NNN REIT, Inc. (NNN) Q3 2014 Earnings Report, Transcript and Summary

Greetings, and welcome to the National Retail Properties Third Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Craig MacNab, Chairman and CEO. Mr. MacNab, you may now begin.

Rob, thank you very much, and good morning to all of you. Welcome to our third quarter 2014 earnings release call. On this call with me are: Jay Whitehurst, our President; and Kevin Habicht, our Chief Financial Officer, who will review details of our third quarter financial results following my brief opening comments. Also, Kevin will update you on our guidance, plus provide some of the key assumptions for how we envision 2015 unfolding. We have just completed another consistent, predictable quarter at NNN. As indicated in our press release, we are projecting another year of terrific FFO per share growth. Equally importantly, we're also guiding towards further per share growth in 2015. Of course, we are also delighted at National Retail Properties recently becoming a member of the elite Dividend Aristocrat Club by virtue of raising our cash dividend for 25 consecutive years. In the third quarter, we had an extremely active quarter, acquiring 121 properties, investing $345 million at an initial cash yield of approximately 7.4%. When the rental growth from these properties kicks in, we will receive an average yield from these acquisitions that will be over 8.5%. The retail properties were acquired from 32 tenants in 29 states across 15 new retail lines of trade, so very well diversified and further evidence that our deal sourcing capability is excellent. In the first 3 quarters of this year, we have invested $531 million in just over 200 different properties at an initial cash yield of, again, about 7.4%. Our fully diversified portfolio continues to be almost fully occupied and is now 98.8% occupied. To me, this very high occupancy reflects 2 things: Firstly, the merits of well-located retail properties which generate extremely predictable cash flow for a long period of time over the duration of their lease; and secondly, the success of our selective disciplined acquisition approach, along with careful underwriting of each and every property. National Retail Properties continues to be very well-positioned. Our balance sheet is strong, our portfolio is in excellent shape and from a growth perspective, we have a differentiated process of sourcing well-located retail properties for acquisition. Finally, as a reminder, the net lease retail category is a very good business as we compete in a highly fragmented, large market. And by sticking to our disciplined of purchasing and underwriting $2.5 million to $3 million properties, we encounter less competition than many other property sectors. Kevin?

Thanks, Craig, and let me start with our normal cautionary statement that we are going to make certain statements that may be considered to be forward-looking statements under Federal Securities laws. The company's actual future results may differ significantly from the matters discussed in these forward-looking statements, and we may not release revisions to these forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in this morning's press release. Now with that, this morning, we've reported third quarter FFO and recurring FFO of $0.52 per share as well as AFFO of $0.53 per share. This represents a 6% increase over prior year results and was in line with our expectations. We increased our dividend by 3.7% to $0.42 per share in the third quarter, which brought our dividend payout ratio to 79% of AFFO. This morning, we also announced an increase in our 2014 guidance, increasing the FFO guidance to $2.04 to $2.06 per share, which is a $0.03 increase from the prior guidance midpoint. Likewise, 2014 AFFO guidance was increased to $2.08 to $2.10 per share. So 2014 is currently tracking to show a 6% FFO per share growth and notably, the comps from multiple prior years, including last year, are not easy ones. We've been able to post this per share growth using well-priced long-term capital and making selective acquisitions at attractive spreads over capital. As we evaluate acquisition opportunities and capital market activities, growth in per share results and sustainable growth in per share results is a driving consideration. To that end, we also introduced 2015 guidance, which indicates another 5% to 6% growth in per share results, and I'll discuss that more in a moment. But first, a couple of details on this quarter. The strong results, again, were a combination of maintaining high occupancy and making new accretive investments while keeping the balance sheet more than strong. Occupancy, as Craig mentioned, was 98.8% at quarter end. That's up 30 basis points from the prior quarter and up 70 basis points from a year ago. And as Craig mentioned, we completed $345 million of accretive acquisitions in the third quarter. Compared to 2013's third quarter, our rental revenue increased $8.2 million or 8.5%, primarily due to the acquisitions we made over the past 4 quarters. In place annual base rent as of September 30, 2014, was $432.7 million on an annual run rate. Property expenses net of tenant reimbursements for the third quarter totaled $1.3 million, and that compares with $1.5 million for the same period last year. Our G&A expense increased to $9 million in the third quarter. It did, however, include $961,000 of real estate acquisition transaction expenses. We see full year 2014 G&A coming in around $34.5 million. But big picture, 2014 is going to be another good year for NNN and the core fundamentals, occupancy, rental revenue, expenses are all performing well with no material surprises or variances. As I mentioned, we were able to increase our 2014 guidance, which puts us in a position to grow per share results around 6% this year. We also introduced 2015 FFO guidance of $2.13 to $2.17 per share and AFFO guidance of $2.19 to $2.23 per share, which results in another 5% to 6% growth in per share results for 2015. The primary notable assumptions in our 2015 guidance include $300 million to $400 million of acquisitions with 1/3 closing in the first half of 2015 and 2/3 in the second half. G&A expense of $35.5 million. No material change in occupancy. Fourthly, $2 million of mortgage residual interest income. And lastly, property expenses net of reimbursements of around $5.6 million. Now turning to our balance sheet. Third quarter, we raised $70 million of common equity. Our average debt maturity of all of our debt, including our bank line, is 6.7 years. Our next debt maturity is $150 million of 6.15% notes due in December of 2015. Last week, we announced an increase in our bank credit facility from $500 million to $650 million and a reduction in the interest rate on that facility by 15 basis points to LIBOR plus 92.5 basis points. This new credit facility will mature in January of 2019, and we have an option to extend that to January 2020. So our balance sheet remains in great position to fund future acquisitions and weather economic and capital market turmoil that might come. Looking at September 30, 2014, leverage metrics, debt-to-gross booked assets was 35.5%. We have significant liquidity with our new increased bank credit facility, liquidity of over $500 million at this point on our bank line. Debt to EBITDA was 4.8x for the third quarter, interest coverage was 4.3x for the third quarter and fixed charge was 3.1x for the third quarter, and that's despite the large preferred offering we did May of last year. Only 6 of our 2,038 properties well under 1% are encumbered by mortgages totaling approximately $11.3 million. So despite the significant acquisition activity over the last 3-plus years, our balance sheet remains in very good shape. So 2014 looks to be another good year. We're optimistic we can produce another year of solid per share results in 2015, including making it the 26th consecutive year of increased dividends per share. We continue to believe we're well-positioned to deliver the consistency of results, dividend growth and balance sheet quality that has supported attractive absolute and relative total shareholder returns for many years. And Rob, with that, we will open it up to any questions.

[Operator Instructions] Our first question is from the line of Vikram Malhotra with Morgan Stanley.

This is Landon, on for Vikram. Just had a few questions about the acquisitions in the quarter. It looks like about -- over $200 million was probably from the Chuck E. Cheese portfolio. Just wondering if you could give any details on that particular portion of it, pricing, rent per foot, anything along those lines.

Sure.

This is Jay Whitehurst. Yes, you are right. In the quarter, we invested about $183 million in 49 Chuck E. Cheese properties located in 21 different states, so it's a very diversified pool there. A couple of points to make about that acquisition. It was very -- is very good real estate. We were very happy with those locations. In our Investment Committee meeting, our head of underwriting described these properties as being primarily located in the shadow of malls and power centers. And so these were excellent retail locations for these properties. And second, we are very happy with the business that's run on those properties. Chuck E. Cheese, it's just an iconic brand. It's been around since the '70s and it's very profitable at the corporate level, at the store level. And one of the things that's notable there with Chuck E. Cheese is that the revenues from entertainment and merchandise at a Chuck E. Cheese is comprised more than 50% of the total, and the profit margin on those revenues are quite high. So these were very stable, consistent profitable businesses on good real estate. And you mentioned the rent. We were also very happy with the rent. The rent was around in the low 20s, around $22 per foot on average, which is very safe for the operator and for the landlord. And the store level rent coverage was very well-covered.

Can you give us the rent coverage?

It was well over 2x, Landon. The -- we are -- probably, the last thing to point out is that we structured this transaction as a 20-year master lease. So on top of good real estate, good business, good operator, we like the lease structure, which you get by dealing directly with the retailer.

Great, great.

One other note on that, I guess, is just the -- we went back and looked at their performance through the 2008 and '09 kind of downturn. Very steady performance throughout that economic turmoil, particularly given the sector that they're in.

Okay. And are you able to share pricing and annual rent bumps as well?

For the pricing on the quarter, all of the properties was just about 7.4% initial cash cap rates. On the portfolio as a whole, or certainly in this quarter, we are looking at bumps somewhere between 1.5% and 2%, Landon.

Okay. And then just one more question, just on your 2015 guidance. Are you able to share what you're underlying cap rate assumption is for that?

I mean, we -- at this point, it feels like a low 7% cap rate, which is close to where we guided for this year. We're at 7.4% year-to-date for 2014 and we're assuming it's a bit lower than that going into next year, but we'll see.

And do you expect fourth quarter external growth cadence to pick up in normal seasonality for this year?

I don't really think so. We had a very, very productive third quarter, sort of unusually active for us. We've got a couple of deals that we're looking at. We're always looking at single properties. I don't -- I think the fourth quarter will be a steady quarter for us, not an uptick in activity, Landon.

Our next question is from the line of Dan Altscher with FBR. Daniel K. Altscher - FBR Capital Markets & Co., Research Division: Rather than focus on the acquisitions, Kevin, I was wondering if you can talk a little bit about that, I guess maybe medium-term maturity as we go into 2015. With the recent upgrade from S&P, have you guys given a new analysis or new thought as to what perhaps your new unsecured debt cost might be as you look to maybe term that out or maybe just refi it or maybe grow it until the end of next year?

And you're referring to the debt maturity, next year's debt maturity? Daniel K. Altscher - FBR Capital Markets & Co., Research Division: Yes, that's correct.

Yes, yes. No, clearly, it will be an accretive refinance opportunity. That has a 6.15% coupon on it. We can currently issue debt probably in the 150 -- 140 to 150 basis points range over 10-year treasury. So that would be a very accretive refinance in the, call it, mid to high 3s. Daniel K. Altscher - FBR Capital Markets & Co., Research Division: Got it. Okay. No, that's great. And just thinking about that also, the balance sheet continues to look in really strong, really strong shape there, which is great. Upside the credit facility a little bit, is there some thoughts about maybe increasing leverage a little bit overall? Or is that just kind of a good opportunity to do it, get some attractive financing as opposed to something fundamentally changing of saying, hey, we want to maybe take the debt-to-cap up a little bit?

At the moment, we don't have any plans to change the overall mix of our capital structure. As we've talked about in prior calls and quarters, over the last 3 years, we've acquired over $2.5 billion worth of assets and a large portion of that, meaning, the vast -- 75% of that's been funded with permanent capital, common and preferred equity. And what we're really trying to do is be able to create sustainable growth and per share results. And so we've been in the fortunate position in the last few years that we've been able to not only improve the balance sheet, deleverage it at the margin, yet still drive per share growth in the 6% to 8% per year kind of range. And so assuming that environment continues, I don't think you'll see us making any leverage shifts at the moment. But we always like having that dry powder. We always like having options. And so that's clearly one of them, but at the moment, that's not incorporated into our guidance. Let's put it that way. Daniel K. Altscher - FBR Capital Markets & Co., Research Division: Yes. No, that's perfect. And maybe as a one quick one for Jay. Beyond the Chuck E. Cheese portfolio in the quarter, were there any other portfolios that were purchased as opposed to relationship-driven one-offs?

There was -- about half of our acquisitions in the quarter would fall into the relationship in direct calling category. There was one other portfolio that we acquired from -- of existing leases, kind of a mixed bag of retailers that were right down the middle of our fairway that made up another piece of the quarter. But in general, I think long-term, our focus on the relationship business and calling on retailers is still going to generate in the range of 3/4 of our volume over time.

[Operator Instructions] Our next question is from the line of Dan Donlan with Ladenburg Thalmann. Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division: Just a kind of quick question on -- and I'm sorry if I missed this, did you guys provide acquisition guidance for 2015?

For '15, yes, we said $300 million to $400 million, yes. Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division: Okay. Some of your peers have mentioned, the market's gotten a little frothy in some -- in the retail segment for single tenant. Can you maybe comment on how you feel about that? Is there something different maybe that you're seeing and kind of is it just simply that you're sourcing deals from different places? What are your feelings on kind of pricing and how it looks for next year?

So Dan, I think it's clearly an important issue because we're an external growth story. And with that in mind, many years ago, we began an initiative to have a differentiated acquisition approach. It's very proactive. Our team travels extensively, visiting tenants. And we -- as Jay pointed out, we hope that over the next several years, just like the past several years, we'll source around 3/4 of our acquisitions directly. And negotiating a deal directly with a tenant is our preferred way of sourcing deals. At a very high level, there is -- in an environment stimulated by QE, et cetera, there is terrific demand for yield assets and there is a great deal -- probably more demand than there is supply, especially with construction activity having been modest the last couple of years. However, the big point is that we play in a vast bucket, the net lease retail market. And we continue to source and find lots of deals at attractive pricing. And at any point in the cycle, we have deal flow. And I think that, for sure, there is competition, but we measure competition in a -- one handful of participants, and that contrasts with other property types. For example, offers in major coastal markets. When a property there is being sold, there are 10 or 15 bidders in the last and final round. We have a small number of competitors. And on our relationship deals, provided the pricing is fair, we get those deals. So I think at a high level, cap rates have trended down, but they haven't trended down as fast as cost of capital has gone down. So spreads are still very wide. And speaking for me individually, I'm delighted that this company is in the net lease retail business. It's a very good business. Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division: I would agree. But I guess, the second question on that would be one of the largest acquirers of assets has recently had a hiccup and could potentially be out of the market for quite some time. Are you starting to see or have you seen that or do you think that's going to impact your ability to -- does it improve your ability to work with tenants? Or were they playing more in -- and more of the brokered marketplace?

Yes. So on relationship tenants, they -- I -- we really weren't encountering them at all. I think the brokerage community clearly has lost a big source of their demand, a major source. And I think that -- I'm very sorry to see them struggling like that, but the benefit to National Retail Properties and our opportunities to selectively, not increase our volume, but to selectively buy good deals has improved dramatically. Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division: Okay. And then lastly in that and the acquisition volume that you have for '15, are you anticipating any type of portfolio transactions in that number? You did almost a $200 million Chuck E. Cheese deal, or do you feel comfortable doing your guidance just on just the organic, if you will, growth that you get from your relationship tenants as well as potentially some new tenants?

Dan, this is Jay. I think the latter comment of yours is more -- a better reflection of our planning for next year's acquisition guidance. We -- as you know, we have -- you really have very little line of sight beyond a couple of quarters at most, for any volume. So you don't really know what's going to be coming in the middle to end of next year, but we know that the relationships will produce a certain level of volume and we know that we'll be in there looking at everything the way we have been this year and prior years and we expect that we'll find good real estate, good retail real estate run by good operators that we'll acquire next year. Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division: Okay. And I lied, I've got one more and this is for maybe Kevin. As you think about your sources and uses of cash flow for next year, given where your stock is trading, is it fair it -- and given where the 10-year is, is it fair to say that you might be kind of overequatized coming into the year, under leveraged, so to speak, because pricing is so attractive right now with your stock relative to where you can buy, that maybe you have a little bit more equity that -- than you need because if these stocks historically have gotten hit a little bit, at least in the short term, if the 10-year treasury spikes? So just kind of curious if you could comment on your kind of your capital strategy into next year?

Well, we are in a good environment in which both our equity and debt is well-priced, and so that gives us some good options. And like I said, we've worked over the last few years to reduce the leverage at the margin, which creates the opportunity to use more leverage. I'm not sure it's a lever that we intend to use in the near term. As long as we can continue to drive what we think is good per share growth results, I don't think you're going to see us make any notable change to our current capital structure.

Our next question is from the line of Chris Lucas with Capital One Securities.

Just a couple of quick questions, Kevin, on the guidance for next year. Any dispositions expected?

Yes. We have assumed about $50 million of dispositions for next year, which is our fairly typical kind of a run rate for dispositions annually. If opportunity presents itself, we may do more than that, but that's what's baked into the numbers.

And then just on the portfolio itself, is there any known move-outs or issues that you're looking at for the tenant maturities or lease maturities for next year?

No. We don't have any issues on that front. And we only have 30 leases expiring next year, which is less than 1.5% of our rent. So again, a very small, manageable lease rollover schedule.

There are no additional questions at this time. I would like to turn the call back to management for closing comments.

Well, thank you very much, folks. We appreciate your interest.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.