Realty Income Corporation (NYSE:O) Q1 2023 Earnings Call Transcript

Realty Income Corporation (NYSE:O) Q1 2023 Earnings Call Transcript May 4, 2023

Operator: Good day, and welcome to the Realty Income First Quarter 2023 Earnings Conference Call. . Please also note, today’s event is being recorded. I would now like to turn the conference over to Andrea Behr, Associate Director of Corporate Communications. Please go ahead.

Andrea Behr: Thank you all for joining us today for Realty Income’s First Quarter Operating Results Conference Call. Discussing our results will be Sumit Roy, President and Chief Executive Officer; Christie Kelly, Executive Vice President, Chief Financial Officer and Treasurer; and Jonathan Pong, Senior Vice President, Head of Corporate Finance. During this conference call, we will make statements that may be considered forward-looking statements under federal securities law. The company’s actual future results may differ significantly from the matters discussed in any forward-looking statements. We will disclose in greater detail the factors that may cause such differences in the company’s Form 10-Q. We will be observing a two-question limit during the Q&A portion of the call in order to give everyone the opportunity to participate. If you would like to ask additional questions, you may reenter the queue. I will now turn the call over to our CEO, Sumit Roy.

Sumit Roy : Thank you, Andrea. Welcome, everyone. We are pleased to report solid 2023 first quarter results, exhibiting continued momentum in our business. I would like to express my utmost gratitude to our One Team whose efforts enabled us to continue delivering on our growth objectives. I would also like to thank our equity and fixed income investors for their continued vote of confidence. Our team’s efforts and the benefits of our size and scale were reflected in our first quarter results, highlighted by approximately $1.7 billion of high-quality investments acquired at a cash cap rate of 7%. This represents a 90 basis point increase compared to the investment cash cap rate we achieved in the fourth quarter of last year and resulted in an investment spread of 163 basis points, which is above our historical averages.

As we have experienced in prior cycles, cap rates for our investments after an adjustment period have historically tended to be positively correlated with interest rates, which is a trend we have largely continued to experience this year after the recent rise in rates. Our ability to access well-priced capital has historically served as a competitive advantage and is a testament to our long history of maintaining a conservative balance sheet and a diversified real estate portfolio, supported by clients who are leaders in their respective industries. Amidst an environment in which capital is expensive and are scarce for many of our clients, our value proposition is even more pronounced. This dynamic is reflected in the recent portfolio acquisitions we have announced, the active deal pipeline we see today and the favorable pricing spread we see for large portfolio transactions vis-a-vis one-off single asset transactions.

Our differentiated platform extends beyond the external growth lens. Recently, we have taken steps to leverage the size of our portfolio and the history of our operating business through the continued development of advanced analytics. The objective of this initiative is to develop predictive and prescriptive insights that harness the collective proprietary data that we’ve accumulated over several decades of investing in managing and releasing single-tenant net lease properties. Our team’s proprietary predictive analytic tool leverages the strove of information in our investment underwriting, portfolio management, asset management and development efforts enabling even more informed investment decisions made by our best-in-class One Team members.

As our business grows, so too will the predictive power of this tool, which we believe will generate significant value for our stakeholders as we refine the accuracy, test conclusions and broaden scope across industries, property types and geographies. As part of our core investment thesis, our size and scale have created opportunities to serve as a capital provider for best-in-class partners looking for alternative means of financing given elevated debt costs. In the first quarter, we agreed to acquire up to 415 high-quality convenience stores from EG Group for $1.5 billion. Over 80% of the total portfolio annualized contractual rent is expected to be generated from properties under the Cumberland Farms brand, and we expect to close on this transaction in the second quarter.

As illustrated by this deal, we believe our ability to offer not only certainty of close, but also attractively priced capital as a one-stop solution for sale-leaseback transactions is particularly valuable to institutional sellers of real estate today. We believe this will continue to expand our competitive advantage. Internationally, we continue to venture into new geographical verticals and grow the total addressable market opportunity. This quarter, we took advantage of favorable pricing internationally to acquire properties worth approximately $390 million at an initial cash lease yield of 7.6%. After our initial entry into international markets in 2019, we now derive 11.7% of total portfolio annualized contractual rent from those markets.

This natural extension of our platform has been a pillar of growth for the last four years and is indicative of our ability to methodically establish and scale a new vertical. Given the continued momentum in our acquisitions pipeline and our progress to date, we are increasing our 2023 investment guidance to over $6 billion from our prior guidance of over $5 billion. Consistent with our investment strategy, we remain disciplined with regard to our balance sheet. Subsequent to our April bond offering, which settled on April 14 and we held approximately $5.6 billion of liquidity, including unsettled forward equity totaling $1.5 billion. As a result, our current financial position has afforded us the ability to lean into near-term investment opportunities.

Moving to operations. Our platform continues to generate durable cash flows, which support our stable earnings profile. For the first quarter, we are pleased to report occupancy of 99%, matching last quarter for the highest rate at the end of a reporting period in over 20 years. Additionally, we generated a 101.7% recapture rate across 176 renewed or new leases executed during the quarter. These results are a reflection of our talented asset management team and our unwavering commitment to core capital allocation principles, which include a focus on industry-leading clients who often operate in a low price point service-based or nondiscretionary industries. Our purposeful diversification across industries, geographies and clients and our emphasis on high-quality real estate locations and rigorous credit underwriting.

Our investment philosophy is nuanced and not simply predicated upon the pursuit of investment-grade clients, which ended the first quarter at 40.8% of our annualized contractual rent. Many of our strongest operators, such as Sainsbury’s have no public debt and thus are not rated at all. However, the consistency of their operations and health of their balance sheet are favorable attributes that are consistent with those of an investment-grade rated company. We estimate that approximately 5.3% of our annualized contractual rent comes from unrated operators without public debt. We remain committed to investments that offer us attractive risk-adjusted returns as evidenced throughout our history. And going forward, where we believe, based upon our disciplined underwriting and analytics, we are achieving better returns per unit of incremental risk.

I would like to briefly touch on Cineworld which represents 1.3% of our annualized contractual rent. Despite the ongoing Chapter 11 bankruptcy, we have continued to receive 100% of contractual rent in the first quarter and through April. As of March 31, 2023, we had cumulative reserves of $33 million on our Cineworld properties. Outstanding receivables net of reserves and excluding straight-line receivables were $14.1 million. We remain in discussions with this client and we’ll update the market on the outcome of these discussions at the appropriate time. Before turning the call over to Christie, I would like to highlight that in March, we published our third annual sustainability report which details our ongoing commitment to operating as a responsible corporate citizen for our stockholders, our team, the communities in which we operate and the environment.

I’m proud of our continued progress on ESG initiatives as we seek to fulfill our commitment to building sustainable relationships and I strongly encourage all of today’s listeners to navigate to the Sustainability page of our website to review the report. With that, I’d like to turn it over to Christie.

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Christie Kelly: Thank you, Sumit. We work together with our clients and our One Team to achieve a successful quarter on a number of fronts, delivering AFFO per share of $0.98 on behalf of all of our stakeholders. We would highlight that the comparable quarter in 2022 benefited from approximately $10.2 million of rental revenue reserve reversals, resulting in an AFFO per share growth headwind of approximately $0.015 per share in the first quarter of 2023. In addition, higher year-over-year short-term interest rates represented an approximate $0.02 growth headwind as our weighted average interest rate on revolver and commercial paper borrowings was approximately 300 basis points higher than it was in the comparative period in 2022 on a similar average borrowing base.

Excluding these two items, our year-over-year AFFO per share growth rate was approximately 3.5% this quarter. As we evaluate the core fundamentals of our business, we remain focused upon delivering for our stakeholders over the long term and are encouraged by opportunities ahead. To that end, we are increasing the low end of our AFFO per share guidance range by $0.01 resulting in a new range of $3.94 to $4.03, which represents 1.7% annual growth at the midpoint of the updated range. It has been a busy and productive start to the year on the capital raising front. Despite continued market volatility, we have raised approximately $3.9 billion of capital this year excluding $1.5 billion of unsettled forward equity. In April, we closed a $1 billion bond offering, which was comprised of $400 million of 4.7% senior unsecured notes due in 2028 and $600 million of 4.9% senior unsecured notes due in 2033, resulted in a weighted average tenure of eight years and semi-annual yield to maturity of 5.05%.

The issuance allowed us to satisfy our near-term debt issuance needs while reducing our exposure to variable rate revolver and commercial paper borrowings and to almost zero after our transaction closed on April 14. In March, we increased our dividend for the 120th time since our public listing in 1994, to an annual rate of $3.06 per share, representing 3.2% growth from the prior year period. Providing a stable and growing dividend is core to our mission at Realty Income, and we take great pride in being one of only 66 constituents in the S&P 500 Dividend Aristocrats Index for having raised our dividend every year for the last 25 consecutive years. I would like to thank our One Team whose focus and diligence has paved the way for our continued growth as we build upon our track record of consistency.

And with that, I would like to turn it back over to Sumit.

Sumit Roy : Thank you, Christi. In conclusion, during periods of market uncertainty or dislocation we look to unearth value by leveraging the inherent advantages of our platform. These trends include our continued access to relatively attractively priced capital and our portfolio scale, which we seek to leverage to produce unique investment opportunities as a leading sale-leaseback capital provider. When combined with the collective talents of our best-in-class team members to source, underwrite and close on creative acquisition opportunities with strong risk-adjusted returns, we believe we are very well positioned to continue amplifying our competitive advantages on behalf of our clients and stakeholders. We thank all our stakeholders for their support, loyalty and trust in our company. And with that, we can open it up for questions.

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Q&A Session

Operator: Today’s first question comes from Nate Crossett with BNP Paribas.

Nate Crossett : I was wondering if you could talk about just deal flow U.S. versus Europe. What was the amount of deals you looked at in the quarter? I think that’s a number you usually give. And then on cap rates, last year, the spread of like the cap rates in the U.S. and Europe was pretty low. I think it was almost the same. But this quarter, Europe is 60 basis points wider. I just want to know if there’s anything to note there.

Sumit Roy : Yes. Thank you for your questions, Nate. Good questions. Let’s start with the sourcing numbers. For this quarter, we sourced about $16 billion worth of product, 25% of which was in the international markets. I would say that if you go back to when we started going into the international markets, the composition of international versus U.S. has been roughly around 30%, 70% in that ZIP code, plus/minus 5%. So this is pretty much within that particular range. What you might have noticed, however, is the amount of closing more recently, both in the fourth quarter of last year, the first quarter of this year. The contribution from the international side has been a little bit lower than what you have traditionally seen.

I would say that the international business has contributed about 35% of volume in terms of what we end up closing versus closer to 20%, 22% this particular quarter. And the main reason for that is we saw a delay in adjustments on the cap rate side in the international markets vis-a-vis the U.S. markets. We started to see cap rate expansion in the U.S. towards the end of — middle of third quarter, fourth quarter and obviously through the first quarter of this year. But we didn’t quite have the same experience in the UK market and some of the other international markets, till, I would say, towards the end of the fourth quarter. And what was largely making potential sellers reconsider the market was not so much driven by actual trades taking place, but more idiosyncratic to their particular needs.

Around redemption issues or refinancings that were coming near term. And that’s largely what’s driven these opportunistic transactions that we’ve gotten over the finish line in the fourth quarter of last year and the first quarter of last — this year. And that’s what’s resulted in cap rates being substantially higher than what I would call the norm or what we are seeing in the everyday market in some of these international markets. So that explains the 60 basis point higher cap rate that we were able to achieve. And I might add, this is excellent product largely driven by idiosyncratic issues being experienced by buyers who wanted to get this off their books to meet some of the things that I’ve just discussed. So that’s the dynamic we’ve seen…

Nate Crossett : Okay. That’s helpful. And then maybe just one quick one on development yields. Those are notably below the acquisition yields. Are those just old commitments before rates moved? Or maybe you can describe what’s happening there?

Sumit Roy : Yes. And Nate, you’ve hit the nail on the head. It’s exactly that. As you know, development obligations have a much longer lead time. So a lot of what you see in — you saw in the fourth quarter, third quarter of last year and the first quarter of this year, though it’s starting to move up, it hasn’t moved quite as quickly, largely because what you’re seeing filtered through the investment numbers, but transactions that we hit struck, I would say, three quarters ago or four quarters ago. But you should expect to see the yield on development creep closer to what we are actually experiencing in the traditional acquisitions market over the next couple of quarters. So it’s just a timing issue.

Operator: And our next question today comes from Brad Heffern with RBC Capital Markets.

Brad Heffern : Christie, one was wondering if you could talk through some of the puts and takes on guidance and why only the $0.01 increase at the low end given the increase in the acquisition guidance and the expense categories moving in the right direction?

Christie Kelly : Absolutely, Brad. I think first, in terms of what Sumit had discussed and the increase of our acquisitions guidance to over $6 billion, we remain conservative in that front and really looking towards the second half of the year, while things remain strong. As Sumit has discussed, we’re really wait and see here as things unfold. I think the other thing, too, in terms of guidance that we’ve articulated, and I mentioned some of this in my prepared remarks, is really the headwinds that we’re seeing from a debt perspective, although we’ve been very focused on ensuring that we’re derisking our balance sheet, and you can see that in the transactions that we’ve executed through April. We’re really looking at where that may unfold in terms of the second half of the year and don’t believe that, that will alleviate over and above the competitive cost of capital that we’ve been able to generate vis-a-vis last year.

And I think finally, in terms of the positive trends that you saw in terms of the tightening of the guidance with G&A, we remain particularly disciplined during this macroeconomic backdrop, and are focused on managing our G&A. But further to that, it’s the benefits of size and scale. And you can see that over the years in terms of the trends of G&A to revenues. And then finally, from an unreimbursed property expense margin perspective and the tightening there, we’re just following in on the positive trends that we’ve been able to execute upon.

Brad Heffern : Okay. And then, Sumit, just thinking about this EG Group deal, are you seeing more of these very large sale-leaseback opportunities versus what you would normally see? And then has the competition for those deals also thinned out?

Sumit Roy : No, no, Brad. I wouldn’t go so far as to say it’s timed out. In fact, the momentum has continued, and we expect that momentum to remain strong. I don’t know how many billion-plus deals, but these large transactions what drives some of the near-term financing issues that a lot of companies are going to have to deal with. And with what we are seeing play out in the banking sector with fewer banks out there to provide capital, the cost of that capital being what it is, given the interest rate environment, I do believe that sale leaseback will continue to be a very attractive alternative to raise capital to help address financing needs at these companies. Keep in mind, EG had never done a sale leaseback. They had that option for many, many years.

And they chose to go down this path largely to address some of the leverage concerns that they had on the balance sheet. And we expect that trend to continue. So — and that’s the reason why that’s the impetus behind why we felt we should increase our acquisition guidance by $1 billion.

Operator: And our next question today comes from Josh Dennerlein with Bank of America.

Joshua Dennerlein : Just a follow-up on the EG Group deal. Just curious how that deal came together and maybe your ability to partner up further with them?

Sumit Roy : Thanks for the question, Josh. So EG is obviously a very well-established name in the U.K. market. Neil and I had been calling on them for a while, along with TDR Capital, they’re capital providers for a while. And this is a relationship. We knew they didn’t have a high level of interest in necessarily going down the path of sale leaseback when we first started to have conversations with them. But I think that, that relationship ultimately played out to our benefit when we were awarded the deal when they did choose to go down the path of sale leaseback to help meet some of their capital needs shorter term. This was a competitive process. It was run by Eastdil. We went through. We were obviously in close contact with EG directly as well.

And there were three finalists, and we felt like we were awarded the deal based on our reputation, surety of close and the fact that we had spent time developing a relationship with them. So that’s what really got us the deal at the end. And our ability to be creative and there were certain asks that they had and our ability to meet those certain asks also, I believe, accrue to our favor. So I think all of those factors went towards us being awarded the transaction despite us not being the highest bidder.