Getty Realty Corp. (GTY) Earnings Call Transcript & Summary

Good morning, and welcome to Getty Realty's Earnings Conference Call for the Third Quarter 2023. This call is being recorded. [Operator Instructions] 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 third quarter earnings conference call. Yesterday afternoon, the company released its financial and operating results for the quarter ended September 30, 2023. Form 8-K earnings release are available, 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 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 2023 guidance and may also include statements made by management, including those regarding the company's future operations, future financial performance or investment 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, 2022, and our subsequent 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 operations, 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 third quarter of 2023. Joining us on the call today are Mark Olear, our Chief Operating Officer; and Brian Dickman, our Chief Financial Officer. I will lead off today's call by providing commentary on our financial results and investment activities, along with some perspective on our outlook in light of the ongoing economic uncertainty. As usual, Mark will then take you through our portfolio, and Brian will further discuss our financial results and guidance. In the third quarter, we produced strong AFFO per share growth of 5.6% and for the 9 months ended September 30, our AFFO per share grew a healthy 5.7%. This growth continues to be driven by our robust investment activity and thoughtful capital markets execution. Year-to-date, we have surpassed the company's previous record for annual investments by deploying $269 million, including $155 million in the third quarter. We also continue to maintain an attractive investment pipeline with more than $95 million under contract for the acquisition and development funding of convenience stores, auto service centers and express tunnel car washes, all of which we expect to fund over the next 6 to 9 months. When combined with our investments to date, our pipeline provides visibility into our earnings for the fourth quarter and our growth prospects for the next year. The ongoing success of our investment platform and steady growth in our cash flow and earnings can be attributed in part to our successful capital markets activity. Since January of 2022, we have raised more than $600 million of attractively priced capital, much of it with a forward or delayed draw execution, including our recently announced $150 million unsecured term loan, $225 million of long-term unsecured notes and more than $230 million of common equity. Our strategic approach to raising capital has enhanced our ability to lock in accretive investment spreads, support a committed investment pipeline that is fully funded and maintain a balance sheet with moderate leverage and ample capacity for future transactions. We believe that Getty's business model of focusing on convenience and automotive retail assets provides us with a competitive advantage in the market, given our sector expertise, tenant relationships and track record of execution. Many of our completed transactions this year have come from repeat business, meaning we already have a lease in place with our counterparty and are capitalizing on our relationships and transaction experience to bring new properties into the company's portfolio with tenants that are well known to us and who have a proven record performance through economic cycles. We have also successfully increased our initial yields with these tenants to reflect current market pricing while not sacrificing our rigorous underwriting standards. The net result is that we continue to buy the same quality properties in sectors where we have a significant knowledge of industry trends and with tenants we know well, but our prices that reflect the rapid rise in financing costs. As we look beyond our pipeline and deal activity, the real estate market has changed significantly since the end of the second quarter. Rapid changes in the availability and cost of capital have outpaced sellers' expectations for the value of their properties. For Getty specifically, we believe prospective tenants who are often making long-term financing decisions related to M&A or development are in the process of reevaluating their capital structures to reflect less access to capital and lower values attributable to real estate financing. While we continue to identify opportunities to acquire assets that meet our rigorous underwriting standards, we expect to be disciplined in our capital deployment, while the market continues to fully digest the reality of higher cap rates for the foreseeable future. Given our performance year-to-date, committed and funded investment pipeline and earnings growth expectations, our Board approved an increase of 4.7% in our recurring quarterly dividend to $0.45 per share. This represents the tenth straight year we have grown the dividend alongside our earnings growth. Our Board believes this annual increase is appropriate as it maintains a stable payout ratio and continues to increase Getty's retained cash flows to have more eventful capital to meet our growth objectives. Additionally, as a result of our year-to-date investment in capital activities, we are raising our 2023 AFFO guidance by $0.01 to $2.24 to $2.25 per share. Getty is well positioned for the current environment, given the essential nature of our assets, the operating strength of our institutional tenant base and our well-positioned balance sheet, including low to moderate leverage and ample liquidity. In a challenging market, we believe that we benefit from the targeted nature of our investment strategy through our sector expertise and strong relationships with operators in our space. Our disciplined approach, which emphasizes owning high-quality real estate in major metro areas and partnering with growing regional and national operators will continue to afford us with attractive acquisition and development funding opportunities to underwrite. As a result, we remain confident in our ability to create shareholder value through earnings growth and portfolio diversification. With that, I'll turn the call over to Mark to discuss our portfolio and investment activities.

Thank you, Chris. As of the end of the quarter, our lease portfolio included 1,074 net lease properties and 3 active redevelopment sites. Excluding the active redevelopments, occupancy was 99.7%, and our weighted average lease term was 9 years. Our portfolio spans 40 states plus Washington, D.C., with 61% of our annualized base rent coming from top 50 MSAs and 79% coming from top 100 MSAs. Our rents are well covered with trailing 12-month tenant rent coverage ratios of 2.7x. Turning to our investment activities. We had a record quarter, so Getty invested $155 million, net of amounts previously funded across 50 properties in a number of different property types and attractive MSAs. Highlights of this quarter's investments include the acquisition of 9 convenience stores located in Las Vegas and various markets across Texas and the Southeast was $55.1 million non-carwash properties, which are located through the U.S. for $48.5 million. To drive through quick service restaurants and an auto service center, we totaled $3.5 million and 9 under construction car wash properties for $31.5 million. As part of this acquisition, we provide additional funding during the construction period to complete these projects. We also advanced incremental development funding in the amount of $16.6 million, including accrued interest for the construction of 20 new-to-industry car washes, convenience stores and auto service centers. These assets are either already owned by the company and are under construction or will be acquired via sale-leaseback transactions at the end of the project's expected construction periods. For the third quarter, the aggregate initial cash yield on our investment activity was approximately 7.2% and the weighted average lease term for acquired properties was 17.2 years. Subsequent to quarter end, we invested an additional $3.3 million towards the development of an express tunnel car wash property. Cumulative results of our year-to-date investment activity is $269 million deployed, an initial cash yield of approximately 7.2% across all of our target asset types. Looking ahead regarding the $95 million of commitments to fund acquisitions and developments, we expect to fund these transactions for the next 6 to 9 months at an average initial yield of approximately 20 basis points in excess of our investment activity year-to-date. From a market perspective, in many cases, we are now submitting offers that are approaching 150 basis points more than where we transacted in 2021 and 2022. The amount of cap rate expansion, combined with the short duration in which these moves in asset pricing have occurred, has caused many sellers to pause. We believe the market will adjust to the changed economic landscape and will stabilize as sellers evolve and modify their expectations. The direct nature of our investment strategy affords us the opportunity discuss these changes directly to the decision-makers, and we believe that we can continue to identify accretive investments as we move through the remainder of 2023 and into 2024. Moving to our redevelopment platform. During the quarter, we invested approximately $460,000 in projects which are in various stages in our pipeline. We completed one redevelopment project where rent commenced on an automotive parts store in Pennsylvania, which is leased to AutoZone. We invested a total of approximately $200,000 in the project, generated incremental return on invested capital of approximately 21%. We also completed the renovation of a convenience store property in Connecticut, which was already subject to a long-term triple net lease. In this project, we invested $450,000 in our incremental return on the invested capital was 7.5%. We ended the quarter with 3 properties under active redevelopment and other in various stages of feasibility planning for potential recapture from our net lease portfolio and expect to continuously complete projects over the next few years. Turning to our asset management activities for the third quarter. We exited 1 leased property and sold 2 properties for aggregate gross proceeds of $1.9 million. With that, I turn the call over to Brian for our financial results.

Thanks, Mark. Good morning, everyone. Last night, we reported AFFO per share of $0.57 for Q3 2023 representing a 5.6% increase to [indiscernible] $0.04 per share we reported in the prior year. FFO and net income in the third quarter were $0.53 and $0.31 per share, respectively. Total revenues were $50.5 million for the third quarter, representing a [ 23% ] increase over the prior year. Base rental income, which excludes tenant reimbursements and GAAP revenue adjustments grew 10.5% to $40.9 million. This growth continues to be driven by our acquisition activity and recurring rent estimates, our leases, the additional contribution from rent commencement and completed redevelopment projects. On the expense side, G&A costs were $5.7 million in the quarter as compared to $5 million in the third quarter of 2022. Change in G&A was primarily due to increased personnel costs, including noncash stock-based compensation. Total property costs were $8.7 million for the quarter as compared to $5.7 million for the third quarter of 2022. This quarter included the growth in property operating expenses in both periods was primarily due to the timing of reimbursable real estate tax payments, partially offset by lower rent expense and also included an increase in leasing and redevelopment expenses due to additional professional fees and demolition costs for redevelopment projects. Environmental expenses, which are highly variable due to a number of estimates from noncash adjustments of $313,000 in the quarter as compared to $632,000 for the third quarter of 2022. Turning to the balance sheet and our capital markets activities. We ended the quarter with $750 million of total debt outstanding. This consisted of $675 million of senior unsecured notes with a weighted average interest rate of 3.9% and a weighted average maturity of 6.7 years as well as $75 million drawn on our $300 million revolving credit facility. As of September 30, net debt to EBITDA was 5x and total debt to total capitalization was 35%, while total indebtedness to total asset value as calculated pursuant to our credit agreement was 37%. Taking into account unsettled forward equity of $48.4 million, net debt to EBITDA will be approximately 4.7x. Subsequent to quarter end, as Chris mentioned, we closed on a new $150 million senior unsecured term loan. Term loan matures in October 2025 with one 12-month extension option. The term loan includes an initial draw of $75 million that was funded at close and used to repay amounts outstanding under our revolving credit facility and an additional $75 million that can be funded at our option any time over the next 6 months. In connection with the closing of the term loan, we entered into interest rate swaps to fix SOFR for the full principal loan. Including the impact of these swaps, the effective interest rate on the term loan is 6.13% based on our leverage ratio as of September 30. So a little bit more color on the term loan. We are obviously pleased to secure this financing in the current environment. It demonstrates continued access to capital and the support of our banking relationships, while providing us with a flexible loan that we can refinance in 2 to 3 years as the capital markets stabilize and importantly, as we continue to scale our platform and position our balance sheet for additional credit ratings at a possible public bond issuance. While the shorter term prevented us from taking greater advantage of the inverted yield curve upon fixing the rate, we were still able to lock in material accretion relative to the returns on our invested capital while keeping our investment pipeline funded and containing the flexibility I mentioned. Moving to our equity capital markets activities. During the quarter, we settled 2.2 million shares of common stock are subject to outstanding forward sale agreements, which generated $71.6 million in net proceeds. We currently have approximately 1.5 million shares of common stock still subject to outstanding forward equity agreements, which upon settlement are anticipated to raise gross proceeds of approximately $48.4 million. Returning to the $95 million of committed investment pipeline. As Chris mentioned, these transactions are fully funded through a combination of proceeds from outstanding forward equity agreements and the new term loan. Pro forma for these investments in capital activity, we expect our balance sheet to remain well positioned to support the company's growth. Leverage is expected to remain in line with our target range of 4.5x to 5.5x net debt to EBITDA and we expect to maintain ample capacity under our revolving credit facility. As our investment pipeline evolves, we continue to evaluate all capital sources to ensure that we're funding transactions in an accretive manner while also maintaining our investment-grade credit profile. With respect to our environmental liability, we ended the quarter at $22.7 million which was a reduction of $438,000 since the end of 2022. Our net environmental remediation spend in the third quarter was approximately $1.6 million. Finally, with respect to our 2023 earnings outlook as a result of our year-to-date investment activity and capital markets transactions, we are raising our 2023 AFFO per share guidance to a range of $2.24 to $2.25 from our previous range of $2.23 to $2.24. As a reminder, our outlook includes transaction and capital markets activities to date, but does not otherwise assume any potential acquisitions, dispositions or capital market activities for the remainder of the year. Specific factors which continue to impact our guidance include variability with respect to certain operating expenses to deal pursuit costs, as well as $300,000 of anticipated demolition costs for redevelopment projects that run through property costs on our P&L. With that, I'll ask the operator to open the call for questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Todd Thomas from KeyBanc.

This is [indiscernible] on for Todd Thomas. I was just wondering if you could disclose what the blended cash investment yield was on the 3Q investments? And could you break out the yields on the acquisitions versus the development funding?

Yes, in the remarks, 7.2% was the initial cash yield in the third quarter. And then roughly, we're the same return between acquisitions and development funding.

Okay. And do you see yields trending higher given the rise in borrowing costs? How should we think about the yields given that you already have a committed pipeline in place?

Yes. Again, with the $95 million that's committed, as we mentioned, we think that, that's going to be about 20 basis points over where we invested in the third quarter. And then as Mark mentioned in his remarks, we are putting out new letters of intent and rates are significantly higher than those levels.

And the one nuance I'd just add -- this is Brian, to Chris' comments is development funding transactions by design are 9, 15-month type transaction. So some of the dollars that are going out in development funding are still at yields from transactions that were cut 12, 18 months ago versus the sale leasebacks on the more traditional acquisition activity, obviously shorter time frame a little bit more reflective above the current environment. So I think it's consistent with what Chris said, we're seeing yields absolutely move up. with some dollars going out are still based on transactions that were cut a while back versus others will reflect the current environment.

Okay. And where are you still seeing the best opportunities in pricing? Has convenience store competition alleviate? Or what about automotive and car wash?

Yes, it's Mark. So we're very active in all our asset classes. We're getting a lot of momentum across all the categories. Certainly, some of the asset classes tend to be a little stickier on pricing as market cycle through, but we remain competitive and a tremendous amount of opportunity certainly in the convenience store, car wash, automotive parts, I would say that the most competitive probably now is the quick service restaurant category as far as pressure on pricing.

Our next question comes from Wes Golladay from Baird.

Just a follow-up on the question about the cap rates moving higher. I guess, how do you balance that versus having rent coverage maybe come under a little bit of pressure? Or are you seeing the operations of the tenants kind of grow in line with this more inflationary environment?

Wes, it's Mark. So we certainly haven't deviated from our underwriting model and our total valuation look at each deal and each portfolio. Yes. So we haven't seen much of a deterioration in tenant rent coverage on the underwriting of new opportunities. So I think the answer is yes. The performance of the tenants, at least that we're underwriting is in lockstep with the move in the market generally.

The other factor, Wes, it's Brian, on proceeds that tenants received. So if you think of a typical sale leaseback transaction, right, where we're going to set rent at a rent coverage ratio and then apply some cap rates to that to determine proceeds to the tenant, right? The math would lead to either higher rent, which is what you're alluding to, but given our underwriting and the consistency there, as Mark mentioned, the net result would be less proceeds to the tenant, which is reflective of Chris's opening comments about folks in the space just having to come to the realization that the real estate isn't as worth as much today as it may have been 18, 30 months ago.

Okay. Yes. I appreciate that, Brian. I guess then with capital becoming a little bit more scarce and maybe looking at alternative forms of equity for you, you do have -- part of the portfolio that's probably not appreciated by the market where you could probably still get relatively low cap rates. Do you have any increased appetite to start monetizing some of these lower cap rate assets?

Yes. We certainly look at the portfolio and are aware of where we think there is maybe outsized value. And we do dispose of properties, and we have disposed of small portfolios over the past couple of years. Certainly something we're aware of. We'll look around. But right now, I think the balance sheet is in great shape. The term loan certainly helps with that, we still have roughly $50 million unsettled forward equity. So we're looking at all the various forms of capital, Wes, and again, we'll transact where it makes sense.

Our next question comes from Mitch Germain from JMP Securities.