Agree Realty Corporation (NYSE:ADC) Q1 2024 Earnings Call Transcript

Agree Realty Corporation (NYSE:ADC) Q1 2024 Earnings Call Transcript April 24, 2024

Agree Realty Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning and welcome to the Agree Realty First Quarter 2024 Conference Call. All participants will be in listen-only mode. [Operator Instructions] Note that this event is being recorded. I’d now like to turn the conference over to Brian Hawthorne, Director of Corporate Finance. Please go ahead, Brian.

Brian Hawthorne: Thank you. Good morning, everyone, and thank you for joining us for Agree Realty’s First Quarter 2024 earnings call. Before turning the call over to Joey and Peter to discuss our results for the quarter, let me first run through the cautionary language. Please note that during this call, we will make certain statements that may be considered forward-looking under federal securities law, including statements related to our 2024 guidance. Our actual results may differ significantly from the matters discussed in any forward-looking statements for a number of reasons. Please see yesterday’s earnings release and our SEC filings, including our latest annual report on Form 10-K for discussion of various risks and uncertainties underlying our forward-looking statements.

In addition, we discussed non-GAAP financial measures, including core funds from operations, or core FFO, adjusted funds from operations, or AFFO, and net debt to recurring EBITDA. Reconciliations of our historical non-GAAP financial measures to the most directly comparable GAAP measures can be found in our earnings release, website and SEC filings. I’ll now turn the call over to Joey.

Joey Agree: Thanks, Brian, and thank you all for joining us this morning. We mentioned on our last call that we remain nimble and opportunistic, ensuring we are well-positioned to capitalize on opportunities as we uncover them. I am pleased to report that is precisely what we have done so far this year and what our organization is focused on every day. While the net lease transaction market continues to sort itself out, our team is doing a tremendous job leveraging our relationships and uncovering unique opportunities. We see little competition in the marketplace and are often the first and last call when a seller is prepared to transact. Though first quarter acquisition volume was light, we’ve seen an acceleration in the second quarter while achieving similar yields and continuing to focus on best-in-class retailers across the country.

This is being driven by the sheer effort of our team, our proprietary data environment, and the depth of our industry-wide relationships. Year-to-date, our origination team has made an average of approximately 420 outbound calls weekly to contacts within our vast database to mine for opportunities, which is up 20% year-over-year. Our conversion rate of deals approved by our investment committee to letters of intent signed is the highest in over two years at approximately 38%. Simultaneously, we have ramped up our efforts and leveraged our tenant relationships, exemplifying how we create proprietary deal flow and accretive off-market opportunities. We continue to work hand-in-hand with the country’s leading operators to drive efficiencies and reduce operating expenses.

Our portfolio remains extremely well-positioned with approximately 69% of rents derived from investment-grade retailers, a weighted average lease maturity of over eight years, and minimal lease term maturities. Similarly, our balance sheet is in excellent shape, with total liquidity over $920 million, more than $385 million of hedge capital, and no material debt maturities until 2028. This quarter marks the first time that we have introduced formal AFFO per share guidance. We believe it is important to demonstrate to shareholders that regardless of the environment, we can provide material earnings growth while adhering to our time-tested strategy. Our enhanced origination efforts, combined with our best-in-class portfolio and fortress balance sheet, give us confidence that we can achieve AFFO per share between $4.10 and $4.13 for the year.

This reflects 4.2% year-over-year growth at the midpoint, demonstrating our ability to provide consistent and reliable long-term earnings growth through different economic environments. We have conviction that we will be able to continue to deploy capital consistent with the spreads we have articulated and achieved year-to-date. At this time, we have visibility into over half of the approximately $600 million acquisition guide. With anticipated full-year disposition activity of $50 million to $100 million, roughly $237 million of outstanding forward equity, and free cash flow approaching $100 million on an annualized basis, we will be able to fund this activity on a largely leverage-neutral basis, ending the year well within our targeted leverage range.

Turning to our three external growth platforms, during the first quarter we invested $140 million in 50 high-quality retail net lease properties across all three platforms. The efforts I highlighted earlier enabled us to push cap rates significantly higher during the quarter, with the weighted average cap rate reaching 7.7%. This represents a 50-basis point increase quarter-over-quarter and a 100 basis point increase year-over-year. Investment-grade retailers accounted for 64% of the annualized base rents acquired. Our focus remains on achieving investment spreads of at least 100 basis points on the best risk-adjusted opportunities and not simply aggregating volume. During the quarter, we also commenced forward development and DFP projects with total anticipated costs of approximately $18 million.

In total, we had 20 projects completed or under construction during the quarter, with anticipated total costs of approximately $82 million, inclusive of the $48 million of costs incurred through March 31st. We mentioned the potential for more opportunistic dispositions on our last call, and that has come to fruition with six properties sold for growth proceeds of over $22 million during the quarter. The weighted average cap rate for the dispositions was approximately 6.2%, and less than a third of the rents were derived from investment-grade retailers. We will continue to sell assets at attractive yields and reinvest that capital at approximately 150 basis point spreads. Included in these sales were a select set of assets, including a Mr. Car Wash and Gerber Collision in Florida, which continues to see elevated 1031 activity relative to the overall market.

On the asset management front, we executed new leases, extensions, or options on approximately 405,000 square feet of gross leasable area during the quarter. Notable extensions or options included a Best Buy in Danvers, Massachusetts, a Hobby Lobby in Port Arthur, Texas, and a Walmart Supercenter in Maynard, Arkansas. Two leases were executed with new tenants during the quarter. A former Rite Aid in North Cape May, New Jersey, was leased to Presidio Medical Care, and a former Big Lots in Jackson, Mississippi, will be home to an O’Reilly Auto Parts Hub store. We achieved favorable releasing spreads averaging 111% for both locations, and are also the beneficiary of significant credit upgrades with long-term leases containing considerable escalations.

Our remaining lease expirations for the year are de minimis, with only 12 leases or 40 basis points of annualized base rents maturing. Additionally, we are very pleased with the progress on the only former remaining Bed Bath & Beyond of the three that were in our portfolio. We intend to demolish the existing box and are currently negotiating leases and finalizing letters of intent with multiple retailers to ground lease to be created pad sites. While I should have more detailed information to share next quarter, I will say that we anticipate a very significant lift relative to the former Bed Bath & Beyond rent, which I believe will further highlight our real estate underwriting. Given the questions that we’ve received, I wanted to address the recently announced Dollar Tree and Family Dollar store closures.

These stores they do plan to close have a weighted average lease term of seven. Any of our stores that have less than three will continue to pay all rents and nets and represent only 30 basis points of our total portfolio base rent. We have already received interest in several of our retail partners to backfill half of the locations that are closing. Lastly, with a best-in-class team and a proprietary technology platform, we see a significant opportunity to continue to drive earnings growth. Our model is built for all markets. We are uncovering opportunities across all three platforms and are pleased that we can deliver AFFO per share growth of over 4% at the midpoint. Combined with a growing dividend that yields over 5%, the country’s leading retail portfolio, and a fortress balance sheet, we believe we offer a very compelling value proposition in the current environment.

With that, I’ll hand the call over to Peter, and then we can open up for questions.

Peter Coughenour: Thank you, Joey. Starting with earnings, core FFO for the first quarter was $1.01 per share, representing a 3.5% year-over-year increase. AFFO per share for the first quarter increased 4.6% year-over-year to 1.03% year-over-year increase. AFFO per share for the first quarter increased 4.6% year-over-year to $1.03. We received approximately $1.4 million of percentage rent during the quarter, which contributed more than a penny of earnings to core FFO and AFFO per share, respectively. Tenants typically pay percentage rent during the first quarter of each year. As Joey mentioned, we have introduced AFFO per share guidance for full year 2024 of $4.10 to $4.13, representing 4.2% growth at the midpoint. We provide guidance on several other inputs in our earnings release, including acquisition and disposition volume, general and administrative expenses, non-reimbursable real estate expenses, and income and other tax expenses.

Our guidance further demonstrates our ability to drive consistent earnings growth, which supports a growing and well-covered dividend. During the first quarter, we declared monthly cash dividends of $0.247 per common share for each of January, February, and March. On an annualized basis, the monthly dividend is very well covered with a payout percent increase over the annual AFFO per share for the first quarter. Subsequent to quarter end, we announced a monthly cash dividend of $0.25 per common share for April. The monthly dividend equates to an annualized dividend of $3 per share and also represents a 2.9% year-over-year increase. Moving to the balance sheet, we remain in excellent position with over $920 million of total liquidity at quarter end.

Including roughly $237 million of outstanding forward equity, $670 million of availability on the revolver, and more than $15 million of cash on hand. We have also entered into $150 million of forward starting swaps, effectively fixing the base rate for a contemplated 10-year unsecured debt issuance at just under 4%. Combined with our outstanding forward equity, this provides us with over $385 million of hedge capital to fund this year’s investment activity. Our revolving credit facility and term loan also have accordion options, allowing us to request additional lenders commitment in this year’s investment activity. Our revolving credit facility and term loan also have accordion options, allowing us to request additional lender commitments of $750 million and $150 million, respectively.

Further bolstering our liquidity position is free cash flow after the dividend, approaching $100 million on an annualized basis and $50 million to $100 million of anticipated disposition proceeds. As of the end of the quarter, pro forma for the settlement of our outstanding forward equity, net debt to recurring EBITDA was approximately 4.3x, which is flat quarter-over-quarter. Excluding the impact of unsettled forward equity, our net debt to recurring EBITDA was 4.8x. Our total debt to enterprise value was approximately 30%, while our fixed charge coverage ratio, which includes principal amortization and the preferred dividend, is very healthy at 4.9x. With that, I’d like to turn the call back over to Joey.

Joey Agree: Thank you, Peter. At this time, operator, we’ll open it up for questions.

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Q&A Session

Operator: Thank you, ladies and gentlemen. [Operator Instructions] First question comes from RJ Milligan at Raymond James. Please go ahead.

RJ Milligan: Joey, I just wanted to start off with the newly issued AFFO per share guidance. Obviously, a long history of not providing it. I’m just curious what the catalyst was to provide it now.

Joey Agree: Hey, good morning, RJ. I think a couple things. I think first, just given the most probably uncertainty in the macro environment, we’re in a pretty crazy world. I think we’re a boring net lease REIT, and that by definition should provide for clarity uncertainty of execution. And I think this guidance solidifies that in this macro environment. I don’t recall a net lease REIT ever performing well with uncertainty surrounding it. And then second, I think our investor deck, the third page, is consistency. And we wanted to once again reinforce that we will be a consistent growth REIT here with a defensive portfolio, obviously, and a fortress balance sheet. And then lastly, I’d say just the confidence in the team here to recalibrate to the new world order that everybody is in.

So this isn’t easy going from a world of free money to today. And so frankly, most of them or none of them have seen it from that perspective, obviously, the last time being the GFC. So as a leadership team, we needed to reset internally. Our theme for the year is dialed in and cascaded down to the entire team. So my hat’s off to the leadership team. Also, thank you to the lineage team, which has been integral in our operating strategy and our operating execution. But everyone here is now embracing the new normal. We talked about it on the last call. And we’re working our tails off here. And we’re not in this game just to play it. We’re in it to win it. And so given those factors, I think it makes sense.

RJ Milligan: It makes sense. Thank you for that. You mentioned that you have visibility on about half of the total acquisition volume guided for the year. Can you just talk about where those cap rates are falling?

Joey Agree: Right in line, effectively in line with Q1. That is Q2. We’re just wrapping up sourcing for Q2 probably in the next few days here. So right in line, plus or minus 10 basis points subject to timing of closings or something leaking into Q3 or falling out. But right in line here, we’re going to hold to that strict mandate of 100 basis point plus spreads without going up the risk curve here.

RJ Milligan: And have you noticed any changes in terms of the pipeline just given the move that we’ve — the recent move that we’ve seen in interest rates?

Joey Agree: The most recent move, I assume? I’ll tell you. Any changes in our pipeline, as I mentioned in the prepared remarks, are a function of the hard work. This isn’t market-based transactions. And so with 400-plus outbounds that we track through ARC with conversion rates that are higher, we’re extremely focused on those sellers that have a strong desire or need to transact. And so we’ll continue to attempt to push cap rates higher here. We’ll look for those unique or asymmetrical opportunities where we have insight or knowledge that can create value or bring value to the table. But, again, it’s hard to see what cap rates will do from here with the volatility of the tenure.

RJ Milligan: And just one follow-up. Joey, I think in your prepared remarks you mentioned 110% on some re-leasing. I’m just curious, whether, if you could clarify, is that 110% recovery or is that 110% a positive rent spread?

Joey Agree: That’s 110% percent recovery. So the Fresenius and Cape May — go ahead. Sorry?

RJ Milligan: I was just going to say, so rents are 10% higher than the previous tenant.

Joey Agree: Correct. The Fresenius and Cape May, New Jersey, which took the former Rite Aid and then

RJ Milligan: So rents are 10 percent higher than the previous tenant.

Joey Agree: Correct. The Fresenius and Cape May, New Jersey, which took the former Rite Aid and then the former Big Lots with the O’Reilly Hub. So I think most importantly, or as important, is we’re getting new 15-year base terms here with significant escalations with, obviously, vastly superior operators as well.

Operator: Thank you. Next question comes from Nick Joseph from Citigroup. Please go ahead.

Nick Joseph: Thanks. Joey, I just want to go over what is really driving the 50 basis points sequential increase in cap rates from first quarter to fourth quarter. Obviously, that was a pretty big jump, so I just want to understand if there’s any change in tenant credit there or the makeup of DO relative to what you saw in the fourth quarter.

Joey Agree: No, very similar composition. We’re operating within the context of our sandbox as we’ve defined it. Obviously, volume was down for Q1. I talked about the acceleration coming for Q2. But we aren’t stretching the box here, and we’re going to remain disciplined. We’re not going to go up the risk curve. We’re not loading up on dollar stores and pharmacies to check the proverbial IG box. And so the composition is very similar to what you’ve seen historically. Frankly, no new names.

Nick Joseph: Thanks. And then just kind of on the theme of where cap rates potentially may move, given what’s happening on the 10-year side, how long of a lag would you expect to see if the 10-year stays where it is before cap rates start to adjust up? Or was the kind of the sequential increase you saw into the first quarter already kind of contemplating a higher rate environment? This is bringing it more into a normalized range.

Joey Agree: It’s a great question. There’s no direct correlation. I think it’s fair to say there’s causation there. But what we see in the net lease and all stabilized real estate asset classes, without a need to sell, I mean, this applies all the way down to the single-family residential market. Without the need to sell, there just really isn’t the impetus for owners to transact. And so, again, our focus around what Peter often references for first two is the three Ds, situations where there’s death, divorce, and debt maturing here. Or shorter-term opportunities that we’re working hand-in-glove with retailers to extend high-performing opportunities. Or just solid underlying fundamental real estate where we know there’s a market-to-market opportunity embedded in it.