this performance will be on the mind of management and our Board of Directors as we assess our dividend policy for next year.

Since our IPO in 2014, we've elevated our quarterly dividend by 24% while maintaining a payout ratio close to 70% of adjusted funds from operations. Such consistent operating performance and dividend growth has helped us to realize double-digit annual rates of return for our shareholders each year since our IPO.

And with those comments, I'd like to turn the call over to the operator for questions and note that we also have Michael Bennett, our General Counsel; and Chris Burbach, our Executive Vice President of Underwriting here to help us with answering any of the questions you might have.

(Operator Instructions) Our first question comes from Collin Mings of Raymond James.

First question from me just on the deal pipeline size. It was up, call it, 300 million on a net basis but appears to have flatlined a little bit relative to the growth seen last year. Are there market dynamics at play here? Is it just timing? And maybe along those lines, how do you feel about the current capacity of your team? Does it maybe make sense to add some more people as kind of that pipeline has obviously seen tremendous growth over the last couple of years?

Hey, Collin, it's Mary. So no, pipeline is good. It's timing. It's growing. And it's interesting you mentioned that because we have added 2 new salespeople this year, and they're coming along. It will take some time for them to get up, but we'll start to see them on the board here shortly. So we are investing in the front end, and we're achieving great market penetration right now, too. So everything's good on the deal flow front.

All right. And then just for my second question just on the disposition front. Appreciate the detail there and kind of the buckets between the opportunistic, strategic. Sounds like you were able to post some gains across the board there. But can you maybe just give us a better sense of some examples of what is showing up right now or what you're trying to process in that strategic bucket in terms of what you're looking to sell? And then maybe where are you finding the best bid for some of the opportunistic deals that you're selling?

Yes. So on the opportunistic front, Collin, it's Mary again, it generally is the granular properties that we have. More restaurants. We had some urgent cares, things of that nature. And on the strategic side, it's really a plethora of asset classes as well. So nothing in particular in terms of all -- anything systemic in any industry-wide. So it's really a mix in both areas, quite honestly.

Yes, right. In the strategic area, we sold some furniture stores, for example, I mean, 1 or 2 furniture stores.

The opportunistic side, yes.

And strategically, just to sort of keep our exposure managed. And so it's been a mix. And then this quarter, we were lucky to make money even on the property management side, which is sort of unusual. You don't expect to make money on the property management side normally.

Correct.

Our next question comes from Craig Mailman of KeyBanc Capital Markets.

Just wanted to hit on guidance here. You guys are -- based on the midpoint, kind of need to do $0.92 in the back half of the year, so just $0.01 uptick from where the second quarter came in. And you noted that a lot of the investment activity is weighted toward the back half of the quarter. Add on the fact that you guys are like 25 basis point ahead of your guidance, you're at the lower end of your leverage range. I'm just curious, kind of maybe what the potential headwinds are in the back half of the year that you're seeing that didn't give you guys the confidence to maybe bump the midpoint a little bit, given the execution you've had.

It's Cathy. A lot of it is timing. So on the acquisition front, as Mary mentioned, a lot of the quarter was very granular. And actually, in the second quarter, a lot of the activity was in the month of June and actually fairly late in the month of June. So because we're more of a flow business, you can't assume the timing is going to be favorable to you necessarily when you're closing properties. So a lot of keeping guidance where it was was just for that reason, for the timing of not only acquisition activity, but the timing of raising equity as well.

And as you go through the rest of the year, what will happen is as you progress, the acquisitions have less and less of an impact on AFFO per share growth, although they do have a big impact on 2019 numbers. So to the extent that we're able to exceed hypothetically $900 million net for the year, that will have more to do with what happens in 2019 than '18.

And as you know, sometimes December is quite a big month. And as Chris mentioned, if you close things in the back half of December, it almost has no impact on AFFO for the year.

Okay, that's helpful. And then just curious, I know you guys have talked in the past about the continual refinement of the STORE Score. I'm just curious how that process is going, if you guys have made any substantial changes. And has that materially impacted at all any of the credits, the way you're viewing them in the portfolio?

Well, at this point, we've made no changes to the STORE Score. So it's been consistent since day 1. And really, if you look at the STORE Score, it's a composite of just a Moody's RiskCalc number, which is a very proven statistically robust number, together with a very loose hypothetical on the impact of that -- of unit-level coverages on contract retention in the case of a bankruptcy or insolvency or a lease expiration. And so you can almost view the piece that we use for our portion of the STORE Score or the property level portion as a bit of a hypothesis. It's less proven, for example, less robust than the Moody's RiskCalc number would be.

We've intentionally tried to make it conservative so we do it after overhead, for example, so we're calculating our coverages after overhead. We're assuming what we think to be conservative probabilities of people affirming leases in the event of insolvency. We have been investing a lot in the last number of months, and will be for the next few years in business intelligence software and artificial intelligence. I mean, we're going to have a lot of data behind this. And so over time, you're going to see us, at some point, move around the STORE Score to reflect more proven mathematical relationships. But for now, I would tell you that the portfolio as a whole performs better than the STORE Score, which, basically, in a way, disproves the hypothesis and says that really, the portfolio is doing better than that.

And I made those remarks in my notes because it's really driven by really high levels of portfolio diversity, active property management, buying assets at a discount to net asset value, strong levels of portfolio management where we're selling really almost sector-leading amounts of our portfolio every year and moving assets around intentionally and trying to get out in front of things as well as property management where we've been very active and done a good job to keep our vacant properties under 10 properties for quite some time at this point, which is pretty low.

I mean, so all of that stuff helps you to realize total rates of return that end up having more of an A-rated type performance. And you can see that on the sort of internal and external growth walk or, really, the internal growth walk in the appendix to our presentation. And we've modified that a bit, and it's a pretty neat presentation.

Our next question comes from Ki Bin Kim of SunTrust.

This is Alexei filling in for Ki Bin. Just 2 quick questions. On the disposition front, it looks like you sold 3 Applebee's assets this quarter. Perhaps, could you give some color on those in terms of like the dollar amount and the cap rates? And are you looking to further reduce their exposure?

So on the Applebee's side, Ki Bin (sic) [Alexei], it's Mary. So yes, we did move some of the -- we had been moving some of the RMH properties for quite some time now, getting out in front of some of the issues that we saw early on from collecting financial statements. So we've been moving those right along. So those are just basic Applebee's.

And what we were able to do actually, interestingly enough, is to lower the rents on those and give the Applebee's guys a permanent rent reduction with their new landlord and still make money on those assets. So it was a neat strategy that aligned our interest with theirs. And it lowered our exposure and again, gave them some permanent rent reduction out in the marketplace. So they were a little over $2 million properties, the average size, in a cap rate range which is at least 100 basis points less than we were acquiring stuff. So we got nice execution on those.

And the cap rate range, in the 7% area, so -- and we've found that restaurant cap rates are holding in pretty tight which is a very desired marketplace. And of course, if you're looking at Applebee's, their same-store sales numbers are up a lot over the last couple of quarters.

8%, yes.

So that's also been a cause for people wanting to buy those kinds of assets.

Okay. And then another follow-up question. So it looks like in the first quarter, you had provisions for loan losses of about $1.5 million. And then in the second quarter, you had another $1 million. Could you just provide some color on that? And is there any more of that to be expected in the second half of the year?

Sure. This is Cathy. Those were 2 different loans. As you know, we are very customer-centric when we're providing capital solutions for our customers. And oftentimes, if they're looking for more proceeds, and we don't see that the real estate would necessarily support those proceeds, we put separate proceeds we may be willing to give them in a loan versus throwing more money on the real estate, if that makes sense to you. So the real estate values are the real estate values. And when we show investing in real estate, it's really all real estate value.

If the tenants needs more funds, we may make a loan secured by other things. Sometimes equipment loans or secured by maybe other properties that he might own. So during the first quarter, we had a write-down of a loan and we ended up grabbing the collateral that was supporting that loan. And so we wrote that loan down to the collateral value. And in the second quarter, we did the same thing for a separate loan. This is a very, very small part of the business we do. There are less than a dozen of them, and they're all very small. Most of them are, frankly, equipment loans. So that's not a big part of the business.

I would add -- yes, right. I mean, we clearly -- it's oftentimes, you could put things -- values on real estate and you wouldn't take any write-down at all on a lease. So it doesn't really affect your overall recovery rate. So we're giving you a performance walk, for example, in terms of internal growth walk on -- in the appendix, whether it's a loan or a lease recovery the calculation is the same, on an AFFO calc.

Our next question comes from Kevin Egan of Morgan Stanley.

Just a quick question for me. Just looking at the sub and just looking that you have average lease escalators that are significantly higher than the peer group. I was just curious, have you had any additional success in terms of negotiating lease escalators maybe above the 1% to 2% range? Or has it been pretty sticky at that range recently?

So ask that question one more time. We had success at negotiating leases above the what range?

So just in the 1% to 2% range, given that there's been higher inflation expectations recently. Have you had any success in possibly pushing that escalator a little bit higher than maybe the 1% to 2% range? Or I guess, it's higher than it has been historically?

Yes. No, Kevin. It's Mary. 2% annual is really market, and we haven't seen anything too much higher than that.

So -- yes, the 1.8% sort of reflects sort of a mix of between -- we've got some 2s and we have some 1.5s. And so it's -- 1.8% is kind of in the middle of this. It's -- 2% is the Federal Reserve's long-term guidance for inflation. You really want to have lease escalators that are lagging inflation. You do not want to have lease escalators that exceed inflation because you like to have your leases be below market rate leases at the time they expire, which is going to give you a much better chance for lease renewals. So trying to push on that is going to be difficult, and as Mary said, it's market. I mean, 2% is about as high as you get.

Yes.

Okay. And then just in terms of acquisition cap rates, have there been any specific sectors that you've been seeing more movements, perhaps upwards or downwards?

So it's really been consistent this year in terms of a movement away from still having movement away from retail and industrial being as sort of the favorite asset class, so some downward pressure on industrial side. And in terms of the other asset classes have been very, very stable.

Our next question comes from John Massocca of Ladenburg Thalmann.

So it looks like you sold one Art Van furniture during the quarter. Can you give maybe some color on the cap rate on that sale? And would you look to do more kind of strategic dispositions of properties leased to that tenant?

We're going to get the cap -- we're going to get the Art Van exposure [self] is 3 and it will be a combination of growth in property sales. So -- and that's been -- the customer knows the -- what we're doing, and so they're knowledgeable about that and it's simply for diversity reasons. And the assets that we sell are always sold below the cap rates we buy at, so we're making some money and we disclose to you what the spread is but we're not going to give you exact disclosure on that property.

Understood. I think you were saying that was in your strategic bucket, correct?

Yes.

Yes, from a lease position.

And then I saw that you kind of gave a little extra disclosure around kind of fixed charge and [4-wall] coverage. You gave the average. Is that -- just to clarify, is that a simple or a weighted average? And also, maybe what would that metric have looked like last year if it was given?

We gave the weighted average, and we did it because there's a -- we try to keep up with disclosure from other companies and there are other companies out there that were disclosing the weighted average. I mean, if you ask us our opinion on this, our opinion is the weighted average is a total waste of time. What you really want to look at is just the median because the weighted average gets -- the weighted average is substantially north of 3, and it gets weighted up by just the right-hand tail that's going to just drag it up. So you're going to have some manufacturing assets. And obviously, they're going to skew it. And so it gives people sort of an artificial sense of security. But on the other hand, I don't like it when people say that their coverages are better than ours and they include weighted coverages and we don't have them. So we're going to give them to you.

More disclosure is helpful. And so would it kind of have trended the same way you think as, just roughly speaking, as the median -- kind of the median ones would have?

Yes, it would trend the same way. It wouldn't -- there might be a little more volatility in the weighted average just because it just depends on, again, the right-hand sale could just drive it. So -- and what you really want to do is focus on the median. And if you look -- by the way, if you look at the appendix, there's a 3-year stack of EDF scores and also, a 3-year stack of STORE Scores. So you can sort of see how all the stuff has trended.

And if you look at the Baa3 point on that chart, it's on top of each other for the last 3 years, meaning that basically the same percentage of our portfolio has been Baa3 or better from a tenant perspective for the last 3 consecutive years. And if you look at the STORE Score, the numbers are on top of each other, which is basically driven by the fact that the unit level coverages have been pretty much flat for the last 3 years. So all that stuff is just flat. And I think that gives you an idea of where the credit trends are and whatnot. So I -- you should just take a look at that. That's on page...

34.

34.

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

Just going back to the investment pipeline, it does look like the deals reviewed this quarter was up fairly significantly relative to the first quarter. Is that correct? And if so, what is driving that?

Yes. Again, it's just timing of transactions and how things get decisioned. It's not necessarily consistent each quarter. So I think this quarter, we probably just made some decisions on some stuff.

Yes. But I would say that, to the point that Mary made earlier, the quarter itself was just hyper granular. I mean, the average transaction was $6 million and change, which is if you look at our average quarter in terms of number of transactions for the last number of years, it's basically 40% over that average. So it's a big number. And we're encouraged by it because it means that we're doing north of $100 million a month but even with smaller deal sizes. Usually, the deal size can drive volume.

So one of the ways to sort of get our volume up is to do an insane number of deals that have -- where the average deal size be $20 million. But we had basically no transactions that were $100 million, no transactions at $50 million, no transactions that were meaningful in terms of size. But if you were to look through to the rest of the year, one of the ways you get more through your $900 million number on the net side would be to throw in some bigger transactions, which normally is likely, but we can't assure ourselves that that happens. But it could happen.

And so we're really encouraged by basically the amount of penetration, the amount of deals that we've done. I mean, it takes -- honestly, it takes as much time to do a small deal as a big deal. So to have your team be able to do this efficiently at a rate of $6 million a copy, I would venture to guess that if you were to ask people a number of years ago, would it be possible to do $1 billion a year at an average number of $6 million a deal, people would say no. You have to have -- you've got to throw in like an extra $100 million deal here or there or maybe $200 million deal here or there to be able to get to $1 billion. And what we're showing is that having a full business that's focused on serious market penetration is able to deliver that in terms of deal flow.

And Spenser, I think you're seeing the line kind of climb up there in the first part of -- end of '17 in the pipeline and the beginning of '18. So it would be -- you should expect some larger review or passed on deals or decision deals. So I think it's pretty normal.

Okay, that's helpful. And then just one last one. Can you provide a little color on what select sub-industries you're kind of targeting in that other retail bucket?

Other retail bucket, so maybe -- let's see, on the other retail side of things would be, just -- probably some things like home decor, maybe things of that nature. Stores you go in and buy, it might be some hobby stores. Yes, exactly. Things like that, home decor, hobby. Sometimes, auto parts. Yes, we've got auto parts. But it's -- think about if you go into a retail firm, buy some stuff, it's mostly hobby and home decor. Specialty stuff like maybe a Michaels or something like that where you don't really get on the Internet, you actually go in and they have classes and teach you how to sew and teach you how to do art and all that stuff.

Our next question comes from Collin Mings of Raymond James.

Just one quick follow-up for me. I was just curious, on your farm and ranch supply exposure, can you talk about if any of those tenants have seen any weakness? Are you seeing any weakness just given some the concerns there about the broader outlook for the agriculture sector just given the uncertainties on trade policy?

No. At this point, it's too early to say whether we're seeing any of that. I mean, we obviously hear discussions about soybean farmers in the Midwest and whatnot having issues. We've not seen, at this point, any change in numbers at the unit level and have not heard from any of our tenants that there's anything adverse going on. Trade wars are not good for anybody. So I would expect that if we have serious trade wars, it could affect farm supply, but it would also affect everything else.

I mean, the good news is, by the way, that the -- I mean, if your average unit cover is at north of 2, that means that sales can drop 30% to 40% for you to break even. So the margin for error that we have in our numbers is really huge, and -- which is why you have companies like Applebee's which has the same-store sales declines and we have almost no Applebee's problem. I mean, it's just one of those things that you want to have just margins for error on the stuff.

But at this point, we haven't seen anything that would suggests there would be huge deals. But we're -- we have concerns about. I mean, I would say it's just broader economic concerns relating to not just ranch and supply stores, but those farmers also go out and eat and they also work out and they do other things, they put their kids up at daycare and that kind of stuff. So I mean -- so all the stuff trickles through the economy if you have tariff issues.

Our next question comes from Ki Bin Kim of SunTrust.

This is Ki Bin. So in the past 3 years, you've almost doubled the size of the company in terms of asset value. So what have you kind of gleaned from just growing the portfolio at that kind of pace? And has any part of the philosophy or how you've done business or source of deals changed over that time? And for the next couple of billion, do you think other parts of the company has to kind of grow or adapt?

Yes. So thanks, Ki. I would say that we've been doing investment activity around $100 million a month for 4 years. And one of the reasons that I pointed that out in the quote that I had on the press release was just because when analysts think about external growth and we're a primarily internally-driven growth company, but when people think about external growth, they tend to discount it because they think that it's not really reliable and -- but of course, we've been doing this at a very steady pace. I mean, it's been almost like clockwork to do $100 million a month.

And we've been just very encouraged by our ability to be able to do that. So we haven't really been thinking about doubling the size of the business so much, but $100 million a month, of course, has done that. So you're adding $1.2 billion a year with gross and then you're selling off assets. And we took the company public, and we had sort of $3 billion and change worth of assets. And now, you're at $7 billion worth of change in assets.

We -- as Mary said, we have additional relationship managers that we've hired this year, which gives us the potential for potentially being able to exceed the $100 million a month at some point in time through better market penetration, which is something that is on our mind. And we've been adding, of course, to the credit side as well and the closing side as well. And the repeat business has been huge. So we've been doing -- from day 1, we've been doing roughly 30% of repeat business.

So as you grow, what happens is you get more repeat business, and that sort of helps fulfill the growth. So for example, if you were to look at us in 2000 before we went public, if you were to look at us in 2000 --when we started the company in 2011, we had no repeat business. So 2012, so when you go from 2012 to '13, basically, we didn't do that much more business. It's just that we had repeat business. So that has kind of carried us to the $1 billion type number, which is sort of like doing $600 million worth of new business, and the rest of it is repeat business every single year. And I think that will hold us to grow.

As far as what we've learned otherwise, we've kept it really diverse. We're trying to look for very noncorrelated risk. We're diversifying by industry. So we're very conscious of this. On the property sale side, on the strategic side, we're thinking about where we need to lighten up from a long-term diversity perspective. We're -- when you underwrite this stuff, you have to assume that there are 2, maybe 3 recessions during the time you hold these assets. So you're not underwriting -- if somebody says where are we in a business cycle, or I'm worried about the business cycle today. I mean, we're worried about the business cycle next year or the year after that. We're worried about the next 20 years. So we can't really change our underwriting to suit a particular business cycle that we're in.

And of course, if you're one of the many thousand people in retail -- 9,000 retail stores that closed last year, you're thinking that the business cycle wasn't too good to you last year. So we're very mindful of where we are all the time and how we underwrite. And we're trying to make investments that will be sustained over time. And as I said earlier in the presentation, if you have a just diverse portfolio, I mean, just pure portfolio diversity. I mean, that underscores the CMBS market, the more -- the residential mortgage market.

When we were at FFCA, our first public company, we would do mortgage loans and have 95% of it at cost be rated BBB or better. So if you have -- choose diversity by itself, you should have investment grade performance, which is our goal. And then we're pairing that with contract seniority which gets you even a better risk-adjusted performance. And so you end up with some of the highest returns in the business, cap rates that are close to 8%, with escalators at 1.8%. And yet you're performing like an A-rated credit on 100% of the portfolio, which is where you end up in the appendix that you've got on the page that talks through the internal growth revenue walk. So that's the goal.

And when you guys mentioned about the 16% sales growth for your tenants, was that at -- in your portfolio only or you're talking about just kind of broader corporate revenue line items for your tenants?

So that was our tenants at the corporate level, their performance for 2017 at their top line. And it was a weighted average based on the rent and interest they have with us.

If you look at unit-level growth last quarter, it's closer to 1%. So it's not massively exciting. So it's a -- and it's been kind of at the 1% unit-level growth for like the last several quarters. But a lot of our tenants are growing through acquisition of other tenants. They're also building some new-built stuff, too. So -- and that together is giving them pretty substantial growth, which we think is a great thing, by the way, because it means our tenants are more diverse. They're more diverse and they're less risky. They've got more points of profit. So that's a good thing.

So just to clarify the -- in a way, I can call that same-store sales for your tenants grew 1% over the past year? In '17 you mean?

It's closer to 1% last quarter, right?

Same-store sales did, yes. But their top line revenue grew 15% at the total corporate level, yes, you're correct -- on average.

This concludes our question-and-answer session. I would like to turn the conference back over to Chris Volk for any closing remarks.

So thanks all for attending the call today. I encourage you to take a look at our second quarter investor presentation, which includes a number of disclosure enhancements that are designed to improve your understanding of STORE. My personal favorite, as I talked about earlier in the call, is the internal growth blocks contained in the appendix. It illustrates our historic internal growth, taking into account rent increases, retained cash flow, recycled cash from asset sales and assets underperformance.

And the one thing that should stand out materially is the dependability of our internal growth which annually is expected to account for the bulk of our AFFO growth per share. And finally, our next investor presentations are going to be at the Wells Fargo net lease conference, which is scheduled to be held in New York City on September 11. And if you're interested in seeing us there, please let us know. And meanwhile, thanks all for listening. And we're around today or tomorrow with any questions that you have. So have a great day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.