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

National Retail Properties, Inc. (NYSE:NNN) Q4 2023 Earnings Call Transcript February 8, 2024

National Retail Properties, Inc. misses on earnings expectations. Reported EPS is $0.53 EPS, expectations were $0.82. NNN isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings. Welcome to the NNN REIT Inc. Q4 and Year-End 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. 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, Steve Horn, Chief Executive Officer. You may begin.

Steve Horn: Thank you, Holly. Good morning, and welcome to NNN REIT’s fourth quarter 2023 earnings call. Joining me on the call is Chief Financial Officer, Kevin Habicht. As this morning’s press release reflects NNN’s performance in 2023 produced 3.8% Core FFO growth along with acquisition volume over $800 million. In addition, the year concluded with high occupancy of 99.5% and dispositions income-producing assets were 140 basis points lower than our acquisition cap rate, all driven by our best-in-class team here at NNN. The end of the year surge positions the company well in the near-term, but a few highlights of 2023 that I’m proud of what NNN accomplished. The 34th consecutive annual dividend increase, the rebranding initiative and the positioning of the executive team for the future.

While the name changed in 2023, the core philosophy to realize long-term value at below average risk for our shareholders remain in the most simplistic form. One, we continue to execute our strategy using a bottom-up approach, continue to increase the annual dividend, maintaining the top-tier payout ratio and focusing on growing FFO per share in the mid-single digits over multiple years. We maintain this core philosophy by keeping disciplined and setting our acquisition activity and our balance sheet management to achieve that objective. Before I get into day-to-day operations and current market conditions, I’d like to welcome Gina Steffens to the executive team. Gina assumed General Counsel role late in the fourth quarter. She joins NNN with a fantastic resume from public and private companies, bringing significant transactional experience.

I look forward to the partnership going forward as NNN grows. As I alluded earlier, NNN is in great shape. At year-end, NNN had $132 million drawn on the $1.1 billion credit facility after deploying over $800 million of capital for the year. Based on our initial 2020 guidance, NNN has the ability to have minimal capital market activity in 2024. This is accomplished by using a nominal amount of the credit facility to roughly $180 million free cash flow we generate and $100 million from dispositions to execute 2024 strategy. Using these three sources I mentioned leaves NNN with potentially zero equity requirements for the year. This strategy continues NNN’s discipline of being selective while deploying capital and opportunistically raising capital over the years.

Management takes great pride in being best-in-class capital allocators, not asset accumulators. And that is a distinction that should not be overlooked for the company to execute in the long run. As we stand here in February, given the macroeconomic forces in the current state of the sector’s equity markets, it makes sense for NNN to maintain its operational discipline while deploying capital. That being said, if there is a change in the market as we progress throughout the year, NNN is well positioned and will capitalize on the right opportunities. Shifting to the highlights for the fourth quarter financial results, the portfolio now contains 3,532 freestanding single-tenant properties that continue to perform exceedingly well. Occupancy levels reached historic highs of 99.5%, which is well above our long-term average of 98%.

The fourth quarter bankruptcy filing of Rite Aid will have minimal to zero impact on NNN. At the time of the filing, NNN was the owner of six assets. And as of the end of January, two of those leases had been rejected by the tenant. In any event, the rent on those assets are near market, so I expect the rent recovery within our historical averages. Turning to acquisitions. During the fourth quarter, we invested nearly $270 million in 40 new properties at initial cap rate of 7.6% with an average lease duration of 19.6. Nearly all the capital deployed for the quarter was provided to our relationship business partners. In addition, the long-term projected yield on those acquisitions is 8.9%, which is a reflection of the sale-leaseback acquisition model versus buying existing shorter-term leases.

2023, the market was constantly in price discovery mode with the bid-ask spread fluctuated but we continue to maintain our thoughtful and disciplined underwriting approach. Throughout the year, NNN ticked up 20 basis points for the last three quarters in acquisitions. That trend continued with pricing of deals in the fourth quarter that will close in the first quarter. There was a moment within the last 60 days that passing through cap rate increases became more challenging. Despite the pressure from our competitors’ acquisition needs hindered that cap rate expansion to a certain extent. Slowing down the cap rate expansion is resulting in the second quarter cap rates being similar to the first quarter. So that change could continue as we move through the quarter.

Also during the quarter, we sold 19 assets at a 6.5% cap, which included 14 vacant assets, raising $26.5 million of proceeds to be reinvested in new acquisitions. For the year, we raised approximately $115 million of proceeds from the sale of 45 properties at 5.9%, which included 21 vacant properties. The 5.9%, as I stated in the opening, was 140 basis points inside where we deployed capital for 2023, which proved NNN’s excellent execution with managing the portfolio. Job one is always to release the vacancies but we’ll continue to sell nonperforming assets, and we don’t see a clear path to generating rental income within a reasonable time period. With that, let me turn the call over to Kevin for more detail and color on our quarterly numbers and 2024 guidance.

Kevin Habicht: Thanks, Steve. And as usual, let me start with the 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 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, headlines from this morning’s press release, we report quarterly core FFO results of $0.85 per share for the fourth quarter of 2023.

That was up $0.05 or 6.3% over year ago results of $0.80 per share. I will be quick to point out, as detailed in the footnote below the earnings table on Page 1 of the press release that the fourth quarter included $0.03 of accrued rental income in connection with the re-class of one tenant from cash basis accounting to accrual basis accounting as a result of continued improvement in that and its financial condition post pandemic. So, with AFFO’s $0.03 per share, the fourth quarter core FFO would have been $0.82 per share or 2.5% over a year ago result. For the full year, as Steve mentioned, full year 2023, we reported core FFO of $3.26 per share, which was 3.8% over a year ago results. Now if we exclude the same $0.03 from the accounting reclass, full year results would have been $3.23 per share or 2.9% over year ago results, which was at the top of our guidance range last provided.

AFFO results, which are not impacted by accrued rent were $3.26 per share for the full year or 1.6% over prior year results, again at the top of our guidance range. As we’ve disclosed since 2020, the last page of our press release provides details of the pandemic deferred rent repayments. And so as those tenants fulfill their deferred rent obligations, the repayment amounts are slowing from $14.5 million in 2022 to just $3.1 million in 2023. And so at the bottom of Page 13 of the press release, we have provided pro forma or adjusted per share amount, excluding these repayments in both 2022 and 2023 to provide a look at what the recurring fundamental per share performance was. And so these adjusted results show full year 2023 per share growth of 4.9% for core FFO and 3.5% for AFFO, both notably better than the reported headline number.

We think this gives a better picture of the core fundamental operating results of our business but overall, a good quarter, in line with our expectations. And as can be seen, again on Page 13, those deferred rent repayments are now 93% completed. And so they will have a much smaller impact in 2024 and beyond. All right. With that, moving on, our AFFO dividend payout ratio for 2023 was 68.4%, and that resulted in approximately $187 million of free cash flow for the year, and that’s after the payment of all expenses and dividends. Occupancy was 99.5% at year-end. G&A expense was $10.5 million for the quarter and $43.7 million for the full year, representing 5.3% of revenues for the year, which again was in line with our guidance. We ended the year with $818.7 million of annual base rent in place for all leases as of December 31, 2023.

Today, we also initiated our 2024 core FFO guidance at a range of $3.25 to $3.31 per share and 2024 AFFO guidance with a range of $3.29 to $3.35 per share. Page 7 of the press release gives you some details on the key assumptions underlying the guidance, and they include $400 million to $500 million of acquisitions, $80 million to $120 million of dispositions. G&A expense of $46 million to $48 million and property expenses net of tenant reimbursements of $9 million to $11 million. We do have $350 million of 3.9% debt coming due in June of this year 2024. And so the refinance of that debt will create nearly a couple of pennies of headwind on 2024 results. Hopefully, as the year progresses and consistent with – as we’ve done in the past, we will have the opportunity to drift our guidance higher.

Switching over to the balance sheet. We maintain good leverage and liquidity profile with $968 million of availability on our $1.1 billion bank credit facility. And as Steve mentioned, despite near-record high acquisition volume in 2023, we funded approximately 37% of our $820 million of acquisitions with free cash flow of $187 million plus the $116 million of disposition proceeds. We continue to be sensitive to our external capital market footprint in this environment. Based on the midpoint of our acquisition and disposition guidance for 2024, we should fund approximately 60% of our 2024 acquisitions with free cash flow and disposition proceeds. Our weighted average debt maturity remains 12 years, which will help us slow the coming refinance headwind that all REITs are phasing in the coming years.

Net debt to gross book assets was 42% at year-end. Net debt-to-EBITDA was 5.5x at December 31. Interest coverage and fixed charge coverage was 4.5x for 2023 and all of our properties owned by NNN are unencumbered by mortgages. We remain focused on working to appropriately allocate capital, which to us means ensuring we are getting what we believe are appropriate returns on equity, while controlling risk through property underwriting and maintaining a sound balance sheet. We believe it’s one of the more fundamental issues for any REIT or, frankly, any company, valuing equity adequately, whether that equity is produced by free cash flow or disposition proceeds or new equity issuance is at the heart of growing per share results over the long-term in our opinion.

So in closing, I think we’re in relatively good position to navigate the economic and capital markets uncertainties and to continue to grow per share results, which we view as the primary measure of success. And we are mindful that this is a long-term, multi-year endeavor, but the fundamentals of our business remain in good shape. With that, we will open it up to any questions. Holly, thank you.

Operator: Certainly. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Your first question for today is coming from Spenser Allaway at Green Street.

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Q&A Session

Spenser Allaway: Thank you. Can you guys just talk about how cap rates are trending thus far into 2024 and similarly how deal volume is trending just based on what you’ve sourced and what you can see maybe looking out the next 30 to 60 days.

Steve Horn: Hey, Spenser, it’s Steve. Yes. So, going into 2024, as I alluded in the opening remarks, we were picking up 20 basis points each quarter. And then I expect that if not a little bit higher for the first quarter for the deals that got priced in the fourth quarter. But we kind of noticed, it felt like the other REITs put some pressure because they have to do acquisition volume, which kind of plateaued the cap rates that we’re seeing that might close in the second quarter. I kind of see the first half of the cap rates being the same, but they’re definitely trending up for the first quarter. As far as deal volume, there’s definitely not as much deal volume out there as there was kind of in the second and third quarter.

And I think that’s more from the seller side, the supply side, when there is discussions of rate cuts coming, that some sellers are holding off, hitting the market, anticipating better cap rates in the near future. But that being said, where NNN, our acquisition guidance, there’s plenty of deal volume out there for NNN to hit its numbers.

Spenser Allaway: Okay. Great. And then just any specific industry within your existing tenant base that’s showing more appetite to grow, or maybe on the flip side, downsize their current footprints just based on discussions you’ve had.

Steve Horn: Yes. The latter part of the question, we’re not hearing anybody wanting to downsize in our sectors. Everybody’s always reevaluating their business models. But as far as growth through M&A or adding stores, there’s still a big push in the auto service center from our client base is still growing and we’re starting to see a little bit of the QSR momentum tick up. And then lastly, there is some activity in the C-store market again, that we’re kind of filtering through opportunities.

Spenser Allaway: Great. Thanks so much.

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

Farrell Granath: Hi, this is Farrell Granath on behalf of Josh. I was wondering if you could elaborate on any bad debt assumption in the – especially compared to historical.

Steve Horn: Yes, sure. This is – yes, so as usual for us, we’ve assumed in our guidance 100 basis points of rent loss baked into our guidance, and that I would say, what is typical and what included in 2023 is that we typically run kind of 40 to 50 basis points in a typical year.

Farrell Granath: And can you walk me through maybe some of the internal external drivers of growth given your lower acquisition guidance?

Kevin Habicht: Yes. For us, in one sense, it’s fairly simple kind of model. Rent growth, we assume in our portfolio is going to be internal growth would be about 1.5%. So that would add about $12 million, 1.5% of $818 million or whatever the number was, call it, $12 million. But we’ve assumed, we’ll lose 100 basis points of rent loss, which I like, we’ve indicated is probably, hopefully a conservative assumption. So that’s negative $8 million and you got 3 – $4 million in G&A creep. And then, as I mentioned, we’ll have interest expense for the year will probably be about $5 million to $6 million higher as it relates to the refinance of that $350 million. And so that – and then you layer in acquisitions, if you assume midpoint $450 million, then those are kind of the pieces, I think, that got us to where we are in terms of our guidance.

And like I said, hopefully, we’ll have an opportunity to drift that higher, that guidance higher as the year progresses and consistent with what we’ve done in the past. But that’s where we were comfortable starting out guidance.

Operator: Your next question for today is coming from Smedes Rose at Citi.

Smedes Rose: Hi. Thank you. I just wanted to go back for a moment to the acquisitions outlook. It just was a little bit light, at least relative to our expectations, and I think maybe relative to some of your 3Q commentary. And you mentioned earlier that sellers are kind of holding off, maybe looking for better pricing for them later in the year. I was just wondering is that something that sort of changed maybe over the last – since your last call or maybe you could just talk a little bit more about the opportunities on that front.

Kevin Habicht: Yes. I mean, as far as the outlook, our acquisition volume, I think we’ve been pretty consistent over the course of the last six months that we are looking at a light capital markets footprint. So the $400 million to $500 million range of acquisitions pretty consistent. What has changed from the last call was the market was expecting rate cuts coming in March. That was the probability. But during the last call, that was not on the table. That was more kind of a mid-December discussion item. And at that point is where we felt that sellers weren’t coming to the market expecting those future rate cuts, but now they’re being delayed.

Kevin Habicht: And Smedes, this is Kevin. One other thing I’d add is that that’s our style and our approach. I think if you look back over history, I’m guessing our initial acquisition guidance has always looked light relative to where the year ended up 2023 included. And so it’s funny in our business, as we’ve said, you really have three months, maybe four, but not very much look into the future in terms of the pipeline, I mean, a real pipeline. And so it’s – we tend to be probably a little more cautious on the front-end going in until we have a better sense of how the year is going to play out.

Smedes Rose: Thanks. And then I just wanted to ask you on the tenant that moves back to accrual rents from I guess, cash payments. Is that sort of just, I guess, more or less unusual or it’s something that you might expect more of as we move through the year.