Four Corners Property Trust, Inc. Q4 FY2022 Earnings Call

Ladies and gentlemen, welcome to the FCPT Fourth Quarter 2022 Financial Results Conference Call. My name is Glen, and I’ll be the moderator for today’s call. I will now hand over to your host Gerry to begin. Gerry, please go ahead.

Thank you, Glen. 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 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, February 16, 2023. 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 fourth 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 raising results. The existing portfolio continued to perform exceptionally well with 99.9% collections for the year ended December 31 and occupancy remaining at 99.9%. We reported fourth quarter AFFO of $0.41 per share, and $1.64 per share for the full year, which represents 5% growth for 2022 over 2021. We grew cash rental revenues 11.4% on a year-over-year basis, including the benefit of rental increases, and $286 million of acquisitions in 2022. This included the acquisition of 42 properties in the fourth quarter for $120 million at an initial cash yield of 6.6%, reflecting rents in place as of December 31. 33 of the 42 acquired properties are corporate-operated, and we remain highly confident we are aligning our portfolio with best-in-class operators at attractive rent levels. Patrick will discuss the current investment environment in more detail, but in the fourth quarter we continued to see acquisition pricing improve in response to the higher cost of capital environment. The Q4 acquisitions average cap rate reflected that dynamic at 6.6% versus 6.3% in Q3. The blended Q4 figure included deals priced earlier in the year prior to the shift in cap rates, with more recently priced deals above the average for the quarter. We note that sale-leaseback transactions have more appeal now to operators versus other forms of financing in recent years. Equity capital, term loans, CMBS have all become more expensive in the last six months. And this has led us to more opportunities in discussions with tenants looking to expand operations or monetize their real estate. I wanted to note two very specific but very minor headwinds we experienced in the quarter regarding FFO. First, our restaurant subsidiary Kerrow experienced a much lower EBITDA margin in the quarter. Sales remain strong and in line with prior quarters, but Kerrow experienced higher food and beverage, labor, utility, and other services costs impacted by inflation. Kerrow has already started to see some relief and the increase in beef and other costs, so we expect this impact to moderate in the first quarter of this year. The second minor headwind was higher interest expense. 90% of our debt is fixed at a rate of 3.39% currently. However, interest rates on the remaining 10% of our debt are variable, and pricing increased on average by over 145 basis points versus the third quarter. A reminder to our investors that we think 90% fixed and 10% variable rate debt is appropriate for our business, and we’ve benefited some quarters, but unfortunately, we were impacted in quarters like last quarter. Our current run-rate as of the quarter-end is 3.6%. In the quarter, we sold one property for a sales price of $4.9 million representing a gain of $600,000. For the full year 2022, we sold eight properties for $26 million. The strong demand for our properties provides us an attractive alternative source of capital while also improving the overall quality of the portfolio. Moving to our tenant’s performance, restaurant operators continue to have strong sales results in the most recent quarter. Although many are experiencing pressure on margins as cost increases in food and labor are not fully passed on to the end consumer, as I mentioned earlier, while discussing it, looks like restaurants are seeing a slowing of commodity cost increases, especially meat prices. Sales continue to hold up as restaurants are operating approximately 120% of pre-COVID weekly sales levels, and approximately 109% of last year’s weekly sales levels, according to a bearish restaurant survey reported on February 6. Our estimated EBITDA to rent covers 4 times for the 72% of our portfolio that reports this statistic. This is amongst the strongest coverage within the net lease industry. Three reorder points we make almost every quarter focus on low rent, providing a cushion when inflationary input prices impact store levels. Turning to the balance sheet, we raised $72 million of equity in the fourth quarter at an average price of $26.70 per share. We also raised $30 million of incremental debt proceeds as part of extending our credit facility in October. We would also expect to continue utilizing dispositions as another solid source of capital. Finally, one comment on the team. We were very excited to announce in January the promotion of Jim Bratt to serve as FCPT’s Chief Operating Officer. Jim has been with us since inception, and during this time, FCPT has acquired 624 properties, grown its employee base from six to 35 and invested significantly in operations. Jim has been an integral part of all of this and our effort to drive value for our shareholders, given his unique skill set and operations, real estate transactions, and legal judgment. Thank you, Jim. With that, I’ll turn it over to Pat.

Thanks, Bill. I'd like to start by discussing the sector mix of the $120 million of closed investments in Q4. For the quarter, restaurants accounted for 40% of new investments, auto service was 33%, medical retail was 24%, and the remaining 3% consisted of other retail. Amongst others, these investments included a portfolio of Buffalo Wild Wings properties in Illinois for $14 million at a 7.3% cap rate. A medical retail portfolio in Chicago for $12 million at a 6.8% cap rate, and a sale leaseback of five unspecified properties in Indiana for $8 million at a 6.5% cap rate. As Bill mentioned, the impact of higher interest rates allowed cap rates to trend upward last quarter. Ultimately, because of how quickly the market moved in the second half of 2022, we did go back to several sellers and discuss price adjustments. I’d also note that deals priced in the latter part of Q4 and now into 2023 have generally been above the 6.6% cap rate average for Q4. We remain highly focused on protecting our positive investment spreads. So far in 2023, we’ve observed cap rates give back a bit of the pricing gains we enjoyed as buyers in Q4, but not much. We believe this is a direct result of lower interest rates in 2023 and some net lease investors reentering the market. That said, we continue to bid on properties 50 to 75 basis points above where they priced in the first eight months of last year. We’ve also had several sellers that previously refused our pricing in Q4 come back to us with adjusted expectations this year. We remain active on the acquisition front, and as we look at our pipeline, we expect to have a busy March with a number of deals closing in the latter half of the quarter. I’d like to remind everyone that Q1 typically ends up being our lowest deal volume quarter for the year. For example, in 2021 and 2022, Q1 was 15% of acquisition volume for those years. Regarding the pipeline, we’re seeing some very interesting outparcel and sale leaseback opportunities. We’ve been able to remain selective on tenant and real estate quality while finding deals that fit in our target yield profile. Momentum on our dispositions efforts has also continued. Bill mentioned we completed the sale of eight properties in 2022 for $26 million. We’ve also sold another two Red Lobsters and one Burger King so far in 2023 for $12 million. These stories were specifically selected as disposition candidates based on relative underperformance versus their respective brands. We expect to continue recycling capital opportunistically into new acquisition, particularly where we can improve portfolio quality. Now turning to Gerry for a discussion on our portfolio and financial results.

Thanks, Pat. We generated $49.2 million of cash rental income in the fourth quarter after excluding $0.9 million of straight-line and other non-cash rental adjustments. We reported 99.7% of collections for the fourth quarter at the end of the year and 99.9% for the full year. There were no material changes to our collectability or credit reserves nor any balance sheet impairments in the quarter. On a run-rate basis, current annual cash base rent for leases in place as of the end of the year is $194.9 million and our weighted average five-year annual cash rent escalator is 1.42%. Cash G&A expense excluding stock-based compensation for the quarter was $3.9 million, representing 8% of cash rental income for the quarter, and cash G&A for the year was $15.1 million. For your modeling purposes, we expect cash G&A for 2023 will be approximately $16 million, representing around 6% growth. The increase is tied principally to compensation expenses. We focus on retention of our existing team, additional team members to bolster our investment operating prowess. We continue to focus on technology and systems to help us with the increased complexity of the portfolio and improve efficiency. Since inception, we have grown from six team members to 35 today. Turning to the balance sheet, we are well capitalized to fund growth. As Bill mentioned, we raised $72 million of equity via our ATM program in the fourth quarter at an average price of $26.70 per share. On December 31, we held $26 million in cash and had $2.5 million shares under forward sell agreements, with anticipated net proceeds of $68 million upon settlement, including the $250 million of undrawn revolver capacity we start the year with over $343 million of capacity. We discussed last quarter, but to remind everyone, in October, we announced an amendment to our credit facility, which reduced pricing, extended maturities by five years on $150 million of existing term loans, and raised $30 million of additional proceeds. The facility was converted from LIBOR to SOFR. Credit margins were improved by five basis points, and our overall leverage remains conservative. Our debt maturities are fully staggered, with the first maturity of $50 million, not due until June 2024. We have an ongoing programmatic interest rate hedging program where we extend hedges on a regular basis to fix the rate on much of our variable rate term loans. As of the end of the year, we are hedged on $325 million of the $430 million of term loans, currently at an average all-in rate of 2.79%. And as Bill mentioned, when you add the fixed-rate private notes, we are over 90% hedged at a 3.39% rate. With respect to overall leverage, our net debt to adjusted EBITDA in the fourth quarter was 5.6 times. Our fixed charge coverage ratio remains at a healthy 4.7 times. Pro forma for settling and deploying the remaining equity, our leverage is approximately 5.5 times and well below our target of 6. As we discussed in the earnings press release, as of December 31, we have $75 million in forward-starting swaps in place, effectively fixing the 10-year treasury base rate at 2.6% for that portion of our next long-term private note issuance. And with that, I’ll turn it back over to you, Glen, for investor questions.

Thank you. We have our first question from Rob Stevenson from Janney. Rob, your line is now open.

Good morning, guys. Bill, I appreciate the color that you guys gave on the dispositions being some relative underperformers, but anything to the underperformance of Red Lobster, specifically, since you’ve been selling a number of those over the last six to eight months?

Yes. Over the years, Rob, we’ve bought 24 Red Lobsters for approximately $75 million. They have long lease terms. And we bought them at about a 6 to 7 cap. We’ve sold three of them, as you mentioned, for just over $14.5 million. So that is a couple of million dollar gain that puts Red Lobster at under 2.5% of our rent. We have five that are on the market. They may or may not sell, but we’ve had good luck thus far. That would leave 16 properties, half of those are in a master lease that has two times coverage with 21 years of term. The rest are low-rent ground leases that we bought in our outparcels strategy. We think those probably have coverage over five times. So those eight properties, I think this is an important point: those ground leases have just over $100,000 in rent. If we sold those, we’d be under 2%—like just over 1.5% of rent. But I think the two important things to consider on Red Lobsters are that those 16 remaining have 40% lower rents than the universe of Red Lobsters that we’ve underwritten to date, which is 65 of them, and 11 of the 16 are next to an Olive Garden or a Longhorn, adjacent to them, and the remainder are also very well located. So we feel pretty comfortable. And Union, who owns Red Lobster, discussed Red Lobster during their call, and they’ve provided more credit support. They are changing out management. So we feel very good about our position there.

Okay, and in the restaurant category, in general, are you seeing whether or not it’s by price point or by offering between QSR and unlimited and full-service? Anything where certain people are having more pricing power in order and able to raise the entree prices to offset some of the higher food input costs? And others are struggling with that or is it fairly even across the board? How should we be thinking about that as long as food input costs remain high?

Yes. So we’re seeing some brands raise prices, while others are really trying to capture market share and not raise prices as much. But I’d also say we’re seeing these commodity costs now sort of recede a bit. So I think it’s across the board, and the branded restaurants, the kinds of restaurants we own, have dramatically outperformed chef-owned and local restaurants and gained significant share. I’d also say dine-out inflation has been more moderate than supermarket or dine-in inflation.

Okay, and then last one for me. You guys talked about how the expenses in the owned Longhorn portfolio, that the expenses were a combination of food input and labor. What was the sort of breakdown? I mean, how much of the additional expenses were the food input costs that may be coming down versus labor costs, which don’t appear to be abating in the near term? And anything tenants are able to do technology-wise these days to reduce staffing needs and mitigate some of the labor costs?

Yes. It’s a really small number. I mean, our business is so predictable that on a $3 billion business, even $100,000 here or there seems to be noticeable, because we’re so predictable generally. So the delta on Kerrow was staffing up over last year, where we were struggling to find labor. We had a specific training program that increased hours in the quarter, which was sort of a one-off thing. And then beef prices are moderating, but Kerrow is an exceptionally well-run business. We’ve had it now for 35 quarters. This is the first quarter that it’s had a result that was a little lower than we expected, so I don’t think there’s anything to read into that. Probably most folks wouldn’t even mention it, but we thought it would be worth calling out just because it was a couple of hundred thousand lower than we thought it would be.

Okay, and then anything on the technology side that either you guys with your own stuff, or you’re seeing widespread among the tenants applying to reduce staffing needs?

I mean, in our acquisition effort, we use the old path to manage the process. We’ve actually taken a number of investors through that. We find that helps efficiency and keeps us very organized. When you buy a building every one and a half days, like we did last quarter, you need to be organized, and that helps us. We use technology to track traffic. I think that’s directionally helpful. But those I think would be the two call-outs for our business. And then at the restaurant level, I think the big call-out would be QSR becoming almost an entirely drive-thru business. It was already a majority drive-thru business, but almost entirely a drive-thru business during COVID. I would imagine over time, it will settle not at the peak of near 100% during COVID, but it will settle at a higher level of drive-thru than pre-COVID.

Thank you, Rob. We have our next question from an unidentified analyst. Your line is now open.

Hey, good morning everyone. I got a question on a little follow-up on the Red Lobster. Obviously, some very low ground rents there now. I guess ideally, would you want to get those back? And I guess a broader picture, are you seeing much distress on the restaurant side where maybe you’re in? Do you still have that JV with Lupard Adler? Could this all come into play at some point?

Yes, we’ve actually had pretty favorable luck on getting properties back. But the sample size is really small. Thankfully, we got back to Ruby Tuesday’s in Maine and released it to Darden to put an Olive Garden there and have a little bit of a pickup. It’s not our strategy; it can be distracting. But you’d much rather be going into those discussions with very low rents. Very low rents are more likely to be reaffirmed in restructuring, all else being equal. We’re not seeing a ton of distress in the restaurant space, as sales are so much higher, and rent as a percentage of sales has moderated. Construction costs are so expensive that people are repurposing old buildings, and they don’t want to move out of existing buildings. So I think that addresses the question.

And then I’m just curious; I think you’ve commented that the pipeline this quarter would be back half loaded, but just curious how much visibility you have into the end of the year? Is it more like a six-month view on the pipeline that you have visibility on, understanding that some of these deals are large and complex, where you have to do a lot of work on the ground leases and such? So just kind of curious how much visibility you have?

Yes. We have substantial visibility over the next three months, I would say, and then some of the properties we know we’re going to purchase them. But we know that there are steps that need to take place, and sometimes in the outparcels, that could take a year, or at certain jurisdictions even more. We try not to be overly fussed with managing the pipeline quarter to quarter. Once you own these buildings, you have to live with the consequences of your decision to buy them. The last thing you want to do is lower your quality expectations in order to even out a quarter. As Patrick mentioned, it’s typically busy at the end of the last half of the year, as it was last year, and then a little softer in Q1. So this is, frankly, the same dynamic we’ve had for the last three years.

Got it, then maybe just one for Gerry. How should we think about timing of a debt deal once you get to the line to a certain level? Just take down the debt issuance?

Yes, great question. Sometime this year would be the answer I would give. Obviously, our line of credit had a zero balance on that at the end of the year. We’ve got forwards at the start of the year. So we’re in great shape. But we will also be opportunistic to take advantage of that market when we see margin rates. In the private note market, you can forward fund. That forward funding option has actually extended as the curve is negative now and investors or insurance companies are more willing to do that. So I think we have a lot of optionality around when we do it.

Thank you, Wes. We have our next question from John Massocca of Ladenburg Thalmann. John, your line is now open.

On the acquisition side of things, as you think about the competitive set, when we’re going into kind of CDs deals are closing deals and what’s been happening with the 1031 buyer over the last couple of months? Is that faded away a little bit as the year has ended? Has that strengthened? I save; I tend to be one buyer and just individual buyers, high-net-worth buyers, etc.

Sure. So 1031 exchanges require what’s called the down leg—the asset that they are selling, where the proceeds get crowded and then reinvested in assets they’re buying. And so the transaction market for the down leg, which is very often not net lease, it’s usually an apartment building, very typically. So the transaction volume of those have fallen, and consequently, with a lag, the amount of 1031 buyers in the market has fallen. That doesn’t mean it’s not still competitive. But those are often levered buyers, and their cost of financing has gone up. So there was a dynamic, as Patrick alluded to in his comments, where properties that were on the market over the summer and fall had to readjust their pricing. Those properties have either been pulled from the market or were actually sold. And now we’re in the process of new properties entering the market with different pricing expectations. I would also maybe add that we were anticipating in 2021 heading into 2022 a large influx of private equity, new private equity vehicles in net lease. Those obviously are much more levered focused, and as cost of financing has gone up, their ability to create attractive yields has declined. So we’re seeing less competition from private equity funds than we thought we would experience.

That makes sense. And then maybe in terms of the input credit or credit on potential acquisition, how are you thinking about franchise versus corporate owned, especially given some of the pricing pressures that are kind of being seen industry-wide? You mentioned kind of Davidson, personally in the care side of your business?

Yes, I think we’ve always been pretty thoughtful and conservative around the kind of credit. Credit is roughly half of our underwriting model; the remaining half is real estate matters. But I wouldn’t necessarily draw the line franchise versus corporate too literally. There are some very, very large franchises, and there are some very small or levered corporate-operated properties. So we’ve never really played in the very small franchisee financing game that some of our peers have. And you’ll see our cap rates are relatively consistent, adjusted for what’s happening in the market. So we’re not going out the risk curve by any means.

Okay, I mean, if you look at kind of either the financials that are being recorded, or financials on new transactions, what are you seeing in terms of responses to some of these pricing pressures in the casual dining space versus the QSRs?

Yes, I think what we felt at Kerrow is pretty consistent with what’s happening in the industry. In 2021, in many cases, you couldn’t get to the staffing levels you wanted, so that led to sort of abnormal profitability, but it was at the consequence of not being able to serve the guest. So I think you’re seeing more staffing; you’re seeing commodity costs increase. But again, both of those factors are moderating in real time. What’s happened is a number of the weaker brands are over-levered; franchisees have struggled, and we don’t play in that sandbox.

Thank you, John. Now we have our next question from an unidentified analyst. Your line is now open.

Yes, thank you. Good morning, everyone. Bill, just getting some of your comments around kind of what’s happening with restaurants and, generally, what’s happening with retail. If you guys would consider at any point looking beyond the world of retail for acquisition opportunities.

Yes, we’re always looking at strategies for acquisitions that are adjacent to what we have purchased in the past. We have a formal process with our board where we review adjacencies annually. We started with restaurants only, but we’ve now bought, obviously, a number of medical, retail, and a number of auto service retail. We continue to try to expand the aperture of our acquisition apparatus thoughtfully, but I wouldn’t expect us to buy hotels or apartments or offices or anything like that. I think it’s more of a natural progression. If you look at some of the older and larger net lease REITs, they follow that same path over a long period, and it’s worked quite well for them.

Thank you. We have no further questions on the line.

Great, thank you everyone. Management’s available for Q&A if anyone is interested. Thanks again for joining the call.

Thank you. Ladies and gentlemen, this concludes today’s call. Thank you for joining. You may now disconnect your lines.