NNN REIT, Inc. (NNN) Q1 2012 Earnings Report, Transcript and Summary

Greetings, and welcome to National Retail Properties First Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It's now my pleasure to introduce your host, Mr. Craig MacNab, CEO of National Retail Properties. Thank you, Mr. McNab. You may begin.

Louis, thanks very much. And good morning and welcome to our first quarter 2012 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 first quarter financial results following my brief opening comments. We are pleased with our consistent and predictable first quarter results. Also, we're delighted to have raised our guidance for 2012, also taking into account the charge for the redemption of our more costly preferred. Also, as you will hear from Kevin, our AFFO continues to be comfortably higher than our FFO. In the first quarter, we acquired 67 properties, investing $198 million at an initial yield of 8.3%. We're very pleased with the yields on our acquisitions completed in the first quarter and they came in a little ahead of what we had been budgeting. As a reminder, an initial yield of 8.3% with the type of annual growth we are getting of almost 2% per annum translates into an average annual yield over the duration of the lease of just under 10%. This is well in excess of our cost of capital. We acquired our properties in the first quarter from 16 different tenants. We did complete one meaningful acquisition with a new tenant for NNN. However, the majority of the transactions were with existing tenants, which is a very good illustration of the depth of our relationships with retailers, with whom we do repeat business. The largest transaction that we completed in the quarter was the acquisition of 34 properties leased to Outback Steakhouse and their various brands, where we invested just shy of $100 million. In this transaction, we acquired mature restaurant locations that are very stable and have a rent coverage ratio that's comfortably in excess of 2X. Outback is performing very well as a company, and you may have seen recent press reports that they're considering going public. The good news is that our acquisition activities came together a little earlier in the year than we'd originally budgeted, and as I mentioned a moment ago, our initial yields remain excellent. We're seeing plenty of acquisition opportunities, but we will maintain our discipline and remain selective, focusing on real estate fundamentals for the properties we acquire. Our portfolio continues to be well leased, with occupancy improving slightly from year end to its current 97.5% occupied. Furthermore, we have very modest expirations for the next 3 years, which will be among the lowest amongst publicly traded REITs. Also, our average lease duration in the portfolio is 12 years. With nearly 1,500 properties located all across the country, our portfolio continues to be more than fully diversified. National Retail Properties continues to be well positioned. As Kevin will describe in a moment, our balance sheet remains very strong. This ensures that we have plenty of dry powder as we identify accretive acquisition opportunities that have attractive risk-adjusted returns. Kevin?

Thanks, Craig. Let me preface my remarks with the statements -- 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 discussed in these forward-looking statements and we may not release revisions to those 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 did report first quarter FFO of $0.39 per share and AFFO of $0.44 per share. The FFO results include a $3.1 million charge in connection with our Series C preferred stock redemption. Excluding those $0.03 per share charge brings FFO to $0.42 per share, which results in a 10.5% increase over prior year results. So 2012 is off to a very good start. It gives us confidence in our earnings growth, as well as our ability to perpetuate our 22 consecutive years of increases in the annual cash dividend paid to shareholders. As usual, the strong results were a combination of maintaining high occupancy and making new accretive investments while keeping our balance sheet strong, so we can weather storms and stay in position to make prudent risk-adjusted returns along new investment opportunities. Occupancy was 97.5% at quarter end. That's up 10 basis points from the prior quarter and up 60 basis points from a year ago. As Craig mentioned, we completed $198 million of accretive acquisitions in the first quarter. Just a few details on our first quarter results. Compared to 2011, first quarter rental revenue increased $16.5 million or 28.1%, that's primarily due to the significant acquisitions we've made in 2011. While we acquired $198 million of properties in the first quarter of 2012, a little over 1/2 of that amount was acquired in the second half of March, which obviously tempered their impact on rental revenue in the first quarter. As we disclosed on the last page of the press release, in-place annual base rent as of March 31, 2012, was $313.9 million. Moving down, the other property expenses net of tenant reimbursements for the first quarter totaled $1.8 million. That was sequentially flat with the previous fourth quarter. G&A expense increased to $7.6 million, with the increase from prior year amounts and the decrease from prior quarter amounts primarily due to changes in incentive compensation accruals. Bottom line is the core fundamentals in the income statement are strong. This morning, we also announced an increase in our 2012 FFO guidance. Excluding, again, the $3.1 million preferred stock redemption charge, we now see FFO results in the range of $1.67 to $1.72 per share and that translates into a range of $1.76 to $1.81 per share for AFFO. The increase is largely driven by the continued strong pace of acquisitions in the first quarter of 2012. Accordingly, we are increasing our 2012 acquisition guidance to $300 million to $350 million. That's up from our prior guidance of $200 million. Also, we now see 2012 G&A expense of approximately $30.4 million and that represents about a 5.5% increase over 2011 G&A. The other assumptions in our guidance are largely unchanged, including our occupancy. Turning to the balance sheet, when we put together our plan for 2012 a few months ago, we did not assume we would issue preferred stock. But when the market moved preferred pricing notably lower, we decided to take advantage of it and we are pleased to get the opportunity to make preferred stock a more significant part of our capital structure at an attractive price. This is good example of maintaining balance sheet flexibility, so that we can fit it when the markets move and access the particular capital that is well priced. We issued 287.5 million of perpetual preferred at a 6 5/8% coupon. With these proceeds, we redeemed all of our 7 3/8% preferred shares, which totaled $92 million and a lower coupon on our new preferred saved us about $690,000 annually in dividends on this $92 million of redeemed preferred. Additionally, during the quarter, we raised $37.7 million of common equity from our Dividend Reinvestment Stock Purchase Plan in the first quarter. At quarter end, March 31, total debt to gross assets was 35.7%. That's down from year end 2011. It's down from first quarter of 2011 as well. So our debt leverage has been drifting lower for a few quarters now. And notably, our debt to EBITDA was 4.8x if you annualize first quarter EBITDA. For the first quarter of 2012, our interest coverage was 3.5x and fixed charge coverage was 3.1x. Only 10 of our properties, well less than 1%, are encumbered by mortgages, and despite $970 million of acquisitions over the past quarter, our balance sheet remains in very good shape, including $424 million of availability on our unsecured bank credit facility. Additionally, despite the material increase in our preferred stock and our capital structure, we currently believe our fixed charge coverage ratio will still pick up modestly, increase modestly to 3.0x in 2012, up from 2.9x, like I said, despite the additional preferred stock and preferred dividend we'll be paying. So we're very pleased with the good start and see 2012 producing 8% FFO growth based on the midpoint of our guidance range with what we believe are realistic assumptions and continuing our moderate leverage capital structure. Notably, last year's FFO grew 8% as well. So 2012, 8% growth does not come in as a result of easy comparisons. So we believe we're well positioned to continue to deliver the consistency of results, the dividend growth and balance sheet quality that supported attractive, absolute and relative total shareholder returns for a number of years. So with that, I think we'll open up for questions.

[Operator Instructions] Our first question comes from the line of Michael Bilerman of Citigroup.

It's Manny Korchman here with Michael. Just wondering if you could share your comments, perhaps, on one of your shopping center peers this morning announced a triple net acquisition of 63 restaurants at an 8.8% cap rate. It looks like you guys have done at least 1/2 the properties you did with the Outbacks and that was kind of at a 8% [ph] rate. Could you help us think about the difference between the 2 transactions?

You probably need to ask that shopping center company about their transactions. But the more important point that I take away from it is I'm really pleased that they're validating our business and continue to find attractive opportunities in the net lease retail category. And certainly, what we find, and it's one of the reasons I mentioned in my prepared remarks that the average yield over the duration of our long-term leases with new tenants, if you take an 8.3% initial yield with annual bumps of close to 2%, we are almost getting a 10% average annual yield over the duration of our lease. And that is contractual. So it's an awfully good business and I'm really pleased that Temco is validating it. They're a fine company.

And then one other quick question for you. It looks -- on the lines of trade disclosure, wholesale clubs went up significantly, but your exposure to at least BJ's didn't change on the tenant list, unless they're looking the same.

I should note that. We made a slight re-class, if you will, from prior quarter where we moved to that wholesale clubs out of general merchandise. And so that's what caused that. So there was no real change if you combine the wholesale clubs and general merchandise line items. And compared to prior quarter, you'll see it's about the same. So that's what drove that. But good catch, and that's a good point.

Our next question comes from the line of Joshua Barber with Stifel, Nicolaus.

I'm wondering, after this acquisition of Outback, if you could give us some of your broader comments of how you're thinking about the casual dining space because that's a space that hasn't necessarily been very kind to everybody in this business in the last few years. How are you guys thinking about Outback and how are you thinking about the entire casual dining space broadly today?

Josh, that's a fair question and I think one way to think about it is to just flip your comments upside down. I'd say, just because there's been a couple of train wrecks doesn't make it a bad category. But I think, more broadly, we are going to continue to underwrite based on real estate fundamentals. That's the starting point. And it's something like the Outback transaction where we bought very mature performing stores, many of which have been in these locations for 8, 10 years time. Those are excellent real estate locations where, in the housing boom, a lot of houses are in that vicinity. But I think, in addition to that, we obviously do pay attention to the trends in the restaurant category. And if we continue to stick to lower price point value necessity type of retailing, we think we're going to be just fine. What happened in the restaurant category broadly is beginning early in the cycle, maybe 2007. Restaurants began to experience negative comp store sales. What you see in the publicly traded companies is that, that trend has more than stabilized, and in fact, it's actually reversed as some of these chains are getting positive comp store sales. And then just to say one more comment on it. Yesterday, a restaurant operator that's not in our portfolio, P.F. Chang's, is under agreement to be purchased by a private equity group at really quite an elevated valuation. So I would guess, what you're seeing is stability in the category and new capital coming into it. So we see some pretty good opportunities in that area, Josh.

That's helpful. One second and unrelated question. It doesn't seem like asset sales have been particularly high in the last few quarters. Do you anticipate that changing in the next 2 to 3 years, that's sort of pruning the bottom half with the bottom quarter of your portfolio?

I think the biggest takeaway in National Retail Properties is that years ago, when the market was red hot in the 2005, '06, '07, '08 timeframe, we sold about 1/3 of our company. We sold more than $1.1 billion of our portfolio. And at that point in time, when a market was red hot, we had an opportunity to exit some of the categories in advance of people having anxiety around it. So in broad brush strokes, our portfolio right now is in very, very good shape and you see it with our occupancy. Having said that, selectively, we're always doing little bits of pruning on our portfolio and we sold a couple of properties in this quarter, and over the balance of the year, we're going to sell some more properties. But it's just really small pruning around different categories.

Our next question comes from the line of Todd Stender of Wells Fargo Securities.

Just to stay on that theme of the Outback transactions, Craig, did you mention that there's other brands that they have? Did I hear that right?

Yes. So Outback Steakhouse owns a couple of different brands. Their highest-end brand is a category called Roy's. They own an Italian concept called Carrabba's. And then they also own Flemings, but by far, their biggest brand and the majority of our stores are the core concept of Outback Steakhouse.

Okay. Is this a new relationship? I don't remember the name in your portfolio?

Yes. For us, it's a new tenant.

Okay. Are there any more properties behind this? Any agreement to acquire future Outback locations?

I don't think so, Todd. In this particular case, I mentioned, we purchased slightly less than $100 million. It was a $200 million approximate total transaction and we partnered with a different company on it. So just for concentration purposes, et cetera, we decided to buy 1/2 of what was available and as a result, we don't see more of that coming down the pipeline in the near term, especially if they go public and strengthen their balance sheet that way.

Sure. And just one last question on this transaction. How many years are left, on average, for the leases?

Now these are brand-new leases, Todd, and consistent with new leases on our deals, they run from 15 to 20 years.

Okay. Just looking at the lease expirations in general across the portfolio, very modest, particularly for the remainder of this year. And you could stay the same for next year. But just wanted to get a feel of what the tenants are saying during your current lease negotiations, just to really get a feel of how retails are thinking about the macro environment and where we are in the cycle and if you are addressing 2013 expirations. Just seeing what the tenants are saying.

And I think that's a good question, and obviously one of the things that for our management team that's fun about our business is we do get a pretty good reflection on the economy as a whole, given our dialogue with tenants and also their financial reporting to us. And I think the biggest takeaway that I would give to you is that given the long duration of our leases, where our tenant has been in place and has continued to operate the store for, say, 14 years of an initial primary term of 15, one of the beauties of the retail business is that there's a very high probability they are going to renew that lease where their customers, which drive their sales, know exactly where their store is and have built a relationship with that retailer. So yes, for the next 3 years, our lease expirations are really, really modest. But we don't see much change, which is a very high probability of the retailer renewing at that location. So one of the things that sets retail apart from some of the other net lease categories is the stability and consistency of the portfolio.

Our next question comes from the line of Wes Golladay of RBC Capital Markets.

Within the various lines of trade, where are you seeing the most of your activity, I guess going forward, outside of the restaurant category?

Wes, that's always a good question and we're looking around at all types of things. But as you well know, convenience stores are our biggest category and there are always opportunities all the way down that list. So if you take a look at our press release, convenience stores, restaurants, auto parts, auto service, theaters, sporting goods, we're looking at all of those categories in our current deal flow. But I think...

Okay. So you do have activity in there -- within all those categories?

Absolutely. But I do want to be clear on one thing, which clearly isn't your question. We had a very, very good first quarter, close to $200 million of acquisitions. We've increased our guidance to $300 million to $350 million. And right now, that reflects exactly what we're seeing. So I don't want anybody to be thinking that $200 million a quarter is in our line of sight.

Okay. It has been for the last 3 quarters, but we'll go ahead with the -- I guess you've been doing really good on the acquisitions. Okay, and a bigger picture question. We've heard from some of the retailers might struggle with their 2013 open-to-buys. Do you see some of the box retailers developing their own pads, and will this create acquisition opportunities for NNN?

So one of the hallmarks of National Retail Properties is we've got close to 1,500 different properties, which on average, cost us about $2.5 million. So for the box retailers, we do a little bit of business with them, but it's a really small part for us. We are -- the sweet spot for us is smaller transactions. Now to be sure, we take a look at everything that's out there. And as Manny mentioned a moment ago, we did in late last year, do a transaction with BJ's, so that's big boxes. And to be honest, we're looking at a small deal right now with bigger-sized retail properties, more than $2,500 of property. Whether we do it or not is another matter. And I don't want you to extrapolate what the retail REITs are seeing to our business. We are generally in corner locations, an acre at a time, with another $2.5 million property. And the thing that's really important around that is for that corner location, we'd pick a number, annual rent of $200,000 if you take 8% of $2.5 million. There are lots and lots of different users for that type of property. So that's why we've got a very stable, predictable business and it doesn't surprise me looking at our category.

Okay. And one housekeeping question. Was there any meaningful term income for the quarter?

That's $80,000.

[Operator Instructions] Our next question comes from the line of Dan Donlan with Janney.

Kevin, you've mentioned preferred stock, you guys finding that attractive. Is there some sort of percentage you guys are looking to have that as a proportion of your capital stack on a going forward basis?

No. There's no bright line target or limit or floor. I guess, all in the context of what we think is managing a prudent balance sheet and maintaining good interest and fixed charge coverages. I guess that'll be the guiding light in some respect. But yes, we've gone from 3% kind of piece of our capital structure to 8%, 9% of our capital structure. And for now, that feels pretty good and I don't envision layering an additional on top of that. But I think we're probably good where we are for now.

Okay. And then Craig, it's been a while since I've done these calls, so I apologize if you've talked about this before. But as you look at your portfolio, is there any sense to maybe trim some of the bigger boxes that you have for maybe smaller boxes? There's been a lot of chatter about Best Buy kind of downsizing their average store size. So was just curious, your thoughts there?

Dan, it's a fair question and every year, we're always taking a look at our portfolio and at the margin. You are going to see us doing a little bit of disposition of some properties, one, in broad strokes. And specifically, it'll be a mix of smaller tenants, as well as 1 or 2 boxes, but -- something like Best Buy, the thing that's really important for people to address there is not only what is the location, what is that retailer doing. But at the end of the day, the thing that's hardest for you to figure out is what is the rent per square foot that you're getting. And in our case, even with Best Buy, I believe that our rent is slightly lower than $8 a square foot. And one thing for sure, construction costs are well north of that. So Best Buy, they've got to do what they've got to do to fix their business, but if our average rents are $8 a foot, I think there are lots of users that would like to be in that space. And guess what, we might even be able on a re-lease the space at a higher rent.

There are no further percent this time. I'd like to hand the floor back over to management for closing comments.

Louis, thank very much. We appreciate all of you participating on our call. Our business continues to be very strong at National Retail Properties and we look forward to seeing some of you in the months ahead, in particular, at Merrill Lynch in New York City. Thanks very much, and we look forward to seeing you there. Cheers.

This concludes today's. Teleconference. You may disconnect your lines at this time. Thank you for your participation.