Earnings Call Transcript - NNN Q1 2022

Operator, Operator

Good morning ladies and gentlemen, and welcome to the National Retail Properties First Quarter 2022 Earnings Call. At this time, all participants have been placed on a listen-only mode and we will open the floor for your questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, President and CEO, Steve Horn. Sir, the floor is yours.

Steve Horn, President and CEO

Thanks, Mathew. Good morning, and welcome to the National Retail Properties first quarter 2022 earnings call. Joining me on this call is our Chief Financial Officer, Kevin Habicht. As this morning's press release reflects, 2022 is also a fantastic start for National Retail Properties. Beyond our financial results post the quarter, early April NNN released its inaugural corporate responsibility and sustainability report. We created this report with the ISOS group. The report includes and highlights NNN’s commitments, achievements, and initiatives on an ongoing basis. Also, before we get into the financial and portfolio detail, I want to address the current direction of NNN. As I mentioned earlier this year, I plan to continue executing the longstanding business model of NNN—locating, underwriting, and acquiring real estate with the right operators, all while delivering consistent year-over-year core FFO growth. We remain vigilant and continuously evaluate market opportunities, but I currently plan to stay the course on delivering repeatable growth. Given our strong beginning of the year, we are pleased to announce an increase in our guidance for 2022 core FFO from a range of 2.93 to 3 per share to a range of 3.01 to 3.08 per share. Kevin will have more details on this increase in his remarks. Turning to the highlights of our first quarter financial results. Our portfolio of 3,271 freestanding single-tenant properties continued to perform exceedingly well. Occupancy ticked up 20 basis points in the quarter to 99.2, which remains above our long-term average of 98. The increase is a result of activity out of our leasing department. The department enjoyed a high level of interest from a number of strong national and regional tenants to occupy some of our vacancies. During the quarter, NNN did not have any credit issues within the portfolio. It's starting to be a trend here at NNN that we can report for five consecutive quarters we had zero tenants defaulting. Although we continue to maintain our traditional discipline in our underwriting, we acquired 59 new properties in the quarter for approximately 210 million at an initial cap rate of 6.2, and with an average lease duration of 17 years. Almost all of our acquisitions in this past quarter were sale leaseback transactions due to the in-depth calling effort of our NNN acquisition department. NNN prides itself on maintaining a relationship-based business model, with which we do repeat business. In an environment where cap rates remain at an all-time low, we will continue to be very thoughtful in our underwriting and primarily pursue sale leaseback transactions with our relationship tenants. Regarding the acquisition pricing environment, the Q1 initial acquisition cash cap rate at 6.2 was at historic lows for NNN. As mentioned during the February call, we expect a little more pressure on the cap rates for 2022 compared to 2021. As we now sit here at the beginning of May, it feels like cap rates have bottomed out and private competition has dissipated a little. As a result, NNN feels that cap rate compression for the moment is behind us. During the first quarter, we also sold 10 properties and generated about $20 million of proceeds, which will be reinvested into accretive acquisitions. This activity is on pace with our disposition guidance of 80 million to 100 million. So I finish up at the risk of sounding like a broken record; Kevin and his team keep the balance sheet rock-solid. We ended the first quarter with 54 million of cash in the bank, zero balance on our 1.1 billion line of credit, and no material debt maturities until mid-2024. Thus, NNN is in a terrific position to fund our 2022 acquisition target of 550 to 650 new properties. In summary, our occupancy rate, leasing activity, and rent collection outcomes validate our consistent long-term strategy of acquiring well-located parcels leased to strong regional and national operators at reasonable rents. We will maintain a strong and flexible balance sheet. With that, let me turn the call over to Kevin for more detail on our quarterly numbers and updated guidance.

Kevin Habicht, Chief Financial Officer

Thanks, Steve. And I'll start with the usual, cautionary note that we may make certain statements that may be considered to be forward-looking statements under federal securities law. The company's actual future results may differ significantly from the matters discussed in these forward-looking statements. And we may not release revisions to these forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in this morning's press release. With that, now on to the headline from this morning's press release. We reported quarterly core FFO results of $0.77 per share for the first quarter of 2022. That's up $0.08 or 11.6% over Q1 2021, and it's up $0.02, or 2.7% from the immediately preceding fourth quarter of 2021. Today we also reported that AFFO per share was $0.79 for the first quarter. That's up $0.02 from the immediately preceding fourth quarter of 2021, which was $0.77. These results include about a penny from some one-time items in Q1, about $1 million of lease termination revenue, and $600,000 of percentage rent. We did footnote that first quarter AFFO included $1.8 million of deferred rent repayment in our accrued rental income adjustment for the first quarter, without which the AFFO would have been $0.78 per share, as we've noted there. As these scheduled deferred rent repayments continue to taper off from peak levels in the first half of 2021, we're seeing improved results from our 2021 and 2022 acquisitions. I will also note that we took a $3.6 million charge in the first quarter in connection with retirement of our CEO, all of which related to non-cash vesting of stock awards and was excluded from our core FFO and AFFO calculations. Excluding the deferred rent repayments, our AFFO dividend payout ratio for the first quarter of 2022 was 68%, and that's fairly consistent with historical levels. Occupancy, as Steve mentioned, was 99.2% at quarter end, which is up slightly from recent quarters. G&A expense came in at $11 million, down from $11.7 million at year-ago levels. We ended the quarter with $732 million of annual base rent in place for all leases as of March 31, 2022, which we think is a good starting point for folks thinking about projections going forward. Today, as Steve mentioned, we increased our 2022 core FFO per share guidance from a range of $2.93 to $3 per share to a range of $3.01 to $3.08 per share. Similarly, we increased the AFFO guidance to a range of $3.08 to $3.15 per share, which reflects the scheduled slowdown and the deferral repayments in 2022 that we noted on page 13 of today's press release. The supporting assumptions for our 2022 guidance are on page 7 of today's press release and are largely unchanged from last quarter's guidance, albeit, we are excluding any executive retirement charges from our guidance. We continue to assume a 1% rent loss assumption in our guidance, which is what we've normally assumed for many years, despite the fact that we typically run at about half of that rent loss level normally, and that's where we are operating today as well. As usual, we don't give guidance on any of our assumptions for capital markets activity except for the general assumption that we intend to behave in a fairly leveraged neutral manner over the long term. Switching over to the balance sheet, there was very quiet first quarter in terms of capital market activity. We were active in the debt markets last year and are not unhappy to be on the sidelines at the moment. We ended the first quarter with $54 million of cash, nothing outstanding on our $1.1 billion bank line. Our liquidity remains in great shape. Our weighted average debt maturity is now 14.5 years, which seems to be among the longest in the industry. Our next debt maturity, as Steve mentioned, is $350 million of 3.9% debt coming due in mid-2024. All of our outstanding debt is fixed rate debt. So leverage and liquidity is in very good shape and the balance sheet is well-positioned for 2022. Just a couple of numbers and stats: Net debt to gross book assets was 40.5% at quarter end. Net debt to EBITDA was 5.3 times at March 31. Interest coverage and fixed charge coverage were both 4.7 times for the first quarter. So 2022 is off to a very good start. While there is an increased level of economic and capital market uncertainty, we are well-positioned for such and as Steve alluded to, possibly may lead to a more disciplined acquisition environment, which we think is helpful to us at the margin. Core 2022 FFO guidance now suggests 6% growth to the midpoint without any heroic assumptions. Our focus remains on growing per share results over the long term. And Matthew, with that, we will open it up to any questions.

Operator, Operator

[Operator Instructions] Your first question is coming from Nicholas Joseph from Citi.

Nicholas Joseph, Analyst

Just maybe starting on acquisition, you maintained acquisition guidance. Obviously, in the first quarter, you did over $200 million. So it seems like you're running ahead of the pace. What was the thought process? And what are you assuming kind of in the back half of the year relative to the busy first quarter?

Steve Horn, President and CEO

Your acquisition guidance we maintained really just as a result of visibility. I believe 60% was our weighted back end, the initial -- 60% of the 550 to 650. In the first quarter, we got off to a strong start, north of $200 million, and the second quarter in the pipeline looks pretty good. But as you know, visibility for the third and fourth quarters is currently unclear, so we thought it would be prudent to leave guidance the same.

Nicholas Joseph, Analyst

And then just maybe in terms of cap rates, you talked about cap rates being lower for the last few quarters, particularly this past quarter. With the rise in interest rates, how susceptible is the broader market, and particularly sale leaseback, to rising interest rates from a cap rate perspective?

Steve Horn, President and CEO

As you noted, our first quarter historic low is notable, but a lot of those deals were priced in January or December. Now that they've cleared the market, we've noticed with the rise in interest rates that some private companies are taking a wait-and-see approach, so we're not feeling them as much. But we are starting to notice that some deals are starting to get retreated or falling out. That's why we think they have bottomed out, and hopefully in the back half of the year, cap rates will catch up when we start getting repriced on the deals.

Operator, Operator

Your next question is coming from Lizzie Doican from Bank of America.

Unidentified Analyst, Analyst

I was wondering if you could comment more on the dispositions closed this quarter. What was kind of the composition of vacant versus occupied assets? And if you could also comment on any signs of outstanding buyer's pool—was it more difficult to find buyers?

Steve Horn, President and CEO

Regarding dispositions, we sold 10 assets. Three of those were income-producing assets that were more of a defensive sale due to the likelihood of lack of renewal in the future. So we thought we should put them in the portfolio. The other seven were vacant assets, which is a little bit higher than our historical norm. We always try to release those assets first and foremost but weren't finding good rental rates. So we decided it was better to dispose of the vacant ones and redeploy that capital into creative acquisitions.

Unidentified Analyst, Analyst

And if I could ask about bad debt expense you guys are assuming within your full-year guidance now?

Steve Horn, President and CEO

Yeah, so we've as I mentioned, we are continuing to assume a 1% rent loss, which is our general assumption for many years. Despite the fact that we usually do not reach that level, it typically runs about half of that, meaning 50 basis points a year. We’ve leased our retailers, and we just assume not everything will go perfectly. So that's the broad rationale behind that. Consistent with our past, in the first quarter, we collected 99.6% of the rent, so there was a 40 basis point loss in that. Thus, collections and rent loss behavior has remained as normal as it had for many years pre-pandemic.

Operator, Operator

Your next question is coming from Spenser Allaway from Green Street.

Spenser Allaway, Analyst

Just looking at recent market activity, it does seem as though implied recession odds have gone up in recent weeks. How do you guys feel about your primary lines of trade in the event of a broader economic slowdown? And is there any high-level color you can provide on your tenants' current rent coverage levels?

Kevin Habicht, Chief Financial Officer

Yeah, it's Kevin, Spenser. At the moment, we don't feel like there are any notable pressures on the rent-paying ability of our tenants. We've not seen a lot of stress there. Fortunately, a lot of our tenants are in fairly low price point, service-related, and food and beverage. So far, we've not seen a lot of change in consumer behavior, despite the fact that prices are definitely rising. So, at the top level, it just doesn't feel like there's a lot of stress with our tenants.

Spenser Allaway, Analyst

And then of the leases coming due maybe this year and even next, can you just comment on what portion of those are CPI linked? And do you have any concerns that the high inflationary environment might impact lease renewals or just the likelihood of tenants agreeing to those same terms in the future?

Steve Horn, President and CEO

Regarding leases coming due, we haven't -- we have 40 properties remaining for 2022. What we are seeing is our renewals are based on our historical norms where 85% of our tenants are renewing at 100% rent. And that's just the retail nature of it. So we are not expecting anything different going forward on renewals. Sitting here today with a 1.3% average daily rate on 2022, we're in outstanding shape, especially considering that a year ago it was 5.3%. Thus, 2022 renewals are looking solid right now.

Operator, Operator

Your next question is coming from Wes Golladay from Baird.

Wes Golladay, Analyst

Can you comment on what drove the big sale leaseback volume this quarter? Was there a few portfolios in there, or was it driven by M&A activity by the tenants? Can you give us a little more color?

Steve Horn, President and CEO

We did about nine transactions; eight of those were with relationship tenants while one was not. We completed a couple of portfolios that occurred post M&A where they reconfigured the balance sheet during the sale leaseback, and then we did a few in the $20 million to $30 million variety that were pure sale leasebacks.

Wes Golladay, Analyst

And then you mentioned seeing a little bit less competition. Are you noticing a bigger difference for larger deals, or the smaller one-off deals?

Steve Horn, President and CEO

The larger deals, historically, have had private companies competing aggressively. However, we haven't felt that pressure recently. On the larger deals, private money is hunting the elephants right now and we've noticed that subsided a little. But there's still a lot of competition in the $10 million to $20 million level.

Wes Golladay, Analyst

And then just a few modeling questions for you. The G&A was taken down; was that a non-cash G&A being lower than cash G&A? And when we look at the 5.3 times debt to EBITDA that you cited at the end of the quarter, is that a recurring number, or does that have the benefit of the term income bad debt and repayment of cash by the cash tenants and their straight-line tenants or master?

Steve Horn, President and CEO

Let me address the first part. The G&A is mostly cash-related. As I mentioned, we took a charge related to Jay Whitehurst’s retirement. So there was a significant non-cash impact in that line. Regarding your second question, you should consider us operating in the low fives going forward. Historically, our debt to EBITDA was in the mid to high-4s, and our debt plus preferred was in the mid to high-5s. We will likely finish somewhere between those two ranges, operating below five. The lease term income for this quarter and the deferral repayments will not materially influence that going forward.

Operator, Operator

Your next question is coming from Pedro Cardoso from TCW.

Pedro Cardoso, Analyst

Can you comment a little bit on same-store NOI?

Steve Horn, President and CEO

Our rents increase about 1.5% a year across the board, which is consistent with what we're seeing. It's fairly contractual. Some of them are tied to CPI, but it's capped. So effectively, it's a fairly fixed rent bump. We expect and are experiencing about 1.5%, so that's just a normal run rate that typically doesn't vary much from there.

Pedro Cardoso, Analyst

Got it. Do you expect to change the cap rate on your leases?

Steve Horn, President and CEO

As far as the acquisitions, we buy at the market cap rates. We do use our relationships, but as I stated in the opening statement, we do not expect cap rates to go down any further. However, we may see an adjustment along with the 10-year rates.

Pedro Cardoso, Analyst

Yeah, I mean, the cap on the annual increase capital has a certain rate, even --

Steve Horn, President and CEO

Got it. In terms of the rent increases, sorry, yes, fair question. Not at the moment, I don't. We're getting 1.5%, that's about the market for the kinds of tenants we work with; mainly large, regional, and national operators. That's where the market is. It will likely take a longer period of persistently higher interest rates or inflation rates to notably influence that number. We always aim for what we can get; sometimes we can get 2%, but I think it's too early to say that the current environment will significantly impact the rent increase numbers in the near term.

Operator, Operator

Your next question is coming from John Massocca from Ladenburg Thalmann.

John Massocca, Analyst

Can you walk us through some of the pushes and pulls that drove the bottom line guidance increase? It sounds like you have lower cash G&A expectations than previously, maybe a more front-end loaded acquisition expectation, and the benefit from no tenant credit issues in Q1. But I was curious if there was anything else really driving the upward move in guidance?

Steve Horn, President and CEO

No, I think you hit on the big points: acquisition timing, collections running better than guidance, a decrease in G&A, and then the wildcard, which I mentioned—we won’t give guidance—is capital markets activity. We make assumptions around what we would like to do concerning capital markets activity, and sometimes the capital markets have a different idea than we would like. That influences guidance, and it's not easy for you to pinpoint a number; that is a wildcard in addition to the variables you mentioned.

John Massocca, Analyst

As you look at the capital markets today, historically, you haven't really used the revolver much. Is that maybe a change in the current market dynamic, or are you still planning to raise capital once you've spent cash?

Steve Horn, President and CEO

Very good question, and a good observation. Over the last six years, we've averaged under $100 million in outstandings on our line. Last year, there was zero all year. I want to try to zig when the markets are zagging and vice versa. We went and issued a lot of long-duration debt last year, and if this environment persists or worsens, you'll likely find us using our bank line more. So, yes, fair comment. We'll see how things evolve. That's not a projection, but that’s our thought process.

Operator, Operator

[Operator Instructions] Your next question is coming from Linda Tsai from Jefferies.

Linda Tsai, Analyst

You noted that inflation isn't impacting shoppers within your tenant base. But to the extent it does, where might you see it first in terms of industry exposure and where might you see it last?

Steve Horn, President and CEO

Regarding our top tenants, they're finding a way to pass through the inflation. It has been a couple of quarters now, but customers for our service base, whether it's convenience stores or quick-service restaurants, are finding a way to manage it. It hasn't gotten out of control, where customers aren't accepting these changes. If it happens, you might see it first in larger ticket items, like Arby's, as consumers tend to pull back on those.

Linda Tsai, Analyst

Automotive services account for about 13% of your industry mix, and it's the industry that has seen the most significant year-over-year increase. Is there a threshold for how high this industry could become?

Steve Horn, President and CEO

We have a long way to go. Historically, we were at 30% convenience stores. We've been focused on underwriting real estate. If it makes sense to buy it because you're buying the right real estate—keeping rents low and covering assets—we'll continue to push, but we have plenty of runway in the auto services area.

Kevin Habicht, Chief Financial Officer

Just to remind folks, there is a wide variety within that line of trade, including car washes, tire services, oil changes, collisions, and many others. We feel that despite it being at 12.6%, which is not overly high, there exists a high degree of diversification not only at the property level but even within various sub-lines of trading in that line.

Operator, Operator

Thank you. That concludes our Q&A session. I'll now hand the conference back to President and CEO, Steve Horn for closing remarks. Please go ahead.

Steve Horn, President and CEO

We thank you for joining us this morning and look forward to talking with many of you at upcoming ICSC or NAREIT events in June. Thank you. Have a good rest of your day.

Operator, Operator

Thank you ladies and gentlemen. This concludes today's event. You may disconnect at this time and have a wonderful day.