National Retail Properties, Inc. (NYSE:NNN) Q2 2023 Earnings Call Transcript

National Retail Properties, Inc. (NYSE:NNN) Q2 2023 Earnings Call Transcript August 2, 2023

National Retail Properties, Inc. misses on earnings expectations. Reported EPS is $0.79 EPS, expectations were $0.81.

Operator: Greetings, and welcome to the NNN REIT Second Quarter 2023 Earnings Conference Call. [Operator Instructions]. I will now turn the conference over to your host, Mr. Steve Horn. Sir, you may begin.

Stephen Horn: Thanks, Ali. Good morning, and welcome to NNN’s Second Quarter 2023 Earnings Call. Joining me on the call is Chief Financial Officer, Kevin Habicht. As this morning’s press release, it reflects NNN’s performance in the second quarter produced 1.3% core FFO per share growth over prior year’s results, along with investments of slightly over $180 million with a 7.2% initial cash yield. The solid acquisitions for the quarter are driven by our tenant relationships. In addition, our portfolio continued with the high occupancy of 99.4% and strong lease renewals for the quarter that have been trending above historical levels year-to-date. These results have NNN in position to create shareholder value as we transition into the second half of 2023 and beyond.

In July, we announced an increase in our common stock dividend to be paid August 15, thus, making 2023 our 34th consecutive year of annual dividend increases. NNN is in select company under 75 U.S. public companies, including 2 other REITs, which have achieved this impressive record of accomplishment. Based on our first 6 months performance, we announced an increase of our 2023 core FFO guidance to a range of $3.17 to $3.22 per share. Our long-standing strategy is designed to deliver consistent per share growth on a multiyear basis. This discipline of this long-term approach is reflected in the guidance increase during the current challenging economic backdrop. Turning to the highlights of the quarter. Our portfolio of 3,479 freestanding single-tenant properties continue to perform exceptionally well.

Maintained high occupancy levels of 99.4% for 4 consecutive quarters, which remains above our long-term 98% average. At quarter end, NNN only had 22 vacant assets, which is the result of our leasing department effort working the nonperforming properties and creating value for NNN. In addition, nearly 90% of the leases that were up for renewal during the quarter exercise an extension at 105% of the prior rent. Moving to acquisitions. During the quarter, we invested just north of $180 million in 36 new properties with an initial cash cap rate of 7.2% with an average lease duration of 19.7%. We closed on 19 transactions in the quarter, and 17 were from our relationship tenants that we do repeat business. The first half of the year, we invested over $337 million in 79 new properties with an initial cash cap rate of 7.1% and an average lease duration of 19.4. Given that NNN closed on roughly 60% of the original midpoint acquisition guidance, coupled with the visibility of our acquisition pipeline, NNN has bumped up acquisition buying guidance to $600 million to $700 million for the year.

Almost all of our acquisitions this year are long-term lease deals, defined 15 to 20 years. And that is a result of the calling effort of NNN’s acquisition team. NNN prides itself on maintaining relationship business model and targeting sale-leaseback transactions. There is a lot that goes into deploying capital at the right risk-adjusted returns, and the value of NNN lease form is a tool to mitigate risk within the portfolio, which is easier to obtain if you have the sale-leaseback model. It can sometimes be overlooked. With regard to the acquisition pricing environment, as I mentioned in the May call, we are seeing that cap rate increases started to plateau and stabilize. That played out in the second quarter as expected with a 20 basis point increase over Q1 versus a 40 basis point pickup in the quarter before.

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The first 6 months cash cap rate was 7.1%, which is 90 basis points higher year-over-year. As far as the second half of the year, I’m seeing NNN’s initial cap rates slightly higher than the second quarter in the range of 10 to 20 basis points. During the quarter, we also sold 7 properties, 2 which were vacant, raised $28 million of proceeds at a 5.1% cap rate to be easily reinvested into accretive acquisitions. Year-to-date, we have now raised $40 million of proceeds at a 5.6% cap rate from the sale of 13 properties, including 5 vacant. Although Job 1 is released vacancies, and year-to-date, NNN has had a 97% rent recapture with minimal TI dollars reinvested. We will continue to sell nonperforming assets if we do not see a clear path to generate rental income within a reasonable time frame.

The current banking conditions along with the higher interest rates are trading a softer 10/31 market, but NNN is navigating the waters successfully. Our balance sheet remains one of the strongest in our sector. Our credit facility has plenty of capacity, no material debt maturities until mid-2024, strong free cash flow and a viable disposition strategy. NNN is well positioned to fund our 2023 acquisition guidance. In closing, I want to thank our associates for their dedication and hard work for putting NNN in position to finish 2023 strong and set us up for 2024 and beyond. With that, let me turn the call over to Kevin for some more color and detail on our quarterly numbers and updated guidance.

Kevin Habicht: Thanks, Steve. As usual, I’ll start with a cautionary statement. 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 for 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. Okay. With that, headlines from this morning’s press release report quarterly core FFO results of $0.80 per share for the second quarter of 2023.

That’s up $0.03 or 1.3% over year ago results of $0.79 per share. And first half 2023 results were $1.60 per share, which represents an increase of 2.6% over the prior year results. AFFO for the first half of ’23 was $1.62 per share, and that’s a 1.3% increase over prior year results. As we footnoted on Page 1 of the press release, absent the accrual basis deferred rent repayments in both 2022 and 2023, this AFFO per share growth would have been 2.5% for the first half of 2023. Similarly, the scheduled cash basis deferred rent repayments continue to taper off as anticipated in 2023 and can be seen in the details provided on Page 13 of the press release. Absent these cash basis deferred rent repayments in both ’22 and ’23, core FFO per share would have increased 3.2% for the first half of 2023.

Separately, I get — I’ll note, too, that in the second quarter of 2023, results included $290,000 of lease termination income, and that compared with $1.7 million in the first quarter. But overall, a good quarter, which was in line with our expectations. Moving on. Our AFFO dividend payout ratio for the first half of 2023 was approximately 68%, and that created approximately $95 million of free cash flow. That’s after the payment of all expenses and dividends for the first half. As Steve mentioned, after quarter end, we announced that we — what will be our 34th consecutive annual increase and our dividend that gets paid in a couple of weeks on August 15. Occupancy was 99.4% at quarter end. That’s flat with the prior quarter and flat with year-end 2022.

G&A expense was $10.7 million for the quarter. That represents 5.3% of total revenues, and it was 5.7% for the first half of 2023. Notably, our midpoint guidance for this line item is still $44 million for the full year 2023, and that should put us closer to about 5.5% of revenues for the year. Lastly, we ended the quarter with $794.5 million of annual base rent in place for all leases as of June 30, 2023. Steve mentioned we did increase our 2023 core FFO guidance, increasing the bottom end by $0.03 and the top end by $0.02 to a range of $3.17 to $3.22 per share. AFFO guidance was increased to a range of $3.20 to $3.25 per share. The smaller increase in the AFFO guidance range is primarily a result of projected capitalized interest expense from increased investment of what we call split funded acquisitions.

These are acquisitions that are funded over time as the property is constructed, which we think is of value to our customer. We’re doing more of that this year than typical. In typical year, probably 20% to 25% of our acquisition dollars are in that type of program where construction gets funded this year. We’re probably pushing closer to 35% in terms of total dollars invested in that sort of mode. But overall, in terms of per share growth, the more modest growth in 2023 reflects really a couple of things in my mind. A, the high bar from last year’s 2022 is 9.8% growth created and the lack of tailwinds that were helpful in 2022, coupled with the slowdown in our scheduled deferred rent repayments in 2023 as noted on Page 13. The ’23 guidance and key supporting assumptions are on Page 7 of today’s press release.

It was really the only notable change being a $100 million increase in our 2023 acquisition volume guidance, which is now $600 million to $700 million. Switching over to the balance sheet. We maintain a good leverage and liquidity profile with over $750 million of liquidity. The second quarter was quiet in terms of capital markets activity. We issued $13 million of equity in the second quarter and $30 million of equity for the first half of 2023. This fairly modest equity raise of $30 million in the first half, plus $95 million of free cash flow in the first half and $40 million of property disposition proceeds totals $165 million, which allowed us to fund nearly all of the equity portion of our $337 million of first half acquisitions on a leverage-neutral basis.

Consistent with our plan and prior comments, we have begun to use our bank line a little more after a few years of virtually nearly no usage, part of the plan to navigate this rockier interest rate and capital market environment. Our weighted average debt maturity is over 12 years, and that includes the bank line. which is among the longest in the industry. Our debt outstanding is all fixed rate with the exception of the bank line, which represents about 8% of our total debt. Couple of numbers. Net debt to gross book assets was 40.8% as of June 30. Net debt to EBITDA was 5.5x at June 30. Interest coverage and fixed charge coverage was 4.6x for the second quarter. All properties owned by NNN are unencumbered by mortgages. So yes, in closing, we’re in good shape to navigate the — what seems to be elevated economic and capital market uncertainties and to be able to continue to grow per share results, which we view as the primary measure of success.

The fundamentals, as Steve mentioned, of our business remain in good shape, occupancy, re-leasing, renewals, acquisition and disposition volumes and cap rates. We feel like we’re on a pretty good track for this year. With that, we’ll open it up to any questions, Ali.

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Q&A Session

Operator: [Operator Instructions]. Our first question is coming from Brad Heffern with RBC.

Bradley Heffern: Kevin, a couple for you. So on the new AFFO guidance, last quarter, I think you mentioned things were trending towards the high end of guide, and obviously the acquisition total went up. So can you talk about what the offset was that kept the high end of guidance from moving higher? I know in the prepared remarks, you mentioned the capitalized interest, but I think that’s backed out. Correct me if I’m wrong on that.

Kevin Habicht: Yes. So you’re talking about the core FFO guidance or AFFO or both?

Bradley Heffern: Just the AFFO.

Kevin Habicht: AFFO, yes. Really what’s driving that back a little bit is two things this year is the scheduled accrual basis deferred repayments, which is a piece of the equation, but that’s been out there for a while. So that’s not changing much. It’s really the capitalized interest piece because we’re — more of our acquisition investments are being done in what we call split-funded program, that creates more capitalized interest. We back out capitalized interest and calculating AFFO. So that’s a bit of a drag on our AFFO for this year relative to prior years. I would say, generally, if you go back pre-pandemic, you would see our AFFO — on a quarterly basis, our AFFO is normally $0.01 more than our core FFO, generally, round numbers.

And so $0.01 a quarter, $0.04 a year, maybe $0.05 a year. That’s typical kind of pre-pandemic kind of levels. We’re working our way back there. We came hand-grenade close this quarter. Our AFFO, $0.80. I mean, I think we were like 700s of $0.01 from rounding to $0.81. So just one rounding, it went to $0.80. And so we think it’s still largely in line with our expectations. But because of the incremental capitalized interest expense currently, it’s a little bit of a weight on our AFFO number in the short term.

Bradley Heffern: Okay. Got it. And then as you mentioned the line of credit is obviously being used more, I think the cost on that 6% plus with the latest Fed hike, it seems like that would be wide of what you could get by issuing bonds or doing a term loan. So what’s your desire to continue to let that float versus terming it out?

Kevin Habicht: Yes, a fair question. Yes, you’re right. It’s — the bank line cost is right at about 6% now, which is not — which I think we’re comfortable getting the bank line up to about 50% of our capacity. That’s probably a line that we prefer not to cross. So I think in some time period, we would obviously be thinking about looking to take that out with longer-term debt, which, as you know, it’s priced as well, if not a little better than the bank line currently is. So yes, we don’t give guidance on our capital markets activities. But yes, fair comment that, over time, we’ll look to take that out with longer-term capital whether it be debt and/or equity.

Operator: Our next question is coming from Joshua Dennerlein with Bank of America.

Farrell Granath: This is Farrell Granath on behalf of Josh Dennerlein. So I had a quick question about bad debt assumptions in your guidance and maybe what’s already been incurred year-to-date, especially with the increase.

Kevin Habicht: Yes. So our typical bad debt assumption, we assume we’re going to lose 100 basis points — or sorry, or 1% of our rent every year. And we — that’s I would think virtually every year for the last number of years. And so it’s not — we don’t have any expectation of it being elevated. Currently, what we’re seeing in terms of our tenants’ behavior and their position, we don’t think we needed to do anything besides what we normally do. We just — over the years, we decided it was prudent to assume now everything will work out perfectly, and so we’ve assumed 100 basis points. We’ve not used very much of that at all. I would say, even though we assume in our guidance 100 basis points, typical is probably closer to half of that, meaning about 50 basis points of rent loss. And so far this year, I would say we’re going to be still in that kind of normal zone the way things look like they’re shaping up.