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NNN REIT, Inc. (NNN)

Q4 2023 Earnings Call· Thu, Feb 8, 2024

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Transcript

Operator

Operator

Greetings. Welcome to the NNN REIT Inc. Q4 and Year-End 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Steve Horn, Chief Executive Officer. You may begin.

Steve Horn

Analyst

Thank you, Holly. Good morning, and welcome to NNN REIT's fourth quarter 2023 earnings call. Joining me on the call is Chief Financial Officer, Kevin Habicht. As this morning's press release reflects NNN's performance in 2023 produced 3.8% Core FFO growth along with acquisition volume over $800 million. In addition, the year concluded with high occupancy of 99.5% and dispositions income-producing assets were 140 basis points lower than our acquisition cap rate, all driven by our best-in-class team here at NNN. The end of the year surge positions the company well in the near-term, but a few highlights of 2023 that I'm proud of what NNN accomplished. The 34th consecutive annual dividend increase, the rebranding initiative and the positioning of the executive team for the future. While the name changed in 2023, the core philosophy to realize long-term value at below average risk for our shareholders remain in the most simplistic form. One, we continue to execute our strategy using a bottom-up approach, continue to increase the annual dividend, maintaining the top-tier payout ratio and focusing on growing FFO per share in the mid-single digits over multiple years. We maintain this core philosophy by keeping disciplined and setting our acquisition activity and our balance sheet management to achieve that objective. Before I get into day-to-day operations and current market conditions, I'd like to welcome Gina Steffens to the executive team. Gina assumed General Counsel role late in the fourth quarter. She joins NNN with a fantastic resume from public and private companies, bringing significant transactional experience. I look forward to the partnership going forward as NNN grows. As I alluded earlier, NNN is in great shape. At year-end, NNN had $132 million drawn on the $1.1 billion credit facility after deploying over $800 million of capital for the year. Based…

Kevin Habicht

Analyst

Thanks, Steve. And as usual, let me start with the cautionary statement that we will make certain statements that may be considered to be forward-looking statements under federal securities law. The Company's actual future results may differ significantly from the matters 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 out of the way, headlines from this morning's press release, we report quarterly core FFO results of $0.85 per share for the fourth quarter of 2023. That was up $0.05 or 6.3% over year ago results of $0.80 per share. I will be quick to point out, as detailed in the footnote below the earnings table on Page 1 of the press release that the fourth quarter included $0.03 of accrued rental income in connection with the re-class of one tenant from cash basis accounting to accrual basis accounting as a result of continued improvement in that and its financial condition post pandemic. So, with AFFO's $0.03 per share, the fourth quarter core FFO would have been $0.82 per share or 2.5% over a year ago result. For the full year, as Steve mentioned, full year 2023, we reported core FFO of $3.26 per share, which was 3.8% over a year ago results. Now if we exclude the same $0.03 from the accounting reclass, full year results would have been $3.23 per share or 2.9% over year ago results, which was at the top of our guidance range last provided. AFFO results, which are not impacted by accrued rent were…

Operator

Operator

Certainly. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Your first question for today is coming from Spenser Allaway at Green Street.

Spenser Allaway

Analyst

Thank you. Can you guys just talk about how cap rates are trending thus far into 2024 and similarly how deal volume is trending just based on what you’ve sourced and what you can see maybe looking out the next 30 to 60 days.

Steve Horn

Analyst

Hey, Spenser, it’s Steve. Yes. So, going into 2024, as I alluded in the opening remarks, we were picking up 20 basis points each quarter. And then I expect that if not a little bit higher for the first quarter for the deals that got priced in the fourth quarter. But we kind of noticed, it felt like the other REITs put some pressure because they have to do acquisition volume, which kind of plateaued the cap rates that we’re seeing that might close in the second quarter. I kind of see the first half of the cap rates being the same, but they’re definitely trending up for the first quarter. As far as deal volume, there’s definitely not as much deal volume out there as there was kind of in the second and third quarter. And I think that’s more from the seller side, the supply side, when there is discussions of rate cuts coming, that some sellers are holding off, hitting the market, anticipating better cap rates in the near future. But that being said, where NNN, our acquisition guidance, there’s plenty of deal volume out there for NNN to hit its numbers.

Spenser Allaway

Analyst

Okay. Great. And then just any specific industry within your existing tenant base that’s showing more appetite to grow, or maybe on the flip side, downsize their current footprints just based on discussions you’ve had.

Steve Horn

Analyst

Yes. The latter part of the question, we’re not hearing anybody wanting to downsize in our sectors. Everybody’s always reevaluating their business models. But as far as growth through M&A or adding stores, there’s still a big push in the auto service center from our client base is still growing and we’re starting to see a little bit of the QSR momentum tick up. And then lastly, there is some activity in the C-store market again, that we’re kind of filtering through opportunities.

Spenser Allaway

Analyst

Great. Thanks so much.

Operator

Operator

Your next question is coming from Joshua Dennerlein with Bank of America.

Farrell Granath

Analyst

Hi, this is Farrell Granath on behalf of Josh. I was wondering if you could elaborate on any bad debt assumption in the – especially compared to historical.

Steve Horn

Analyst

Yes, sure. This is – yes, so as usual for us, we’ve assumed in our guidance 100 basis points of rent loss baked into our guidance, and that I would say, what is typical and what included in 2023 is that we typically run kind of 40 to 50 basis points in a typical year.

Farrell Granath

Analyst

And can you walk me through maybe some of the internal external drivers of growth given your lower acquisition guidance?

Kevin Habicht

Analyst

Yes. For us, in one sense, it's fairly simple kind of model. Rent growth, we assume in our portfolio is going to be internal growth would be about 1.5%. So that would add about $12 million, 1.5% of $818 million or whatever the number was, call it, $12 million. But we've assumed, we'll lose 100 basis points of rent loss, which I like, we've indicated is probably, hopefully a conservative assumption. So that's negative $8 million and you got 3 – $4 million in G&A creep. And then, as I mentioned, we'll have interest expense for the year will probably be about $5 million to $6 million higher as it relates to the refinance of that $350 million. And so that – and then you layer in acquisitions, if you assume midpoint $450 million, then those are kind of the pieces, I think, that got us to where we are in terms of our guidance. And like I said, hopefully, we'll have an opportunity to drift that higher, that guidance higher as the year progresses and consistent with what we've done in the past. But that's where we were comfortable starting out guidance.

Operator

Operator

Your next question for today is coming from Smedes Rose at Citi.

Smedes Rose

Analyst

Hi. Thank you. I just wanted to go back for a moment to the acquisitions outlook. It just was a little bit light, at least relative to our expectations, and I think maybe relative to some of your 3Q commentary. And you mentioned earlier that sellers are kind of holding off, maybe looking for better pricing for them later in the year. I was just wondering is that something that sort of changed maybe over the last – since your last call or maybe you could just talk a little bit more about the opportunities on that front.

Kevin Habicht

Analyst

Yes. I mean, as far as the outlook, our acquisition volume, I think we've been pretty consistent over the course of the last six months that we are looking at a light capital markets footprint. So the $400 million to $500 million range of acquisitions pretty consistent. What has changed from the last call was the market was expecting rate cuts coming in March. That was the probability. But during the last call, that was not on the table. That was more kind of a mid-December discussion item. And at that point is where we felt that sellers weren't coming to the market expecting those future rate cuts, but now they're being delayed.

Kevin Habicht

Analyst

And Smedes, this is Kevin. One other thing I'd add is that that's our style and our approach. I think if you look back over history, I'm guessing our initial acquisition guidance has always looked light relative to where the year ended up 2023 included. And so it's funny in our business, as we've said, you really have three months, maybe four, but not very much look into the future in terms of the pipeline, I mean, a real pipeline. And so it’s – we tend to be probably a little more cautious on the front-end going in until we have a better sense of how the year is going to play out.

Smedes Rose

Analyst

Thanks. And then I just wanted to ask you on the tenant that moves back to accrual rents from I guess, cash payments. Is that sort of just, I guess, more or less unusual or it’s something that you might expect more of as we move through the year.

Kevin Habicht

Analyst

Yes. Yes. It’s unusual. It was unusual due to the pandemic for us to actually go from accrual to cash basis and then it’s unusual to reverse it and its gap accounting unusual that you would recognize revenue or income when you do always do this. And so we currently have about 5% of our base rent is still on a cash basis. So there’s the potential for more of that in the future. Now that 5% consists – 90% of that 5% is two tenants, AMC and Frisch's [ph]. And so I don’t sense – in the near term, there’s going to be that reclassification that we just did. So I’d say in the near term, I don’t – I wouldn’t expect anything on that front.

Smedes Rose

Analyst

Great. Thank you.

Operator

Operator

Your next question is coming from Alec Feygin with Baird.

Alec Feygin

Analyst

Hi, thank you for taking my question today. So, I want to ask about the size of the development pipeline right now and how you see it trending?

Steve Horn

Analyst

I would say 2023 was a bit, what we call split-funded program. Just to be clear, we don’t develop assets. We’re more of a funding source to our current tenants on that. So, we’re not having any speculation, permits and leases all in place by the time we deploy capital. Now that being said, the 2024 pipeline currently is not as large as 2023, but 2023 was a historic high for us, and that was a result of the banking market where our tenants on the regional banks weren’t deploying capital, so they came to us for money. So, we had a really strong year in 2023.

Alec Feygin

Analyst

Okay. Got it. And the second question is, what are you thinking for capitalized interest in 2024?

Kevin Habicht

Analyst

Yes. And so based on that activity in our split-funded program, we’ll continue to have capitalized interest and so for last year, it totaled $4.3 million for 2023. I think it will be somewhat less than that. So, let’s call it around $3 million maybe. But we’ll see how it plays out. I will now just for everybody. And as a reminder, we do deduct capitalized interest in our calculation of AFFO. I don’t think that’s probably – I don’t think everybody does that. And so I just wanted to kind of highlight that.

Alec Feygin

Analyst

Thank you. Have a great day.

Kevin Habicht

Analyst

Thanks, Alec.

Operator

Operator

Your next question is coming from Linda Tsai with Jefferies.

Linda Tsai

Analyst

Yes, hi. Could you discuss some of the trends you’re seeing in the sale-leaseback market?

Steve Horn

Analyst

Hey, how are you doing, Linda. Yes, the trend is pretty much similar to the way it’s been the last few years. I think with the banks pulled back, there is more of an opportunity for sale leaseback funding. I’m not going to say 2024 is going to be a larger opportunity in 2023 because the regional banks are starting to lend a little bit more. But the cap rate, it's always a pricing question, as you know, and the bid ask spread was fairly large throughout 2023. It has narrowed substantially. Just case in point of us doing nearly 270 million in the fourth quarter. But we're being very selective going into 2024 until the capital markets on the equity side, as we feel, are a little bit more open. But the sale leaseback market, again, there's plenty, it's undefined by size and there's plenty of opportunity out there to do deals.

Linda Tsai

Analyst

And then the delta between acquisition and disposition cap rates, where do you think that trends each quarter?

Steve Horn

Analyst

Yes. Historically, it's always been kind of 100 basis points for us. We try to get a little bit more than that. 140 basis points was a significant year for us and that's kind of why we kind of highlighted on the call. But in our model, we look at 100 basis points.

Linda Tsai

Analyst

Just one last one. I know bad debt expectations are low, but could you just compare the tenant watch list for you today versus a year ago?

Steve Horn

Analyst

I have to think about a year ago, but I'd say it's pretty – the list is consistent. There's no real new names popping up. A couple have dropped off for better or worse in terms of we had three Bed, Bath & Beyond. We've got a handful of Rite Aids and so they'll die a natural death, I believe. But others that we've talked about in recent quarters are still on the list. The at homes we got two big lots or three big lots and two JoAnns. We also own some Frisch's restaurants, which is a restaurant concept, Big Boys, Midwest Big Boy hamburger concept that we have concerns about and we've talked about and then of course the theater exposure. But that's kind of, I put in a separate bucket a little bit and to be honest, I don't feel – we feel pretty good about where they are at the moment in terms of their liquidity and ability to pay us rent in the near term. So – but yes, so all that to say is yes, not, no real change in the list or the composition or size of the list.

Linda Tsai

Analyst

Great. Thank you.

Operator

Operator

Your next question is coming from Ronald Kamdem with Morgan Stanley.

Ronald Kamdem

Analyst

Hey, just staying on the tenants a little bit. I know you get sales with a lag, obviously from the tenants. But are you sort of seeing anything suggesting that that low end consumer is slowing? I think we hear a lot about it, but curious if any of your concepts or tenants are showing sort of softness there?

Steve Horn

Analyst

No, I mean, from the data exactly, it is stale. It takes time to get it in and then process it. And not every tenant devolves it quarterly, sometimes it's annually. But more through discussions I think is more live real time data that we obtain is we're not seeing the sales of our tenants dropping, so not thinking it's getting soft by any means. Currently, they're all performing, I'm not going to say killing it out of the park, but they're performing well. We do see some margin expansions within the QSR, meaning that they still can get the price through and their labor costs are not eating them up. But overall, we're not seeing a significant softness within our tenant base.

Ronald Kamdem

Analyst

Great. And then just switching gears to the acquisition market a little bit, maybe talk a bit more about the competition today versus previously? I know you mentioned some of the REITs maybe in your opening comments, but curious about 1031 private buyers just today versus six, 12 months ago, what is that – who are you competing now? Thanks.

Steve Horn

Analyst

Yes, because we go after the sale leaseback approach, that's our model. We think it's a lot better of a risk-adjusted return. That we don't play in the 1031 market. So we don't run into the 1031 guys at all to speak off. But we would run into the private equity buyers that have been on the sidelines for a while. We are hearing rumblings that they're starting to thinking about getting back in the market but they're not the groups I would lean on that were hurting the price – cap rate expansion. It was more our competitors. But Ron, to be honest, that happens typically in the late in the fourth quarter, early in the first quarter when companies are coming out with their guidance for the year. They feel the pressure to do the volume. So we see that year-over-year.

Ronald Kamdem

Analyst

Right. Thanks so much.

Operator

Operator

[Operator Instructions] Your next question is coming from Connor Siversky with Wells Fargo.

Connor Siversky

Analyst

Good morning. Thank you for the time. A quick question for Kevin on the balance sheet. I'm just looking at this $350 million maturity in June. I'm wondering how the swaps are set up. Can you just roll that over and keep the same rate in? Or should we expect the kind of cash outlay associated with paying down that stack?

Kevin Habicht

Analyst

Yes. So yes, we have no derivatives or swaps connected to that debt or any debt at the moment. And so any swaps that we or derivatives that we use were only pre-issuance if you will, and those were terminated at the time we issued the bond. And so any cost or gain associated with those get amortized over the life of the bond. But like I say, all of those derivatives get terminated at the time of debt issuance. So nothing outstanding there. So yes, you should think about that as a true $350 million debt maturity. We'll see what we want to do in terms of accessing the debt markets. They're obviously open right now. They are, I would say, reasonably priced at the moment. For us today, we're probably kind of a mid-5% for a 10-year kind of issuance would be my guess. And – but we do love the optionality and this may or may not be plan A, but we can use our bank line, too. We have sufficient capacity on our bank line that if the markets weren't aware we might like or we wanted to wait, we could easily pay off that maturity just using our bank credit facility.

Connor Siversky

Analyst

Okay. Thank you for the clarification. That's all for me.

Operator

Operator

Your next question is coming from John Massocca at B. Riley.

John Massocca

Analyst

Good morning.

Kevin Habicht

Analyst

Good morning John.

John Massocca

Analyst

Sorry if I missed some of the responses to earlier questions, but do you have like brackets around the amount of contractual rent you have in place from cash basis tenants today, just given the movement of one tenant to an accrual basis?

Kevin Habicht

Analyst

Yes. So yes, we have 5% of our annual ABR, annual base rent is on a cash basis. And like I say, really 90% of it really consists of two tenants, AMC and Frisch's. And – but we – through the year, 2023, they are all current. And so there was no delta between cash and book basis or booked revenue as it relates to that. And again, as I mentioned, we don't expect – I don't expect either of those tenants moving from a cash basis to accrual basis in the near term. And so they'll remain cash basis. But it has no real impact really on the way we operate or the way we think or frankly, and I wouldn't include it in the way we model things. And so we assume they'll continue to pay rent going forward. Having said that, we created 100 basis point rent loss assumption baked into our guidance to hopefully account for any kind of hiccups on the tenant rent side.

John Massocca

Analyst

Okay. And then I know we're dealing with small sample sizes, but what's the plan for the Rite Aids you're getting back or might potentially get back? And do you think there's a market out there to release them as pharmacy or that they need to be kind of repositioned for I guess, higher and better use, if you will.

Steve Horn

Analyst

Yes. Currently, the two that were rejected out of the six, we have a lot of interest if it’s not surprising the car wash, but we have some QSR interest as well. So I'd expect those two to be redeveloped and put on a ground lease the other four as far as Rite Aid performed fairly well. So we'll see what happens if and when we get those back. But again, kind of what I stated in the opening remarks, they're well positioned. They're near market rent. So I'm not expecting anything outside our historical averages as far as a recapture rate.

John Massocca

Analyst

Okay. And then just in terms of kind of modeling and AFFO, anything to be aware of in terms of rent bumps – I just know given a good portion of the portfolio has kind of five year look backs on bumps. Just is there any seasonality this year or last year, just to be aware of as we're kind of updating your models.

Kevin Habicht

Analyst

Yes. No, in terms of rent increases, while we have a variety of one year annual increases or increases every three years or increases every five years, we have a sample size that's sufficiently large that it all pencils out to be about 1.5% a year despite those varying terms for rent increases. So the way I would think about it is a 1.5% rent increase for this year and going forward.

John Massocca

Analyst

Okay. That makes sense. And that's it for me. Thank you very much.

Kevin Habicht

Analyst

Thank you, John.

Operator

Operator

We have reached the end of the question-and-answer session, and I will now turn the call over to Steve for closing remarks.

Steve Horn

Analyst

Thanks, Olli. Thanks for joining us this morning. Just to kind of reiterate and then we're in good shape as we head into 2024. We're willing to pivot if market conditions change. We look forward to telling the story to many of you guys kind of in the upcoming conference season. Take care. Thanks.

Operator

Operator

Thank you. This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.