NETSTREIT Corp. (NYSE:NTST) Q3 2023 Earnings Call Transcript

NETSTREIT Corp. (NYSE:NTST) Q3 2023 Earnings Call Transcript October 26, 2023

Operator: Greetings and welcome to the NETSTREIT Third Quarter 2023 Earnings Call. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Amy An, Director of Investor Relations. Thank you. You may begin.

Amy An: We thank you for joining us for NETSTREIT’s third quarter 2023 earnings conference call. In addition to the press release distributed yesterday after market close, we posted a supplemental package and an updated investor presentation. Both can be found in the investor relations section of the company’s website at www.netstreit.com. On today’s call, management’s remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. For more information about these risk factors, we encourage you to review our Form 10-K for the year ended December 31, 2022, and our other SEC filings.

All forward-looking statements are made as of the date hereof, and NETSTREIT assumes no obligation to update any forward looking statements in the future. In addition, certain financial information presented on this call includes non-GAAP financial measures. Please refer to our earnings release and supplemental package for definitions of our non-GAAP measures, reconciliations to the most comparable GAAP measure, and an explanation of why we believe such non-GAAP financial measures are useful to investors. Today’s conference call is hosted by NETSTREIT’s Chief Executive Officer, Mark Manheimer, and Chief Financial Officer, Dan Donlan. They will make some prepared remarks, and then we will open the call for your questions. Now I’ll turn the call over to Mark.

Mark?

Mark Manheimer: Morning, everyone, and thank you for joining us today for our third quarter conference call. With the recent changes in the capital markets and subsequently the property markets, I want to begin with how NETSTREIT is positioned for what we foresee as an increasingly challenging landscape for the consumer, and by extension, certain retailers. We will also discuss where we see opportunities and how we plan to operate in this environment. The challenges we expect to occur for many retailers center around a consumer that is unlikely to spend at the same level that they have in years past, especially when it comes to purchases by lower income consumers on more discretionary type items. While a small handful of our tenants have a diversified product mix that includes some exposure to discretionary items that may come under some pressure, the portfolio is built around necessity retailers, off-price value merchants, and resilient service providers.

We believe this defensive industry focus, coupled with our tenant’s strong balance sheets, and ready access to capital, position our portfolio to deliver predictable cash flow generation over the long term. While there may be some headline risk associated with top line performance and gross margin pressures for some of our investment grade tenants, we do not see these pressures threatening their ability to meet their financial obligations, including paying rent. We continue to be vigilant in monitoring our portfolio and where we have seen risk, we have actively recycled and redeployed capital into less-challenged assets at generally higher going-in cash yields. Turning to credit, our watchlist consists of just one tenant, Big Lots, which now represents 1.9% of ABR versus 2.4% last quarter.

A Real Estate Investment Trust (REIT) property manager inspecting a newly acquired apartment complex.

While we may look to further decrease this exposure over the coming quarters, we do want to highlight the that the nine infill assets that we now own have solid demographics below market rents and excellent foot traffic. More specifically, our remaining locations have an average five-mile population density of over 100,000 people and an average household income of approximately $80,000, which is attractive for most retailers when looking for expansion markets. Additionally, we believe our average rent per square foot of $6.90 is well below market. Lastly, when using Placer.ai to track store-level foot traffic, our Big Lots rank in the top 75 percentile of the entire chain on average. Again, while we may continue decreasing our exposure to Big Lots, we do not believe that there is long-term economic risk to these assets, given the positive underlying fundamentals of the real estate, which is a testament to how we have underwritten our portfolio since inception.

The other area of risk that we see developing across the retail space resides in tenants that have a high exposure to floating rate debt, and our low cost debt that is maturing soon. Given the financial transparency we receive from our tenants each quarter, we are able to quantify our tenant exposure to the aforementioned. Specifically, less than 9% of our tenancy, as measured by ABR, has debt coming due between now and year end 2025. And the majority of this concentration — or 7.5% — is with Walgreens who has exceptional access to capital. With that in mind, based on our limited exposure to retailers that are reliant on discretionary spend from low income consumers, our tenant base, having little to no refinance risk over the next few years, and only 2.3% of our ABR expiring expiring through 2025 year end, we continue to expect our portfolio to generate consistent cash flow as we navigate a potentially choppy macro environment.

Turning to the portfolio, as of September 30, we had 547 investments that were leased to 85 tenants that operate within 26 retail and industries across 45 states. The annualized base rent for our portfolio was $124.3 million, 83.3% of which is leased to tenants with investment-grade ratings or investment-grade profiles. Our occupancy remains at 100%, and our weighted average remaining lease term was 9.3 years. Moving on to external growth, we closed on $117.5 million of investments this quarter at a blended cash yield of 7%. The weighted average lease term remaining on these investments was 10 years, and 97.2% of these investments were leased to investment-grade, or investment-grade profile tenants. Turning to quarterly disposition activity and loan payoffs, we divested of six properties for gross proceeds of $13.5 million at a blended cash yield of 6.9%, continuing to demonstrate our ability to accretively recycle capital while improving the quality and risk profile of our portfolio.

All told, we completed $103.9 million of net investment activity in the third quarter, which brings our year to date net investment activity to $327.9 million. While we are seeing significantly more opportunity for acquisitions in the fourth quarter at higher cap rates than what we have seen in 2023, we are also seeing plenty of opportunities to sell assets at stubbornly low cap rates to trade buyers and thus plan to ramp up our selling efforts to take advantage of this spread. Before I hand the call off to Dan, I want to provide additional commentary on our strategy and expectations as we finish 2023 and head into 2024. Since our inception and IPO several years ago, we have exercised diligence in creating one of the highest credit quality net lease portfolios in the freestanding retail space by partnering with the strongest retailers in the country.

We have had no rent interruptions to date, even through a global pandemic, and have experienced zero vacancies. With the current narrative being dominated by headlines discussing looming recessionary concerns, higher for longer interest rates, and rising delinquencies in consumer credit, we believe the underwriting discipline we have exercised since inception have positioned our portfolio to outperform during a time of heightened macro uncertainty. With that, I’ll let Dan go over our third quarter financial results, balance sheet, and 2023 guidance update.

Dan Donlan: Thank you, Mark, and thank you, everyone, for joining our call today. Turning to our third quarter earnings release yesterday after the market close, we reported net income of $4.2 million or $0.06 per diluted share. Core FFO totaled $21.2 million for the quarter, or $0.31 per diluted share. AFFO totaled $21.4 million for the quarter, $0.31 per diluted share — a 3% increase from the prior year period. Total G&A expense, excluding one-time items, was $5.1 million, which represented 14.9% of total revenues. This compares favorably to last quarter and the prior year quarter, when G&A as percentage of revenues was 16% and 18.2%, respectively. As we look out to next year, our G&A should continue to rationalize relative to our asset base and total revenues, as the company has reached the proper scale to effectively operate our business on a go forward basis.

Moving onto the balance sheet, total net debt was $567.5 million at quarter end, and our weighted average interest rate was 3.57%. In addition, when including the impact of extension options, which are solely at our discretion, we have no debt maturing until January 2027. Turning to capital markets activities, we raised $126 million of equity through our ATM during the quarter, which was primarily completed on a forward basis. As of quarter end, we had $98.7 million of ATM equity that remained unsettled. As previously announced on July 3, we closed a new $200 million senior unsecured term loan with delayed draw option, which has a fully extended maturity date of January 2029. The term loan includes an accordion feature that allows the company to increase the total loan amount to $400 million.

At closing, we drew $150 million and plan to draw the remaining $100 million in the first quarter of 2024. Before we $250 million term loan at an all-in fixed rate of 4.99% through January 2029. At quarter end, our liquidity was $564.6 million — which is comprised of $7.9 million of cash on hand, $358 million available on our revolving credit facility, $98.7 million of available forward equity, and $100 million remaining available principal on our 2029 term loan. From a leverage perspective and adjusting for the foreign equity, our net debt to annualized adjusted EBITDAre was 4.2 times at quarter end, which remains company below along on the low end of our targeted leverage range of 4.5 times to 5.5 times. Moving to guidance, we are updating our AFFO per share guidance range to $1.21 to $1.23, from $1.20 to $1.23, which includes year over year growth of 5% at the midpoint.

On the external growth fund, we now expect to close around $450 million of net investment activity. Lastly, turning to our dividend, on October 24, the Board declared a quarterly cash dividend of $0.205 per share. The dividend will be payable on December 15 to shareholders of record as of December 1. Based on the dividend amount, our AFFO payout ratio for the third quarter was 66%. With that, operator, we will now open the line for questions.

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Q&A Session

Operator: [Operator Instructions]. Our first question comes from Todd Thomas with KeyBanc Capital Markets.

Todd Thomas: Hi, thanks. Good morning. Mark, first question — you mentioned that you’re seeing attractive capital still available as you look at recycling capital. What’s the spread look like today between disposition and acquisition cap rates that you’re seeing?

Mark Manheimer: Yes, sure. So I mean, we’re focused on really trying to find a trade buyer in 1031 exchanges. So in kind of one-off type situations, we’re selling assets anywhere from, call it a five cap to seven cap depending on lease term and where we think we can redeploy that capital. I’m always hesitant to give a real concrete number on where we’re going to go with dispositions just because we’re relying on other parties to complete the transaction, and that’s out of our control. So the mix could really swing that one way or the other, but for like kind — types of assets, we think we’re picking up anywhere from typically 50 basis points to 100 basis points.

Todd Thomas: Okay. And then it sounds like you’re starting to see investment yields improve a little bit on new deals that you’re looking at. Can you just describe a little bit more about what you’re seeing there in terms of price trends? You know, I guess sort of vis-a-vis you know that the sort of 2023, you know, cash yields that you’ve achieved and sort of the 7% in the third quarter?

Mark Manheimer: Yes, sure. No, absolutely. We are seeing cap rates move up, and so we, at one point, were acquiring assets at kind of the low-sixes, and that kind of trended up to mid-sixes year end of the year last year, and early this year up into the high sixes, and now a seven cap in the most recent quarter. We would expect the fourth quarter to be even higher than that. We’re certainly not looking to transact really anything in the sixes. So I would expect to see 20 plus basis points in the fourth quarter. Some of that’s really just going to be dragged down by some developments that we had signed up in the past that were already already funding. I think on new transactions that are likely to close more inin the first quarter are likely to pick up even another 20 basis points, 30 basis points beyond that.

Todd Thomas: Okay. And then just last question, I guess. I realize conditions are sort of fluid here, but I was just wondering if you can maybe provide a little bit of insight around how you’re thinking about investments and maybe dispositions as well? So net investments, you know, really heading into 2024 just given the current environment today?

Mark Manheimer: Yes, sure. I mean, I think with where we’re seeing the acquisition market, while it’s getting better, it’s really I don’t think we’re getting enough spread to go out and raise equity and deploy capital where we see it today. We do see opportunities like we mentioned on the disposition, and then redeploying through capital recycling, and see some pretty attractive opportunities there. But we’d really need to see a material improvement in our stock price, or see cap rates really move into the eights, for us to consider turning on the spigot of acquiring assets and raising equity.

Todd Thomas: Okay. All right. Thank you.

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

Joshua Dennerlein: Hi. This is on behalf of Josh. Just a quick question about as you had mentioned, the headlines — pharmacy specifically — I was curious about with your current acquisition, are you seeing a change in competition for the assets that you’re going after? Kind of like the higher credit quality assets?