Earnings Call Transcript - FCPT Q1 2025

Operator, Operator

Hello and welcome everyone to the FCPT First Quarter 2025 Financial Results Conference call. My name is Becky, and I'll be your operator today. I will now hand over to your host, Patrick Wernig, Chief Financial Officer to begin. Please go ahead.

Patrick Wernig, CFO

Thank you, Becky. During the course of this call, we will make forward-looking statements, which are based on our beliefs and assumptions. 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 at fcpt.com. All the information presented on this call is current as of today, May 1st, 2025. 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. With that, I'll turn the call over to Bill.

Bill Lenehan, CEO

Good morning. Following our typical cadence, after my introductory remarks, Josh will comment further on the investment market and Patrick will discuss our financial results and capital position. The start of 2025 continued the momentum we had in the second half of 2024. We took advantage of our sustained strong cost of capital and added to the pipeline, finding deals that both met our quality standards and had pricing that made sense. This led to Q1 being the highest acquisition volume for a first quarter in the company's history, which similarly followed our highest Q4 volume. So far this year, we've closed $70 million of acquisitions at a blended 6.7% cap rate. Looking back to when we fully turned the acquisition machine back on in late August, we have closed $269 million of acquisitions over the past eight months. While we do not give acquisition guidance, we are continuing to add to the pipeline and are seeing opportunities that are consistent with our quality thresholds and within our pricing standards. We note that we have not seen much change in cap rates for recently priced deals. We've continued to build significant liquidity while de-levering to preserve optionality on funding new opportunities as they arise. This includes leaning in on the equity sales via our ATM program, which we have used to raise $475 million in equity since July of last year. Including our unsettled equity forwards, we now have our lowest leverage levels in the last seven years. Simply put, we're well-positioned for uncertainty. Shifting to our in-place portfolio, we continue to perform well with high rent collections and occupancy. Our rent coverage in the first quarter was 4.9 times for the majority of our portfolio that reports this figure. This remains amongst the strongest coverage within our industry. FCPT's largest tenants are nationally branded restaurant operators, namely Olive Garden, Longhorn, and Chili's. They are leaders for their sectors and generally outperform the industry peers as well as fine dining or local mom-and-pop brands. Most recently, Brinker reported Chili's same-store sales grew 31.6% for the quarter ended March 2025. Similarly, Olive Garden and Longhorn reported same sales growth of just shy of 1% and 2.6% year-over-year for the three months ended February 2025 respectively. While these brands remain core to our portfolio and strategy as we approach 10 years as a public company, we would also highlight our diversification progress over that period. We've grown from 418 properties at inception to 1,236 leases today. Darden has dropped from 100% of our rent roll to now 47% combined across all of their brands. This improvement is despite acquiring 47 Darden properties post-spin. Our top five brands make up 55% of our annual base revenue. On sector diversification, 67% of our annual base rent comes from casual dining and 11% from quick service. Outside of restaurants, automotive service is our largest sector at 11% of ABR, followed by medical retail at 9% of ABR. As for portfolio management, we are not yet experiencing any material tenancy issues in the portfolio and have no current indicators that inflation or tariff issues will impact our rent payments. Further, while the current tariff environment remains uncertain, we expect restaurants to be one of the least tariff-affected sectors. Similarly, our other service-based tenants should fare better than average retail operators given their low exposure to imported goods as part of their operations. While we would expect that in a recession we would see some pullback in our tenant performance, we believe that we are well positioned with a cushion on our rent coverage to weather any potential issues. Turning to the materials we published last night, we would like to highlight a few new slides in our investor presentation that point to what we believe is FCPT being a calm port in the storm. Our portfolio was built brick by brick to be resilient, and we’ve paired that with prudent capital management. We have significant liquidity, no near-term debt maturities, granular low basis properties, high rent collections, and low overhead. FCPT’s portfolio is made up of well-capitalized sophisticated operators who we believe will be able to navigate and gain share in this challenging macro environment. We pride ourselves on transparency and best-in-class disclosure. So in addition to our press release regime on new acquisitions, this quarter we decided to further break out our portfolio to the top 35 brands, which make up more than 80% of our ABR. Our goal is for our investors to understand our tenant exposures and have confidence that we’ll stay disciplined on meeting quality expectations for the properties we buy. To that end, you will see in our filings, we have zero or near-zero exposure to the problem net lease sectors such as theaters, pharmacy, high rent car washes, and big box retail. Over to you, Josh.

Josh Zhang, Chief Investment Officer

Thank you, Bill. During the first quarter, we acquired 23 properties for $57 million at a blended 6.7% cap rate with a weighted average lease term of 17 years. We did not sell any properties in the quarter. While Q1 is typically our slowest quarter, we continue to deliver on the strong investment momentum we achieved in the second half of 2024. As a result, we believe that we stand very well positioned at the end of the first four months in 2025, having both come off a record Q1 to start the year, right after a record Q4 last year as we continue to build out the pipeline. We are achieving this without compromising on the quality of our asset selection or the credit standards to meet yield or volume targets. Our disclosure regime is particularly helpful in times like these where investors can read through our frequent press releases to see how our acquisitions and the brands we work with are highly consistent with past years. Our team is being patient and organized, tracking our opportunity sets for both on and off-market investments and including robust analytics to help us identify the best opportunities. In other words, we are not chasing deals, but rather selecting the best ones that fit our portfolio even if that means leaning in slightly on cap rate to capture these higher quality deals, all while still protecting accretion. Reflecting back on Q1, 83% of our investment volume was via COE spec as operators continue to seek stable financing solutions in this current market. As such, our weighted average lease term this year was much higher at 17 years. In particular, we have three sale leasebacks of note with QSR operators: one with Burger King Corporate, another with a large multiunit Burger King franchisee, and lastly with the Whataburger franchisee. The two Burger King deals were both part of M&A transactions, while the Whataburger deal was for their newly built stores. It's worth noting that similar QSR properties typically command very aggressive cap rates in the upper 5% to low 6% cap rate range when sold piecemeal. Individual investors favor the small price points per property and the fungibility of the real estate. However, our team was able to achieve accretive pricing here by offering a portfolio solution and efficient execution for operating partners. All three transactions were negotiated off-market and are a product of leveraging relationships cultivated by our investment team. Looking forward, we will continue to target similar opportunities, nationally recognized brands operated by best-in-class operators with appropriate basis. While this quarter ended up having more quick service restaurants, some automotive, and no medical retail investments, we remind everyone that our team does not specifically allocate target buckets or quotas across our investment sectors. Rather, we make investments when opportunities meet our underwriting criteria. That being said, we still expect these sectors to be roughly evenly split between these three target categories of ours over the long term. Looking forward, FCPT's opportunity set continues to grow despite a volatile macro environment. We have a steady pipeline build-out for Q2 and aim to continue to execute on our strategy with discipline. Patrick, back over to you.

Patrick Wernig, CFO

Thanks, Josh. I'll start by talking about capital sourcing and the state of our balance sheet. At FCPT, we are highly focused on efficient capital raising. We raised over $169 million in 2025 to date on top of the $318 million equity in 2024. Today, we have $254 million of unsettled equity forwards. The ability to raise forward ATM quickly and at scale has allowed us to match sources and uses more effectively. Furthermore, the high SOFR rate has allowed for a minimum drag on our forward balance given we receive interest income on the balance of over 4%. With respect to overall leverage, our net debt to adjusted EBITDAre in Q1 continued to move lower to 4.4 times inclusive of outstanding net equity forwards as of March 31. This leverage is at a 7-year low and provides capacity for us to continue to execute our business plan even if the current volatility persists or we are unable to raise additional capital for the rest of the year. We've also layered in additional hedges to our floating-rate exposure, raising us to over 95% fixed through Q3 2027. Our revolver is fully available at $350 million and we have extension options, essentially no debt maturities for nearly 2 years. Additionally, our fixed charge coverage ratio is a healthy 4.4 times. Altogether, this puts us in a great liquidity position. We have approximately $617 million available for funding acquisitions between cash, unsettled forward equity, and undrawn revolver capacity. Assuming no further equity issuance, we have an approximate $565 million of available capital reaching 6 times net leverage. Now turning to some of our financial highlights for Q1. We reported Q1 AFFO of $0.44 per share, which is up 2.3% from Q1 last year. Q1 cash rental income was $63.2 million, representing growth of 9.1% for the quarter compared to last year. On a run rate basis, current annual cash base rent for leases in place as of quarter end is $243.9 million, and our weighted average 5-year annual cash rent escalator remains 1.4%. Cash G&A expense, excluding stock-based compensation was $4.9 million, representing 7.7% of cash rental income for the quarter compared to 7.9% for the quarter last year. This progress illustrates our continued efforts and efficient growth in the benefits of improving scale. We're still expecting cash G&A will be in the range of $18 million to $18.5 million for 2025. As a reminder, we take a conservative approach and do not capitalize any of the compensation costs related to our investment team. As we're managing our lease maturity profile, our team has made significant progress on 2025 maturities with 88% of those tenants already extending their leases or indicating an intent to do so. As of quarter end, expirations represent just 0.5% of ABR and 2.3% in 2026. Our portfolio occupancy today is 99.4%, and we collected 99.5% of base rent for the first quarter. There are no material changes to our collectibility or credit reserves or any balance sheet impairments. With that, we'll turn it back over to Becky for questions.

Operator, Operator

Our first question comes from John Kilichowski from Wells Fargo.

John Kilichowski, Analyst

Maybe just on a little bit of slight yield compression in the quarter. Is that due to the fact that there's maybe more competition in your sector for these assets given the insulation from tariffs?

Bill Lenehan, CEO

Hard to say. I would say the vast majority is related to the high percentage of QSR restaurant acquisitions in the quarter.

John Kilichowski, Analyst

And then maybe just on the pipeline more generally. You have a big fourth quarter followed up with a very strong first quarter. What's your governor on growth? And maybe just color around what your pipeline looks like. I'm curious, Patrick, you talked about smart capital raising. I'm curious if that's it or if it's just the amount of deals or if it's the size of your team. I'm curious what keeps you from maybe taking it up a step further from here.

Bill Lenehan, CEO

Sure. And John, maybe just to more completely answer your first question. I think if we were targeting sectors that were very exposed to tariffs, we would have a much higher cap rate, obviously. But as the great research you've published recently, we have very low tariff exposure in our portfolio. As far as governors to growth, that's a much longer answer. But I think the kind of acquisitions that we're working on is what largely determines how much we buy in a quarter. So whether it's sale leasebacks, which were prominent in this quarter and are much more efficient. Individual one-off deals, it becomes challenging to have that many balls in the air on $2 million acquisitions, $3 million acquisitions to put up larger volumes. But we really don't look at it that way. We're trying to score assets and buy assets that have sufficient quality and then making sure that we raise the money the right way. And I think we feel particularly proud over the last couple of years that when the environment was sufficient for acquisitions, but our cost of capital wasn't there. We responsibly paused. But then when there was alignment where there were acquisitions to do and our cost of capital was there, we acted with emphasis.

Operator, Operator

Our next question comes from Michael Goldsmith from UBS.

Catherine Graves, Analyst

This is Catherine Graves on for Michael. So my first just looking at the volume that you achieved in Q1. Last year, the acquisition sort of ramped up through the year. Can you provide any color on what you’re expecting as far as the cadence for this year, especially starting at such a higher base?

Bill Lenehan, CEO

Yes. Q4 has historically been a very strong quarter for us. And I’m not sure why, Catherine, to be honest with you. There’s a dynamic where people want to get things done in a fiscal year perhaps. But we have a very good pipeline right now. Deals typically have 60 to 90-day sort of life cycles, 60 would be a minimum. So we really don't have a lot of visibility on the second half of the year. And certainly, with all the macro uncertainty, it's very hard to tell. But we are staffed and capitalized and very focused and organized in executing the rest of the year, but we don't give guidance because really, we want to make sure that we have the best sort of decision-making hygiene in making the acquisitions.

Catherine Graves, Analyst

Fair enough. And then my second question, you acquired several Burger Kings in this past quarter, and I'm sure you saw there was recently a large franchisee who filed for bankruptcy. Is your sense that this is sort of a franchisee-specific issue? Or has anything changed as far as how you monitor the health of your Burger King tenants?

Bill Lenehan, CEO

Very much of a specific issue to that franchisee.

Operator, Operator

Our next question comes from Anthony Paolone from JPMorgan.

Anthony Paolone, Analyst

I know this may not be completely apples-to-apples because I understand the skew towards QSRs with your cap rates. But we do see some of the other net lease names doing deals in the 7s. And so I was wondering if you can maybe give us some sense as to maybe how you see the difference between going from high 6s into the low mid-7s and what the give and take might be there?

Bill Lenehan, CEO

We definitely observe properties for sale with cap rates at 7.5 and above. These typically fall into sectors that we prefer to avoid, such as pharmacy or experiential, or they are areas we have not historically engaged with. Additionally, the credit quality may not be strong, or the rental rates may be excessively high. All of these factors contribute to our assessment, indicating they do not meet our criteria for investment. However, this doesn't imply that every transaction lacks merit; there can be instances where a purchase appears to offer significant value or where strategic reasons justify a slight adjustment. Generally, properties with cap rates noticeably higher than our typical thresholds carry increased risk. I believe one of the advantages of our reporting approach is the clarity it provides regarding our acquisitions at those cap rates. Some competitors might employ strategies that show appealing tenants to investors while omitting details about less favorable properties. Therefore, our clear and transparent strategy should reassure you that our purchases are made with careful consideration, rather than simply to achieve certain metrics for quarterly reporting.

Anthony Paolone, Analyst

Okay. And then, just on the pipeline, are there any larger type transactions that you see in the mix? Or is it pretty much all the one-by-ones?

Bill Lenehan, CEO

It's a mix. We're always working on larger transactions. We have a handful in the hopper. I would reflect that we haven't really seen a dynamic where there's portfolio discounts. In fact, in some cases, we found that the larger transactions have more competition. And I think we saw that clearly in a large transaction that one of our peers did last winter. So it's a mix, Anthony, but I also wouldn't say that large transactions come at bargain prices by any means.

Operator, Operator

Our next question comes from Wes Golladay from Baird.

Wes Golladay, Analyst

Can you talk about how you underwrite the smaller franchisees? I think you mentioned you do get a corporate guarantee, but how small are some of these franchisees?

Bill Lenehan, CEO

Yes. So our small franchisees, I think, would be considered very large for our peers. We don't have a ton of franchisee exposure, and the franchisee exposure we have tends to be with franchisees times 100 type size franchisees. So we get financials, we do a typical credit underwriting, but franchisee credit is not a big part of our business. And I would say the dynamic where some of our peers will sort of put people into business by buying real estate for them. We're developing real estate for them. And by definition, that's a very, very small sort of individual-sized business entity; it's not something we do.

Wes Golladay, Analyst

Okay. And then you have been building up the team, developing a lot of new relationships over the last few years. Just curious how much the new deal flow is from these new relationships?

Bill Lenehan, CEO

There is some of that, but a lot of our recent deals are ones we've been tracking for years. Now, with an advantageous cost of capital, sellers are more willing to negotiate on price due to the overall macro uncertainty. So, I don't view it as a simple algorithm where a new acquisition person with limited relationships can guarantee deal flow. We have increased our outreach recently, and as you noted, we've grown our acquisition team. This summer, we're welcoming the largest class of acquisitions, with three individuals from underground and two interns, and we're eager to get them acclimated. I believe they will have a significant impact.

Operator, Operator

Our next question comes from Kyle Katorincek from Janney.

Kyle Katorincek, Analyst

Where is the range of EBITDAre coverage ratios for recent acquisitions? And is there any difference between restaurant and non-restaurant segments there?

Bill Lenehan, CEO

We do not disclose coverage ratios on a quarterly basis due to confidentiality agreements related to financials, so we will not be able to provide that information regularly. However, the credit metrics tend to be fairly similar across various industries. In the medical field, it's a bit more complex to define 4-wall, as a patient might visit our retail outpatient center while also receiving care from the associated hospital system. Therefore, stating a specific number for 4-wall can be somewhat ambiguous. That said, credit remains comparable on a corporate leverage scale, typically in the mid-single digits, with 4-wall coverage generally exceeding three times.

Kyle Katorincek, Analyst

And then at what point would you guys consider lease too conservative where there's potential opportunity cost in the form of lost rents? And then on the flip side, at what point would you feel uncomfortable underwriting a new lease in terms of coverage? Just trying to get a range in how you guys think about that.

Bill Lenehan, CEO

Yes. So if I understood your question is, could we take more risk and still be in a safe position. That's the gist of it?

Kyle Katorincek, Analyst

Yes, exactly. And then the upper limit too conservative of the coverage ratio, like at what point is that? Is that 6 times, 6.5 times?

Bill Lenehan, CEO

Sure. So, I have two thoughts on this. First, we often reflect on whether we might be too conservative. We review previous opportunities that we passed on, and it's evident that the results from those missed chances have tended to be much worse than our current investments. Sometimes we see properties that appear attractive but are plagued with short leases, high rents, or financially unstable tenants, which leads to negative outcomes for us when we choose not to proceed. Second, I’ve noticed that rental prices can be quite erratic. For example, one Burger King could have a rent of $70,000, while another similar location could be at $107,000 or even $170,000, despite appearing identical aside from their rent amounts. This variance means that the financial coverage we see would differ significantly from the lowest to the highest rent. A core part of our job is to find properties that deliver strong performance but come with reasonable rental rates. I don’t think there's a strict upper limit on what we would consider. When a lease eventually matures, which is often far into the future due to extension options, we anticipate some rent increases and have seen positive results from that. Additionally, having navigated through several economic challenges in my career, I've learned that in times of significant uncertainty, having the ability to actively seek opportunities is a major benefit. Currently, we are operating with our lowest leverage in years, and we have substantial liquidity available. Our portfolio is in excellent condition. So if being slightly more conservative is what it takes to remain in a position to seize aggressive opportunities when they arise, I’m comfortable with that approach.

Operator, Operator

Our next question comes from R.J. Milligan from Raymond James.

R.J. Milligan, Analyst

Bill, you talked about running leverage at the lowest level it's been in quite some time, if not ever. I'm just curious, given the fact that your cost of capital is attractive here, how do you think about potentially further delevering or loading up the balance sheet to capitalize on opportunities that might arise later?

Bill Lenehan, CEO

Yes, that's a great question. The interesting aspect is that when the SOFR is at 4%, you essentially pay your dividend based on the forward, and you receive SOFR, factoring in some fees. The cost of maintaining this liquidity is very low. Previously, when rates were at zero and you had a 5% dividend, it became costly if you held too much of it forward without timely utilization. We determined that the opportunity cost of holding significant liquidity was minimal. We're taking an opportunistic approach due to the fee structure of the ATM, which has been our primary method for raising equity for about the last 7 or 8 years and offers a favorable fee and discount structure. Given that holding that forward position had minimal opportunity cost, we seized the chance. I believe this places us in a strong position. The market is volatile, as reflected in the VIX, but we prefer to be very liquid in times of stress.

R.J. Milligan, Analyst

Okay. And so Bill, you had given some same-store stats on some of the tenants at the beginning of the call. Obviously, concerns out there that we might head into a recession downturn; obviously, the data has been pretty mixed. But if we were to see a downturn or a recession, how do you think that might change the pipeline whether it be volume, competition or pricing?

Bill Lenehan, CEO

We experienced COVID, during which our portfolio performed exceptionally well, but I wouldn't characterize that period as having sustainable bargains. This situation is different, and I believe our portfolio will continue to perform strongly. We're nearly fully occupied, so I can't guarantee improvements beyond this level. However, I think we are in an advantageous position. As for potential acquisition opportunities, it's difficult to say. In response to an earlier question, we generally focus on sectors with limited exposure to tariffs. There have been two Wall Street research reports regarding the net lease industry and tariff risk, and we came out as the most favorable in both. I recommend looking for those reports. While I can't confirm if we'll encounter significant investment opportunities, I can assure you we have the necessary funds and team, and we are concentrating on this area. What we need now is for the market to present us with high-quality deals that we can purchase at prices better than historical norms.

Operator, Operator

Our next question comes from Jason Wayne from Barclays.

Jason Wayne, Analyst

Rent collections ticked up a bit this quarter, and they're still strong, but I'm just wondering what types of tenants are not paying now and if you're working on anything at those properties to increase the collection numbers further?

Bill Lenehan, CEO

Yes, there is essentially one tenant involved. We have a personal guarantee from that tenant that we are actively pursuing, and we have made significant progress in leasing the buildings. Therefore, it is a very minor, isolated issue.

Jason Wayne, Analyst

And what kind of re-leasing spreads, I mean, you've gotten on tradeouts like that historically?

Bill Lenehan, CEO

Yes, it's just a couple of buildings. I think we'll be in a good spot, but we're not going to comment on ongoing negotiations when it's only a couple of buildings.

Operator, Operator

Our next question comes from James Kammert from Evercore.

James Kammert, Analyst

Kind of a bigger picture question, Bill. You mentioned you're building acquisition staff and have the balance sheet in a great position. Are you adding other sort of capabilities or data sets to your underwriting? I know you've been pleased with like Dealpath technology, etc., to date, but I'm just curious how you're setting up for the next phase of growth. And if that entails any other incremental steps that you're doing to further enhance the underwriting.

Bill Lenehan, CEO

That's a really good question. Like every company, we're figuring out how AI can improve our efficiency. We have more personnel dedicated to projects and exploring potential new industries. We have strengthened our asset management team with some exciting new hires who are getting up to speed. In the past, we didn't require much of that function, but with the addition of several hundred buildings to our portfolio, which is in fantastic shape, there's still more to accomplish. I'm really excited about the new team members; they will utilize our existing technology, allowing us to focus more on automating tasks that can be automated. However, there’s much we can do with our current technology. Dealpath is a crucial part of our operations, and we've conducted several investor sessions demonstrating our underwriting process using Dealpath. We would be happy to offer this to anyone interested, as most investors have found it to be a valuable use of their time.

Operator, Operator

We currently have no further questions. This concludes our Q&A and consequently today's call. Thank you for joining us. You may now disconnect your lines.