Global Net Lease, Inc. (GNL) Q3 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the Global Net Lease Third Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Matt Furbish, Director of Investor Relations. Please go ahead sir.

Thank you, Operator. Good morning, everyone, and thank you for joining us to review Global Net Lease's earnings for the third quarter 2016. With me today is Scott Bowman, GNL's President and Chief Executive Officer, and Tim Salvemini, GNL's Chief Financial Officer, Treasurer and Secretary. This morning's call is being webcast on our website at globalnetlease.com in the Investor Relations section. Before I turn the call over to Scott, I would like to remind everyone that certain statements and assumptions in this earnings call which are not historical facts will be forward-looking and are being made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to certain assumptions and risk factors, which could cause GNL's actual results to differ materially from these forward-looking statements. The risk factors that could cause these differences are more fully discussed in our filings with the SEC. In addition, the forward-looking statements included in this conference call are only made as of the date of this call. As stated in our SEC reports, GNL disclaims any intent or obligation to update or revise these forward-looking statements except as expressly required by law. Finally, all references to per share earnings including funds from operations, core funds from operations and adjusted funds from operations, are on a basic and diluted weighted average share basis. Now, I'd like to turn the call over to GNL's CEO, Scott Bowman. Scott?

Thank you Matt. Good morning everyone and thank you for joining GNL’s third quarter 2016 earnings call. I'll begin with a review of our operating results and highlights for the quarter and update everyone on the progress we've made with our previously announced asset recycling program. Tim Salvemini, our CFO will then provide detail around our financial performance. Before we discuss the results for the quarter, let me first say that I’m happy to announce that on November 8, we received SEC approval to go effective with the merger proxy statement for acquisition of American Realty Capital Global Trust II or Global Trust II. We are limited in what we can say today about this transformative transaction that will create a premier global net least REIT. However, I will share a few brief remarks later in the call. Now on to the results for the quarter, we are pleased to report another strong quarter of results growing net operating income to $49 million, up 4.6% year over year and AFFO to $0.20 per share, up 15.7% year over year. These results were generated by the strong underlying cash flows from our best in class portfolio of primarily mission critical assets leased to largely investment grade tenants on long duration leases. We remain focused on managing our balance sheet reducing leverage and strengthening our liquidity all intended to position the company well for long-term success. We continued our efforts in Q3 to enhance our debt metrics in preparation for future rating agency discussions. Through proceeds from the asset recycling program and free cash flow from operations, we continued to pay down our corporate credit facility. As of September 30, our interest coverage ratio was 5.3 times, our net debt to EBITDA was 6.6 times and we have nearly $120 million in dry powder. Since we last updated you on our second quarter earnings call, we have made considerable progress on our asset recycling program. As of September 30, we completed the sale of three properties for $13.9 million at an average cash cap rate of 6.6%. And since the end of Q3 have sold an additional 27 properties for $44.5 million at an average cash cap rate of 6.54%. This brings total sales for the asset recycling program since the beginning of third quarter to 30 properties sold generating $58.4 million in proceeds at an average cash cap rate of 6.55%. As we have previously stated, the focus of our asset recycling program is to refine our high quality global real estate portfolio, which includes fine tuning certain portfolio concentrations. Specifically, our recent property sales brought down exposure to dollar stores and big box retail as well as eliminated certain assets that are outside of our core portfolio focus. As an example, we've closed on the sale of our only two medical office facilities. Our property portfolio remains best in class in terms of the quality of our assets, the percent of our investment grade tenancy and our geographic mix. As of quarter end, key metrics for the portfolio were 100% occupancy, 61% US and 39% Western European properties based on NOI, 86 tenants across 32 industries in five countries. The property mix based on NOI includes 53% office, 31% industrial and distribution, and 16% retail. And our top ten tenants comprised 35% of our NOI. Turning to our tenant base which remains a pillar of GNL’s differentiated strategy. As of September 30, 70.4% of our portfolios NOI was derived from investment grade or implied investment grade rated tenants amongst the highest in our net lease peer group. At quarter-end, our weighted average remaining lease term was 10.5 years with 90.1% of leases by NOI possessing contractual rent increases which are tied to both fixed and/or index escalators. Before I turn it over to Tim, I would like to make a few comments regarding Europe. We continue to feel good about our positioning in Western Europe. In fact, we've seen markets in the eurozone experience tightening cap rates and continued real estate capital inflows. Additionally, with the low cost of debt which continues to provide large spreads to acquisition cap rates, Europe remains an attractive investment environment. As it relates to recent volatility in Europe, let me remind you that the GNL portfolio was built with rigorous underwriting standards on a foundation of mission critical assets, long Duration leases to largely investment grade tenants. This is married with a three-part hedging program designed to mitigate risk of currency fluctuations between foreign currency and the US dollar. This program is core to GNL and includes asset liability matching to protect portfolio asset values, FX forwards and other instruments to hedge operating cash flows and finally interest rate swaps. With regard to our UK portfolio, we have a weighted average remaining lease duration of 14 years and 84% of our UK tenants are designated investment grade or implied investment grade. This positions us well to withstand short-term volatility in the UK. My final point before I turn it over to Tim is I'd lied like to remind everyone that because 77% of our debt is denominated in either euro or pound sterling, GNL is well positioned to minimize the impact [ph] of FX of a potential rising rate environment in the US. Now, let me turn it over to Tim.

Thank you Scott, and good morning everyone. As you saw in our press release yesterday afternoon, we posted another strong quarter of operating results, which were driven by our stable and transparent underlying cash flows from our premier single tenant global net lease portfolio. We continue to focus on the quality of our balance sheet and transparency of our cash flows as we build GNL into a premier global net lease REIT. Now let me walk you through our financial results and provide detail on our balance sheet, liquidity and hedging program. For the quarter, we reported net income attributable to stockholders of $8.9 million or $0.05 per share, a year over year increase of 64.6%. Net operating income of $49.1 million, a year over year increase of 4.6% mainly defined funds from operations of $30.9 million or $0.18 per share, core funds from operations of $33.4 million or $0.20 per share, and adjusted funds from operations of $33.1 million or $0.20 per share, a year over year increase of 15.7%. A reconciliation of GAAP net income to non-GAAP measures can be found starting on page 9 of our earnings release as well as other GAAP financial information. In the third quarter, we maintain our cash distribution at an annualized rate of $0.71 per share resulting in a payout ratio of 90% based on our third quarter AFFO. Now let's turn to our balance sheet. We continue to focus on maintaining a strong balance sheet and over the quarter paid down our credit facility. On September 30, the company had total combined net debt of $1.1 billion including $508.5 million of outstanding mortgage debt. Our enterprise value was $2.5 billion based on September 30 closing price of $8.16, resulting in a net debt to enterprise value of 44.8%. We remain focused on actively managing our debt, which along with the impact of movement in foreign exchange rates has lowered our annualized net debt to adjusted EBITDA to 6.6 times in Q3 from 6.7 times in Q2. As of September 30, 2016, the company's total combined debt carried a weighted average interest rate of 2.7% consisting of approximately 63% fixed rate and 37% floating rate debt and an interest coverage ratio of 5.3 times. Our outside spreads between cost of debt and acquisition cap rates is inherent in our ability to source low rate debt in either the US or Western Europe and positions us to invest opportunistically to market cycles on both sides of the Atlantic. As a September 30, $847 million or 77% of our outstanding debt is denominated in either euro or pound sterling. Our debt consists of both local mortgage loans and a company level revolving credit facility. Given that we have less than 30% US dollar denominated loan exposure, we're less exposed for a rising interest rate environment in the US. As a September 30, company had $50.3 million of cash and cash equivalents and $59 [ph] million available under its corporate revolving credit facility. And just to remind everyone, we have another extension on our credit facility available to us in July of 2017, which would extend the facility to July, 2018. Now let's turn to our hedging program. As part of our strategy to manage risk, we have a comprehensive hedging program in place which consists of three main components. First, we manage currency risk on net operating cash flow from foreign currency into US dollar with the use of FX forwards and other hedging instruments. Second, we mitigate the impact of currency fluctuations to the value of our assets through asset liability matching. And third, we hedge interest rate movement through the use of interest rate swaps on our floating rate debt. The first component of our hedging program utilizes FX forwards and other hedging instrument designed to minimize the impact of exchange rate volatility on earnings. We actively manage these instruments and have contracts in place through 2019 to mitigate foreign currency risk and manage cash flows. We continue to evaluate and manage our exposure on a quarterly basis. The second component of our hedging strategy is the use of asset liability matching to hedge the value of our European portfolio. This program strives to match the underlying asset value and borrowings in the same currency allowing the two to move in concert with changes in exchange rates providing a natural hedge. The last component of our hedging program is the use of interest rates swaps. These instruments mitigate the effect of interest rate movements on our floating rate debt. As of September 30, 63% of our debt is rate hedged with interest rates swaps allowing it to effectively act in the same manner as fixed rate debt. From an economic perspective, our hedging program has been effective in minimizing risk associated with currency volatility in European markets. Through the use of our three part hedging strategy as well as our stringent acquisition underwriting standards we’re able to navigate recent short term uncertainty and mitigate the effect of foreign currency fluctuations on our net operating cash flow. I will now turn the call back over to Scott.

Thank you, Tim. Before we take questions, I would like to reiterate a few points. We are happy to have reported another solid quarter of our earnings. GNL maintains its consistent focus on fine tuning and building a best in class portfolio of high quality mission critical assets as well as maintaining a strong balance sheet to best position the company for long-term success. We are well positioned in our target markets and believe our competitive advantages will result in building long-term shareholder value. To reiterate GNL’s strategic advantages are, GNL is a pure-play real estate company focused exclusively on equity investments in properties. Our investment strategy affords us the flexibility to invest in the US and in Western Europe. Our portfolio is built on long duration leases to predominantly investment grade tenants. We have the ability to access capital markets in both the US and Europe. Our strong management teams are resident on both sides of the Atlantic. Returning to the transaction to acquire Global Trust II, we believe the quality of the Global Trust II portfolio and the added size and scale better positions GNL for future success. The final proxy statement is currently being printed and mailed and should be received by investors in the coming days. We will also be hosting a series of webinars that will further inform our shareholders on this transaction. We expect this accretive transaction to close around year end. This concludes our prepared remarks and we're now happy to open up the call for your questions. While we wait for calls to come in I would like to remind everyone that we will be limited in what we can say today with regard to the Global Trust II transaction. And now we can proceed with questions. Operator?

[Operator Instructions] The first question will come from David Corak of FBR Capital Markets. Please go ahead.

Good morning, guys. This is actually Matt on for Dave. Congrats on the proxy. My first question is, could you give me an update on the financing plan surrounding the Global Trust II deal, specifically, it doesn't look like you need to use the bridge loan now. So what's changed around that?

Hey, Matt, this is Scott and thanks for the question and pass on our thanks to yourself and David for the note you guys put out this morning. It really captured the value of GNL and we appreciate that. Yes, you are absolutely correct. We no longer have the need to utilize the bridge loan as was disclosed in the proxy filing and we've received consents from all Global II lenders to have their debt roll. So we’re in a great position going into this deal.

Okay. Thanks. That’s helpful. My second question is, you guys mentioned you had a 120 million in dry powder and I was just wondering, longer term, what is your appetite for acquisitions?

Sure. Thanks again, Matt. So first off, we do have about $120 million today in dry powder. As we continue to close on sales of properties through the asset recycling program, we continue to pay down our corporate facility to create additional room. We believe that as we get to the closing of the transaction with Global II, we'll be in an excellent position to not only be able to take out the mezzanine and second mortgage debt that exists within Global II, but also to have in the range of $200 million of dry powder available to us after taking out that debt to utilize and creating value for the GNL shareholders.

The next question will come from John Frisch of Alliant Wealth Advisors. Please go ahead.

Yeah. Hi. You said you'd be limited in what you could address as far as the purchase of Global II, but if I understand the transaction right, you're offering 2.27 shares of GNL for every one share of Global II and that would put where Global IIs worth are at least, its NAV for leases is $22 a share I believe. The GNL transaction would be offered in $17 a share. So why would the Global II shareholders vote for the transaction?

John, thanks for your question and one of the restrictions we have is that we are really not allowed to talk about the value it has seen as marketing for the sale, which is not allowed to occur on our earnings call, but just some of the points that we have in the investor decks that have been filed include the upside opportunity for GNL post transaction and the quality of the GNL balance sheet. So just looking at the combined companies without talking about why someone should or should not tender at a particular price, just looking at the future opportunity is important and that as we have discussed, whether it's liquidity available for future growth is something that's important to see strategically long term. And just John to add to that, we will have a series of webinars and on those webinars, we will be trying to inform either Global II or GNL shareholders on separate webinars about the details of the transaction and trying to ensure that not only do we present those details, but we answer any questions that may be asked at that time.

[Operator Instructions] The next question will come from Mark Berger, a private investor. Please go ahead.

Scott, thanks for taking the call. A question on your dividends. What are your anticipations with regard to dividends going forward, especially after the steel, will it be accretive, will it stay the same, will it be a percentage of what your earnings will be or how do you look upon that?

Good morning, Mark. Thanks for your question. Just to provide some information that was included in our filings yesterday, the GNL payout ratio for Q3 was 90%. So we feel good about where we are in terms of covering our dividends. Also at the beginning of the quarter was disclosed that for fourth quarter, our board had authorized the continued annualized rate of $0.71 a share for this quarter. Each quarter, we present to our board and update them on many of the different factors with regard to GNL to ensure that they are fully informed and aware. At this point, we have no public filing or information provided in terms of rates for our 2017. We do continue to feel good about where we are and as we have information to share publicly, we will do that, but again we were 90% payout ratio. So well covered dividend in Q3 and will continue forward on that basis.

And with the new acquisition, is it accretive, will that continue the dividend at this rate, possibly increase it or any effects negatively?

So in the presentations that we put out when the deal was announced, it does show that as being an accretive deal however, again moving down that road, starts to sound like marketing for the deal and really prefer to take that question on a webinar, one we are specifically focused on discussing the transaction with either GNL or Global Trust II shareholders.

Okay. Thank you. With regard to currencies, do we have any effect or what effect it would have on us or is the Trump election anything that we have to be concerned about one way or another?

Okay, Mark. Thanks. That's a really good question in talking about currency. When GNL was created, it was looking at opportunities to invest in the strong markets in both the US and in Europe and it was built on a foundation of high quality assets on long duration leases to largely investment grade tenants and from a portfolio standpoint, we looked at managing risk by the quality of our portfolio, the quality of our assets and the quality of our tenants. With regard to currencies and having assets in - and cash flow in three different currencies, we also wanted to look at how we could manage risk and so from the outset, we have always put in hedges against our cash flow as well as managing a program of asset liability matching where we match the value of assets to debt in local markets. Again, over 70% of our debt is in European currency, even though only 40% of our assets are in European markets. That is a way of matching the value of our assets to the value of debt, so that as currency moves, both the value of the assets and the debt move in concert, providing a natural hedge. I'm going to let Tim talk about the programs that we have put in place pre-Brexit vote and then since that point.

Thank you, Scott. So just to summarize, so prior to the Brexit vote, the company actually entered into FX forward contracts in both euros and British pounds to hedge through 2019. In addition, since then, the company has also added additional FX options, both in euros and British pounds, which our hedge brings us - extend our hedging through Q1 of 2018 on those products. Essentially, the FX options allow the company to enjoy the improvement or the upside of FX currency rate movements, but at the same time, protecting against the downside movement of FX rates.

The next question will be from Paul Damon of Family Capital Management. Please go ahead.

Thank you. Could you provide some color or commentary around your asset disposition strategy that always it’s curious to me and this is common to a lot of reads that I’m familiar with that are selling asset in a time when it seems like the portfolio is so new, buying an asset, two or three years ago and then already we’re rotating out of that. This strikes me as that when we're building the portfolio, when we have a really good idea of what we're trying to build and what the long term strategy is and why would we be two years later or three years later selling assets already, can you just help me understand that? And then in relation to what you have sold at the cap rates you’ve sold, generally where did you buy those at cap rate, are we making gains on those or are we selling assets at losses. That would be helpful.

Sure. Thanks, Paul. First to the kind of more strategic part of your question, as we build the portfolio, we were looking to, as we said, create a portfolio of high quality assets to largely investment grade tenants on long duration leases. And over time, there are changes in the marketplace. There are changes in the economy and also as our portfolio became more fully molded at the end of non-traded cycle whereas that capital was being deployed, it became clear that while we believe there's all great assets in the GNL portfolio, there was an opportunity to fine tune and with - over the last two or three years or certainly as an example have been a surge in online retail. There's been opportunities in terms what type of retail is done. There are also some assets that just ended up being the only in their kind of asset class type. We disclosed that we have sold two medical office facilities. They ended up being the only two medical office facilities that we own. We sold them at a substantial premium to what we had paid, substantially lower cap rate than our purchase cap rate. In general, we are selling and seeing gains. I think we will, at the end of the program, disclose the final results of the program. I think we're at an interim piece where some have been closed, a number of assets are still to be closed through year-end and those final statistics will be shared. But I think that all of these efforts from a strategic point are continuing to fine tune GNL. I don't think you ever stand still and we believe that creating a best-in-class portfolio is constant work and we're constantly evolving and evaluating every investment that we make and sometimes we realize we might be better rotating our capital from one investment into another, both to position the portfolio as well as to realize value and that may be for reducing debt metrics, which is in preparation for looking to secure an investment grade rating from agencies and other strategic opportunities that we see as management as we are active daily and creating value for shareholders of GNL.

The next question will be from Stephanie Anderson of Pulse Financial Services. Please g o ahead.

Hi, Scott. This is Andy in for Stephanie actually. I know a couple of your objectives for the end of the period, it gets third party in all its research, but it looks like you have one group on board with FBR. The other was to get an investment grade credit rating. What's the status of the investment grade credit rating, what are you still fine tuning to hopefully reach both objectives here by the end of the year, already reaching the first.

So, thank, Andy. So yes, David Corak and FBR did pick up coverage and we see additional coverage coming, especially as we get ready to hopefully close this transaction. With regard to rating, we have been working diligently and quite honestly using some of the proceeds of the recycling program, continues to help us profitably position GNL to move through the process with the agencies. Clearly, when you see our net debt to EBITDA down at 6.6, we're clearly in the investment grade realm. Our interest coverage ratio at 5.3 times is amongst the best in our peer group and that really is a hats-off to the investment strategy, which provides outsized returns and by having those outsized returns to our peer group, we're able to have these high 5.3 time coverage ratio, something that many of our peers would like to have. We are positioned well to have these conversations, completing the acquisition of Global II helps us in terms of size and scale, as it continues to get us up at or over the $3 billion value mark. It also allows us the opportunity to improve some of our portfolio metrics, such as rent per square foot and reduces top 10 tenancy and other things. So we believe we're well positioned and we are actively preparing for discussions and just making sure that we time that right to get the best result.

Are you still hoping to do that by the end of this calendar year then?

I don't really think we should be talking about timing. I'll just say that it is - it's on the horizon for us and we will be going through that process as appropriate.

And ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to Scott Bowman for any closing remarks.

Thank you, Denise and I just want to take this time to thank everyone for joining us today. We look forward to updating you again soon. Have a great day and I'll turn it over to Matt.

Thanks, Scott and Tim and thanks everyone for joining us today. As always, our management team is available to speak with you should you have any follow-up questions. And if so, please don't hesitate to contact me directly at 9174752153. Have a great day.

Thank you, Mr. Furbish. Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.