NNN REIT, Inc. (NNN) Q4 2014 Earnings Report, Transcript and Summary

Greetings, and welcome to the National Retail Properties Fourth Quarter 2014 Earnings Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [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. Thank you. Please go ahead.

Brenda, thank you very much. Good morning and welcome to all of you to our 2014 year-end earnings release call. On this call with me is Jay Whitehurst, our President; and Kevin Habicht, our Chief Financial Officer, who will review details of our fourth quarter as well as our year-end financial results following my opening comments. 2014 was another excellent productive year for National Retail Properties as we increased our recurring FFO per share by a meaningful 7.8%. Expanded our already fully diversified and well occupied portfolio, while at the same time maintaining a fortress like balance sheet. We have now concluded three consecutive years of terrific per share growth in recurring FFO. Significantly we have achieved these results while decreasing leverage as Kevin will expand upon in his comments. As our press release indicated we acquired 221 net lease retail properties last year, investing $618 million. The average initial cash yield on these acquisitions was an impressive 7.5%, despite the cap rate compression that seems to be occurring in all property types. As you are aware this attractive yield improves overtime as the rents increases contractually over the duration of our very long leases. One interesting detail of our acquisition activity is that the vast majority of the transactions was single property acquisitions throughout the year, many of which are purchased from existing tenants with an average investment per property of only $2.8 million. Only three of our deals in 2014 were larger than $50 million in size. So we continue to adhere to our strategy of focusing on carefully underwritten retail properties at low price per property with initial cash yields that are both above what is found in the broker auction market as well as comfortably in excess of our cost of capital. As indicated a moment ago we have a strong preference for acquiring retail properties where the rent grows over the duration of the lease, this means that we seldom purchase investment grade properties at very low yields, high rents and with flat leases. Our portfolio continues to be in excellent shape and at the end of the year we were 98.6% leased this is another year where we have operated at effectively full occupancy. Over the next two years we have very modest lease rollover with only 2.8% of our leases coming up for renewal through the end of 2016. As of the end of the year we own 2,054 properties, which are leased to about 375 different national or regional tenants in 47 states. These tenants operate in over 30 different segments of the retail industry which provides us with very broad diversification. Finally on average these tenants have contractually obligated to pay us rents for approximately 12 years. The health of our tenants continues to be very good. In the short-term the decline in the price of oil is meaningfully assisting the gas margins realized by a single largest category convenient store tenants who are achieving elevated margins at the top. Perhaps more significantly 2014 is another year where M&A activity is boosting the credit quality of our tenants and I want to highlight here that we are delighted that our third largest tenant is in the process of being acquired by the investment grade rated [indiscernible]. What is not fully appreciated in that approximately 66% of our rent comes from companies that are either public or have rated securities outstanding. Last year we continued our multi-year track record of capital recycling using our in-house expertise to sell 27 properties for $54 million, generating $11 million of gains that are not included in FFO. Importantly the sale of these properties has the effect of qualitatively strengthening our portfolio as many of these dispositions involve the sale of what we consider weaker assets. In conclusion our portfolio is in excellent shape and very importantly as you will hear from Kevin our balance sheet is fortress like, which will allow us to take advantage of carefully underwritten acquisitions that we expect to make this year. While we are early 45 days into the quarter, we have already made a couple of property acquisitions and perhaps more importantly are conducting due diligence on what we think are a number of attractive acquisition opportunities. Kevin?

Thanks Craig and I will start with the cautionary language as usual. We will 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. With that, this morning, we reported fourth quarter FFO $0.56 per share and recurring FFO of $0.55 per share as well as AFFO of $0.56 per share. This represents a 7.7% increase over prior year results. For the full year 2014 we reported FFO of $2.09 per share and recurring FFO of $2.08 per share, which is a 7.8% increase over 2013 results. The AFFO for 2014 was $2.12 per share and that represents a 6.5% increase over 2013. The common dividend was increased 3.1% in 2014 to $1.65 per share and this dividend increase was our 25th consecutive year dividend increases a record we intend to perpetuate and one that puts us in a very small group of public companies and literally less than a handful of public REITs. Our dividend payout ratio is decreased to 78% of AFFO. A primary objective for NNN is growing per share results on a multi-year basis, our primary objective is not simply growing our asset base or growing per share results by relying on the one-time benefit of increasing leverage. But looking over the three years, recurring FFO per share has grown 32.5% or 9.8% annually, with AFFO per share growing 7.6% annually over the last three years. As Craig mentioned notably, we achieved these results, while using less leverage. Now looking on a couple of details on the past quarter, the strong results were a combination of maintaining high occupancy making an accretive new investments while keep in our balance sheet more than strong, occupancy was 98.6% at year-end. And as Craig mentioned, we completed $87 million of accretive acquisitions in the fourth quarter and $618 million for the year. Compared to 2013 fourth quarter rental revenue increased $11 million or 11.1% that’s primarily due to the acquisitions we made over the past four quarters. In place annual base rent as of year-end 12/31/14 was $439.8 million on an annual run rate. Property expenses net of tenant reimbursements for the fourth quarter totaled $1.1 million and that compares with $1.6 million for the fourth quarter of 2013. For the full year property expenses net of tenant reimbursements was $5 million for 2014 versus $5.3 million in 2013. G&A expense increased modestly to $7.7 million in the fourth quarter. For the full year of 2014, G&A increased 4.6% over 2013 levels. Couple of notes on G&A, first we’ve begun to account for third-party real estate acquisition transaction costs in a separate line item. Before it was included in G&A and created some variability if we happen to acquire portfolio in a given quarter or not. And so we thought it would better to breakout this transactional spend in a separate line item. Second, in the context I previously mentioned of driving per share results over the past three years. Over those three years revenues have increased 60%, while G&A has increased 15% over that same time period. So we continue to generate positive operating leverage in our growth, as G&A is declined from 10.5% of revenues in 2011 to 7.5% in 2014. So big picture 2014 another very good year for NNN core fundamentals of occupancy rental revenues, expenses all are performing well with no material surprises or variances. Turning to the balance sheet briefly, during the fourth quarter we raised $205 million of common equity and that was primarily through an equity offering, we completed in November that raised $200 million and notably that’s the first equity offering we’ve executed since November of 2011 three years earlier. We also amended our bank credit facility in the fourth quarter expanding it from $500 million to $650 million and its maturity to January 2019 with the option to extend it to January 2020. Pricing on that bank line was reduced by 15 basis points to LIBOR plus 92.5% - LIBOR plus 92.5 basis points. We had no outstanding balance on our credit facility at year-end leaving us with the full $650 million of availability. The average debt maturity for all of our debt including the bank line is 6.7 years. Our net debt maturity is a $150 million, 6.15% notes due in 2015, December of 2015. Our balance sheet remains in great position to fund future acquisitions and weather potential economic and capital market turmoil. So looking at year-end 12/31/14 leverage metrics, debt-to-gross booked assets was 32.6%. We’ve got significant liquidity with our $650 million of availability on our bank line debt-to-EBITDA was 4.2 times for the quarter, interest coverage 4.4 times for the fourth quarter and fixed charge was 3.1 for the fourth quarter. Only 11 of our 2,054 well under 1% are encumbered by mortgages totaling $25.4 million. So despite the significant acquisition activity over the past of the four years our balance sheet remains in very good shape. So during that four year period we have acquired $2.7 billion of properties and funded 76% of those acquisitions using permanent capital, which consistent of prominent deferred equity as well as asset disposition proceeds. The balance was funded with long-term 10 year fix rate debt. So we are clearly not driving per share results with short-term or variable rate debt. Again we are raising capital and investing capital with the multi-year horizon. Early but 2015 look to be another good year for NNN we are optimistic we can produce another year of solid per share results growth and including making it our 26th consecutive year of dividend increases. We continue to believe we are well positioned to deliver the consistency of result dividend growth and balance sheet quality that has support attractive, absolute and relative total shareholder returns for many years. And with that Brenda we will open it up to any questions.

Brenda any questions?

Thank you. [Operator Instructions]. Our first question comes from the line of Vikram Malhotra with Morgan Stanley. Please go ahead with your question.

Thank you. Good morning Craig, good morning Kevin. Just quick question on cap rates, I guess towards the mid of last year you had kind of indicated that you probably see cap rates tick down further we have seen at least for your results cap rates remain stable, but I am wondering if you can just your view over the next few months the next few quarters given the steep decline in oil, which was probably unexpected and on the other side potentially just changes in competition levels kind of what’s your view on pricing and what could be the drivers of that change?

Vikram, good morning. A good question, I think it start with competition we plan a very, very big market and there is plenty of net leased retail properties available for sale. We have any of a number of competitors some of which are stronger one year and weaker the next year, but no matter how what happens with competition et cetera it’s a big market, we have got an excellent team we have found a way to source $600 plus million of properties in each of the last several years at very attractive initial cash yields, low market rates and good rental growth over the duration. I think cap rate is clearly more demand for real estate everyday cap rates have gone lower, we thought we would end with a lower cap rate last year then we actually achieved in the mid-7 type percent range. I think primarily lower cap rates are going to catch up with us. So we are guiding this year to cap rates that are well lower than 7.5% obviously our day job is to exceed that and if we find opportunities to do it we will do it. But there is plenty of products out there and our job is to find that, which is attractive to hold shareholder value, are not focused on volume, which a couple of people think we should be. We are focused on carefully underwriting each individual property and being selective as we deploy capital.

And just on the oil prices, I mean is that do you mentioned had some comments on that, but I am just wondering if we are kind of current levels for a while would that somehow impact pricing in certain select categories?

It’s not clear to me there is any correlation at all. What happens is that gasoline prices means that the consumer has more money in their pocket, whether they put that money into savings or greater spending we are all going to find out. But with healthier consumer retail is a good price to be for the next couple of years, I don’t see it having any impact on cap rate at all.

Okay. And then just one last on the acquisition side, I am assuming that the initial guidance you provided is the same in terms of acquisition volume, but just I mean given the fact that obviously you’re focused on per share results and the accretion that you can achieve I obviously acknowledge that CapEx are much lower, but if we look your stretch to cost of capital and you are still at very, very healthy levels I would argue probably even a little better than what we’ve seen over the last 18 months given the move in the stock price. So should we anticipate that even though you are not focused on volume given the spreads you have and the potential accretion you could kind of take up the momentum on the external growth front?

So just as a reminder in terms of our 2015 guidance most of our acquisition activity that we are talking about in 2015 in our guidance and in our model is for more acquisitions to takes places in the second half of the year than the first half. So obviously that has a small impact on total rent realized. Jay Whitehurst and our acquisition team are working everyday trying to build volume earlier in the year, it’s too early to tell whether we will be successful, because any of a number of things have to happen the properties that we are currently underwriting need to meet our thresholds and standards inevitably many of them drop out, but right now Vikram our pipeline is pretty attractive.

Okay. And would that include anything you might have seen whether it’s a retrade or anything that maybe one of your largest competitors may have just had to step away from?

It’s hard to say what’s causing it or greater M&A activity or more intensive sourcing by our team, but I think it’s early yet and a lot of things have to happen for this to come together, but our pipeline today is quite healthy.

Okay, thanks guys.

Thank you. And our next question comes from the line of Nick Joseph with Citigroup. Please proceed with your question.

Hey Craig it’s Michel Bilerman, Nick along with me as well, I just sort of had a corporate governance question and curious how your Board sort of think about your outside business commitments? You just went on American Towers Board, you are on your own Board, you are on Cadillac Board, you are also on DDR’s Board so I am just curious how in the discussions with your Board they think about the time that you have outside of the company in terms of the commitments that you have?

Nick that’s a very good question, where we are is we gave published guidelines that I can be on the Board of two public external companies, technically I am currently on the Board of two external companies public given the Cadillac Fairview is a private companies. However I think that the intention is to only have somebody like me on the Board of two large external companies given that I am passed that point already and probably better do something to remedy it and we are working on it.

Thanks. And then you mentioned the cap rate compression that advance the real estate are you seeing a differential of cap rate compression between the larger portfolio transaction versus smaller?

Hey, Michael it’s J Whitehurst yes definitely so I think to reiterate one of our big focus is on relationship building with growing retailers and doing business with those folks off market whenever possible and 2014 was a good year for that we also saw some good portfolios in 2014 that we bid on, but just to a little fact to put some color on that, Craig mentioned the three of our closings in 2014 were greater than $50 million. Well we had 34 separate closings that were less than $5 million and the cap rate differential between those big closings and the little closings was well over 100 basis points difference. And that really highlights the most of those small closings were our relationship closings, so it really highlights the value of the hard work that goes into doing those small one-off closings. We’re going to continue to build our relationship tenant base we’ve got over 2,000 relationship tenants that we work with regularly to do recurring programmatic transactions we’re going to continue to build that. And then look at all the big deals that are out there being broadly marketed and pursue those where we are happy with the retailers, interested in the real estate and the lease makes sense. And so in those instances we’re going to pursue the ones that we selectively chose to chase after and in the meantime continue to focus on those relationship deals that are just a great core business for us.

Thanks for the detail on that. And then finally in terms of the occupancy it looks like it was down a little in the fourth quarter, I am wondering what drove that occupancies now that typically it either increases or remained flat in the fourth quarter?

This is Jay again, I would say that it’s flat Michael for the number that we are at 98.6 we have 29 vacancies in the portfolio, we might have had 28 in the prior quarter something like that. So it’s really effectively fully occupied anywhere in this ballpark. And any one given quarter is really not I don’t think is indicative of any kind of longer term trend at all.

Thanks.

Thank you. And our next question comes from the line of [indiscernible] with Bank of America. Please proceed with your question.

Hi guys, good morning. Just hoping you could speak to guidance with relation to your fourth quarter run rate, just looking at the annualized number that you have the number that you’ve put out there for ‘15 may look a little conservative, I was wondering if there was anything sort of unusual we should be backing out on the fourth quarter number or any sort of headwinds that you could remind us like we should be filling in for the balances of ‘15? And if you wouldn’t mind commenting on kind of what the numbers that potential there cap rates for ‘15 acquisitions?

Hey Brian it’s Kevin. So not a lot of headwinds in this year one thing we don’t give guidance on is capital markets activity, so that’s a pretty significant piece of the puzzle as to type, amount and timing of any particular capital raise. One thing that is obviously a headwind of this is the - we did a large equity offering late last year and so that rose into the equation somewhat and we did that after announcing our earnings and guidance for the year. So that away on per share results so we really don’t have that. I mean we’ll consider every quarter we reproject how our results are going and whether we should tweak our guidance and didn’t feel like we had enough visibility on things at this point to do that. But hopefully we can. Yeah and the cap rate assumption we used about 7% cap rate. So I think our guidance for 2014 was 7% in the quarter we actually did 7.5% like we said we were surprised genuinely, but as Craig indicated we think the cap rate compression trend that’s been going not only in our sector, but broadly in real-estate is will likely catch up to us a little bit in 2015 and so we and our guidance for 2015 it was a 7.0 cap rate assumption.

Great, thanks. And just wondering if you could comment on the build to suite opportunity set kind of what you think a run rate number on an annual basis which you can achieve? And maybe just a little color on cap rates for those types of opportunities versus acquiring assets through typical relationship to just a bread and butter acquisition and if you could just comment on that? Thanks.

Sure hay it’s J. Whitehurst. It’s hard to put too precise number on kind of the run rate that we want to get to with our tenant development financing. Historically we've been in the $100 million to $150 million per year kind of run rate in that business and we are always hoping to grow at even more, but I suppose that’s probably a good kind of run rate to think about. And those cap rates are in the 50 to 75 basis point range above what we are would otherwise be able to get out in the open market. So they’re thinking of them as kind of mid to high 7s for Pennsylvanian numbers.

And then just as a reminder, we’re not in the development business one without having that effort. So from my perspective it doesn’t really make a lot of difference whether we buy an existing store from a retailer or we finance their construction of a new store. However, some of my colleagues are listening to this phone call will check for that comment because there is a lot more work and a lot more detail if we are financing their construction of a new store that becomes a typical sale or lease back. So just where we get it in the cycle, but again that’s part of our relationship efforts with our partners as we tell this.

Thanks. And then just a last question can you give any color on G&A I think you gave us an expectation $35 million to $36 million last quarter are you still happy with that any additional person are you thinking to bringing on for ‘15?

So I think our guidance for last year was around $35 million and $35.5 million kind of number that did include real estate acquisition transaction cost of about $900,000. So depending how you’re thinking about G&A going forward the way we’re thinking about it, the G&A will be call it $34.25 million and add another $900,000 for real estate acquisition transaction cost. And to be clear we have pretty good handle on the G&A expense the real estate acquisition transaction cost that’s just a number we’re estimating as you know over it can vary from $500,000 to $1.5 million depending on just what kind of properties and portfolios we’re acquiring. And so I don’t have a lot of visibility on that number, but we assuming $900,000 for now.

Great thanks guys.

Thank you.

Thank you. [Operator Instructions]. Our next question comes from the line of Dan Donlan with Ladenburg Thalmann. Please proceed with your question.

Thank you, and good morning. Just had a quick on the tenants that did not renew for the year or even for the quarter maybe, what was the emphasis for them leading to withdraw the business kind of what happened to those tenants, why they didn't renew?

Dan it’s J. Whitehurst. I think first to step back and just point out that one of the things that we love about our business is than the retail business is the high recurrence rate the renewal rate of the tenants at the end of the lease. And we’re having a very active portfolio management group asset management group that stays in touch with tenants and has a lot of dialogue with them as the leases are running down. We this past year 82% of our tenants renewed the long-term history is that we are around a 90% renewal. But I don’t think you should read any trend into that the numbers are so small there were 32 tenants that renewed in 2013 and if it had been 35 it would have been the same as our long-term average. So the long-term numbers are seems to be kind of still tracking and reasonable at kind of the 90% renewal rate. For the tenants that don’t renew those are instances almost always where they are just not making money at that units, tenants don’t like to move and have their customers have to find them all over again in retail businesses. And so these are ones that were just going out of businesses at that location at the end of lease, but it’s really a very few property.

Okay, that’s help. And then so how should we view kind of the - I mean do you feel as your kind of operating at full occupancy how should we kind of view the remaining vacancy that you have in the portfolio? And do you call that by particularly selling some vacant assets this year?

As I mentioned earlier we only have 29 vacancies, so yes I really think you should look at it as if we are at full occupancy. The philosophy here is to try lease the vacancies much more than going ahead and just selling them quickly. So we had a very talented group in house that works on leasing those properties. At some point if you don’t lease it then we just go ahead and sell it. But we are going to try to lease all of those properties for an extended period of time before we give up of them. We are in the business of collecting rent, but there is really no matter what happens next small of the sample group is not going to move the needle very much.

Sure, sure. And then just lastly on acquisitions for this year. Are you baking in any type of portfolio transaction and I guess that would mean kind of something greater than $50 million let’s say into that acquisition guidance would that be incremental to kind of what your acquisition guidance is for this year?

Dan the acquisition guidance is an aggregation of everything individual properties and portfolios. As it so happens we have pretty good visibility right now on a little more activity then we had when we talk you to in November. So there is work to be done deals always drop out but right now our pipeline of deals we’re evaluating is quite encouraging. So we’ve always got a way to go before we closed it. My colleagues are just kicking me under the table, but right now our visibility is good.

Okay. And sorry just one more after this, what is really driving the cap rate compression is it in your sector, I mean do you think people are more used to it now than maybe last cycle I mean with 7% cap rate I don’t think you ever guided to that low it is just the 10.31 market coming back more robustly or and it’s just a tenure relative to cap rates is there anything different other than simply interest rates going on here?

Dan it’s just simply the fact that alternative yields are very, very low for the average investor. So what you are seeing is enormous amount that are predictable returns of real state. We frankly model how attractive our yields are at 7 plus percent with contractual growth, when you compare that people are buying other property types in the 4.5 type percent or low 5%, it just seems to me net lease retail continues to be quite an attractive category.

Okay, thank you.

Thank you. It seems that we have no further questions at this time. I would like to turn the floor back over to management for closing remarks.

Brenda, thank you very much. We appreciate that there are lots of calls today. Thanks very much for your interest. We are going to see any of a number at a conference in a couple of weeks. And if you have any comments or questions please call either Kevin, Jay or me. Thank you very much for your interest and Brenda thank you.

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