Earnings Call Transcript - NNN Q4 2024

Operator, Operator

Greetings, welcome to the NNN REIT, Inc. Fourth Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the conference over to your host, Steve Horn, CEO. You may begin.

Steve Horn, CEO

Hey, thanks, Holly. Good morning, and welcome to NNN REIT’s fourth quarter 2024 earnings call. Joining me today is the current Chief Financial Officer, Kevin Habicht, and our incoming CFO, Vincent Chao. As outlined in this morning's press release, NNN delivered 1.8% core FFO growth for 2024, alongside over $550 million in acquisition volume. The year concluded with a strong 98.5 occupancy rate, while our dispositions of income-producing assets were executed at a cap rate 40 basis points lower than our acquisition yield, including several strategic and defensive asset sales. These achievements reflect the dedication and expertise of our best-in-class team at NNN, positioning us well for the near term. Key highlights I'm particularly proud of for the year include 35 consecutive years of annual dividend increases, maintaining a sector-leading 12.1-year weighted average of debt maturity, and strategically positioning our executive team for the future. Despite the overall theme of maintaining a light capital markets footprint for 2024, our core philosophy remained unchanged, delivering long-term value with below-average risk for our shareholders. At its simplest, our strategy focuses on a bottom-up investment approach, continuing to increase the annual dividend while maintaining a top-tier payout ratio, FFO growth per share in the mid-single digits over multiple years. This disciplined approach drives our acquisition and disposition strategy, as well as our balance sheet management, ensuring we stay on track to achieve our objectives. Before diving into the market conditions and operational updates, I would like to formally welcome Vincent Chao to the executive team. Vincent joins NNN in early January and officially assumes the CFO role at the start of the second quarter. He brings extensive public company and investment banking experience with expertise in capital markets, corporate finance, and investor relations. I look forward to our partnership as we continue to grow NNN. Now, to Kevin. After over 30 years of dedicated service, including four CEOs and over $5 billion of cash dividends paid, Kevin's commitment to excellence is an integral part of the fabric of NNN. His work ethic, leadership, and passion for doing the right thing have been consistently evident, leaving an indelible mark woven deeply into the very DNA of NNN. Through every challenge, he has not only contributed to our success, but has also shaped the values of our culture that will continue to guide us long after his departure. His legacy is not just in the work completed, but in the principles and standards he's instilled in those who had the privilege to work alongside him. With that, Kevin, on behalf of the entire company, the board, the analysts, and the investor community, we want to express our heartfelt gratitude and acknowledge that you will undoubtedly be missed as you move forward to the next chapter in your life, and we wish you nothing but the best. As we move forward to the first quarter of 2025, NNN maintains a robust position. We anticipate another strong quarter of acquisitions and are making significant progress with the assets related to Frisch's and Badcock Home Furnitures. Kevin will provide a lot more detail on the activities concerning these tenants during the upcoming remarks. Regarding the fourth quarter financial highlights, our portfolio now comprises 3,568 freestanding single-tenant properties, and they continue to perform exceptionally well. Occupancy decreased to 98.5 due to challenges with two specific tenants. However, this rate remains above our long-term average of roughly 98%, plus or minus. I anticipate the level increasing as the year progresses because as we report today, I feel good about the remaining tenants in the portfolio and the activities the leasing team is generating currently. In terms of acquisitions, during the quarter, we invested $217 million in 31 new properties, achieving an initial cap rate of 7.6 and an average lease duration of approximately 20 years. Over 80% of the capital deployed this quarter was allocated to our business relationship partners. Additionally, the long-term projected yield on these acquisitions would be 8.8%, reflecting our preference for the sale-leaseback acquisition model, as opposed to purchasing existing shorter-term leases, despite them potentially offering higher yields. They don't align with our assessment of optimal risk-adjusted returns. Disposition activity was elevated this year, with nearly $150 million sold at a 7.3 cap. At the start of the year, as I mentioned earlier, the team identified several non-performing assets for strategic and defensive sales, leading to a more compressed spread between disposition and acquisition cap rates compared to previous years. However, this proactive portfolio management enhances the overall strength of the portfolio as we move forward. We need to go back over a decade to find an acquisition year with an initial cap rate higher than our 2024 deal flow. The current pricing for the pipeline coming in this quarter will be slightly tighter than the fourth quarter of 7.6. As I look ahead in the next few quarters, I expect pricing to compress a little bit further at the margins due to the heightened competition as market players push to achieve high acquisition buy-ins. That said, I am confident in our team's ability to identify and execute the right risk-adjusted deals to meet our 2025 annual objective. With that, let me turn the call over to Kevin for the final time to provide more color and detail on our quarterly numbers and 2025 guidance.

Kevin Habicht, CFO

Great, thanks. Thank you, Steve. As usual, I'm going to start with a cautionary statement that we will make certain remarks that may be considered 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. 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. Okay, with that, headlines from this morning's press release report. Quarterly core FFO results of $0.82 per share for the fourth quarter of 2024. That's flat with year-ago results once you adjust 2023 results for the incremental accrued rental income that we noted in footnote one on the press release. AFFO results were $0.82 per share for the fourth quarter, which was also flat compared to year-ago results. For the year, core FFO and AFFO were $3.32 per share and $3.35 per share, respectively, resulting in a 1.8% increase in core FFO per share results for 2024 and a 2.8% increase in AFFO per share. These results were generally in line with our expectations and put us at the top of our previous guidance range. Results in the fourth quarter included $1.2 million of lease termination fee income and for the full year of 2024, $11.4 million, which we noted throughout the year was well above historical norms and was above our full year 2023's $2.4 million of lease termination fee income. Also in the fourth quarter, 2024 G&A expense included a state franchise tax refund due to our retroactive change in Tennessee tax law that reduced G&A by $1.7 million to $8.7 million for the fourth quarter and to $44.3 million for the full year, representing 5.1% of total revenues for the year and 5.2% of total NOI. Occupancy was 98.5% at quarter end, which, as anticipated, dipped 80 basis points for the quarter due to two failing tenants we talked about on last quarter's call, more about which in a moment. Our AFFO dividend payout ratio for the year 2024 was 68.2%, resulting in approximately $196 million of free cash flow, after the payment of all expenses and dividends. We ended the quarter with $860.6 million of annual base rent in place for all leases as of December 31, 2024, which would take into account all the acquisitions and dispositions completed through the year-end. First, a quick update on our two troubled tenants, which we discussed last quarter. First, Badcock Furniture, which was in liquidation, completed its going-out-of-business sales and in the fourth quarter rejected the leases on all 32 properties we had leased to them. Prior to the fourth quarter, those leases produced $5.2 million of annual base rent, which was 0.6% of our ABR at the beginning of the fourth quarter. Before rejecting the leases, Badcock paid us roughly half of what they would normally have paid during the fourth quarter. We've been working on plans to lease or sell these properties and have had a good start in that effort given we just took possession of the stores mid-fourth quarter. By year-end, we were able to release five of those properties at roughly our long-term average of 70% rent recovery, with no tenant improvements for our vacancy releasing. Additionally, we were able to sell six properties, generating net proceeds of $21.8 million, which using prior Badcock rent on these properties would produce a 5.1% cap rate on those dispositions. Assuming we invested these sale proceeds at the fourth quarter's 7.6% acquisition cap rate, this would result in generating 49% more rent on those stores than Badcock was previously paying us. If you combine the outcome of the five released properties and the six sold properties, the rent recovery on those 11 stores is approximately 113% of prior rent. While these averages may not hold up for all Badcock stores, we are off to a very good start in minimizing downtime for this first batch or about 35% of our former Badcock stores. The second tenant of note is Frisch's, a Midwest Big Boy hamburger concept that has been around for several decades. They only paid us half the rent owed in the third quarter last year and paid us no rent in the fourth quarter. We owned 64 Frisch's properties at the beginning of the fourth quarter, representing 1.5% of our annual base rent, or $12.6 million. As you may recall, the tenant did not file for bankruptcy, so we had to go through the time-intensive process of getting back possession of the stores through evictions. We've initiated that eviction process for all 64 stores and, as of year-end, had possession of 33 stores. Of those 33 stores, we've released 28 of those stores to another restaurant operator. Because we had a read on prior store sales for these properties and to speed up the leasing process on a large group of properties, we were willing to trade off some base rent for more potential percentage rent. These 28 stores will produce approximately $2.8 million of annual base rent, but we will also get 7% of store sales above a fixed breakpoint, with rent commencing May 1 of 2025. At this time, we are not looking to outline other lease terms as we have several other Frisch's to release. We will soon have possession of all the former Frisch's properties and are in full leasing mode on that batch of stores. The bigger picture and key point of the combined Badcock-Frisch's vacancy, consistent with these early resolutions I just reviewed, is that we remain optimistic to, first, get them leased or sold more quickly than usual and, second, hopefully improve our typical vacant property rent recovery of 70% versus prior rent with no tenant improvements. We will provide further updates with first-quarter results, but most importantly, when the dust settles on all this in 2026, we believe per share results should be impacted by less than 1% versus the prior rents we were receiving from the original tenant. So a very modest impact on bottom line results when the dust settles. Switching gears, today we initiated our 2025 core FFO guidance at a range of $3.33 to $3.38 per share and 2025 AFFO guidance with a range of $3.39 to $3.44 per share. Page 8 of the press release gives you some details on the key assumptions underlying that guidance, which includes $500 million to $600 million of acquisitions, $80 million to $120 million of dispositions, $47 million to $48 million of G&A expenses, and property expenses net of reimbursement of $15 million to $16 million, which is higher than usual due to the Badcock and Frisch's vacancies. Hopefully, we will have the opportunity to increase FFO guidance higher as the year progresses, as we have done in the past. Moving to the balance sheet, we ended the year with no amounts outstanding on our $1.2 billion bank line, so we're in a very good leverage and liquidity position as we roll into 2025. Our next debt maturity is November 2025, and our weighted average debt maturity stands at 12.1 years at year-end. Maintaining our light capital market footprint, we funded 61% of our $565 million of 2024 acquisitions with free cash flow of $196 million plus $149 million of disposition proceeds. Net debt to gross book assets was 40.5% at year-end, down about 150 basis points from the year before. Net debt to EBITDA was 5.5 times at December 31st. Interest coverage and fixed charge coverage was 4.2 times for 2024. As a reminder, none of our properties are encumbered by mortgages. We remain focused on working to appropriately allocate capital, which to us means ensuring we're getting what we believe are sufficient returns on equity while controlling risk through property underwriting and maintaining a sound balance sheet. Valuing equity adequately, whether that equity is produced by free cash flow, disposition proceeds, or new equity issuance is at the heart of growing per share results over the long term, and it helps us not to confuse activity with achievement. Steve, thanks for your kind words earlier. In closing, it is very bittersweet for me to be on my last quarterly earnings call. I think I've been on over 100 of them. NNN is in very good shape, and its approach to navigating investment opportunities and capital markets is well ingrained in this institution. I leave you in the very capable hands of Steve, Vin, and the rest of the team here at NNN. Thanks to many of you on this call whom I've known and worked with for many years and who have been gracious to tolerate my many issues. These long-term relationships have made the journey for me much more enjoyable and satisfying. As I've said several times this past month, the boundary lines of my life have fallen in pleasant places, and that includes my time and relationships in the REIT world. It's been a great ride, and I can be nothing but thankful to the investor and capital markets community and especially my colleagues here at NNN. I will cherish the memories and welcome the opportunity to stay in touch. With that, Holly, we will open it up to any questions.

Operator, Operator

Certainly. At this time, we will be conducting a question-and-answer session. Your first question for today is from Brad Heffern with RBC.

Brad Heffern, Analyst

Hey. Good morning, everyone. Congratulations, Kevin. Hope you have a great retirement. Knowing you, I suspect you've been saving up for it, and welcome to Vincent as well. For the AFFO guidance, I'm a little surprised that you're able to deliver this 2% growth just given the elevated lease termination from last year, the impact of Badcock and Frisch's. There's also this 4Q tax benefit. Is there some sort of offset to that that I'm not thinking of, or just any color you can give on the bridge that would sort of preserve that growth number?

Kevin Habicht, CFO

Yeah, not in particular. We are having, I would say, somewhat better than expected kind of releasing outcomes or resolving our Frisch's and Badcock. That's all happening more quickly, particularly timing is of great value, as you know in that process. And so that's been very helpful. But, yeah, there's no other big major items to speak of. Lease termination fees are always difficult to get guidance on. That will play out as it plays out during the year. But yeah, nothing else to provide of note. Timing is really critical. We had a solid fourth quarter of acquisitions and a solid second half of '24. Those factors accumulate to help push results along a little bit.

Brad Heffern, Analyst

Okay, got it. And then maybe you didn't provide this on purpose, but the $2.8 million for the released Frisch's, how does that compare to the prior rent on those stores? And then for the percentage rent, is that set at a level where you would expect to regularly realize that right away, or is that something that requires upside?

Kevin Habicht, CFO

Yeah, fair question. The $2.8 million, I would call it roughly 50% of prior rent. As I said, we were willing to take that kind of pain on the annual base rent to get the benefit of what we think will produce notable potential percentage rent on those stores. We had the prior store sale, and this was a way for us to speed up the process. We just got those 33 stores back in the fourth quarter, and we had them released in the fourth quarter, quite quickly again with no tenant improvements. We saw material value in that part of the equation, and since we had prior store sales, we're optimistic that we will be able to achieve something above our normal 70% rent recovery on releasing vacant spaces. We will see how much better we can do than that, but we think there is upside there.

Spenser Glimcher, Analyst

Thank you. I'm just curious on the transaction front, what you guys have been seeing in terms of 4Q activity and then 1Q, just as it relates to the mix of portfolio deals versus one-off or anything that you're doing outside of relationship deals?

Steve Horn, CEO

Outside the relationship deals, there has not been much large-scale portfolio activity for our market. It's been a little bit slow. That's why over 80% of our deal flow in the fourth quarter was through the relationships, one of the transactions was pretty notable, and it wasn't marketed as a direct deal. First quarter is looking pretty good right now, but it's a lot of what I would call mid-size deals in the $20 million to $30 million range. We're not seeing the $150 million-$200 million deals. However, there is one potential large portfolio coming out in the family entertainment space that we're aware of, but it's a bit early to discuss the pricing on that right now.

Kevin Habicht, CFO

Yeah, not materially. As for our guidance, we've assumed 60 basis points of rent loss for this year, historically, we've been closer to the 100 basis points category. We typically don't experience that level, so we believe we've baked in enough for credit loss for this year. We don't have any other tenants in the immediate horizon that feel like we have real exposure to in terms of credit loss. A, and B, the 60 basis points obviously shows any pain from Badcock and Frisch's goes beyond that 60 basis points.

Michael Goldsmith, Analyst

Good morning. Thanks a lot for taking my questions, and congratulations, Kevin, on a wonderful career. As a going-away president, I'll ask you to walk us through kind of what you've baked into your guidance for Frisch's and Badcock related to the timing of the leasing and recovery rate for 2025. Thanks.

Kevin Habicht, CFO

In my usual way, I will be sufficiently elusive because it's a work in progress. The only thing I can say is we are historically good at releasing something in 9 to 12 months. That being said, it is going along more quickly than that on both Badcock and Frisch's, as evidenced in the fourth quarter, and that continues into the first quarter. I don't have many details to give you on that releasing effort. It's very current, and it’s tough to put a hard stake in the ground on that. But it only speaks to the fact that it is going better than normal in timing and economic outcome.

John Kilichowski, Analyst

Good morning, and congrats again, Kevin. Maybe if we could start by discussing the transaction market here and how deal flow looks at this point in comparison to this time last year. You mentioned some elevated deal flow, but also elevated competition; how do you think that could manifest in changes to your acquisition guidance near the lower or high end? And when you talk about that elevated competition, who is that and what are the returns that they're looking for?

Steve Horn, CEO

Our guidance for the year has historically been conservative. We usually start on the lower end. As for competition, I've been doing this for over 20 years; Kevin has been doing it for over 30 years. The market is always competitive, but the names have changed. Private money has begun to return to the market a little bit, but their return expectations are a bit higher. The amount of money they have to deploy into acquisitions is significantly higher than ours. They will go after what we call the elephant deal flow, not smaller deals. Overall, though, I feel good about activity and what's in the pipeline. Our acquisition team has evaluated all deals made by our competitors.

Farrell Granath, Analyst

Hi. Good morning. This is Farrell Granath. I want to say congratulations to both Kevin and Vincent on your next chapters in your life. I also wanted to ask about the demand you're seeing for both the Badcock and Frisch's assets. Are you receiving a lot of inbounds, and are they within the same industry verticals?

Steve Horn, CEO

We are seeing a lot of interest in Frisch's and a fair amount in Badcock. We're doing really well with Badcock, but it is a portfolio, and the easier assets to sell are the good ones, which go first. So our team has some work to do as we move through the process. As for industries, yes, there’s a lot of restaurant interest; not only casual dining but also QSR. Again, we're seeing a fair amount of interest in car washes and auto service. It’s across a wide range because the reality is these are 5,000-6,000 square foot boxes on an acre and a half. Significant numbers of tenants find that use appealing. I would be concerned if they were 20,000-30,000 foot boxes, which makes it a little more challenging to release, but a small restaurant on an acre and a half at a hard corner location has many users.

Kevin Habicht, CFO

We own some Denny’s properties. I will say again that the price we paid for those assets is attractive and the rents are very reasonable. Some are operated by franchisees. So it’s hard when examining headlines to determine if that's particularly applicable to us or not. The chain Denny's has been struggling for quite some time, and we have been monitoring that, but we feel that our locations and the rents on those locations are at levels which don’t cause us too much concern.

Rob Stevenson, Analyst

Good morning, guys. Kevin, you talked about the revenue from Badcock and Frisch's, but can you also elaborate on any material elevation of expenses that you are experiencing today, which might taper off over the course of '25?

Kevin Habicht, CFO

Yes, fair question. The net property expense number of $15 million to $16 million is probably $4 million to $5 million higher than what I would classify as normal for a typical year. That relates almost entirely to Badcock and Frisch's. As we progress into 2026, that expense should naturally dissipate.

John Massocca, Analyst

Thanks for taking my question, Kevin. Just looking for a little color on the outlook for lease expirations in 2025. Anything notable standing out? I assume you're expecting the typical recovery rate on rents expiring?

Kevin Habicht, CFO

Yes, nothing of significant note comes to mind. We are a little bit heavy in convenience stores in terms of lease expirations this year, but they are fairly solid performers. Therefore, we do not anticipate adverse outcomes compared to historical norms.

Steve Horn, CEO

I appreciate you taking the time today. Thanks for joining us, and we will see you all in person during the upcoming conference season. Kevin, one last goodbye.

Kevin Habicht, CFO

Thank you. All right. Thank you. It's been a good time.

Operator, Operator

Thank you all. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.