National Retail Properties, Inc. (NYSE:NNN) Q2 2024 Earnings Call Transcript

National Retail Properties, Inc. (NYSE:NNN) Q2 2024 Earnings Call Transcript August 1, 2024

National Retail Properties, Inc. misses on earnings expectations. Reported EPS is $0.583 EPS, expectations were $0.83.

Operator: Greetings, and welcome to NNN REIT Inc. Second Quarter 2024 Earnings Call. At this time all participants are in listen-only mode. And a question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to your host, Mr. Steve Horn, Chief Executive Officer of NNN REIT. Sir, you may begin.

Steve Horn : Thanks, Holly. Good morning, and welcome to NNN REIT’s second quarter 2024 earnings call. As usual, joining me on the call is Chief Financial Officer, Kevin Habicht. As the press release reflects the company’s consistent performance carried through the second quarter and produced strong results, including high occupancy and in-line acquisitions volume driven by our proprietary tenant relationships. We are in a position to continue enhancing shareholder value as we move deeper into 2024 and start setting up for 2025. Highlights of the second quarter financial results emphasize our continuous effort actively managing the portfolio with data analytics and experience. The portfolio of 3,548 freestanding single-tenant properties continue to perform exceedingly well maintained high occupancy levels of 99.3%, which remains above our long-term average of roughly 98%.

Knowing the acquisition pipeline, market conditions and portfolio performance, NNN feels comfortable about increasing the midpoint of core FFO per share guidance by $0.02 to $3.30. The leasing department continued the strong start of the year by identifying and executing with QSR tenants. Having 158% recapture rate from the prior rent during the quarter, which brings year-to-date recapture of 102%. This recapture is above historical levels of approximately 70%. Just want to be clear to remember that NNN does not — tries hard not to give TI dollars to quote buy up rent. Currently, NNN only has 26 vacant assets in the portfolio which is a testament to working with relationship tenants to maximize value for shareholders. During the quarter, we also sold 14 properties, which 11 were income producing, raising $67 million of proceeds to be reinvested into new acquisitions.

Over the course of the year, NNN sells assets defensively and proactively but overall, we target a blended disposition cap rate to be about 100 basis points lower than the deployment of capital pricing. Year-to-date, NNN has sold $85 million of assets which has resulted in the lift of the disposition guidance lower end to $100 million from $80 million. Staying on the portfolio, I’d like to mention with regard to 2024 lease expirations, which we originally had about 90 headed into the year is all but wrapped up, and we landed right near our historical average of 85% for renewals. Now the asset management department is kind of turning its attention to 2025 renewals, which I see no cause for concern based on the makeup of assets and tenants. On to acquisitions.

During the quarter, we invested $110 million in 16 new properties at an initial cash cap rate of 7.9%, a potential yield or if we are required to straight line it would be about 8.9%, with an average lease duration of over 16 years. 100% of the deals were from relationship tenants which we do repeat business, creating the barriers to the competition to solidify NNN deal for. As far as the acquisition pricing environment, last quarter, our initial acquisition cap rate was approximately 10 basis points tighter than the first quarter of 2024 and 70 basis points wider than the second quarter of 2023. My expectation is for NNN’s cap rates on the target acquisitions will remain kind of in the mid- to high 7s for the remainder of the year. This assumption is a result of, one, kind of the third quarter transaction pricing for the most part is locked in.

Two, the run-up in equity prices in the sector create marginally better cost of equity, and lastly, the market is starting to price in the short-term rate cuts. Knowing our current pipeline and dialogue with our partners, we remain comfortable with our ability to meet and hopefully exceed our 2024 acquisition guidance of $400 million to $500 million, primarily via the direct sale leaseback on our long-duration triple net lease form, which is a lot more landlord-friendly than the 1031 market deals. Our balance sheet remains one of the strongest in the sector with a leading 12.6 year average debt maturity, and our next debt maturity isn’t until the fourth quarter of 2025. The credit facility has plenty of dry power with a quarter end balance of approximately $12 million, down from $132 million at year-end, and we just increased the capacity to $1.2 billion.

NNN is positioned — well positioned to fund our 2024 acquisition guidance and beyond. With that, let me turn the call over to Kevin for more color, detail in the quarterly numbers and updated guidance.

Kevin Habicht : Thanks, Steve. As usual, I’ll start with our typical cautionary statement 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 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. With that out of the way, yes, so headlines from this morning’s press release report, quarterly core FFO results of $0.83 per share for the second quarter of 2024, and that’s $0.03 or 3.8% over a year ago results of $0.80 per share.

AFFO results were $0.84 per share for the second quarter, which is $0.04 or 5% higher than year ago results. Second quarter results did include $2.1 million of lease termination fee income, which is relatively high for us and that compares with $300,000 in the second quarter of 2023. And as you might recall, we reported $4.2 million of lease termination fee income in the first quarter of this year. So for the first half, we’re reporting $6.3 million of lease termination fee income, first half of 2024 versus $2 million for the first half of 2023. If you look back over the last five years, we have averaged $3 million of annual lease termination fee income. So, all that to say, this year is running well above normal. But even without that incremental income overall, it was a good quarter and in line with our expectations.

As Steve mentioned, occupancy was 99.3% at quarter end, G&A expense was $11.8 million for the quarter and that represents 5.4% of revenues for the quarter and 5.6% of revenues for the first half, which is in line with our guidance. And I’ll begin my push here for folks to also think about G&A as a percentage of NOI, which for us was 5.6% in the second quarter. And I’ll talk more about this in due course. But I think it highlights one of the advantages net lease companies enjoy versus what I’ll call gross lease companies in that more of our revenue drops to the bottom line, which obviously supports total shareholder returns. Our AFFO dividend payout ratio for the first half of 2024 was 67.1%, which resulted in approximately $101 million of free cash flow for the six months after the payment of all expenses and dividends.

Incorporating the increased dividend we recently announced, we currently anticipate this free cash flow amount coming in at approximately $195 million for the full year 2024, which is about 68% payout ratio for the year. We ended the quarter with $837.6 million of annual base rent in place for all leases as of June 30, 2024, which would take into account all acquisitions and dispositions completed during the quarter. As Steve mentioned, we did increase our 2024 guidance by the bottom end and the top end by $0.02 a share with a new range for core FFO per share of $3.27 to $3.33 per share. The underlying assumptions really did not change notably. G&A acquisition volume all staying the same, as Steve mentioned, a small increase in the disposition volume expectations to a new guidance of $100 million to $120 million for the year.

Switching over to the balance sheet. There was a very small amount of equity issuance in the second quarter at a little over $42 per share, generating $13 million in net proceeds. With a big thanks to our supportive bank group in April, we completed a recast of our bank credit facility, increasing the capacity by $100 million to $1.2 billion and extending the term to 2028. There were not any other material changes to the terms of that bank line. In May, we issued $500 million of 5.5% notes due in 10 years. And in June, we paid off $350 million of 3.9% notes that came due in June 15. So with this debt refinance activity, our weighted average debt maturity ticked up to 12.6 years at quarter end, which will help us slow the refinance headwind that all companies are facing in the coming years.

We maintain good leverage and we have kept the balance sheet and strong liquidity position with $1.2 billion of available liquidity at quarter end. Maintaining our life capital market footprint, we funded nearly 79% of our $235 million of year-to-date acquisitions with free cash flow of $101 million and $86 million of disposition proceeds. For the full year 2024, based on our midpoint of our acquisition and disposition guidance, we should fund close to 68% of 2024 acquisitions with free cash flow and disposition proceeds. A couple of stats balance sheet. Net debt to gross book assets was 41.6%. Net debt to EBITDA was 5.5x at June 30. Interest and fixed charge coverage was 4.2x for the second quarter. And as a reminder, none of our properties are encumbered by mortgages.

So we remain focused on working to appropriately allocate capital, which us means ensuring we are getting what we believe are sufficient returns on equity, while controlling risk through property underwriting and maintaining a sound balance sheet, valuing equity adequately, whether that equity is produced by free cash flow, disposition proceeds or new equity issuance is at the heart of growing per share results over the long-term and helps us not to confuse activity with achievement. In closing, 2024 is tracking largely as expected for us, and we believe we’re in a relatively good position to navigate any of the uncertainties that are out there as we continue to focus on growing per share results. And we are mindful this is a long-term multi-year endeavor.

So with that, we will open it up to any questions.

Q&A Session

Operator: [Operator Instructions] Our first question is coming from Spenser Allaway with Green Street.

Spenser Allaway : Can you guys just provide some updated color on the transaction market and kind of where cap rates have been trending thus far in the 3Q?

Steve Horn: So the overall market, my expectations, talking to the acquisition guys are current tenants, deal volume starting to pick up a little bit. The overall opportunity set is larger today than it was 60 days ago. So that’s a good deal. And there’s a couple of larger portfolios starting to hit the market. As far as cap rates, kind of what I mentioned in the opening statements, third quarter is starting to get baked and I’m seeing the cap rates in line with our second quarter. Timing of deals might give or take 5 basis points, 10 basis points, but pretty much in line with our second quarter, not as wide as our first quarter. For the remainder of the year, that being said, I’m kind of — what our second quarter was in my head, I’m projecting that out from the second half of the year.

Spenser Allaway: And then can you just share a little bit more color on the dispositions made in the quarter. I think you mentioned there were 11 income producing assets. So, perhaps just the rationale for the divestments. And then if you could just talk about the depth of the buyer pool as well, that would be great.

Steve Horn: Yes. So yes, we sold 14 assets, 11 were income producing. So we had a couple of vacancies that over time, we decided it was a better use of — to sell the vacant and redeploy into accretive acquisitions. But it was pretty much a mixture, leaning more to defensive sales. We sold a couple of multi-tenant assets in there that are not core assets to the portfolio over a decade or so, we picked up one or two. We don’t think owning shopping centers is a good investment for a net lease company. So we decided to exit those assets. And then we had a few kind of people love the real estate a lot more than we did, and they were sold at some really accretive cap rates.

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

Farrell Granath : This is Farrell Granath on behalf of Josh. I just wanted to follow-up on your comments on the term fees that have been coming in and now the second quarter being also elevated over historic levels. Are you seeing any trend or in these situations? Are they coming to you earlier? And is there any specific category that these are falling under?

Kevin Habicht : Farrell, it’s Kevin. Not — no real trends. I will say, and this is totally anecdotal because I don’t pay much attention to what other companies are kind of going in. I’ve seen more lease termination fee income discussions of late, just in various notes and comments out there by various REITs. So I don’t know if there’s a trend or not. For us, it’s very kind of episodic and it’s difficult to, frankly, even for us to kind of predict if and if and when any of that might come together. Specifically, the process involves at least three parties, and each of them have competing priorities, so it’s not really prone to a real degree of predictability. But I think it comes from just working the portfolio, staying in contact with our customer, the tenant and then trying to maximize our returns while helping the tenant.

Because usually, there is something going on with that property. And so in the most recent quarter case, the biggest chunk of the lease termination fee income related to a property that had some condemnation proceeds involved a store that was underperforming. And so we had an opportunity to take condemnation proceeds, a lease term fee and a buyer to buy the property. And all those things had to kind of line up those plants, had line up to make sense for us to kind of pull the trigger. And so I’m not trying to be elusive, but it’s hard to predict. And I encourage folks to think more about our five year average of $3 million a year of lease termination fee income rather than getting to — trying to project the high levels of the first half into the indefinite future.

Farrell Granath : And also, I was curious, anything in your top 20 tenant list any of those on your watch list and those not on the top 10 — or excuse me, top 20 list? Are you also increasing any monitoring, when it comes to performance level?

Kevin Habicht : Yes. I mean we’re always monitoring. So it doesn’t really increase notably. Obviously, those on the watch list get a little more attention, but it’s a part of what we do. The one we’ve talked about with some regularity on our top tenant list is that restaurant concept called fishes, and so that’s been one that we’ve talked about a good bit, and they continue to pay rent and — but just kind of struggling never really quite came out of what I call the pandemic fall, if you will. And so I’d say that’s it. And then others that aren’t on our top tenant list. I mean AMC movie theaters that’s been out there well discussed. I wasn’t really going to go back into that frankly, we feel much better about them today than we did 12 and 18 months ago, given the slate of movies and the box office results of late and as well as that company’s AMC’s refinancing and equity issuance over recent quarters has been very productive.

And so feeling better about that one. So those are the two in the top 20. Others that we’ve talked about on our list include At Home, which we have a dozen stores, it’s 1.1% of our rent watching that One Home Furnishings struggling a bit as well as connected to that big lots. We have three of those stores, which is 0.1% of our rent. The only other one I’d mention, again, not in our top 20, but we have two tenants that are in bankruptcy. One’s called Badcock Furniture and within which we have — it’s 0.7% of our rent, 0.7%. And then we have two Rite Aids left over from that bankruptcy. And we’ll see where that goes, but that’s a very small percentage. The Badcock is early. They just recently filed and we do have that company, Badcock got bought by a company called Conn, which is a retailer that’s been around for a long time.

We own no Conn stores. But the Badcock became a part of Conn about a year ago, the company that sold Badcock to Conn remains a guarantor on our lead. And so hopefully, at the end of the day, that may provide some incremental support to us. But it’s early in the process with Badcock. We’ll see where it goes and at the moment, they’re turn on right.

Operator: Our next question is coming from Michael Goldsmith with UBS.

Kathryn Graves : This is Kathryn Graves on for Michael. I just wanted to ask, just generally, consumer trends and particularly strain on the low-end consumer, how that might be impacting your tenants and how you’re thinking about tenant health in the context of the consumer?

Steve Horn: So we do our — we look at our property level across all industries. And our data we have lately was through March. So it’s a little bit stale. It’s not real time because it just takes time to get the data and then process the data. And we have seen, for the most part, our rent coverage ratios throughout the portfolio across all industries. For the most part have been stable. Now when you go from a 3.5% coverage or 3.25% covers, yes, it’s trending down, but not a cause for concern. But yes, when we’re underwriting assets in certain industries. We do kind of put a little discount on the EBITDA for future softness of the consumer. But for the most part, the low-end consumer and the mid-range consumers held up within our portfolio.

But that’s a result of our business model. When we do sale leaseback financing, the tenant does a self-selection of an asset. So they actually picked the better assets to sell off as opposed to what we would call the dogs, because they’re signing that 15- or 20-year lease. So they’re committing to a long-term relationship with us. So they send us the above-average properties.

Kathryn Graves : And then my second question, are you seeing any increased competition going into the second half of 2024, particularly any competition from private equity buyers, buyers you may have been sitting on the sideline coming off of them now?

Steve Horn: We’ve always been in a highly competitive market since I’ve been doing this for 20-plus years, Kevin, 30-plus years, just the names have come and gone. But with the banking market, for the most part, not as active as they were three years ago. We haven’t seen really any new entrants into it. The private money still on the sidelines as far as our target acquisitions. But again, we’re always in a highly competitive market. But because of our business model of doing repeat deals with our current tenant base, we have plenty of opportunity to hit our acquisition targets.

Operator: Our next question is coming from John Kilichowski with Wells Fargo.

Unidentified Analyst: This is Cheryl on for John Kilichowski. I was wondering what does bad debt look like? I know you have 100 basis points in your guide, and it’s typically been 30 basis points to 50 basis points on average. Curious to know, if it will be any different this year with Conn’s bankruptcy and Walgreens store closure announcement?

Kevin Habicht : Yes. And I appreciate you asking that question because I should have mentioned in my earlier discussion about the kind of the credit watch list. Yes. It’s important — no, yes, we always assume about 100 basis points of rent loss in any given year. We have not changed that in our projections, which is maybe a way of telling you all that at the moment, we don’t see anything outside of what we would consider kind of normal wear and tear on retail tenants at the moment in terms of impact on our portfolio and our cash flow. And so — but yes, to answer your question, we don’t see any real need to change that at this point for this year. And as we think about even next year, think it will operate within those levels.

Historically, we’ve been more — while we assume 100 basis points of rent loss in our guidance, the actual is closer to 30 basis points to 50 basis points, where this year will end up, I’m not exactly sure. It’s probably 50 basis points. It might be touch higher, but it’s well under 100 basis points, I believe, at the moment, it feels that way anyway. We think we’re in good shape in that regard.

Unidentified Analyst: And just a follow-up. With the weakness in QSR sector, are you hearing concerns from tenants in the QSR portfolio?

Steve Horn: No. Nobody has thrown up the cautionary flag to us in our QSR portfolio. And again, at the property level, the rent coverage on our QSR portfolio is very solid. But no, we’re not hearing anybody calling us up asking for rent reductions because their sales are softening.

Operator: Our next question is coming from Smedes Rose with Citi.

Unidentified Analyst: This is [Maddie Varges] on for Smedes. Given the shares issued during the quarter, how are you thinking about share issuances going forward to build dry powder going into 2025?

Kevin Habicht : Yes. Not to be overly elusive. I mean, we’ll see where that goes. We don’t — the key point, I guess is that we don’t need to issue any as I mentioned in my comments, over 2/3 of our acquisitions for this year can get funded just with free cash flow and dispositions. So we really have no need for equity. So we can pick our points as to when we think it’s appropriate to issue some equity or not. As you look back at our history in recent years in our institutional investor deck online, you can see that we’ve — over the last 18 months, we’ve only issued about $60 million worth of equity. So we’re very share price dependent and our thoughts around that. We’ll source it when it’s available and well-priced. But most importantly, we’ll look to not source it when it’s not well priced in our opinion. And we understand that’s an opinion that others may differ on. And so no real need to raise any equity at this point we see things playing out.

Unidentified Analyst: And just circling back on the transaction market, are there any particular areas, sectors or tenants where you’re seeing the most opportunities through the balance of the year?

Steve Horn: Yes. As I kind of look at our opportunity set as far as outside our portfolio. It seems like the convenience store sector is starting to pick up some with activity and the auto service has been pretty frothy recently. As far as our current portfolio, I’ll try lean to maybe a little family entertainment side of things, less carwash activity and there hasn’t been too much QSR activity of recent time.

Operator: Our final question is coming from John Massocca with B. Riley.

John Massocca : So maybe just thinking about guidance a little bit. What were some of the kind of pushes and pulls there? Obviously, a slight increase to disposition volume expectations. But just was the lease termination fee income received in the quarter something you were anticipating when you put the guidance out in 1Q? And also, I mean, is there any kind of change? Or I guess was the debt issuance kind of in line with your expectations as well?

Kevin Habicht : Yes. I mean, fair question. There weren’t a lot of variables to be quite honest. A, we tend to start the year a little — some would say, conservative in guidance. And so that creates an opportunity for some upside. And hopefully, as the year progresses, we can increase guidance. So that’s kind of the base we start with. Yes, there is — as we mentioned, more lease termination fee income than we might have thought. And that, like I say, is kind of episodic. I won’t say it’s a lightning strike because it’s a lot of pieces involved. But the timing of that, if and when that may happen is not very predictable. And so we tend not to bake too much into that into our forward-looking thoughts generally. And then like I said, we a little bit of room.

And to the extent we haven’t fully utilized these 100 basis points of rent loss assumption in the first half, and that helps numbers at the margin. I mean, these are all things that are pretty small at the margin that allows us to increase guidance by $0.02 for the — based on the first half results. And so yes, that’s kind of the way we think about that.

John Massocca : And within the margin — or the margin in mind, the real estate expense in the bottom end of that came up a little bit. I mean is that just reflecting some of the credit events that you talked about earlier on the call, I mean, are some of those things that are a little bit more recent kind of baked into that guidance expectation at this point?

Kevin Habicht : Yes. I guess that’s the case. I mean you can see at the bottom of Page 6 of our press release, near the bottom. We highlight what our real estate expenses, net of tenant reimbursements and you can see they’ve been kind of running $2.5 million, $2.6 million in recent quarters. And so yes, we increased the guidance range on that for the year to — from $9 million to $11 million to $10 million to $11 million. So at the margin, call it a $500,000 increase in that line item, in terms of the midpoint of the guidance and that’s about where we see it. So we don’t — we’re not seeing any material change in that. But at the margin, it’s a little bit.

John Massocca : I mean, essentially, it reflects all the stuff you kind of talked about earlier in the call already?

Kevin Habicht : Yes.

John Massocca : And then maybe kind of bigger picture, as we kind of think about investment activity for the remainder of the year and kind of maybe tenant partner psychology. How are they broadly responding to the fairly rapid decline in interest rates essentially, has that helped close the bid-ask spread in the net lease marketplace? Or are tenants and potential tenants holding out for even lower cap rates given just the trajectory of where interest rates are moving?

Steve Horn: As a whole, it’s probably tightened at the margin a little bit, but the combination, the sector’s equity run really started early July. So nobody’s really priced deals off site or close deals, I should say, of the new equity price. But sellers — I think with the expectation of the rate cut but it’s more of a result of the lack of activity for 9, 12 months that human nature is people want to transact. And so they’re coming back to the market, realizing that a higher cap rate is in order not quite as high as the sector would probably like. But it’s definitely tightened a little bit. But the overall activity of deals coming to market has picked up.

Operator: We do have a final question from Ronald Kamdem with Morgan Stanley.

Ronald Kamdem : Yes, apologies jumped on late. But just I wanted to touch on if you could remind us on the bad debt on the guidance. And obviously, there’s been a lot of news on the furniture sector, maybe touch on your exposure there and how you’re thinking about some of the tenants?

Kevin Habicht : Yes. So our primary exposure in the furniture category is a company called Badcock, which is 0.7% of our rent. As it recently just entered in the bankruptcy and as I mentioned that company was bought by a company called Conn, which is a retailer that we did not have any business with, but they bought Badcock about a year ago. The company that did sell Badcock to Conn remain a guarantor on our lease. And so, we’ll see if that comes into play here in the coming months and quarters. But at the moment, we don’t have a whole lot of news as it relates to that. Our rents on those properties are reasonable. So — and kind of the worst case, we think we have the opportunity to replace that tenant without too much economic harm.

And so — but it’s very early and so we’ll see how that all plays out, but at 0.7% of our rent and rent — and a guarantor in place for the lease and our rent being very moderate. We don’t feel like there’s a material risk in the near and medium-term.

Ronald Kamdem : And then my second one is just the $1.68 AFFO in the first half of the year. Can you just remind me how much of that is sort of one-time? Because trying to think about the full year guidance and what the second half implies, the guidance seems a little, I guess, conservative? So maybe the $1.68, how much is sort of non-recurring that we shouldn’t be annualizing?

Kevin Habicht : Yes. So I’d say the primary non-annuities income in our first half numbers was $6.2 million of lease termination fees. And so that’s call it $0.03, $0.04 a share for this year’s results. Now we normally have some level of lease termination fees that might be for a half of a year, it might be $1.5 million. So maybe there’s, call it, $4 million plus maybe $4.5 million of unusually high lease termination fee income might be the way to think about it. So I’d say in the quarter, there’s $0.01 and in the half, there’s at least there’s $0.02 of incremental lease terminations be above what I would might consider normal levels for us. So that’s the way I think about it.

Operator: Thank you. As we have no further questions in queue, I will hand it back over to Mr. Horn for any closing comments.

Steve Horn : I appreciate you guys taking the time and interest in NNN. We’re positioned well for the remainder of the year and enjoy the rest of your summer, and we’ll see you guys when conference season kicks off. Thanks.

Operator: Thank you. This does conclude today’s call, and you may disconnect your lines at this time, and we thank you for your participation.