Four Corners Property Trust, Inc. Q3 FY2021 Earnings Call

Hello and welcome to the FCPT Third Quarter 2021 Financial Results Conference Call. My name is Charlie and I will be coordinating your call today. I will now hand you over to your host Gerry Morgan, Chief Financial Officer to begin. Gerry, please go ahead.

Thank you, Charlie. During the course of this call, we will make forward-looking statements, which are based on beliefs and assumptions made by us. Our actual results will be affected by known and unknown factors including uncertainty related to the remaining scope, severity and duration of the COVID-19 pandemic that are beyond our control or ability to predict. Our assumptions are not a guarantee of future performance and some will prove to be incorrect. For a more detailed description of some potential risks, please refer to the SEC filings, which can be found at our website fcpt.com. All the information presented on this call is current as of today, October 27, 2021. In addition, reconciliation to non-GAAP financial measures presented on this call such as FFO and AFFO can be found in the company's supplemental report also on our website. And with that, I'll turn the call over to Bill.

Good morning. Thank you for joining us to discuss our third quarter results. I will begin with some introductory remarks, and then Patrick Wernig, our Director of Acquisitions, will provide details on our acquisition pipeline. Following that, Gerry will discuss our financial results. In summary, we achieved industry-leading collections of 99.8% for the quarter, and occupancy also improved to 99.8%. Our restaurant and retail tenants are showing strong performance, often exceeding 2019 pre-pandemic levels. This quarter, we acquired 53 properties, noted for their low rents and high-quality tenants. We reported an AFFO of $0.39 per share for the third quarter, reflecting a year-over-year increase of $0.02. We are pleased to see strong performance from restaurant operators in the third quarter, with quick service restaurants operating at 118% and casual dining at 107% of 2019 levels, according to Baird's latest weekly restaurant survey. Regarding investments, we acquired 53 properties this quarter for a total of $107.4 million, yielding an initial cash return of 6.4%. This acquisition showcases strong tenant credit profiles, including two dual-tenant properties, with 44 of the 55 leases held by corporate operators. The investments this quarter brought in six new brands, raising our portfolio total to 101 brands. Additionally, we have closed an extra $9 million worth of properties in the fourth quarter so far, taking our total closed investments for the year to $196 million. To put this $196 million in perspective, it compares to $132 million during the same 10-month period in 2020 and $94 million in 2019. We are entering the last two months of the year in a strong position with a solid pipeline. In terms of investment volume, restaurants and auto services each made up about 44%, while medical and other retail accounted for the remainder. For the year, medical and other retail have represented about 20% of the total volume. We are pleased with the range of opportunities available and, while restaurants remain our main focus for new acquisitions, we are also seizing the chance to invest in other sectors. As I mentioned, our pipeline remains very strong, and I want to reiterate my earlier comments from the second quarter about our satisfaction with the remaining pipeline for the year. Now, I will turn it over to Pat for further insights on recent acquisitions and the overall investment environment.

Thanks, Bill. As we mentioned, our third quarter was quite strong in terms of new acquisitions and building out the pipeline. Reflecting on recent deal volume, it's worth noting that this was our biggest quarterly investment volume since the fourth quarter of 2019 right before the pandemic. It's also one of the highest volume quarters in our company's six-year history. We believe that success has been due to our note maturing and expanding. The universe of properties we're going after is much broader than in the past. And so pricing shifts against us in one sector where there are fewer restaurant opportunities than any given three-month period. We can now find opportunities in other sectors and make our volume less choppy quarter-to-quarter. Case in point, we noted on our last earnings call that the pricing environment was very competitive for restaurants and retail net lease in general. Despite that pricing headwind, we've still been able to build out the pipeline in the mid-six cap rate area with high-quality tenants and real estate. Our pipeline sector mix for restaurants, auto services, and medical is similar to what we've seen so far this year. As we look towards new opportunities for Q4 and into 2022, you can expect us to stick with the same formula that made Q3 a success. First, we're actively engaging our existing tenant roster for new direct sale-leaseback deals. In Q3 we benefited from several of these transactions, including a $21 million Chili's deal and others with restaurant operators that have been repeat sellers to Four Corners. The fact that these operators are coming back to Four Corners demonstrates the positive relationship and deeper ties that came out of our tenant interaction during the pandemic. Second, we continue to explore new subsectors in retail and adjacent services. There's still principally auto services and repair, convenience stores, and medical retail, but it may further diversify in the future. Finally, we're focused on quality operators and being flexible to lean and fight for strong brands and credit profiles. Just to expand on that for a second, we still believe every deal needs to stand on its own merits and economics. We achieved a 6.4% average cash yield for the quarter and stand at 6.6% for the year. We think it's a great outcome particularly given the asset quality we've added to the portfolio. And now I'll turn it back over to Gerry.

Thanks, Pat. Just a recap of a couple of the financials we reported. We generated $42.2 million of cash rental income in the third quarter after excluding $1.4 million of straight-line adjustments. And as Bill highlighted, we reported 99.8% of collections for the third quarter, with no material changes to collectibility or credit reserves in the quarter and no balance sheet impairments. On a run-rate basis, our current annual cash base rent for leases as of the end of the quarter is $168.8 million. Our weighted average 10-year annual cash rent escalator is 1.4%. To remind everybody, that number was $94 million when we started in late 2015, so nice progress. We estimated the portfolio rent coverage is 4.6 times for the third quarter, which is on par with pre-pandemic levels. That includes coverage for the Darden properties of approximately 5.5 times using the latest reported sales results from Darden on our portfolio and their brand average margins for the quarter ending August 2021. Additionally, non-Darden restaurant coverage is estimated at approximately 3 times, also approaching or passing in some cases pre-pandemic levels. We note that while not all of our tenants report financials to us, rental coverage at these levels would translate often to rent-to-sales values of 5% to 8% for restaurant operators in the portfolio, which is lower than typical levels and shows both the strength of our tenants' operations and the low rents that are in place. Turning to the balance sheet, in the quarter we issued $27.7 million of common stock on our ATM program at a weighted average price of $27.67 per share. We ended the third quarter with $204.8 million of liquidity, which included $197 million of availability on the revolving line of credit. Our fixed charge coverage for the quarter was 4.9 times, and our quarter-end net debt-to-EBITDA is 5.8 times. Finally, we paid a dividend for the quarter of $0.3175 per share. With that, I'll turn it back to Bill for closing comments.

In conclusion, we're very happy with our results for the third quarter. We look forward to speaking with many of you at the upcoming NAREIT. And now we'll open it up to questions.

Our first question comes from R.J. Milligan of Raymond James. Your line is open. Please go ahead.

Hey. Good morning, guys. Bill, there's a lot of capital out there chasing restaurants. We're seeing improving fundamentals as you pointed out and it seems like cap rates are going to continue to compress. I'm just curious if you see anything out there that kind of pauses that cap rate compression or if you expect that cap rate compression to continue? And then secondly, Pat, you mentioned that the pipeline is pretty similar in terms of mix between restaurants and non-restaurants. And I'm just curious how you guys view that trending as we move into 2022 if you expect to do a greater percentage of non-restaurants versus 2021?

To your first point about cap rate compression on restaurants, we own over $2.5 billion worth of restaurants. So that's not a bad thing for our portfolio overall. I don't have any specific callouts, R.J. on what would change cap rates other than obviously rates moving around, but the brands continue to do well, and it's a dynamic where the strong brands continue to get stronger. So that is beneficial to our portfolio strategy since our existing portfolio is with industry-leading brands and we tend to focus on the higher end of the credit spectrum. As far as the mix of the pipeline, I think it will, as Pat mentioned, remain relatively consistent with what we have closed to date.

Okay. And my second question is, still have some outparcel closings left for the transactions already announced. I'm just curious if there's any opportunity out there or what you're seeing in terms of either off-market opportunities similar to what you did with the outparcel strategy or if pricing is slightly better for maybe a portfolio of assets versus individual one-off assets?

Yes. We do have a number of outparcel portfolios in the pipeline, and we do think the pricing is a little advantageous. But R.J., that often becomes because outparcels come with a lot of work. And so in some ways, we are getting paid for labor. But once it's in the portfolio, they're very strong properties with again low rents typically corporate operators and the vast ground leases.

And my final question is, third quarter volume obviously pretty big relative to the first half of this year. I think traditionally we've seen quite a bit of activity as sellers look to sell before the end of the year. I'm just curious if you anticipate another rush as we head into the end of the year?

Yes. I think it's going to be really busy, R.J. I don't think there's anything in particular that I would note. But I would anticipate the fourth quarter being busy as we said in our prepared remarks for sure.

Thanks, guys.

Thanks, R.J.

Our next question is from Sheila McGrath of Evercore. Your line is open. Please go ahead.

Yes, good morning. Bill, you mentioned broadening the opportunity set has helped in acquisition volume. I just wondered if you could remind us how big your acquisition team is currently? And how does that compare to a year ago? And do you plan on growing that team at any point in the future?

Yes, Sheila, that's a great question. Currently, our acquisition team consists of six members, which aligns with our situation from last year. It's encouraging to hear that Pat, Josh, and Balji have gained significant experience recently. The team is stable and has successfully acquired over $1 billion in properties, making them well-acquainted with the market. Regarding recruitment, we are continuously seeking talented and driven individuals to join our team. There is strong competition for skilled acquisition professionals in the market. However, as we continue to grow, we feel more confident in our ability to attract early-career individuals and train them in our acquisition process, consistent with our past methods.

Okay, great. I’m curious about the deals when targeting guarantees or the larger portfolio you mentioned, worth $21 million. Is the initial yield on those transactions lower than that of non-corporate guarantees? What is the pricing like for the portfolio?

Sure. Having a corporate guarantee is an important aspect of credit underwriting. We consider credit to be about half of our assessment, with the other half being real estate. In your question about whether there is a portfolio premium or discount, I would say there is currently a portfolio premium. However, for the two larger portfolios we had going into Q3, both included a time-compressed timeline component and involved repeat tenants. We had already negotiated a lease for those, so the portfolio premium was likely lower than it would be in a fully-marketed transaction.

Okay. Great. And last question, just curious on your insights, given that you own some restaurants. Give your big picture thoughts on current labor channels and food cost challenges to the restaurant industry.

Yes, Sheila, great question. We see advantages in our Carrols subsidiary in San Antonio, which operates seven Longhorn steakhouses as a franchisee for Darden. The management team running that subsidiary is exceptional. Carol, who leads that business on a daily basis, is a fantastic people leader with a deep understanding of the business and a strong drive. However, I believe if Carol were on the call, she would mention that there is a significant labor shortage. Currently, the main constraint in the restaurant industry is the availability of labor, not consumer demand. This situation is likely applicable to many retail sectors as well. Regarding food costs, they are a consideration, but they are probably less impactful compared to supply chain issues in other retail areas. The labor shortage is a very real problem.

Okay. Thank you.

Thanks, Sheila.

Our next question comes from Nate Crossett of Berenberg. Your line is open. Please go ahead.

Hey, good morning, guys. I was wondering, if you could potentially put some figures on just what is the actual size of the pipeline right now? And then, maybe just related to that, if you could give us an update on the Lubert-Adler JV? And what you're seeing come out of that so far?

Sure. We don't provide guidance on certain pipeline or acquisition volumes. On the other hand, we announced transactions the day they closed. As far as Lubert-Adler, we have not seen much activity there. I think Gene Lee on Darden's conference call referenced the level of speculation in vacant properties and unbuilt sites. We just have not been able to find properties at the right price point, such that you could redevelop them and earn a reasonable profit. So, it speaks to the supply-demand dynamic and that these brands are growing, but we have not been able to find vacant properties at bargain prices.

Okay. And as it relates to kind of the outparcel strategy, obviously, what you're disclosing there's not a lot left on that. So, how should we think about those relationships, I guess going into '22 in terms of like the total addressable market of those outparcel relationships? Is there anything to note there?

Yes. You'll see some close in Q4 Q1. We have some in our pipeline. We continue to think that is an opportunity set. We've been aggressive. I think we've bought nearly $300 million worth of outparcels. They performed exceptionally well through COVID. So, I would certainly not say that that opportunity set is over. But obviously, we've made very good progress thus far in addressing that unique avenue for acquiring properties. I would also say that, there are folks now who are trying to imitate that strategy. I think they're finding it very labor-intensive as we have. But like many things, when you have figured out a good idea and begin to implement it. Sometimes people follow in your footsteps.

Okay. Maybe just one last one on the disposal side. Is there anything that you'd be looking to grow, or is there anything on the watch list that we should be aware of?

We occasionally think about selling properties. We regularly get inbound inquiries for properties, but nothing notable. And nothing along the lines of the disposition watch list.

Okay. Thanks.

Thanks, Nate. Operator, any more questions?

Yes. The next question comes from Wes Golladay of Baird. Your line is open. Please go ahead.

Hey. Good morning, guys. I just had a quick question on the drivers of the acquisition closing this quarter. Is it primarily the deal flow or are you having a higher close right now?

It's deal flow.

Okay. And would you look at that as a total in those verticals?

Yes, no notable change in selectivity is how I would describe it; it’s just happens to have some timing of when things occur.

Okay. And you have built out the team over the last year. And I guess has that deal flow been ramping throughout the year?

I think there is a dynamic of that, but the team is relatively stable year-over-year; certainly, the senior members of the team. I think it's just, acquisitions are lumpy, Wes.

Okay. And then when we look at leverage, can you remind us of your targeted leverage? And I guess, how would you fund the future pipeline? Would dispositions be part of the mix?

Thanks, Wes. This is Gerry. Just to remind everybody, our targeted leverage is 5.5 to 6 times net debt to EBITDAR. We're at 5.8 right now. We'll continue to fund our investments through a combination of both equity and private notes and using our revolver in the interim. Dispositions is always a great card to have and one we could always pull if those other markets weren't cooperating. But as of now, it really hasn't been to date.

Okay. Thanks, guys.

Thanks.

Our next question is from John Massocca of Ladenburg Thalmann. Your line is open. Please go ahead.

Good morning, everyone.

Good morning.

So with regards to the mix on non-restaurant acquisitions, is the focus that kind of seemed to be out there in 3Q on auto service, tire, veterinary health, etc. Is that being driven by underwriting? And how you view that real estate in those ten industries? Is it potentially maybe being undervalued, or is that just where deal flow is today? Just trying to think of why those kind of industries versus maybe car washes, off-price retail, home décor, etc.

We haven't focused much on off-price retail, home décor, or dollar stores. However, when considering the various net lease subsectors, we find that the sectors we prefer, similar to restaurants, where pricing is as favorable or better than restaurants, include auto services and a broad range of medical retail for both humans and pets.

I mean, is any of that driven by just kind of your thoughts on the size of the footprint? I mean, obviously, some of those categories you haven't invested in a larger footprint. Is that a focus going forward?

Do you mean footprint, property leasable area?

Yes, yes. Total square footage.

Yes. I don't think that's a driver. I don't think that's a driver, Wes. They're very often the same square footage as a casual dining restaurant, as an example. I don't think that's the real driver. And we focus on low rent. So our average purchase price has been highly consistent.

Okay. And then, maybe how is pricing trending for portfolios versus one-off transactions? If I look at the 3Q transaction activity. You did a sonic portfolio that was on the lower end, the cap rates, but it was also QSR. So, I mean, is there any pricing premium or discount there if you do kind of either these midsized ones that are 8, 9, 10 assets or even maybe larger than that?

Yes. I would say that what we're seeing in the market, especially for larger well-marketed portfolios, is a portfolio premium, if anything. Those two Middle East transactions that we spoke to earlier, both had, as I mentioned, a timing component to them. So we were able to get them at pretty good prices. But yes, if anything, the market’s quite strong and our competitors are really volume-focused is our view. And so, portfolios tend to be well bid.

Okay. That’s it for me. Thank you very much.

Thanks so much.

Thanks.

The next question is from Anthony Paolone of JPMorgan. Your line is open. Please go ahead.

Thanks. There isn’t much left to discuss. Regarding yields, at the beginning of the year, it appeared that cap rates, especially for restaurants, were compressing, and it seemed to be a trend across various leases. Do you think that over the past quarter they have changed at all because of interest rates, or have they settled into a consistent pattern?

It's a great question. I think we sort of have a little bit of a stabilization. They have not increased because of interest rates by any means, but seem to be able. If anything, I would anticipate continued compression. But as of today, we've been pretty consistent in the low to mid-6s as what we've been looking at to acquire.

Okay. Yes, it seems as if earlier in the year like maybe we were going to head into the 5s in terms of your deal flow, but it sounds like you think you could hold here with the six handle, is that fair?

I think that's fair. Certainly, lots of properties that we're seeing are in that high 5s, mid-5s cap rate range. And some of our competitors have gone aggressively into that area, but we've tried to have sufficient deal flows, strong deal flow, but at a low to mid 6% cap rate.

Okay. And then just I think following up on a prior question about just the type of things you're looking at as you look at other areas. Any plans to go into things like industrial or products where just the average ticket size could go up meaningfully from like a smaller box retail or restaurant or auto type service?

It's something we're constantly testing in the acquisition of our Board. But I think thus far has been to feel very comfortable with what we're acquiring versus just migrating to asset types that will allow us to deploy more capital and perhaps regret it later. So, we're always testing that open-minded. But thus far, I think you should expect to see a continuation of the kinds of properties we bought historically.

Great. Thanks.

Thanks.

We have a follow-up question from Sheila McGrath. Your line is open. Please go ahead.

I guess, Bill, for the last couple of years you've announced the dividend increase in November. I was just wondering if you could remind us of your dividend policy. Are you aiming for a specific AFFO payout ratio?

Yes. Sheila, we address it with the Board annually. It's always been in the late fall, early winter. We've said that we wanted a payout ratio in and around 80%. I don't think any of that's changed overall, but it's a decision we bring to the Board in our November meeting.

Okay. Thank you.

Thanks, Sheila.

There are no further questions on the line at this time.

Thank you, Charlie. Thank you for a robust set of questions. We're here if anyone would like to talk. And again, thank you. We feel great about the quarter and the pipeline for the remainder of the year. Thank you, everybody.

This concludes today's call. Thank you for joining. You may now disconnect your lines.