National Retail Properties, Inc. (NYSE:NNN) Q4 2022 Earnings Call Transcript

National Retail Properties, Inc. (NYSE:NNN) Q4 2022 Earnings Call Transcript February 9, 2023

Operator: Good morning, everybody and welcome to National Retail Properties 2022 Year End Earnings Call. Please note this conference is being recorded. I will now turn the conference over to your host, Mr. Steve Horn, President and CEO of National Retail Properties. Sir, over to you.

Steve Horn: Thank you, Jenny. Good morning and welcome to National Retail Properties’ fourth quarter 2022 earnings call. Joining me on the call is Chief Financial Officer, Kevin Habicht. As this morning’s press release reflects, NNN’s performance in 2022 produced 9.8% FFO growth along with an all-time high in acquisitions of nearly $850 million. In addition, the year concluded with high occupancy of 99.4% and an impressive rent collection of 99.7% all driven by our best-in-class team here at NNN. The end of the year surge positions the company well headed into the uncertainty of 2023. A few highlights of 2022 that I am proud of what NNN accomplished. One, 33rd consecutive annual dividend increase, released its inaugural corporate responsibilities and sustainability report, positioned the Board of Directors for the foreseeable future, and 1 of only 13 REITs included in the 2023 Bloomberg Gender Equality Index.

While there is a change at the helm in 2022, the building blocks to realize long-term value at below average risk for our shareholders remain in the most simplistic form. Continue to execute our strategy using a bottom-up approach, continue to increase our annual dividend maintaining top-tier payout ratio, focused on growing FFO per share in the mid single-digits over multiple years. We do this by setting our acquisition, disposition activity and our balance sheet management to achieve that objective. As I stated earlier, NNN is in solid footing as we were a month into 2023. First, at year end, NNN had $166 million drawn on our $1.1 billion line of credit after fishing the year at all-time high acquisitions. We have the option keeping leverage neutral to use a reasonable amount of availability of the credit facility to roughly $180 million of free cash flow plus $110 million of dispositions to execute our 2023 strategy.

Using those three sources, as I mentioned, leaves NNN with a manageable equity requirements for the year. Secondly, NNN’s longstanding strategy of being selective while deploying capital and opportunistically raising capital over the years will not change for 2023. The sizable fourth quarter, which I will cover shortly, allows NNN to continue being opportunistic with acquisitions as the price discovery continues. The cap rates have been out there slowly increasing evidenced by our fourth quarter initial cap rate 30 to 40 basis points higher than our third quarter and we are still seeing further expansion in the first quarter of 2023. Shifting to the highlights of the fourth quarter financial results, our portfolio of 3,411 freestanding single-tenant properties continue to perform exceedingly well and we expect that trend to continue, maintain high occupancy levels of 99.4% for two consecutive quarters, which remains above our long-term average of 98% plus or minus a fraction.

We also collected 99.6% rents for the fourth quarter. The recent headlines of certain retailers, Bed Bath, Party City, Regal, Red Lobster, etcetera that are assumed or have filed bankruptcy in the near-term have minimal effect on NNN. NNN’s exposure is limited, if not zero, in some cases. Turning to acquisitions. During the quarter, we invested just north of $260 million in 69 new properties at an initial cash cap rate of 6.6% and with an average lease duration of 16 years, a term you typically don’t associate with NNN and deviate. While we deviated from our historical trend this past quarter, typically, we sourced the majority of our deals from our relationships and don’t target investment grade deals. But during the quarter, NNN was in position to be opportunistic.

As you noticed in the press release, our exposure to drug stores increased from 1.3% to 2.6% year-over-year. Over the years, NNN passed on drug store portfolios, because we viewed the opportunities as not the best risk-adjusted return to deploy capital at that given time, market pricing real estate metrics lease form. This particular portfolio was in line with our underwriting standards, the real estate and the lease form. But more importantly, the transaction is an excellent real estate play, well-performing assets, excellent locations for the long run. Currently, we are well into the price discovery period of the bid-ask spread has continued to adjust and we continue to maintain our thoughtful and disciplined underwriting approach. NNN continues to emphasize acquisition volume through sale leaseback transaction.

Our 2022 average lease duration was slightly over 16 years with our stable relationship tenants with our long-duration net lease and more landlord-friendly than a 10/31 market. During the quarter, we sold 5 properties at 5.9% cap plus 2 vacant assets, raising $16 million of proceeds. For the year, we raised $65 million of proceeds from the sale of 17 properties at a 5.9% cap plus 16 vacant assets. Although job one is always to release vacancies, we will continue to sell non-performing assets, if we do not see a clear path to generating rental income within a reasonable timeframe. With that, let me turn the call over to Kevin for more color and detail on our quarterly numbers and updated guidance.

Kevin Habicht: Thanks, Steve. And as usual, I will start with the cautionary statement that we will make certain statements that could be maybe 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 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, headlines from this morning’s press release report quarterly core FFO results of $0.80 per share for the fourth quarter of 2022, that’s up $0.05 or 6.7% over year ago results of $0.75 per share and full year 2022 core FFO results were $3.14 per share, which is a strong 9.8% increase over year ago results.

Photo by Kara Eads on Unsplash

Today, we also reported that AFFO per share was $0.81 per share for the fourth quarter and that’s up $0.04 per share or 5.2% over 4Q 2021 results. As usual, we did footnote fourth quarter AFFO included $681,000 of deferred rent repayment in our accrued rental income adjustment for the fourth quarter without which would have produced AFFO of $0.80 per share for the quarter. Likewise, the full year of 2022 AFFO included $5.4 million of deferred rent repayments in our accrued rental income adjustment without which would have produced AFFO of $3.18 per share for the full year and that represents an 8.9% increase over the similarly adjusted $2.92 per share results in 2021. These scheduled deferred rent repayments and they continue to taper off materially in 2023, as you can see in the details that we provided on Page 13 of the press release, but the headline growth of 9.8% core FFO per share in 2022 is a very good result for us and notably above our historic mid single-digit growth rate.

Admittedly, we did have some tailwinds in 2022, which added something probably in the $0.09 to $0.10 per share range for the annual results. These tailwinds, which we have talked about in prior calls, included some of the refinancing we did in 2021 most notably redeeming our 5.2% preferred which probably added $0.03 a share. We also €“ there was a $3.3 million increase in our cash basis deferred rent repayments in 2022. We did resume full rent from Chuck E. Cheese in 2022 that added about $3.3 million of rent at the beginning of the year. And we did have one less executive position, which generated some G&A savings in €˜22. Of course, layered on top of all of that, we entered 2022 with $171 million of cash on the balance sheet, which created some notable accretion once that got invested, but a good year.

But let me move on. Our AFFO dividend payout ratio for the full year 2022 was approximately 67% and that created about $188 million of free cash flow after the payment of all expenses and dividends for the full year. As we think about it, this free cash flow funded over 40% of the equity needed to fund our 2022 acquisitions. Occupancy was 99.4% at quarter end. That’s flat with the prior quarter and up 40 basis points for the year. G&A expense came in at $10.8 million for the quarter, and that’s up from $9.9 million year ago levels. But more importantly, probably for the full year, G&A expense was $41.7 million and that’s down 6.6% from 2021 and it represented approximately 5.4% of total revenues and side note 5.6% of NOI. We ended the quarter ended the year with $772 million of annual base rent in place for all leases as of December 31, 2022.

Today, we also introduced 2023 guidance with a core FFO per share guidance range of $3.14 to $3.20 per share and an AFFO guidance range of $3.19 to $3.25 per share. Core FFO guidance suggests about 1% growth to the midpoint in 2023. The more modest growth in 2023 guidance reflects the high bar of last year’s 9.8% growth that was created and the lack of tailwinds that were helpful in 2022 that I just outlined. And one particular headwind in 2023, I will mention in a moment. All of this is coupled with the slow repricing of cap rates on new acquisitions that we are all dealing with, but it’s coming along, price discovery, like I say, continues to move along. The supporting assumptions for our 2023 guidance are on Page 7 of today’s press release and include $500 million to $600 million of acquisitions, 100 to 200 €“ I’m sorry, $100 million to $120 million of dispositions and G&A expense of $43 million to $45 million.

We modeled acquisitions at €“ running at 30% in the first half of 2023 and 70% in the second half of 2023, a little more back-end weighted than our more typical kind of 40-60 assumption. As we typically do, we have assumed 100 basis points of rent loss in our guidance and that’s a general assumption despite the fact that we usually experience less than half of that amount of rent loss. The one headline €“ I am sorry headwind of note in 2023 is the scheduled $5.8 million slowdown in the cash basis deferred rent repayment. And again, that’s detailed on Page 13 in the press release. Tenants continue to repay these rent deferrals on time, but what is owed is slowing notably. As usual, we don’t give guidance on any of our capital markets assumptions regarding our capital markets activity except for the general assumptions that we intend to behave in a fairly leverage-neutral manner over the long run.

We are hopeful we can move our guidance higher through 2023 as we have done in most years. But for now, this is where we feel comfortable. Quick side note on our AFFO guidance, Page 13 details the slowdown we faced on the accrual basis, deferred rent repayments which has weighed on our headline AFFO growth in recent quarters. With these repayments largely completed, our 2023 AFFO per share guidance is back to its usual relationship with our Core FFO, meaning the annual AFFO is normally a few pennies more than Core FFO, and that’s reflected in our guidance today. Let me switch over to the balance sheet. We maintain a good leverage and liquidity profile with over $900 million of bank line availability. Fourth quarter was fairly quiet in terms of capital market activity.

We did issue a $121 million of equity in the fourth quarter, executing trades and the $45 plus per share level. If you think about our funding of last year’s $848 million of acquisitions, equity issuance funded $250 million of that, operating cash flow after dividends funded $188 million and property dispositions funded $65 million. Sum of those three being $504 million, and that’s about 60% of our total acquisitions funded with those equity sources. After a few years of nearly no usage, we did begin to use our bank line a bit in 2022, largely because we can. Our weighted average debt maturity is now a little over 13 years, which seems to be among the longest in the industry. Our net debt maturity is $350 million with a 3.9% coupon in mid-2024, and all of our debt outstanding is fixed rate with the exception of the $166 million on our bank line, which represents about 4% of our total debt outstanding.

A couple of stats €“ net book to gross €“ sorry, net debt to gross book assets was 40.4%. Net debt-to-EBITDA was 5.4x, interest coverage and fixed charge coverage for us is 4.7x. So we’re in very good shape to navigate the elevated capital market uncertainties and continue to grow per share results, which in our minds is the primary measure of success. The sector’s acquisition volume growth focus over the past 2 years has downshifted in recent months as the marketplace seeks to adjust to the new environment and appears to be getting a little more disciplined on price, which we think is a better environment. I’ve gone on long enough. Let me add, Jenny, with that, we will open it up to any questions.

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Q&A Session

Operator: Your first question is coming from Brad Heffern of RBC Capital Markets. Brad, your line is live.

Brad Heffern: Yes. Thank you. Good morning, everyone. You spoke a bit about the drug store deal. I’m curious if you’re seeing a narrower spread between investment grade and sub-investment grade deals that might push you up the credit quality spectrum or if that deal was just a one-off?

Steve Horn: Yes, our strategy isn’t going to change in 2023. It was a one-off deal. We were in a great position, balance sheet and a lot of our competitors already had significant exposure to the drug store sector where NNN since we kind of laid low for a decade essentially of the drug store. And then this deal really because it was above average lease term that the company was willing to do is that’s why we jumped in and the economics were good. We don’t get into specific economics on deals but the drug store deal was above our average. Average is 6.6% cap rate for the quarter.

Brad Heffern: Okay. Got it. Thanks for that. And Kevin, on the watch list, you mentioned a few tenants where you have a small or no exposure, but I’m interested to get your thoughts on AMC, given that the debt is obviously yielding 30% or so?

Kevin Habicht: Yes. I mean that’s been perpetually on our list for the last couple of years as well, a lot of folks, I guess, at this point. But yes, still current on rent, the liquidity to pay rent feels like they have a little bit more runway left. We will see if they have the ability to continue to raise some more capital here in the coming quarters. But I don’t have a lot of news to share on that front. They represent 2.8% of our total €“ total rent and ABR.

Brad Heffern: Okay, thank you.

Operator: Thank you very much. Your next question is coming from Spenser Allaway of Green Street. Spenser, your line is live.

Spenser Allaway: Yes. Thank you. Just going back to the acquisition guidance, I know you guys mentioned you’re waiting to see how that bid-ask spread continues to adjust. But €“ just curious how much of that conservatism on guidance is reflective of your current tenant base not wanting to grow right now versus maybe conservatism on new prospective tenants?

Steve Horn: Yes. Spenser, yes, we’re always conservative in what we see in the pipeline. That being said, our pipeline is fairly robust as we sit here early February for 2023. Comfortable with our first quarter numbers if everybody behaves appropriately and deals close. Our development pipeline for 2023, to answer your question, it feels like our current relationships are growing, but our development pipeline is as robust as it’s been in 5 years. So very comfortable with that. Where we’re seeing the slowdown, there hasn’t been as much M&A with our relationships of picking up 3, 5-unit operators across the board. But no, we feel comfortable that they are still growing. And our acquisition guidance, as you always know, we pick it up through the year as time goes, we don’t want to get above our skis at this time.

Spenser Allaway: Okay. Great. And then can you provide some color on cap rate assumptions embedded in your guidance?

Steve Horn: Yes. We don’t disclose cap rates in our guidance, but given that we were €“ we picked up 30, 40 basis points in the fourth quarter. I’m seeing expansion as we sit here today for the first quarter projecting that for the first half of the year. And then the second half of the year, your guess is as good as mine at this point.

Spenser Allaway: Okay, that’s very helpful. Thank you.

Operator: Thank you very much. Your next question is coming from Joshua Dennerlein of Bank of America. Joshua, your line is live.