Agree Realty Corporation (NYSE:ADC) Q4 2022 Earnings Call Transcript

Agree Realty Corporation (NYSE:ADC) Q4 2022 Earnings Call Transcript February 15, 2023

Operator: Good morning, everyone, and welcome to the Agree Realty Fourth Quarter and Full Year 2022 Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. We do ask you please limit yourselves to two questions during the call. And please note today’s conference is being recorded. At this time, I would like to turn the conference call 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 fourth quarter and full year 2022 earnings call. Before turning the call over to Joey and Peter to discuss our record 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. 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 a discussion of various risks and uncertainties underlying our forward-looking statements.

In addition, we discuss 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 these 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: Thank you, Brian. Good morning and everyone thank you for joining us today. I’m pleased to report that 2022 was another record year for our company. Notable milestones over the past 12 months included record investment activity over $1.7 billion, surpassing our record high by 20%. The addition of over 440 high-quality net lease properties to our growing portfolio, the commencement of a record 28 development and Partner Capital Solutions projects for total committed capital of nearly $110 million, the receiving of an upgraded investment grade credit rating of Baa1 and from Moody’s Investors Service and positioning our balance sheet to execute in 2023 without the need for additional capital, while raising approximately $1.7 billion including $1.3 billion of equity.

We closed 2022 with approximately $1.5 billion of liquidity at year-end, including more than $550 million of outstanding forward equity available at our election. Including our forward equity, pro forma net debt to recurring EBITDA was approximately 3.1 times at 12/31. As demonstrated by our fourth quarter acquisition activity, cap rates crept higher, but bid-ask spread remains as sellers are slow to adjust to current market dynamics. As always, we remain disciplined to our investment strategy, and refrain from going up the risk curve via credit or residual risk to create the appearance of a quickly expanding cap rate environment. Similarly, we will not chase cap rates down to levels that fail to create sufficient spreads to drive appropriate returns for our shareholders.

Our focus remains on the best retailers in the country with strong balance sheets to allow them to withstand the current macroeconomic environment regardless of the level of deterioration. Our team is doing a terrific job navigating this environment, leveraging our strong industry-wide relationships and track record while uncovering opportunities to add to our growing portfolio. Our pipeline includes both smaller one-off transactions and larger sale leasebacks with our leading retail partners. Given that pipeline, I am confident our team will be able to source north of $1 billion of acquisition activity at spreads that are appropriately accretive. During the fourth quarter, we invested approximately $421 million across 157 properties via our three external growth platforms.

131 of the properties originated through our acquisition platform, representing acquisition volume of approximately $405 million. The properties acquired during the quarter are leased to best-in-class operators in the auto parts, tire and auto service, home improvement, dollar store, off-price retail, convenience store and farm and rural supply sectors, among others. The acquired properties had a weighted average cap rate of 6.4% and a weighted average remaining lease term of 10.6 years. Over 73% of the acquired rents are derived from investment grade retail tenants. For the full year 2022, nearly 70% of the annualized base rent acquired was derived from leading investment grade retailers, while ground leases represented more than 5% of rents acquired.

Photo by Mustafa Matkawala on Unsplash

Moving on to our development and PCS platforms. We again had a record year with 31 projects, either completed or under construction, representing over $118 million of committed capital. This includes 28 projects commenced during the year with the total anticipated costs of $110 million. During the fourth quarter, we commenced six new development and PCS projects with total anticipated costs of approximately $37 million. We completed the development of 2 projects while construction continued on another 18 projects. We continued to call noncore assets from our portfolio with seven properties sold during the prior year for gross proceeds of over $45 million. These dispositions were completed at a weighted average cap rate of 6.5%. On the leasing front, we executed new leases, extensions or options on approximately 850,000 square feet of gross leasable area in 2022, including 198,000 square feet during the fourth quarter.

Notable new leases, extensions or options included a Chase Bank ground lease in Stockbridge, Georgia, where we had our first opportunity to recapture a ground lease due to the tenant’s lack of options. We eventually executed a new 15-year lease with Chase and were able to increase the rent by approximately 160%. The NOI lift we were able to generate is emblematic of the embedded value in our ground lease portfolio. Moving into this year, we are in a very strong position with 1.3% of annualized base rents maturing. Subsequent to year-end, we have executed a number of lease extensions, bringing this number down to only 1% for the remainder of the year. At year-end, our portfolio encompassed 1,839 properties across all 48 continental United States, including 206 ground leases representing 12.4% of total annualized base rents.

Occupancy remained a very healthy 99.7%. Again, our investment grade exposure stood at nearly 68%. And all of our top 10 tenants carry an investment grade credit rating. Our best-in-class portfolio is very well positioned to withstand the current macroeconomic environment. With that, I’ll hand the call over to Peter and then we can open up for any questions.

Peter Coughenour: Thank you, Joey. I’ll start by recapping our balance sheet and capital markets activities during the year. As Joey mentioned, we were highly active in the capital markets, raising approximately $1.7 billion to further bolster our balance sheet and position us for continued growth. Notable activities include $1.3 billion of gross equity proceeds raised through two overnight offerings and our at-the-market equity program, and a $300 million public bond offering of 4.8% senior unsecured notes due 2032 with an effective all in rate of 3.76%, inclusive of prior hedging activity. Our capital markets activities during 2022 provided us with approximately $1.5 billion of liquidity at year-end, including $557 million of outstanding forward equity, $900 million of availability on the revolver and $29 million of cash on hand.

Our existing liquidity plus free cash flow after the dividend of approximately $85 million and any disposition proceeds enable us to opportunistically execute our growth strategy in 2023 without the need for additional capital. As of December 31st, pro forma for the settlement of the $557 million of outstanding forward equity, our net debt to recurring EBITDA was approximately 3.1 times. Excluding the impact of unsettled forward equity, our net debt to recurring EBITDA was 4.4 times. At year-end, our weighted average debt maturity stood at approximately eight years. With limited variable rate debt and no material debt maturities until 2028, we remain well positioned to withstand interest rate headwinds and capital markets volatility. Total debt to enterprise value at year end stood at 23%.

While our fixed charge coverage ratio, which includes principle amortization and the preferred dividend remained at a healthy level of 5 times. Moving to earnings, core FFO was $0.96 per share for the fourth quarter and $3.87 per share for full year 2022, representing 3.5% and 8.1% year-over-year increases, respectively. AFFO per share was $0.95 for the fourth quarter and $3.83 for the full year, representing 3.9% and 9.2% year-over-year increases, respectively. As a reminder, treasury stock is included in our diluted share count prior to settlement, if ADC stock trades above the deal price of our outstanding forward equity offerings. The aggregate dilutive impact related to these offerings was less than half a penny in the fourth quarter and roughly $0.02 for the full year.

Our consistent and reliable earnings growth continues to support a growing and well covered dividend. During the fourth quarter we declared monthly cash dividends of $0.24 per common share for each of October, November and December. On an annualized basis, the monthly dividends represent a 5.7% increase over the annualized dividend from the fourth quarter of 2021. For the full year, the Company declared dividends of just over $2.80 per share, a 7.7% increase year-over-year and a 16% increase on a two-year stack basis. Our payout ratios for the fourth quarter and full year remained at or below the low end of our targeted range of 75% to 85% of AFFO per share. After year-end, we announced a monthly dividend of $0.24 per share for each of January and February.

The monthly dividend reflects an annualized dividend amount of $2.88 per share, or 5.7% increase over the annualized dividend amount of approximately $2.72 per share from the first quarter of 2022. General and administrative expenses in 2022 totaled $30.1 million. G&A expenses were 7% of total revenue or 6.5%, excluding the noncash amortization of above and below market lease intangibles. We achieved 50 basis points of G&A leverage during 2022. Given our investments in systems, including our recently implemented ERP system, and further improvements to our proprietary ARC database, we anticipate achieving similar G&A leverage this year. Lastly, total income tax expense for 2022 was approximately $2.9 million, including $723,000 of expense during the fourth quarter.

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: Ladies and gentlemen, at this time, we will begin that question-and-answer session. Our first question today comes from Nick Joseph from Citi.

Nick Joseph: Thanks. Joey, I was just hoping to get some more color on kind of current cap rate trends, maybe specific to what you’re seeing on the merchant builder side and the impact it’s having on any recent deals?

Joey Agree: Yes. Good morning, Nick. Well, first, on the merchant builder side you saw during the during the fourth quarter, we had a number of transactions with merchant builders for Dollar General, O’Reilly, Dollar Tree Family, Dollar, we were taking advantage of distressed situations where they need to clear their inventory. I’ll tell you, we’re still talking to a number of retailers that leverage — historically have leveraged their merchant builder platform for net new stores, since that business is effectively interrupted on a timeout at this point. And so for 2023 year-end and 2024 new openings, retailers that were focused on merchant builders are all looking for new solutions. And that’s where we think we can potentially play a part.

In terms of cap rates, it’s a complicated situation, frankly. I think cap rates, it’s — I wouldn’t call it bifurcated, I would call it trifurcated. If you want to go up the risk curve, which we will not do here, that is something that is readily available. You can clearly go acquire things with seven handles in front of them, they’re private equity backed operators or second or third tier operators in their respective spaces. What we see in the IG space, there is no shortage of opportunities out there, we could acquire over $2 billion if we wanted to in 2023. It’s finding the right opportunities where we can drive AFFO per share while maintaining our quality of this portfolio in those qualitative hurdles. And so, there’s a lot of nuances to it.

Much of it is price point driven, much of it is credit driven. But cap rates have obviously come off their lows in 2021 and 2022. But I think first of all, everyone understands that this is a bond like — this is bonds like business, right? And that leads to bonds like assets. And so in the last year we witnessed the debt financing costs, both short-term and long-term go up significantly. We have yet to see cap rate — commensurate cap rate expansion in the space. And so, what we’re seeing as a result is, frankly, private and public investors in net lease space moving up the risk curve to drive the appearance of spreads. That’s something that we won’t do — we will never sacrifice long-term value creation for a short-term path. And so, we’ll remain disciplined, and we’ll see how this plays out.

Nick Joseph: And then just maybe on the current pipeline, you talked about at least $1 billion of acquisitions, maybe less specificity than the normal given the environment. How are you thinking about the timing of those? Maybe you can talk about the current pipeline and then is the opportunity more in the back half of the year to exceed that $1 billion if deals start to materialize?