Four Corners Property Trust, Inc. Q3 FY2022 Earnings Call

Hello everyone, and welcome to the FCPT Third Quarter 2022 Financial Results Conference Call. My name is Maxine, and I will be coordinating the call today. I will now hand over to Gerry Morgan to begin. Gerry, please proceed when you are ready.

Thank you. 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 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 our SEC filings, which can be found on our website at fcpt.com. All the information presented on this call is current as of today, November 2. 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.

Thank you, Gerry. Good morning. Thank you for joining us to discuss our third quarter results. I am going to make introductory remarks; Patrick will review some details around acquisitions in the pipeline, and then Gerry will discuss the financial and capital results. The existing portfolio continued to perform exceptionally well with rental collections at 99.8% for the quarter and occupancy remaining at 99.9%. We reported third quarter AFFO of $0.41 per share, which represents a 5% increase year-over-year. We grew cash rental revenues 12.7% on a year-over-year basis, including the benefit of rental increases and $236 million of acquisitions over the trailing 12 months. This included the acquisition of 26 properties in the third quarter for $70 million at an initial cash yield of 6.3%, reflecting rent credits at closing and near-term rent increases of 6.2% on rents in place as of September 30. Twenty-three of the 26 acquired properties are corporate-operated, and we remain highly confident we are aligning our portfolio with best-in-class operators at attractive rent levels. Eleven of the properties were mall outparcels with strong operators, top brands, and 12 of these are ground leases, further evidencing the low rents in place. Patrick will soon discuss the investment environment in more detail, but we continue to see acquisition pricing improve in response to the higher cost of capital environment. This has been especially acute in the last month as the higher interest rate environment became more entrenched in sellers' expectations on cap rates. We are actively bidding on portfolios 50 basis points to 100 basis points above where they would have priced a few months ago. We are already seeing momentum of this shift in pricing in our Q4 investments, but we note that in many circumstances, there is a delay between price agreement and closing. We have also, in selective cases, readdressed pricing on properties in our pipeline. Since inception, we have run this business sensitive to our cost of capital, and we've been careful to align incentives to this goal. For example, our acquisition team has not paid on acquisition volume. We have a team-based approach to acquisitions, and we don't provide acquisition guidance. This has allowed us to keep a clear head when markets are in flux. In the quarter, we also sold four properties for a combined sales price of $8.6 million, representing a 5.5% weighted average cash capitalization rate. The strong demand for our portfolio of properties provides us an alternative source of capital and validation of our portfolio quality. Moving on to our tenants' performance. Restaurant operators continue to have strong results in the most recent quarter, although many are expecting a downturn and focusing on keeping meals affordable, which has put pressure on pricing. Quick-service restaurants are operating at approximately 120% of weekly sales levels and casual dining is operating approximately 103% of weekly sales levels as compared to 2019 according to Baird's most recent restaurant survey reported on October 24. Our estimated EBITDA to rent coverage stood at 4x for the 75% of our portfolio that reports this statistic. We believe that 4x coverage is amongst the strongest within the net lease industry. This is when we reflect on the importance of rent setting and how that ultimately leads to stable landlord cash flows even in challenging economic environments. These high levels of coverage provide a cushion for periods where inflation impacts store level performance. Turning to the balance sheet. We raised $79 million of equity in the third quarter at an average price of $28.09 per share to support our investment program and delever. And additionally, the $8.6 million of dispositions helped fund our pipeline in the quarter at accretive rates. We've looked at dispositions more often and opportunistically in 2022 than in prior years. We would expect to continue utilizing dispositions as an alternative capital source to raising debt or equity in certain circumstances. Last week, we also announced the amendment to our credit facility, which reduced pricing and extended maturities by five years on $150 million of existing term loans and raised $30 million of additional proceeds. Our leverage remains conservative, and our debt maturities are fully staggered with the first maturity of $50 million not due until June of 2024.

Thanks, Bill. I'd like to start by discussing the sector exposure of closed investments in Q3. For the quarter, restaurants accounted for 52% of our new investments; auto service was 22%; medical retail was 19%; and the remaining 6% comprised of other retail. Turning to the cap rate environment. There has been a significant shift from Q2. Since April, we've been observing a general softening of the market and sellers' expectations on cap rates. However, over the past 10 weeks, the momentum in that trend has accelerated considerably. The rising borrowing costs have narrowed the pool of potential buyers for net lease, both on a local and institutional level. As a result of the reduced competition, we're seeing some very interesting investment opportunities; many are going in cap rates near or above 7%. To be clear though, we think that now is the time to be particularly prudent and selective on new investments. As we consider where to deploy our capital, we think about: one, how well the tenant's credit profile or the sector that they operate in fits within FCPT's previously established criteria; and two, whether the cap rates still make sense in a high interest rate environment. So we're remaining highly focused on sticking with the niche we know best in protecting positive investment spreads. We'll continue to exercise price discipline with what we introduced to the pipeline. Bill mentioned this earlier, but we are now regularly submitting offers at cap rates that are 50 basis points to 100 basis points higher than where those assets would have priced earlier this year. Some of those deals are already in the pipeline and are expected to close in the coming months. Speaking of the rest of the year, we've built out a pipeline of properties with high-quality tenants in well-located retail corridors. We're seeing more and more sale leaseback and outparcel opportunities. This influx is directly related to the rise in debt costs, making real estate sales a more attractive capital source on a relative basis. We anticipate that those opportunities will continue to present themselves into 2023. On the disposition front, as Bill mentioned, we completed the sale of four properties in the quarter for $8.6 million at a 5.5% cap rate. Those were comprised of an Applebee's, two Burger King's, and a Popeyes. These stores were specifically selected as disposition candidates based on underperformance versus their respective brands or store level profitability. We are particularly pleased with the strong cap rate achieved while still pruning our portfolio for quality. To cap off my comments, I'd reiterate that we're reacting to the changing landscape for net lease in real time, and we're optimistic about our outlook for Q4 and 2023.

Thanks, Pat. We generated $47.6 million of cash rental income in the third quarter after excluding $1.1 million of straight-line and other non-cash rental adjustments. We reported 99.8% collections for the third quarter. No material changes to our collectability or credit reserves, nor any balance sheet impairments in the quarter. On a run rate basis, our current annual cash base rent for leases in place as of September 30 is $185.5 million, and our weighted average five-year annual cash rent escalator is 1.44%. Cash G&A expense, excluding stock-based compensation for the quarter, was $3.7 million, representing 7.8% of cash rental income. Turning to the balance sheet. We are well-capitalized to fund growth. As Bill and Pat mentioned, we raised $79 million of equity via our ATM program in the third quarter at an average price of $28.09 per share. At September 30, we held $37 million of cash and had 2.6 million shares under forward sales agreements with anticipated net proceeds of $71 million upon settlement. This $71 million is made up of $48.5 million of forwards that were entered into in the third quarter and $22.5 million of forwards from prior quarters, including the $250 million of undrawn revolver capacity; we start the quarter with over $358 million of available liquidity. On October 25, we announced an amended $680 million bank credit facility, and I wanted to highlight three aspects of this refinancing. First, the amendment extended $150 million of term loans due in 2023 and 2024 to mature in 2027 and 2028. Existing term loan tranches due in 2025 and 2026 were unaffected by the amendment. Overall, our first debt maturity is now $50 million of private notes not coming due until June 2024. We remain committed to layering and using conservatism on our debt maturity stacking. Second, we converted the facility from LIBOR to SOFR and improved the credit margin by 5 basis points to 95 basis points over adjusted SOFR on the amended term loans. And finally, we increased the size of the facility by $30 million for additional proceeds to fund Q4 investments. Thank you to all of our existing and new bank partners who reiterated their support for FCPT in this transaction. I remind everyone that we have an ongoing programmatic interest rate hedging program where we extend hedges on a regular basis to fix the rate on much of the variable rate term loans. We are hedged on $325 million of the $430 million of term loans currently at an average all-in rate of 2.79%, including the credit spread for 2023. Overall, including the $575 million of fixed rate private notes we have issued, Four Corners has fixed the rate on over 89% of our outstanding debt. More information on all of our term loan interest rate hedges can be found in the investor presentation also posted on our website yesterday. A final capital comment. As also disclosed in the earnings press release, we have $75 million of forward starting swaps in place, effectively fixing the 10-year treasury base rate at approximately 2.6% for contemplated long-term debt issuance. With respect to overall leverage, our net debt to EBITDA in the third quarter was 5.5x, and our fixed charge coverage remains at a healthy 4.9x. Pro forma for settling and deploying the remaining equity forwards and for the increased credit facility described above, we estimate our leverage is approximately 5.4x, well below our target of 6x leverage. And with that, we'll turn it back over to Maxine for investor Q&A.

Thank you. Our first question comes from Tony Paolone from JPMorgan. Please go ahead. Your line is now open.

Great. Thank you. Hi, I guess, first question, Bill, you'd mentioned when you talked about the 50 basis point to 100 basis point move in yields, you'd talked about it, I think you mentioned portfolios. And so just wondering if that type of movement is only being seen for larger transactions? Or are you seeing this just across everything?

Across the board. Across the board.

Okay. Okay. And can you talk about just the size of the pipeline and whether this movement and you're seeing buyers kind of dropout of the pool if that gives you an opportunity to perhaps do more here? And I know you don't manage to volume, but just wondering how to size like sort of this movement and your ability to lean into it.

I believe it’s worth mentioning that this spring, we anticipated the second half of the year would offer more opportunities for acquisitions. Therefore, we adjusted our pipeline to leverage pricing during that period, and it has worked out very well.

So do you think the fourth quarter will be stronger? Or how should we think about the near-term?

Yes, we plan to hold these buildings for 50 years, so I don't focus on quarterly fluctuations. We are confident in our acquisition pipeline, which is priced at or very close to the market. We've also adjusted the pricing of some properties in our pipeline and are pleased with our current position. Additionally, we are glad that last year we did not fall into the mid-5s cap rates like many of our competitors. Our previous pricing discipline and adjustments to our bidding in the spring have positioned us well for the rest of this year and the start of next year.

Okay. I would like to ask about the tenant side of things. Historically, during recessions, casual dining tends to decline as people's discretionary income decreases, and now with delivery options available, do you think that delivery might actually support the tenant credit trends if we face another recession? Or do you view delivery as more of a discretionary choice as well? How are you considering the impact on the next downturn?

Yes. Darden has been quite conservative regarding delivery as a tenant, similar to Brinker. Consequently, we don't have significant delivery exposure, and our rent coverage in casual dining has been established at very cautious levels. We have prepared ourselves for tougher times. As a reminder, during COVID, we collected 99.8% of our rents by June or July. We have built a very conservative portfolio designed for challenging conditions. Therefore, as long as our cost of capital remains stable, we believe we are well-positioned to navigate difficult macroeconomic environments.

Okay. Thanks for the time.

Thank you. Appreciate the questions.

Thank you. Our next question comes from Rob Stevenson from Janney. Please go ahead. Your line is now open.

Good morning. Bill, restaurants, non-restaurant transactions, are you seeing better opportunities in one over the other or better cap rates, et cetera?

QSR typically trades at a premium. But even in QSR, we're seeing really good stuff now in the mid to high 6s. I would just reflect that having a broader aperture to our acquisition strategy is really paying dividends because we're seeing really interesting stuff to do across our three main verticals. But the whole market has readjusted in pricing because, frankly, the cost of borrowing is being affected across the board, not just by any particular industry.

Okay. And then other question, looks like you guys basically have about two quarters plus or minus of acquisition funding available from the current unsettled forward deals. Your stock price has hung in there better than many of the peers. Do you become more aggressive here on forwards to make sure you have capital in 2023, no matter what? Is $70 million plus or minus the right number there? Or is it just as simple as the stock price is 28, and we'll do more. If it goes to 22, we won't. How are you guys thinking about the right amount of forward equity to have in the current environment?

I think it's the second of the two arguments that you put forward. We're price-sensitive, market-sensitive, and we try to be opportunistic. As you saw us be opportunistic now that we're making it clear in the summer when our stock price we felt was an attractive funding source.

Okay. Thanks, guys. Appreciate the time.

Yes. Great questions.

Our next question comes from Wendy Ma from Evercore. Please go ahead, Wendy. Your line is now open.

Hi, good morning, everyone. Thank you for taking my questions. I have a quick question about the acquisition cap rate for the third quarter. You mentioned improvements in acquisition calculations, but the cash cap rates for the third quarter are actually lower than those in the first and second quarters. I'm curious if there's a specific reason why the acquisition cap rate decreased in the third quarter.

Yes. There are a couple of points to mention: first, the mix in Q1 and Q2 included a 6.7% cap rate that I remember. We experienced a higher mix during that time. It's important to note that the Q3 acquisitions or properties were likely priced in May and June, and the process of due diligence, negotiating purchase agreements, conducting site inspections, and reviewing environmental reports can take 30 to 60 days. This is why the Q3 acquisitions reflect prices that were established earlier. However, moving forward, we've reassessed pricing on several properties in our pipeline, and the agreements we are currently making are at higher cap rates. Additionally, the Q3 properties were financed with capital raised in Q1 and Q2. Lastly, our reporting system will provide you with real-time insights on pricing that exceeds our competitors' capabilities.

Thank you. Our next question comes from John Massocca from Ladenburg Thalmann. Please go ahead. Your line is now open.

I have a quick question regarding the bifurcation related to cap rate expansion. You mentioned an increase of 100 to 150 basis points. How much of that consists of properties that were previously priced at the 6.3 level and have now risen above a 7 cap? Also, how much of that is from properties that were outside your target range and have become more appealing due to this expansion?

Sure. So we said 50 basis points to 100 basis points; you're trying to sneak 50 basis points in us, but I'll relay that to the acquisition team that they need to work a little harder. Fifty basis points to 100 basis points, John. I would say it's a combination, right? It's QSR deals that they might have sold on the 1031 exchange market earlier this year a 100 basis points lower. Now there's additive pressure around the capital markets and they want proceeds and they want surety of close. It's deals that have been re-traded from individual buyers who can't get financing. It's folks who typically would rely on the high-yield market to finance their business who now are looking at net lease as an attractive alternative. It's the whole gamut. And so we're seeing really interesting stuff to work on. We're very happy that we were sort of slow playing it earlier this year to have plenty of capacity to execute our business plan the second half of this year or the beginning of next year. So we feel really well positioned. But John, to your point, it's really a diverse range of acquisitions, many, frankly, that we bid on earlier and were not selected. And now they're coming back to us because they know we have the capital to close deals.

Okay. I apologize for raising expectations too high regarding acquisitions.

That's actually my job, but I appreciate it.

As I think about the 1031 market, is there a point you look back over the last six months where maybe that demand has kind of broken or become a little bit more interest rate-sensitive? Or is that even still both on the disposition side for you and maybe on the granular acquisition side, is that still a kind of very competitive buyer on price that you potentially have to compete with or even sell to?

Yes, we have experienced success in our sales efforts. While we do compete in the market, it's important to note that everyone is subject to the same treasury rates. This applies whether you're involved in 1031 exchanges or purchasing large portfolios. We have taken advantage of raising capital at attractive rates in the past, which provides us with the necessary resources for acquisitions. However, for buyers engaged in 1031 exchanges, borrowing in the mortgage market—which we don’t pursue—requires them to pledge their properties, and current mortgage rates are quite high, falling in the low to mid-7% range. Consequently, the opportunity for positive leverage through financing is limited, making REIT buyers a more appealing option.

Thank you. This concludes our Q&A session for today. So I'll hand you back to Bill for closing remarks.

Well, thank you, everyone, for joining our call. If anyone has any questions, please reach out. We'd be more than happy to help. Cheers.

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