Essential Properties Realty Trust, Inc. (NYSE:EPRT) Q1 2024 Earnings Call Transcript

Essential Properties Realty Trust, Inc. (NYSE:EPRT) Q1 2024 Earnings Call Transcript April 25, 2024

Essential Properties Realty Trust, Inc. 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, ladies and gentlemen, and welcome to the Essential Properties Realty Trust First Quarter 2024 Earnings Conference Call. [Operator Instructions]. This conference call is being recorded and a replay of the call will be available two hours after the completion of the call for the next two weeks. The dial-in details for the replay can be found in yesterday’s press release. Additionally, there will be an audio webcast available on Essential Properties website at www.essentialproperties.com. An archive of which will be available for 90 days. On the call this morning is Pete Mavoides, President and Chief Executive Officer; Mark Patten, Chief Financial Officer; Rob Salisbury, Head of Capital Markets; Max Jenkins, Head of Investments; and AJ Peil, Head of Asset Management. It is now my pleasure to turn the call over to Rob Salisbury. Thank you. You may begin.

Rob Salisbury: Thank you, operator. Good morning, everyone, and thank you for joining us today for Essential Properties’ first quarter 2024 earnings conference call. During this conference call, we will make certain statements that may be considered 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 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 yesterday’s earnings press release. With that, I’ll turn the call over to Pete.

Peter Mavoides: Thank you, Rob. And thank you to everyone joining us today for your interest in Essential Properties. On our year-end earnings call in February, we noted an industry backdrop of heightened volatility in the capital markets and wide bid ask spreads in the transaction markets. That backdrop persists today as markets have again readjusted to contemplating a higher for longer interest rate environment. Our business is well-suited for this environment, with a well-capitalized balance sheet and a value proposition of providing reliable growth capital to middle market companies and our targeted industries. Against this backdrop, we started 2024 on a positive note with healthy portfolio credit trends and $249 million of investments in the quarter, translating into a solid AFFO per share growth of 5%.

In the first quarter, 87% of our investments were generated from existing relationships, underscoring the value we provide as a reliable and efficient capital provider funding their growing businesses. Our sale leaseback capital is particularly attractive as the continued dislocation in the credit and bank markets has contributed to tighter lending conditions. With quarter end pro forma leverage of 3.6 times and liquidity of over $850 million, our balance sheet positions us well to grow our portfolio by deploying into these tailwinds resulting in risk-adjusted returns for our shareholders. Based upon our first-quarter results and the building momentum in our investment pipeline heading into the second quarter, we have refined our 2024 AFFO per share guidance to a range of $1.72 to $1.75, which implies over 5% growth at the midpoint.

As our first quarter results indicate, our portfolio continues to operate at a strong level. We ended the quarter with investments in 1,937 properties that were 99.9% leased to 383 tenants operating in 16 industries. The portfolio had just one vacant property at quarter end, down from three at the end of last year. Our portfolio continues to demonstrate excellent durability and extraordinarily high occupancy. Our weighted average lease term stood at 14.1 years at quarter end, which is up slightly year over year with only 4.5% of annual base rent expiring through 2028. From a tenant health perspective, our weighted average unit level rent coverage ratio was 3.9 times this quarter, up slightly from last quarter. Same store rent growth in the first quarter was 1.5%, which was consistent with last quarter and suggest minimal leakage from credit losses.

During the quarter, we invested $249 million through 36 separate transactions at a weighted average cash yield of 8.1%, representing an increase of 20 basis points from last quarter and 50 basis points from two quarters ago. Our investment activity in the quarter was broad-based across most of our top industries with no notable departures from our well-defined investment strategy. Our investments this quarter had a weighted average lease term of 17.2 years and a weighted average annual rent escalation of 1.9%, generating an average GAAP yield of 9.3%, which is the highest GAAP yield in our company’s history. Our investments this quarter had a weighted average unit level rent coverage of 2.7 times and the average investment per property was $2.8 million, consistent with our focus on owning granular liquid properties.

100% of the investments this quarter were originated through direct sale leasebacks, which are subject to our lease form with ongoing financial reporting requirements. 82% contain master lease provisions and 87% were generated from existing relationships. Looking ahead to the second quarter of 2024, we have closed $61 million of investments quarter to date, and our pipeline remains robust as an increasing number of middle market companies are seeking sale leaseback capital as a financing alternative as other sources of capital have become unavailable or uneconomic. A persistently high interest rate backdrop supports our ability to continue to generate attractive risk-adjusted returns, and our current pipeline suggests that investment cap rates should be stable in the near term.

From a tenant concentration perspective, our largest tenant represents 4.3% of ABR at quarter end, and our top 10 tenants now account for only 19.1% of ABR. Tenant diversity is an important risk mitigation tool and a differentiator for us, and it is a direct benefit fit of our focus on middle market operators, which offers an expansive opportunity set. In terms of dispositions, we sold seven properties this quarter for $11.9 million in net proceeds at a 6.5% weighted average cash yield and a weighted average unit level rent coverage of 2.7 times. As we have mentioned in the past, owning fungible and liquid properties is an important aspect of our investment discipline as it allows us to proactively manage industries, tenants, and unit level risks within our portfolio.

Going forward, we expect our disposition activity over the near term to remain relatively in line with our trailing eight quarter average driven by opportunistic asset sales and ongoing portfolio management activity. With that I’d like to turn the call over to Mark, who will take you through the financials and our balance sheet for the quarter.

Mark Patten: Thanks, Pete, and good morning, everyone. As Pete noted, we had a solid first quarter, which was punctuated by a record level of investments at an 8.1% cash cap rate. Among the headlines from the quarter was our AFFO per share of $0.42, which is an increase of 5% versus Q1 2023. On a nominal basis our AFFO totaled $71.1 million for the quarter. That’s up $12.9 million over the same period in 2023, which is an increase of 22%. This AFFO performance was in line with our expectations underlying the guidance range we provided last quarter. Total G&A was $9.4 million in Q1 2024 versus $8.6 million for the same period in 2023, with the majority of the increase relating to an increase in compensation expense. Our recurring cash G&A as a percentage of total revenue was 6.2% for the quarter, which compares favorably to the 7% in the same period a year ago.

We continue to expect that on an annual basis, our cash G&A as a percentage of total revenue will decline this year as our platform generates operating leverage over a scaling asset base. We declared a $0.285 dividend in the first quarter, which represents an AFFO payout ratio of 68%. Our retained free cash flow after dividends continues to build, reaching $23.9 million in the first quarter. Turning to our balance sheet, I’ll highlight the following. With our $249 million in Q1 2024 investments, our income producing gross assets reached $5.1 billion at quarter end. The scale of our income producing assets continues to build, and we expect to approach $6 billion by later this year. The diversity, quality, and scale of our asset base enhances the reliability and durability of our cash flows and provides an increasing level of risk mitigation.

On the capital market side, it was a productive first quarter, highlighted by a successful overnight equity offering in March, generating gross proceeds of $256.2 million. The offering was completed on a forward basis. Through our ATM program, we completed the sale of approximately $53.4 million of stock, also all on a forward basis. Combined during the first quarter, we raised over $300 million of equity capital. During the quarter, we settled $244.7 million of forward equity, including the remaining unsettled shares from our September 2023 offering, all of the shares issued on our ATM, and a portion of our March 2024 offering, leaving us with a balance of unsettled forward equity totaling $184.2 million at quarter end. Our pro forma net debt to annualized adjusted EBITDAre adjusted for unsettled forward equity was 3.6 times at quarter end.

We remain committed to maintaining a well-capitalized balance sheet with best-in-class leverage and liquidity. At quarter end, our total liquidity stood at over $850 million. Our conservative leverage, strong balance sheet, and significant liquidity positions the company well to fund our growth plans for 2024. Combined with the strong performance to start the year, as Pete mentioned, this supports our refined 2024 AFFO per share guidance range of $1.72 to $1.75, implying an over 5% growth rate at the midpoint. It’s important to note that with the equity issuance executed this quarter, we didn’t not require any additional equity to achieve our 2024 guidance range. With that, I’ll turn the call back over to Pete.

Peter Mavoides: Thanks, Mark. We’re very pleased with our first-quarter results and remain optimistic about the prospects for the business. Operator, please open the call for questions.

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Q&A Session

Operator: [Operator Instructions]. The first question comes from Eric Borden with BMO.

Eric Borden: Hey, good morning, everyone. With the rates now seemingly higher for longer, how should we think about the appropriate funding mix to fund external growth for the remainder of the year? And then I guess as a part two, if you’ve already issued that today, what’s the most attractive source of debt capital? And at what rate could you raise that?

Peter Mavoides: Yeah, Mark, why don’t you answer that?

Mark Patten: Got it. Look, I think I’ve tried to catch that at the tail end of my remarks in terms of the equity side of that equation. So if you think about it what we really have today is equity that we have available to us from the standpoint of debt financing. Our view is that where you could maybe execute a term loan, so if you think about that avenue, it’s probably somewhere in the , given the 10 years move swapping that out. We think that the bank debt market is available to us and that would probably be an avenue we pursue, and unsecured bond issuance, albeit we’d love to be back in that market even with our spread down to . The 10 years have been on a tear, so that’s still less accretive and certainly not constructive for us right now. But I think what I’d also mention is we could do $1 billion worth of investments sitting with the liquidity we have today and not even crest 5 times leverage.

Eric Borden: Okay. That’s helpful. And then maybe one for Pete. Just how competitive is the sale leaseback market today? Are you seeing investors appears kind of stepping off the sidelines just given how attractive that sale-leaseback capitalized for the potential tenants?

Peter Mavoides: Yeah, I think overall, our narrative is that has been some competition has been muted in the last couple of quarters. As you know, back to what Mark was talking about the financing costs for these assets is a little challenging, but there’s certainly competition out there from other investors as well as alternative capital sources. So I wouldn’t say the market is devoid of competition, but it’s certainly a lower level than we’ve seen in past years.

Operator: The next question comes from Smedes Rose with Citi.

Smedes Rose: Hi, thanks. Acknowledging that your four wall coverage actually increased sequentially. But I’m just wondering if there’s a lot of concern that consumers, particularly kind of on the lower end of the economic spectrum are kind of increasingly topped out. And I’m just wondering if that concern is sort of bleeding over into your conversations with tenants around things like escalators or their willingness to transact right now just sits at especially in a higher for longer environment, something if that’s maybe showing up at all.

Peter Mavoides: Yeah. You know, listen, we’re in industries that aren’t really reliant on the low-end consumer. We’re in essential service and experience based industries. And we’re not really seeing those concerns come through in our tenant discussions or new operator discussions. I would say overall, the guys that are growing are fewer than they’ve been in the past, and a little less reliant on debt capital as they’ve been on the past, and which means they’re using more sale leaseback capital and equity capital. But overall, the industries that we’re investing in have been and continue to be pretty healthy.

Operator: The next question comes from Greg McGinniss with Scotiabank.

Greg McGinniss: Hey, good morning. I was hoping you could just talk about some of the movement around the tenant risks, click the less than one time rent coverage population growing the CCC+, although mostly that’s 2x coverage increasing, but just about some of the movement on the tenant risk there, what’s causing that? And then also, if you could touch on your comfort with Red Robin, is the share price kind of decline over the last few years, just how those assets are doing and what gives you comfort around those acquisitions? Thanks.

Peter Mavoides: Sure thing. Listen, there’s always going to be ebbs and flows and credit and coverage overall are less than is down sequentially and our overall coverage is up sequentially despite adding of assets at the 2.7 times rent coverage. So you’re always going to have the flows, so really the folks around the CCC and even the , those are very idiosyncratic events relative to those specific names and operators and rest assured that we’re watching and working with those guys closely to figure out if those assets are permanently impaired or temporarily impaired and whether or not what the long-term solution is. But I would say, overall, we feel really good about where the portfolio is, when you see that with one vacant property and our same-store sales coverage, solid as well as our increase in guidance.

So overall, the ebbs and flows are kind of a natural part of the business. And our job is to manage that great spot and supporting the business. Getting into Red Robin, we’ve done a number of deals with them. And you know, we’re not equity investors, we’re not buying the shares, we’re buying their real estate. And ultimately, the restaurants we own that they lease from us are great real estate. And with a solid coverage, they’ve been at operating these restaurants for over 20 years. And we have confidence that they’ll continue to operate these restaurants. We’ve had a very positive credit experience in the casual dining space. And so when we do have credit events, we actually end up better relative to our ABR going into it. Red Robin is a good company.

We have a lot of confidence in their management and they’ll get that brand turnaround in, but ultimately as real estate investors, that’s equity risk.

Greg McGinniss: Thank you for that. And sorry, can you just expand on what you meant in terms of the credit improvement on the casual dining side?

Peter Mavoides: As we look at credit losses when we have a credit experience, we look at ABR after the credit events versus ABR before the credit events. And in the casual dining space, specifically when we re-tenant assets, our ABR is higher.