NNN REIT, Inc. (NNN) Q4 2011 Earnings Report, Transcript and Summary

Greetings, and welcome to the National Retail Properties Fourth Quarter and Year-End 2011 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Craig MacNab, Chairman and Chief Executive Officer. Thank you, sir. You may begin.

Thank you, Christine. Good morning, and welcome to our 2011 year-end earnings release call. On this call with me is Jay Whitehurst, our President; as well as 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. 2011 was an excellent year for NNN as we maintained a very high level of occupancy, continued to do more deals with our relationship tenants and expanded our already fully diversified portfolio. Similar to last year, we had a very active fourth quarter on the acquisition front, which exceeded our earlier expectations. And even though this activity has little impact on 2011, it positions us very well for this coming year. In terms of acquisitions, as I indicated earlier, the fourth quarter of last year was productive for NNN as we invested $327 million, acquiring 111 properties at an average cap rate of about 8.36%. About 2/3 of this activity was purchasing convenience stores from a well-established, Texas-based convenience store operator called C.L. Thomas that was acquiring the Exxon stores in Austin and San Antonio. We also purchased a number of mature real estate locations from C.L. Thomas that the company previously owned themselves. Our team had spent several years cultivating a relationship with this very strong operator, and we were delighted to consummate our first transaction with them this past December. In the fourth quarter, we acquired our real estate from 21 different tenants of which only 6 were new tenants, including C.L. Thomas. The remaining 15 tenants that we purchased real estate from are all what we describe as relationship tenants, meaning we purchased other properties from them earlier in 2011, and in many cases, we expect to acquire additional properties from them in 2012. Our team, led by Jay, has executed well, expanding the number of relationship tenants and increasing our activity with several of these successful growing retailers. As our press release indicated, in calendar 2011, we acquired 218 different properties this past year, investing $772 million at an average initial cash cap rate of approximately 8.4%. We are delighted to have strengthened and further diversified our portfolio with these acquisitions. Many of these acquisitions were noncompetitive, off-market transactions, where we were able to acquire excellent real estate while achieving very strong yields. We've continued to like the granularity of our business. And with an average purchase price per property of approximately $3.5 million last year, with land in many cases representing in the range of 40% of the total purchase price, these are clearly very attractive opportunities. One of the reasons that we obtain higher yields than those realized by other REITs who compete in different real estate sectors is that the net lease retail category is less competitive than several other property types, and this is influenced by the small dollar size of the properties that we invest in. As some of my colleagues remind me, it is a lot of work to acquire over 4 properties every week of the year, which we accomplished in 2011, with each one of these properties being individually underwritten by our team. However, if I may be so bold, we are still getting above-average yields for this effort. Our portfolio continues to be in excellent shape and, at the end of the year, was 97.4% leased. By the way, this is the 8th consecutive year that we have been at least 96% leased, which speaks to the low risk of our portfolio. In 2012, we have less than 2% of our leases coming up for renewal, and some of these tenants have already renewed, which is good news. As of the end of the year, we owned 1,422 properties, which are leased to over 250 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 are contractually obligated to pay us rent for approximately 12 years. As we look to the future, I like the way National Retail Properties is positioned. Our portfolio is in excellent shape, and very importantly, as you'll hear from Kevin, our balance sheet is fortress-like, which will allow us to take advantage of the carefully underwritten acquisitions that we expect to complete this year. Finally, our first quarter acquisition activity is off to a better start than we had anticipated on our last conference call, with much of the activity taking place with our relationship tenants who value doing business with us. The rent that we're already receiving from some of this early activity plays a role in our ability to raise guidance for 2012, which I will leave for Kevin to describe. Thanks.

Thanks, Craig. Let me start off with the standard cautionary language that 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, as you noted this morning, we reported fourth quarter FFO of $0.42 per share and AFFO of $0.43 per share. For the full year 2011, FFO was $1.57 per share and, excluding impairment items, results in an 8.3% increase over 2010, $1.45 per share. AFFO for 2011 was $1.70 per share, which represents a 6.9% increase over 2010's $1.59. 2011 was a very good year for NNN's results, and it's allowed us to perpetuate our 22 consecutive years of increases in our annual dividend paid to shareholders. The good results for 2011 were driven by maintaining high occupancy and substantial new accretive investments. Occupancy was 97.4% at year end. That's up 20 basis points from the prior quarter and up 50 basis points from a year ago. As Craig mentioned, we completed $772 million of accretive acquisitions in 2011. Notably, this was accomplished while ending the year slightly less leveraged than when we started. All this not only drove 2011 results but also positions us well for 2012 and allowed us to raise 2012 guidance, more about in just a moment. First, a few details on our 2011 results. The primary positive variance from guidance projections, as well as prior periods, was the strong acquisition pace that continued into year end. Rental revenues increased $14 million or 24.7% in the fourth quarter, which was driven by the $772 million of property acquisitions made over the preceding 12 months. Property expenses net of tenant reimbursements totaled $1.8 million in the fourth quarter. That's down from $2.0 million in the prior third quarter. G&A expense increased to $8.6 million in the fourth quarter, primarily due to short- and long-term incentive compensation accruals. We also saw transaction due diligence expenses increased by about $450,000 for the full year. Bottom line is the core fundamentals and the income statement performance is very strong. As I mentioned this morning, we also announced an increase in our 2012 FFO guidance to a range of $1.65 to $1.70 per share. That's up $0.03 on both the low and high end. And that translates into a range of $1.74 to $1.79 per share for AFFO. This increase is largely driven by the continued strong pace of acquisitions in the fourth quarter of 2011, which has some spillover into the first quarter of 2012. Accordingly, we are increasing our 2012 acquisition guidance from -- to $200 million, more evenly spread over the year versus our prior guidance of $150 million, skewed to the second half of the year. We now see G&A expense of approximately $29.4 million, representing a 2% increase over 2011. Other assumptions are largely unchanged, including occupancy. $0.09 of the noncash adjustments bring 2012 AFFO results to $1.74 to $1.79 per share guidance, with the primary AFFO adjustments being noncash interest expense on our convertible debt and noncash stock-based compensation expense. Turning to balance sheet. Craig has already talked about our recent acquisitions, which drove the use of proceeds from the December common equity offering we completed, which generated about $198 million. As of year-end 2011, total debt to total gross book assets was 38.5% and debt to EBITDA was 5.3x. Interest coverage for the year was 3.2x, and fixed charge coverage was 2.9x for the year. Only 10 of our properties, less than 1%, are encumbered by mortgages. Our balance sheet remains in very good shape, and despite the large acquisition volume, we have a balance sheet less leveraged than the beginning of the year and $384 million of availability on our bank credit facility. So we're very pleased with 2011 results and see 2012 producing another 6-plus percent growth in FFO per share with realistic assumptions and continuing our moderate leverage capital structure, all of which should allow us to continue 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. So with that, Christine, we'll open it up to any questions.

[Operator Instructions] Our first question is from Gregory Schweitzer with Citigroup.

I’m here with Michael Bilerman, as well. Could you guys talk a little bit about the new C store tenants, perhaps how the deal came about and any of the attributes of the specific tenants, the credits or the locations that you could discuss in terms of your underwriting?

Sure. As I mentioned, C.L. Thomas, which has become a meaningful tenant of ours, purchased the Exxon markets and all of the real estate in Austin and San Antonio. They are a big company. They've been operating for about 40 years, I believe. They've got quite a diversified business model, including jobbing with stores in a variety of states. Historically, oil companies have tended to over-invest in their real estate locations, and these properties were no different. They were on large pieces of real estate, very well-located corner locations, and ultimately, this is going to be a very, very good transaction for us. C.L. -- in terms of the credit, this is a private company. So we're not going to share that information, but I would observe that they have the characteristics that would allow them to be a public company.

And how do you think about your C store industry exposure overall? Is it as high as you'd like to see it now? Or could you notch it up a bit more?

I think, Greg, we clearly pay attention to that, but the fact of the matter is the performance of the convenience store sector has been very, very strong for the last 5 or 6 years since we got involved in that category. We're doing business with dominant market leaders in their respective geographies. But the most important thing that we continue to like about the C store business is the quality of the real estate is very, very strong. At the end of the day, corner locations are very attractive pieces of real estate that if they weren't convenience stores, they could be bank branches, drugstores or many other uses. So we look at other opportunities, but right now, C stores remain very attractive to us. Having said that, at this level of concentration, we are mindful of that. I'm sure in the near -- in the first half of this year, we're doing some deals in other categories, which will moderate our exposure to the convenience store sector.

Okay. And then just one more for Kevin. Is there anything in guidance for any potential tenant weakness that may occur this year?

No, we view occupancy as pretty much flat where we are at the moment. So no.

Our next question comes from the line of Lindsay Schroll with Bank of America.

Can you guys discuss the health of your restaurant tenants that make up the full service category and particularly what exposure within that category you have to casual dining?

So as we disclosed in the press release, our full-service restaurants are about 9.5% of our annualized base rent. There are many different tenants in that category, including some of the legacy National Retail Properties, the Golden Corrals, that have been around for a very long time. We also have in there, if you'll take a look at our tenant exposure, some transactions that we've previously announced, including several years ago, we did a deal with Denny's. So we've got a number of small properties there. It's less than 2% tenant, a tenant that sort of just put its head above the disclosure areas. Logan's Roadhouse, which is a small restaurant -- I mean, a steak restaurant that serves on the lower price point. They continue to do very, very well. They were recently purchased by a very large private equity firm. Their balance sheet is in good shape. Right now, Lindsay, we don’t have much worry in that category. In 2007, 2008, we chose not to do some of the higher leveraged restaurant deals. At that time, we continued to do convenience store deals. And with the benefit of hindsight, it appears that we avoided some road mines.

Okay, great. And then in terms of your book and office supplies categories, I guess how aggressively are you trying to get out of those industries? Or are you happy with the assets that you actually own?

Let's start out with the assumption that there's no greater fool theory out there. So in other words, if we really don't like a property and nobody else -- it's unlikely anybody else is going to do it. The office category is not in the sweet spot of retail. We have some exposure to that category. Most of these leases were done years ago. So given the flat lease nature of that sector, the rents tend to be at markets or below that. We have a couple of leases coming up in 2012, and the good news is the tenants have renewed those leases. I don't think you're going to see us doing any new deals in that category. But generally, we feel comfortable with what we’ve got.

Our next question comes from the line of Rich Moore with RBC Capital Markets.

Looking at C.L. Thomas, is that one of the tenants, Craig, that you guys might buy more assets from?

Well, we're not going to announce the deals we haven't made. Let's start with that. But C.L. Thomas is a very good company. It's a growing convenience store operator. We've got an excellent relationship with them, and we're going to be talking to them in 2012.

Okay. So they have more -- I guess I was thinking, they have more product that would be interesting?

Okay, they’re a growing retailer. So yes, they do have more products, and they continue to open new locations.

Okay, good. And then also home improvement and RV dealers also seem to be higher. Any thoughts on those? Anything in particular going on in those 2 sectors?

In the home improvement sector, we have identified a new tenant and just done a little bit of business with them. Excellent real estate and -- I mean, really, really good real estate, slightly lower cap rates, but, Rich, what we're continuing to do is identify new retailers that we think we can [indiscernible] attractive risk-adjusted returns with. And I think just getting back to Lindsay's question, one thing for sure. Our portfolio, at the end of the day, reflects consumer spending. But despite whatever concerns are out there, we have been 96-plus percent occupied for each of the last 8 years. Yes, there's always some noise that occurs in the portfolio, but our excellent leasing team is doing a very, very good job of re-leasing that space.

And are there any new categories maybe that you guys are exploring beyond your -- the categories we see typically in the press release and in your documents?

No, Rich. Not really. We're in over 30 different retail categories. So one way or another, that covers all of the exposure.

Okay. And if I could, I got a couple of quick questions for Kevin. There was an impairment reversal in the quarter. What was that?

Yes, there was. Yes. In the fourth quarter of 2010, we took a $5.6 million impairment charge related to a mortgage loan receivable in which the borrower went bankrupt. And so while we accounted for getting the property back, which we did, we didn’t assume we would collect a meaningful additional recovery. Well, it didn't turn out that way, and without going into a lot of details, we ended up recovering $3.1 million in the fourth quarter of 2011. So we took that, obviously. But despite the fact the $3.1 million was a cash recovery, we did exclude it from our AFFO since we felt it might be a little disingenuous to have an impairment add back in 2010 AFFO and then not adjust for the recovery 1 year later in 2011. It might be a little distortive in comparing AFFO for those 2 years. So that's what kind of drove that.

Those are the good kinds of impairments.

We have enough experience. We have our share of issues to deal with along the way, and that just resulted in a better outcome than might be typical.

Okay, and then on the G&A, too, it was higher, obviously. You guys mentioned that it was higher for a couple of reasons and a couple million over our estimate. Does it change your outlook for G&A in 2012?

Slightly. I mean, I noted, we're looking at $29.4 million in G&A for 2012, and that’s a 2% increase over 2011. So it's not much of an increase from last year.

Okay. And then last thing is on the leverage. The leverage has come down, and that is obviously a good thing. Would you guys let it creep back up as you make more acquisitions this year? Or is your intent to issue equity to keep it at these levels, as you make acquisitions?

I think we've long lived in the kind of the 35% to 45% of debt to gross book assets. As you noted, we're on the lower half of that range. And we're probably going to be fairly leverage-neutral, I would say, going forward, but there's always some minor fluctuations up and down.

[Operator Instructions] Our next question comes from the line of Todd Stender with Wells Fargo.

Can you go into some of the details of the C. and L. Thomas (sic) [C.L. Thomas] acquisition, the lease terms, initial lease yield and the rent coverage?

The initial yield was just above 8% initially with growth over the duration of the lease. And these are 20-year leases, and the average yield over the duration of the lease is going to be in the mid 9s. In terms of the rent coverage, it's better than 3x covered.

Okay. And the rent bumps, is that an inflation-adjusted rent bump? Or are they fixed?

Inflation-adjusted. So they will not be straight lined, Todd.

Okay. And just with your acquisition assumptions going up this year, say, $200 million, how much of that would you say is going to be from relationships? And what's a reasonable number just going maybe over the next couple of years?

A reasonable number just from relationships?

Yes.

It sort of depends on store openings and what's going on at these retailers and who comes in and who goes out and so forth. But right now, we're running, I think, somewhere between $100 million and $125 million annually from the relationship tenants. And in the first quarter, much of the activity is coming from relationship tenants. Over the course of the year, I'm sure there will be a couple of opportunities to acquire portfolios from other tenants that we're not currently doing business, but we do not, at this point, have any of those lined up.

Okay. And can you talk a little bit about the health of the disposition market for your properties? Just looking at maybe the 10/31 exchange buyer and how cap rates have trended lower, could we see more disposition volume from you guys?

No, cap rates are clearly going lower, Todd. Last year, acquisitions, our average cash cap rate was about 8.4%. And this year, we're guiding to something just a hair above 8%. On the disposition side -- on the one-off market, prices that people are paying for properties are continuing to trend lower, and they are really, really low right now. We're currently selling a property for another landlord. It's in a good SMSA [ph]. It's leased to a credit bank, and the cap rate is 5.25%. And I'll tell you this, the buyer is a very successful, sophisticated investor, and there are no bumps in that transaction. It's just extraordinary in this low yield environment what some people are paying for good real estate. So yes, there are some opportunities, and I suspect we may be able to sell some properties. But we like our portfolio the way it is, and we'll see what happens there.

Great, and last question, probably for you, Kevin. Some -- with your acquisitions going up, your guidance has gone up, is there any change in your debt funding costs at the spreads? Are you assuming they're a little wider than you thought?

No, not really. I mean, to the contrary, I think the credit spreads really across the capital spectrum is going to -- have been grinding in a little bit, if anything. So no. We anticipate we would be able to borrow at equal or better than where we were able to accomplish last year.

One of the reasons, Todd, cap rates are going down for real estate is the borrowing costs are coming down faster.

[Operator Instructions] It appears we have no further questions at this time. I would now like to turn the floor back over to management for closing comments.

Christine, thanks very much. We appreciate all of your support. We’re going to be going on the road a little bit here in March, so we may see some of you. Otherwise, we look forward to talking to you in about 90 days. Thanks very much, and best of success to all of you in 2012. Good morning.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.