Getty Realty Corp /Md/ Q2 FY2021 Earnings Call

Good morning, and welcome to Getty Realty’s Earnings Conference Call for the Second Quarter of 2021. This call is being recorded. After the presentation, there will be an opportunity to ask questions. Prior to starting the call, Joshua Dicker, Executive Vice President, General Counsel and Secretary of the company, will read a safe harbor statement and provide information about non-GAAP financial measures. Please go ahead, Mr. Dicker.

Thank you, operator. I would like to thank you all for joining us for Getty Realty’s second quarter earnings conference call. Yesterday afternoon, the company released its financial results for the quarter ended June 30, 2021. The Form 8-K and earnings release are available in the Investor Relations section of our website at gettyrealty.com. Certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management’s current expectations and beliefs and are subject to trends, events and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Examples of forward-looking statements include our 2021 guidance and may also include statements made by management in their remarks and in response to questions, including regarding the company’s response to the COVID-19 pandemic, future company operations and financial performance and the company’s acquisition or redevelopment plans and opportunities. We caution you that such statements reflect our best judgment based on factors currently known to us and that actual events or results could differ materially. I refer you to the company’s annual report on Form 10-K for the year ended December 31, 2020, our subsequent quarterly report on Form 10-Q and our other filings made with the SEC for a more detailed discussion of the risks and other factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. You should not place undue reliance on forward-looking statements, which reflect our view only as of the date hereof. The company undertakes no duty to update any forward-looking statements that may be made in the course of this call. Also, please refer to our earnings release for a discussion of our use of non-GAAP financial measures, including our definition of adjusted funds from operation, or AFFO, and our reconciliation of those measures to net earnings. With that, let me turn the call over to Christopher Constant, our Chief Executive Officer.

Thank you, Josh. Good morning, everyone, and welcome to our earnings call for the second quarter of 2021. With Josh and me on the call today are Mark Olear, our Chief Operating Officer; and Brian Dickman, our Chief Financial Officer. I will begin today’s call by providing an overview of our performance for the second quarter of 2021 and highlight the continued execution of our growth initiatives. And then, we'll pass the call to Mark and Brian to discuss our portfolio and financial results in more detail. The net result of our stable-in-place portfolio and a continued execution of our investment strategies was a 4.5% increase in total revenues, and almost 19% increase in adjusted funds from operations and 11.4% increase in AFFO per share. The company invested $44.1 million for the quarter, another $4.6 million just after quarter end bringing our year-to-date total investment activity to $79 million in aggregate. The quarter was highlighted by the growing and steady pace of our investment activity in convenience and automotive retail assets. We continue to successfully execute our multiple investment strategies, which include traditional sale leasebacks, creative acquisitions of net leased properties, and construction loans for new-to-industry assets. We also broadened our portfolio further during the quarter by adding both new geographies as we added the State of Michigan and new tenants as we added both Valvoline and Mavis Tires to our roster. The company also continues to benefit from the strong performance of target asset classes as evidenced by our stable rent coverage of 2.6 times. Once again, Getty realized full normalized collections of our recurring rental income during the quarter, as well as the COVID-related deferments we agreed to in 2020, which were due this quarter. More broadly, industry data published this month by the National Association of Convenience Stores further demonstrates the health of the overall convenience store sector, which had another record year of profits in 2020 despite the COVID pandemic. As we enter the second half of the year, we are pleased that our year-to-date investment activity has positioned the company to raise our AFFO guidance at quarter end. Looking ahead, we are committed to maintaining our healthy portfolio through active asset management. In addition, our team continues to work diligently to source and underwrite new opportunities to invest in our target asset classes, including convenience stores, car washes, and automotive-related retail properties, and by unlocking embedded value through selected redevelopments. We remain encouraged by the growing opportunities in our investment pipelines. We are confident with our targeted investment approach, which prioritizes acquiring real estate in strong metropolitan markets across the country. We'll continue to drive additional shareholder value as we move through 2021 and beyond. Finally, I would like to formally welcome Evelyn Infurna to our Board of Directors. Evelyn has a long track record of advising and investing in real estate companies and REITs, and I'm excited about the value she will bring to our company. I look forward to working with her for years to come. With that, I will turn the call over to Mark to discuss our portfolio and investment activities.

Thank you, Chris. At the end of the quarter, our portfolio includes 994 net lease properties, six active redevelopment sites, and five vacant properties. Our weighted average lease term was approximately 8.9 years, and our overall occupancy excluding active redevelopments remained constant at 99.5%. Our portfolio remains spread over 35 states plus Washington D.C. and our annualized base rents, 65% of which come from the top 15 MSAs in the U.S., continue to be well covered by our trailing 12-month tenant rent coverage ratio of 2.6 times. In terms of our investment activities, we had another busy quarter in which we invested $44.1 million in 53 properties and subsequent to the quarter, we acquired one additional property for $4.6 million, bringing our year-to-date investment activity to $79 million across 60 properties. Our completed acquisitions during the second quarter included the purchase of 46 Valvoline branded oil change centers for $31 million. The triple net leases, which are guaranteed by Valvoline Inc, were acquired with 11.5 years of remaining base term and have multiple renewal options. The properties are located primarily throughout the Detroit, Grand Rapids, Lansing, MSAs in Michigan and the Toledo metropolitan area in Ohio. Additionally, we've closed on the acquisition of three additional car wash properties for $10.4 million during the quarter. These properties were added to our existing unitary lease with WhiteWater Express car wash and have approximately 15 years remaining on the base term with multiple renewal options. These properties are located in Cincinnati, Ohio. Subsequent to the quarter end, the company acquired a Mavis Tire Center located in the Chicago, Illinois MSA for $4.6 million. In aggregate, we expect all of our completed acquisitions to generate cash yields that are in line with our historical quoted acquisition cap rate range for our targeted asset classes. Getty also funded an additional $2.7 million of construction loans for four new-to-industry convenience stores with Refuel, a c-store operator with more than 100 locations across the Southeast United States and Texas, bringing the total amount funded by Getty to $11.1 million year-to-date. As part of this transaction, we will accrue interest on our investment during the construction phase of the project, and we expect to acquire the properties via sale leaseback transaction at the end of the construction period. We ended the quarter with a strong investment pipeline, remain highly committed to continuing to grow our portfolio with convenience and automotive retail real estate. We expect that we will continue to pursue direct sale leaseback acquisitions of net lease properties and funding for new-to-industry construction. Moving to our redevelopment platform. During the quarter, we invested approximately $200,000 in sites which are in our pipeline. At quarter end, we had 11 signed leases or letters of intent, which includes six active projects, four signed leases on properties which are currently subject to triple net leases but which have not yet been recaptured from the current tenants and one signed letter of intent on a vacant property. At quarter end, rent commenced on a redevelopment project leased to 7-Eleven in Baltimore and Maryland MSA. We invested approximately $125,000 in the project, expecting to generate a return of nearly 40% on that investment. The company expects rent to commence at a number of additional redevelopment sites during the second half of 2021. In total, we have invested approximately $2.1 million in the 11 redevelopment projects in our pipeline and estimate that these projects will require total investment by Getty of $7.8 million. We project these redevelopments will generate incremental returns to the company in excess of where we can invest these funds in the acquisition market today. Turning to our asset management activities for the quarter, the company did not sell any properties but did exit four leased properties which had a minimal impact on our financial results. As we look ahead, we will continue to selectively dispose of properties that we determine are no longer competitive in their current format and do not have compelling redevelopment potential. With that, I will turn the call over to Brian to discuss our financial results.

Thank you, Mark. Good morning, everyone. I will start with an overview of our earnings. For the second quarter, Adjusted Funds From Operations was $0.49 per share, which is an 11.1% increase from the previous year. Our total revenues were $38.7 million, reflecting a 4.5% increase compared to last year. Excluding tenant reimbursements and interest on receivables, rental income rose by over 8% to $34.4 million, primarily driven by strong acquisition activity over the past year and contributions from rental projects. On the expense side, general and administrative costs increased this quarter mainly due to employee-related expenses such as stock-based compensation and one-time retirement costs, along with some professional fees. However, property costs and environmental expenses decreased during the quarter. The drop in property costs was largely due to lower real estate taxes and certain professional fees associated with redevelopment efforts, while the reduction in environmental expenses was mainly attributed to decreased professional fees and related costs that impact AFFO. As we emphasize every quarter, environmental expenses are based on various estimates and non-cash adjustments and can change. Turning to our balance sheet and capital markets activities, we ended the quarter with total debt of $542.5 million, which includes $525 million in long-term fixed-rate unsecured notes and $17.5 million drawn from our $300 million revolving credit facility. Our average borrowing cost was 4.2%, and the average maturity of our debt was 6.8 years. Our total debt to total market capitalization was 29%, total debt to total asset value was 38%, and our net debt to EBITDA ratio was five times. All leverage metrics are calculated according to GAAP. We have no debt maturities until June 2023, except for our revolving credit facility maturing in March 2022, which has a one-year extension option available. During the quarter, we selectively issued equity under our ATM program, raising $9.5 million at an average price of $32.94 per share, making our total year-to-date raises under the ATM program $30.3 million. Moving forward, we are dedicated to maintaining a strong credit profile, ensuring adequate liquidity and access to capital, keeping leverage at low to moderate levels, and adhering to a well-structured capital strategy. Regarding our environmental liability, we finished the quarter with $47.9 million, a decline of $150,000 since the end of 2020. For this quarter, net environmental remediation spending was about [indiscernible]. Finally, due to our investments and capital markets activities in the first half of the year, we are raising our 2021 AFFO guidance to a range of $1.89 to $1.91, which is a $0.03 per share increase from earlier guidance. This updated guidance reflects transactions completed year-to-date and does not factor in potential acquisitions or capital market activities for the remainder of 2024. Several factors may affect our guidance, such as fluctuations in certain operating costs like environmental expenses, variability related to recapturing properties for redevelopment which may lead to lost rent, and our ongoing expectation of actively pursuing acquisitions and redevelopments, which could incur additional costs, including demolition and transaction costs for unfinished deals. With that, I'll pass the call back to Chris.

Thanks, Brian. Operator, we will take questions.

Thank you. Our first question comes from Todd Thomas with KeyBanc. Please proceed with your question.

Hi. Thanks. Good morning. First question I have is just on investment activity, which increased in the quarter compared to the first quarter. But looks like closings have slowed up a little bit in the last one to two months since the last update. I realized there's no incremental investment activity in the guidance. But just curious if you can comment generally on the pipeline and the pace of investments going forward as we move further into the second half of the year?

So, this is Mark. As we broaden our investment strategy that we announced recently to include all other automotive asset classes, we're pretty comfortable with the current state of our pipeline, the pace of opportunities both inbound and opportunities that we've been generating through our business development. And so, I think that some of the closings are just merely a factor of timing in the pace of the deal in each individual deal. But I think we're pretty comfortable where the pipeline is right now.

Okay. I believe you mentioned that initial yields or cap rates are consistent with the market. What do they look like today? What were the cap rates for the acquisitions made this quarter? Can you discuss the future trends for cap rates?

Sure. So, our acquisitions, as I said, have been in the mid to high 6% range. Some of that compression is due to the overall market tightening, and as well as the broadening of our investment targets through different automotive verticals, some of those being more mature and more competitive. But we continue to feel comfortable that we'll be able to deliver creative acquisitions as we've done over the last few years.

Okay. And then, just on the construction loans, can you just talk about that opportunity that you have there? Your desire to originate more construction loans. And also, can you just remind us what kind of premium spread on pricing through the sale leasebacks you're achieving relative to market pricing?

Yes. I think on the loan program, broadly speaking, the industries that we target have been consolidating obviously. Multiples are high as you'd expect. And certain of our operators have chosen to really focus on their organic growth pipelines. And as we partner with existing relationships or new relationships, it's really a way for our operators to grow their business and for Getty to find a path to ownership at the end of the construction period. So I think the opportunity will continue to grow for us quite comfortably. We have the redevelopment capabilities in-house and this is a natural extension from that team. So we're pretty comfortable operating there. In terms of premium yield, there's certainly a premium over the acquisition market. I would call it significant, and it does vary a little bit by sector, but I think we like the opportunity. We think it's going to continue to grow and certainly applicable to all the target asset classes that we're focused on.

Do you believe there is an opportunity to significantly ramp up that program?

I think it's going to continue to grow over time. I don't want to put a number on it or a target range behind, Todd, but I certainly feel like it's an avenue to deploy capital accretively.

It's Brian. The one thing I would add. I think we spoke about the objective someone reiterated what Chris said; it's not to build a large loan portfolio per se. That's not the business that we're looking to get into. It's ways that we can add value to our partners, to our tenant partners and continue to work with them to help grow their platforms which obviously helps us grow as well. And as Chris said, explicitly it gives us another path to feed simple ownership of the type of assets we want to own. And that's probably the key – those last two pieces are really key components to it.

Okay. All right. Thank you.

Thank you. Our next question comes from John Massocca with Ladenburg Thalmann. Please proceed with your questions.

Good morning.

Good morning, John.

So maybe just a little more on the kind of construction loan opportunity you mentioned and ultimately trying to pull those assets onto your balance sheet. Are those types of transactions you're looking at primarily kind of Greenfield de novo construction? Or is that like redevelopment where you're kind of coming in and funding a developer's redevelopment of an existing maybe out-of-date c-store concept and they're revamping that?

Yes. It's Mark. We've got a little bit of both, both with our existing in-place tenants where they want to put material capital improvements into our lease properties. We'll partner with them to bring them up to industry standards. I would say it's more heavily tilted towards the greenfield, as you said, the de novo buildings where it's a net new operation for our tenant partners that is truly state of the art. So, in addition to all the financial metrics that were just discussed, it's kind of a reinforcement of our partnership with operators that want to be on the leading edge and new-to-industry, delivering all the latest and greatest in meeting the consumer demands. So these are not only state-of-the-art facilities, but obviously have a tremendously long useful life, present well, look great. And the program is repeatable with these key partners where it’s ease relationship to rinse and repeat on their new program. And we've become kind of a dependable partner for them in that process.

I'm wondering about the overall size of the opportunity in terms of new construction in the convenience store sector right now. Do you think that the merger and acquisition activities will be somewhat less active in the near future?

Todd had sort of a similar question. I don't want to put a box around it, John. But what I would tell you is if you look across the c-store sector, the car wash sector in particular, right, there is a significant amount of growth with what we call chain store operators, right? So as the traditional mom-and-pop c-store operator or car wash may be going away, there's an opportunity for tenants in the space to grow their brand with their prototype store that Mark was talking about, the state-of-the-art facility, whether that's an Express car wash tunnel or whether that's a 5,000, 6,000 square foot c-store with a QSR inside of it. The opportunity is certainly there for c-stores and car washes to create brand recognition, which also has the royalty partner, M&A absence side of it, whether it becomes sort of that go-to destination that the consumer is looking for right across specific regions or a chunk of the country. So, again, I think it’s certainly repeatable, but I'm not going to put a high frame or a dollar amount behind it, but I think the opportunity is significant.

Okay. And then on the balance sheet side of things, I mean how should we think about ATM issuance going forward? I think if I heard correctly, you issued $9 million during the quarter in terms of dollar amount, which would seem on a gross invested basis a little bit kind of light versus kind of in-place portfolio today. But I know that can kind of be variable quarter to quarter. But should we still expect maybe on a net debt to EBITDA this 5x range to be a good target going forward?

Yes. John, the ATM issuance is influenced by various factors, including leverage metrics, liquidity at the time, balance sheet status, stock price, and investment pipeline. Our primary focus, as mentioned earlier, is to ensure we maintain strong liquidity and access to capital while keeping leverage low to moderate. At the end of 2020, our leverage was just under five times, and the revolver was completely undrawn in January after we paid off the year-end balance. Due to some asset sales and legal settlements, we have significant cash on the balance sheet. Reflecting on the end of the year, this situation contributes to us being somewhat less active with the ATM in the first half of the year. Moving forward, we plan to continue using the ATM, as it is a valuable tool for our business. Our leverage typically falls between 4.5 to 5.5 times, and sometimes 5 to 6 times, but we remain towards the lower end of that range. That’s our strategy as we proceed with the ATM.

Thank you. Our next question comes from Joshua Dennerlein with Bank of America. Please proceed with your questions.

Hey. Good morning everyone. I guess I was just curious about maybe an impact on inflation on your portfolio. Could you remind us maybe what percent of your portfolios has escalators linked to like the CPI or fixed? Just trying to get a sense of what we can see an acceleration there as a result of more inflation?

Yes, it's Brian. I'll start by noting that over 97% to 98% of our leases include some form of annual escalator. The majority of our portfolio features these annual escalators, with about two-thirds of them falling into that category. The remaining leases typically have a structure of a 10% increase every five years. On a CPI basis, it's minimal; there might be one or two leases that don't follow the standard structure we've maintained. Overall, we expect an annual increase of approximately 1.6%, which I believe provides a solid foundation for each year. Our earnings growth and value creation will mainly rely on acquisitions and redevelopment, as is common in our industry. Entering the year with this level of escalator is advantageous. Additionally, since most of our activity involves sales-leaseback transactions, as Mark and Chris mentioned, we continually purchase existing leases. However, when we originate our leases, it offers us more opportunities. The current market environment is shifting, which allows us to negotiate different levels or types of escalators with tenants and prospective tenants, giving us more control over our direction compared to only acquiring existing leases.

Yes, interesting. Have those conversations changed a lot in maybe the last like year or two? Or is like what you would want in a lease?

I would think that if you're talking specifically about escalators, there's more, as Brian just mentioned. We strive for annuals. We do our best to get an increase if not something certainly near term, but not a material change in the dynamics of those conversations.

Okay, awesome. Thanks guys. We'll leave it there.

Thank you. Ladies and gentlemen, we have reached the end of the question and answer session. I will now turn the call over to Mr. Christopher Constant for closing remarks.

Great. Thank you, operator. Thank you everyone for participating in our call this morning. We look forward to getting back on. We look forward to our Q3 earnings in October. And we appreciate your interest in Getty.

This concludes today's conference. And you may disconnect your lines at this time. Thank you for your participation and have a wonderful day.