National Retail Properties, Inc. (NYSE:NNN) Q3 2023 Earnings Call Transcript

National Retail Properties, Inc. (NYSE:NNN) Q3 2023 Earnings Call Transcript November 1, 2023

National Retail Properties, Inc. misses on earnings expectations. Reported EPS is $0.59 EPS, expectations were $0.8.

Operator: Greetings, and welcome to the NNN REIT Inc. Third Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to your host, Steve Horn, Chief Executive Officer. Sir, you may begin.

Stephen Horn: Thanks, Ali. Good morning, and welcome to NNN REIT’s Third Quarter 2023 Earnings Call. Joining me on the call is Chief Financial Officer, Kevin Habicht. As this morning’s press release reflects NNN’s performance in 2023 continues to produce strong results, including high occupancy, solid acquisitions driven by our proprietary relationships, which is the NNN mode to creating quality earnings. We are in a position to continue the performance through the fourth quarter as our pipeline and capital are in place. Based on our year-to-date performance, we announced a further increase in our 2023 guidance for core FFO to a range of 3.19 to 3.23 per share and we raised the midpoint of total acquisition volume to 750 million from 650 million.

Before I get into the day-to-day operations and market conditions, I would like to discuss significant third quarter events for the company. First, I’m excited to welcome Mr. John Adamas to the executive team as Head of Portfolio Operations. John joined NNN in 2003 and has been a valuable contributor since day one. Currently, he is overseeing the asset management, leasing, underwriting, dispositions and development financing functions for the company. I’m confident we have the right person waking up everyday thinking about the best way to extract value for the shareholders out of the already solid end portfolio. In addition, on the capital markets front, we completed a 500 million 10-year unsecured bond offering with a 5.6% coupon. In traditional NNN fashion, the execution and timing of the deal in today’s market are looking pretty stellar.

More importantly, the timely transaction has entered then in terrific position to continue executing the strategy. NNN’s long-steaming discipline of being selective while deploying capital and opportunistic raising capital over the decades as NNN in great shape. In a time of prolonged uncertainty like today’s macroeconomic conditions NNN’s discipline of maintaining a solid balance sheet and reasonable acquisition volume does put NNN in a place to execute the remaining deal flow for 2023, but more importantly, to execute 2024 with limited, if any, needs to access the capital markets. At the end of the quarter, we had nothing drawn on our 1.1 billion line of credit after completing over 550 million of volume through the first nine-months.

Coupled the line of credit with NNN’s industry-leading free cash flow as a percentage of acquisition volume, we are ready to execute when the right opportunities present themselves. Shifting to the highlights of the third quarter’s financial results. Our portfolio of 3,511 freestanding single-time properties continue to perform exceedingly well with 10.1-years of term, maintained high occupancy levels at 99.2 which remains above our long-term average of 98%, plus or minus, and only 27 vacant assets. With regard to acquisitions, during the quarter, we invested 212 million in 46 new properties at an initial cash cap rate, I can’t stress enough cash cap rate of 7.4% and with an average lease duration of 16.5%. 18 of the 34 closings were under five million, which shows NNN’s belief that the smaller deals still move the needle, and we believe smaller fungible real estate is the best risk-adjusted investment.

The first nine-months, we invested roughly 550 million and 125 properties at a cash cap rate of 7.2%, which is about 100 basis points higher than the comparable period in 2022. Currently, the industry continues in the price discovery mode, and that is resulting in the overall market volume down nearly 50%, but we do see the bid as spread showing signs of tightening, so we will continue our thoughtful and disciplined underwriting approach. There has been an increase in cap rates for NNN as the year progresses, and we are seeing that trend continuing. NNN has been listed on the New York Stock Exchange since 1994. It is one of the few net lease companies that it is operated with success a high interest rate environment with a proven operating model and strategy over many decades.

The model is about prudent capital allocation, creating predictable, consistent, high-quality cash flow by emphasizing acquisition volume through sale-leaseback transaction with our stable of relationships using the company’s long-term triple net lease form, which is a lot more landlord-friendly than a 1031 market deal. During the quarter, we sold 13 properties, two are vacant, raised $49 million of proceeds at a 6.0 cap rate and reinvested it at 7.4 million. Year-to-date, we have now raised approximately 90 million of proceeds from the sale of 26 assets, which included seven vacant at a 5.8% cap rate. The mission is always to re-lease vacancies but we will continue to sell nonperforming assets, if we do not see a clear path to generating rental income within a reasonable time frame.

Our balance sheet is one of the strongest in the sector. Our credit facility has plenty of capacity, as I mentioned earlier, we have no outstanding balance. We have no material denatures until mid-2024, and we have the industry best 12.6-year weighted debt maturity. NNN is well positioned to fund our remaining 2033 acquisition guidance and beyond. With that, let me turn the call over to Kevin for more color and detail on our quarterly numbers and updated guidance.

Kevin Habicht: Thanks, Steve. And as usual, I will start with the cautionary statement that we will 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. Okay. With that, headlines from this morning’s press release report quarterly core FFO results of $0.81 per share for the third quarter of 2023.

That is up $0.02 or 2.5% over year ago results of $0.79 per share. First nine-months 2023 results were $2.42 per share, which represents an increase of 3% over prior year results. AFFO for the first nine-months was $2.44 per share, and that represents a 1.2% increase over 2022 results. As we have disclosed since 2020, the last page of our press release provides details of the pandemic deferred rent repayments. As tenants fulfill their deferred rent obligations the repayment amounts, as you can see, are slowing from 14.5 million in 2022 to 3.1 million in 2023 and then at the bottom of that Page 13, we have provided pro forma per share amounts, excluding these repayments in both 2022 and 2023 to provide a look at the recurring fundamental per share performance.

These adjusted results show nine-month per share growth of 3.9% for core FFO, and that is instead of a 3.0% headline number and also shows 3.4% growth for AFFO, and that is instead of the 1.2% headline number. So 90 basis points higher for core, 220 basis points higher for AFFO versus the headline numbers. We think this just gives you a better picture of the core fundamental operating results of our business. But overall, a good quarter, in line with our expectations. Moving on, our AFFO dividend payout ratio for the first nine-months of 2023 was approximately 68%. And which resulted in approximately $141 million of free cash flow for the first nine-months after the payment of all expenses and dividends. And this equates to a $188 million annualized free cash flow rate.

Occupancy was 99.2% at quarter end. That is down 20 basis points from prior quarter and year-end 2022. G&A expense was $10.2 million for the quarter, representing 5.0% of revenues and 5.4% for the first nine-months of 2023. But our midpoint guidance for this line item remains at $44 million for the full-year of 2023, which would put our – put it close to 5.3% of revenues for the year. We ended the quarter with $800.2 million of annual base rent in place for all leases as of September 30, 2023. As Steve mentioned, today, we increased our 2023 core FFO guidance, increasing the bottom end by $0.02 and the top end by $0.01 to a range of $3.19 to $3.23 per share. AFFO guidance was increased by the same amount to a range of $3.22 to $3.26 per share.

This new guidance suggests 2% to 2.5% growth in core FFO for 2023 versus 2022 on the headline number. But again, if the deferred rent repayments are eliminated from both years, then core FFO growth would be in the 3% to 3.5% range. Similarly, AFFO per share would go from around 1% growth at the midpoint for 2023 to around 3% growth if we exclude the deferred rent repayments. As we have previously discussed, the more modest growth in per share results for 2023 reflects in part the high bar created by last year’s 9.8% growth, the lack of tailwinds that were helpful in 2022 as well as the slowdown in the scheduled deferred rent repayments as noted on Page 13. The 2023 guidance and the key supporting assumptions are on Page 7 of today’s press release with the only notable change, as Steve mentioned, the $100 million increase in our 2023 acquisition volume guidance now a range of $700 million to $800 million.

Switching over to the balance sheet. We maintain a good leverage and liquidity profile with $1.2 billion of liquidity at quarter end. We funded approximately half of our year-to-date $550 million of acquisitions with free cash flow, disposition proceeds and a little bit of equity issued very early this year. In mid-August, we opted to issue $500 million of 10-year unsecured debt with a 5.6% coupon and a 5.9% yield, while we really had no pressing need to issue debt, we just wanted to stay in front of the curve in what appears to be a growing supply of debt issuance from a variety of sources. But as I have said, we will know in a couple of years the wisdom of issuing that debt. So far, it feels like a reasonable call, and there is also very real value in maintaining our low balance sheet risk.

Our weighted average debt maturity remains over 12-years, which will help us slow the coming refinance headwind that all REITs are facing. All of our debt outstanding is unsecured at fixed rates. A couple of numbers, net book to gross book assets was 40.9%. Net debt-to-EBITDA was 5.4 times at September 30. Interest coverage and fixed charge coverage was 4.6 times for the third quarter. We are happy to see more attention and discussion in the marketplace about capital allocation. Those of you who know us well, have heard us hanging that from the last few years. We believe it is one of the more fundamental issues for any REIT or frankly, any company 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 in our opinion.

A low view of the return requirements for deploying equity and debt capital likely leads to suboptimal accretion when deploying that capital. Not valuing equity capital rate also frequently leads to asset growth over time that is in our minds, not sufficiently accretive to per share results. So we are glad the topic is getting more attention. Unfortunately, only now that the capital markets are rock here and the citing contrast of recent years is producing some indigestion in every corner of the investment world. Over the last few months, we have been talking with investors about what the world might look like in a no new equity environment, which is why we are glad that our free cash flow from operations relative to our typical acquisition volumes will help us better navigate that rocky capital market environment.

We will likely give more details in this regard on next quarter’s call in connection with our 2024 guidance. So in closing, I think we are in relatively good positioned to navigate the elevated economic and capital market uncertainties and to continue to grow per share results, which we view as the primary measure of success. And we are mindful this is a long-term multiyear endeavor. The fundamentals of our business remain in good shape, occupancy, re-leasing, renewals, acquisition and disposition volumes and cap rates. So feel good about where we are at the moment. With that, we will open it up to any questions.

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Q&A Session

Operator: Thank you, sir. At this time, we will be conducting our question-and-answer session. [Operator Instructions] Our first question is coming from Josh Dennerlein with Bank of America.

Joshua Dennerlein: Yes, I appreciate the time. Maybe I will just start with a big picture question. Just kind of thinking through the dynamic that we are seeing in the public markets. Like how should we kind of think about like the response in the private markets for cap rates going forward?

Stephen Horn: Josh, I appreciate the question, its Steve. The private market, we don’t bump into them, especially in the last 18-months. We haven’t seen it at all. However, the picture as far as cap rates, we are seeing a trend up in cap rates for NNN’s target market and more it is a result of then still being selective. If I had to do $1.3 billion, $1.5 billion, my selectivity goes down, so therefore, I have to win more deals. But our relationship with tenants who are sophisticated understand with debt market pricing that cap rates have to go up. So we are seeing a pickup, and you see it in the numbers, 15, 20 basis points a quarter. And I’m expecting that trend to continue through the first half of the year. Second half is too far out to speak of.

Joshua Dennerlein: Okay. I appreciate that color. And then, Kevin, maybe just maybe some for later, but just kind of curious, I think you started to mention it a little bit. Just kind of – I think you have pretty good free cash flow, just kind of how you think about how you can kind of layer in acquisitions with that free cash flow without additional equity? And then just like – I’m just trying to think maybe what kind of base rate we can get out of you for volumes?

Kevin Habicht: Yes. And we will go into more detail as we lay out guidance for 2024. But the math that we have talked generally about and this is not guidance, to be clear. As if you think about $180 million a year of free cash flow, which we, by the way, charge in our minds as we think about deploying that capital at about 8.5% cost to us. It is not three. You could leverage that, call it, $100 million round numbers, maybe a little bit more. And so that would create around $300 million of acquisitions. And then if we are selling $100 million of properties in a given year, so disposition proceeds enter into that equation, that would take acquisition volumes to around $400 million potentially, in a very leverage-neutral light capital market footprint kind of way. And so that is the way we would think about it, I think, generally. But we will, like I said, we will look to provide a little more detail on our thoughts on that next quarter.

Operator: Our next question is coming from Ron Kamdem with Morgan Stanley.

Ronald Kamdem: Just a couple of quick ones for me. Just – I saw the occupancy dip 20 basis points quarter-over-quarter. Maybe can you talk about that and Lupin, just how bad debt is trending and what’s baked into the guidance?

Kevin Habicht: Yes. I wouldn’t read too much into that. As Pete folks know, we had three Bed Bath & Beyond that went dark on us as they have filed for bankruptcy projected all the leases. So that is a chunk of that 20 basis points decline and the rest is a little bit of noise. As it relates, more broadly speaking, – we don’t have any – I mean, look, we got a lot of concerns because we leased properties to retailers so we are perpetually worried. But yes, in terms of our exposure and how we are thinking about not reserve, but our guidance incorporates typically 100 basis points of rent loss for things that might not go well. And so we are this feels like at the moment, it will be – despite assuming 100 basis points, this feels like it will be more of a normal year of, call it, 40 to 50 basis points of kind of rent loss from a variety of things, which includes tenant bankruptcies and also in the weeds that it is the things that we do on a daily basis as we are thinking about future renewals and dealing with those from maybe a defensive position and making sure to support our occupancy and consistent cash flow.

At times, it makes sense to trim rent a bit to get lease extensions. And so from time to time, we will do a little bit of that. So all of that is baked into that kind of rent loss number. But so far this year, it is playing out as a fairly typical year, which for us is 30 to 50 basis points of rent loss. But as I said, we assume in our guidance that will lose around 100 basis points.

Ronald Kamdem: Got it. And that is pretty conservative. So just going back to the acquisition, obviously, over $200 million this quarter. I think all your peers have talked about basically activity slowing in this rate environment. So I guess I’m just trying to figure out, is this an environment where – and then is potentially better positioned because you are only trying to do $400 million, $500 million, $600 million – or is the messaging that you guys are seeing slowing as well and we should think about acquisitions next year potentially being down and so forth. So I’m not asking for guidance for next year, obviously. Just trying to get a sense of how that pipeline of the building and if you guys are being impacted just like your peers?

Stephen Horn: I think the opportunity set is still the same out there minus some M&A activity that has definitely slowed down. Our pipeline has never really been more robust. It is more NNN being disciplined when allocating capital to what acquisition opportunities that are out there. I will let Kevin talk about 2024. But as far as the opportunities of it, it is as good today as it was six-months ago, and cap rates are increasing. New money going out the door is higher today than it was two weeks ago.

Kevin Habicht: Yes. And as it relates to next year, we will give more detail around what we are thinking for that number. As I just heard on the prior question, we think we have in essence, kind of capital in hand, if you will, to do a decent amount of acquisitions. But it is all – it is frankly all dependent on kind of returns. I mean – and so we are not we are not particularly focused on trying on asset growth. We are trying to grow per share results at the end of the day. And that is a little bit or a lot of bit of acquisitions, the returns that we can achieve and the accretion that we can achieve will drive kind of our thought process on acquisition volume.

Operator: Our next question is coming from Eric Wolfe with Citi.

Eric Wolfe: I just want to clarify on the guidance. You are still assuming 100 bps of credit loss versus the 40 to 50 basis points that you are sort of trending to. And then if you could just remind us in terms of defining that credit loss to would include, say, like the vacant properties that you decide to sell and not being able to recoup the full NOI after reinvestment? Or do you sort of think about that separately? Just trying to understand what’s included in the full credit loss.

Kevin Habicht: Yes. That is fair. Yes. So yes, we are assuming it for the fourth quarter, 100 basis points granted it is only a quarter’s worth of rent, 100 basis points. And now to your second part of that question is that, yes, it would not assume reinvesting disposition proceeds of a vacant property that is, in our minds, a little bit separate bucket. And it is a little bit of a sum cost in that a vacant property. It may have had some rent a year ago, but of late, and the rent obviously is zero. And so there’s potential upside, obviously, from reinvesting kind of those proceeds that had no return for a period of time. And so – but yes, that is not included in our thoughts around the 100 basis points.