NNN REIT, Inc. (NNN) Earnings Call Transcript & Summary

Good afternoon, everyone. My name is Simon Yarmak, a senior analyst at Stifel covering REITs. I'd like to thank everyone for joining us this afternoon for the National Retail Properties' virtual fireside chat at our 3rd annual Cross Sector Insight Conference. I hope everyone on the line that you and your families are doing well and that you are safe. From NNN, we have CEO and President; Jay Whitehurst; we have CFO, Kevin Habicht; we have Chief Investment Officer, Steve Horn, joining us today as well. Overall, NNN is a conservative blue chip, triple net REIT that emphasizes a relationship-driven approach to acquisitions and a focus on non-investment-grade tenants. Management believes that this approach allows them to generate superior risk-adjusted returns. And we believe, coming out of this pandemic, NNN should once again continue to post consistent mid-single-digit per share growth as well paying its well-covered and growing 5.1% dividend yield. With that, I'd like to turn it over to management to give a bigger background on the company. Jay?

Thank you, Simon, and welcome, everyone. What I'm -- as Simon mentioned, I'm joined by our CFO, Kevin Habicht, and Chief Acquisition Officer, Steve Horn. I'm going to run through some slides quickly here about our business model and results, and then we'll take some questions. I'm also joined by Chris Barry, who runs Investor Relations for us. So Chris, if you can click on through. This slide lays out the business model that we've been executing for the past 30 years. We focus solely on single-tenant retail properties, and we are -- our portfolio is broadly diversified with a high occupancy rate, and we are retail real estate experts and focus our acquisitions and underwriting on well-located parcels along high-traffic roads, leased to large regional and national operators in e-commerce-resistant businesses at market rents. And we maintain a conservative balance sheet with a flexible capital structure. And the result of all that is a consistent multiyear per share growth and a dividend that we've increased for 30 consecutive years. This slide highlights our activities and results for the first quarter of 2020. We've discussed these results on earnings calls. And in the face of COVID-19 pandemic, many of these bullet points fall under the category of old news. But I would say that our solid first quarter results were consistent with our results over the last several years and have positioned us well heading into the turmoil that started in April. An important driver of our long-term value creations, our history of raising the dividend every year for the past 30 years, as we note, this feat has only been accomplished by 2 other REITs and by less than 90 public companies across the whole U.S. And a longstanding philosophy at National Retail Properties is to maintain low leverage and constructive fortress-like balance sheet. We ended the first quarter with a very strong liquidity position, $217 million of cash in the bank and $900 million of available credit on -- capacity on our line of credit. Our debt maturities are well laddered with a weighted average duration of over 11 years and no material debt coming due until 2023. What's not on this slide, but also bears mentioning, is our deep pool of individual properties that can be sold one by one into the private market at very low cap rates. These properties, which we can sell at cap rates below our investment yield, provides us with another source of well-priced capital to be deployed into our business. This is a COVID slide. Here's a COVID-19 kind of update. What I'll touch on just for a moment is that we recently reported that we received 52% of our base rents for the month of April, and we're working with tenants representing approximately 37% of annual base rent on short-term rent deferrals. And we deal with these deferrals on an individual case-by-case basis, but they're generally 1 to 3 months of second quarter base rent only with the deferred rent to be repaid commencing later this year through the end of next year. And generally, the tenants remain responsible for paying their triple net charges for these things. These are our long-term customers. As Simon mentioned, we have focused our acquisitions on long-term -- on tenants that we build long-term relationships with, and we've been very collaborative with our long-term relationship tenants as we deal with this unexpected disruption. I would point out, too, that we have not agreed to any rent forgiveness with any of our tenants nor have we advanced any fines to our tenants to be repaid as rent in order to make the April rent numbers look better. We've been very pleased with this approach. It's met with a good response from our customers, these relationship tenants that we do business with, and we feel very good about the trajectory of rent for May and for the rest of the second quarter. Looking a little deeper into our portfolio metrics. We own over 3,100 properties leased to these large regional and national retailers broadly diversified by geography, industry and tenant mix. I would point out our properties have strong real estate characteristics. They're typically well located along high-traffic roads and they are -- they're small parcels. Our typical property cost is only $3 million. These are lots of well-located, small-box retail properties. You can see our long-term occupancy rate has been consistent at 98% plus or minus 1%. That's some of the best in commercial real estate. And at the worst of the last recession, 2008, 2009, we dipped down to 96.4% and recovered relatively quickly after that. Another attribute of our properties that I really want to highlight is the high tenant lease renewal rate. 80% to 90% of the time at the end of the lease, the retailer renews its lease at the then current rent without the landlord putting in any lease incentive or tenant improvement dollars to generate that renewal. This is a very impressive statistic, and it was true right through the end of the first quarter of this year. So it highlights, I think, our expectation that our tenants will make great efforts to get their stores reopened as soon as they can safely and practically do so post pandemic. The primary lines of trade in our portfolio focus on customer service and e-commerce-resistant consumer necessities. And our top line of trade is convenient stores, which -- that business has fared very well through this current pandemic and fared very well through the last recession. If you drill a little deeper, you see -- our top 25 tenants operate over 1,000 units each. These are large companies. They're typically the industry leaders in their respective lines of trade. And we think dealing with large regional and national operators puts themselves and us in a better position as to withstand this disruption than dealing with smaller tenants. This next slide talks about our acquisition volume. A real moat around our business is our ability to source acquisitions directly from relationship retailers. When we buy the property directly from the retailer, the tenant self-selects properties to be included in the long-term sale leaseback. Tenants not -- tenants typically cull out the properties that they're worried about when they're putting together a sale leaseback, which means we get better-performing properties and we get these properties at the tenant's cost without any developer markup. And lower cost per property means lower rent per property, which means a greater margin of safety and a higher probability of the tenant's ability to pay rent if its business is disrupted. As you can see, about 2/3 of our volume has come from doing off-market direct business with our relationship tenants. We did take a pause as the pandemic began to spread in late March and early April, much like we did in 2008, 2009. We're watching the markets closely, but we are being cautious with our capital until we feel like we get a better feel for appropriate pricing. The last driver behind our strategy is great people and a supportive culture. We maintain a very flat organization with low overhead. The main point I want to make on this slide is the long tenure of our entire team. 2/3 of our team has been with the company for more than 5 years, and half of us have been here for at least 10 years. And this is a stark contrast with many other companies. And we think it's a competitive advantage when it comes to institutional memory and consistency of execution, especially in a time when folks are working remotely. And with that, Simon, I think we'll turn it over to you and some questions.

Thank you, Jay, for your remarks. If anybody has a question, feel free to e-mail through the system or you can e-mail to me directly at [email protected]. So Jay, we're living in unprecedented times. I mean, you lived through the GFC in '08/'09, things are a lot different now than they were then. How is NNN built to endure such an event? And what are the steps you've taken over the last several years to prepare yourself for today?

Yes. I think there's all different kinds of ways to approach that question. But probably, the first one that jumps to mind, Simon, is to just maintain the strong balance sheet and have the financial flexibility that will -- that you need to be ready for any kind of black swan event. We -- lots of folks have said and we've said this current disruption in the market is worse than others. But when you're in the middle of them, they all feel terrible. The folks around this table, Kevin and Steve and I, have been here through lots of other downturns. And so we've -- what you can do is just do the -- have a balance sheet that's prepared for it and then be able to manage from there. I do think another aspect that will ultimately be valuable as we come out of this is our focus on good real estate locations. As I mentioned, we have high occupancy and high tenant renewals. These properties were in great demand by the tenants before all this happened. And that gives me comfort that the properties should be in high demand when it's behind us. And maybe the third thing to point out is what you mentioned in your opening comments is the relationships with the retailers. And when you think about the way we dealt with this pandemic when it first struck is we were very focused on our customers, the retailers. Their business had been disrupted and in many cases, their businesses have been disrupted, and they didn't see it coming. And it didn't strike us as being the -- what struck us as being the right way to deal with that is to grant them these short-term rent deferrals, just kind of let them run a tab for a brief period of time and then start to pay it back later this year through next year, but not to punch them in the nose that they were dealing with something they didn't see coming either. And we've gotten very good feedback from our customers in that instance for that behavior. Anecdotally, we've had a few tenants come back to us and say that their business has popped back sooner than they expected. And they've said let's -- they would prefer not to run a rent payable liability and so asked if we could just tear up the deferral agreement and go back to getting rent paid as per the original lease, which is the best of both worlds to us. We got the benefit of being a good partner, and we got the rent. So I think if you do business with strong operators with good real estate locations and maintain a flexible balance sheet, you are in a position to weather whatever the world might throw at you. Kevin, you got anything to add to that?

No, I don't think so. It's a degree of patience and like Jay said, a balance sheet that allows you to buy time to muddle through it and not needing capital at terrible time to get capital, which is in the midst of a market meltdown. And so that's really been the key over the years.

Sure. So what do you -- can you talk on the positive categories? Jay, you touched on, I think, convenience stores in your opening prepared remarks. Because everybody has held 2 portfolios, right? The good part and the bad part. If you could touch on some of the stronger parts of your portfolio, and then we'll touch on, right after that, the more challenged area.

Other -- yes, right. I will -- yes, absolutely. I'll turn -- let me turn it over to Steve and let him talk about both ends of that spectrum.

Yes. The obvious one you touched on, Simon, was convenience stores. Convenience stores have held up in '08, '09, and now they're holding up again through the pandemic. Restaurants, limited service, the QSR, even though they were hit right at the beginning, have all snapped back to the pre-virus levels. So they're holding up very well. Another -- the equipment rental sector of ours held up extremely well as far as wholesale clubs as well. I think, as a group, we didn't think the RV dealer group was going to hold up. But surprisingly, Camping World, our largest tenant in that category, held up extremely well. And to kind of take Jay's joke that he's been telling for the last week or so that the RV dealership now is kind of turning into the...

Winnebago is a rich car.

There we go. The Winnebago. So those are the sectors that have held up extremely well for us. And then I think kind of go to the struggling ones, it's the obvious: movie theaters, family entertainment, restaurant, the full service. Those are the groups that have really been hit hard along with health and fitness.

So maybe you can get Markit to do an episode on the profit on Camping World. Maybe that will help that out going forward and still continue to be top tenant there.

Right. That business -- yes. They -- that business has done really well. Simon, there was one question that -- a couple of questions that -- which showed up on our screen here about kind of generally, do we look to change exposure to any of the segments that have been hit? And what percentage of our properties -- kind of strategically, how are we going to deal with vacancies, I think. And I would say that right now we are not inclined to do -- to make a significant change to our long-term business model. Again, to beat the dead horse, we're going to continue to focus on good real estate locations leased to large operators and keep our cost per property down and therefore, keep the rent down and keep the rent safe. So I think that approach to our acquisitions and underwriting, you should not expect to see much of a change on. We had already become more selective on acquisitions for big-box-type properties, the movie theaters and some other bigger boxes. There -- those are more challenging to re-lease if something goes wrong. And so we try to be more selective about that. We do have some movie theaters in the portfolio. Our primary movie theater tenants being AMC and Cinemark. And Cinemark is doing relatively well. We're not losing sleep over Cinemark. AMC has had a lot of problems publicized and -- but the theaters that we had were performing well before this, and we bought them a number of years ago at lower prices and lower rents than you could be buying movie theaters at for today. So we're -- we expect we'll have to deal with some of that, but we're in a position where we don't feel terrible about it. Strategy for filling any vacancies is -- job 1 is to re-lease the properties. And so we have in-house expertise in leasing and redevelopment that will be brought to bear on whatever vacant properties we end up with coming out of this. What you have seen us do in the last year or so is to, within about a year, make the judgment of whether we can -- whether we found a tenant to re-lease the properties or whether it's time to just sell the vacant property and take those proceeds and put them with Steve and his team and let them reinvest them in new income-producing properties. What we want to produce in this portfolio is consistent rental income. So let's -- to the extent we have a vacancy, let's try to re-lease it. To the extent there's not an obvious re-leasing opportunity after reasonable efforts, then let's monetize that asset and redeploy that money into other income-producing properties.

Sure. Maybe you want to touch on some of the success you had with the SunTrust portfolio a couple of years ago. Maybe just to demonstrate your leasing ability?

Yes, that's -- yes, we -- I'd say often, at its core, National Retail Properties is a real estate company. And you can tell from the remarks about what we focus on as to how we think you really ought to manage risk, and it should start with buying good real estate at a reasonable price and at reasonable rents. There was a portfolio of bank branches that we acquired about 5 years ago or so that we were able to acquire at low prices per property and safe rents. And bank branches are certainly a property type that is, I'd say, kind of in the decline. They were doing more and more mobile banking. And the question is, how many bank branches do you need? But this, to us, was an opportunity to get good real estate locations at a reasonable price. And at the expiration of that lease, we cut an arrangement with the tenant where a large percentage were renewed. And we were able to sell a number of those properties into the one-off market at very low cap rates. The properties that went vacant, we either re-leased or sold such that, at the end of the day, it was -- the overall exercise was a good example of creating value as a real estate company. The value of what we had -- we paid something like $210 million for something that had significantly more value than that when we were all done working out the lease renewals and then the dispositions or re-leasing of the vacancies. But it's all part of what you can do and should do if you're a real estate company.

Jay, you mentioned in your prepared remarks that as the pandemic started to rear its ugly head in March, you sort of paused acquisition activity. You obviously didn't back out of anything, but it's more a pause than anything else. What would get you back in the market from a capital deployment perspective? When do you feel you're -- it's comfortable, that you're all clear to start deploying capital? And how long do you think it will take to sort of assess where asset pricing is post the last couple of months' hiatus here?

Yes. There's no bright-line test to that answer. And that you've asked the -- that question, there's -- and you've asked the right question. It's -- we took a pause just to kind of see where everything would fall out. I think as we see the -- let's find out in the next few weeks, probably, whether there's any kind of new spike in the coronavirus that would cause places to go back into lockdown. Most of our properties are suburban that -- all of our properties are suburban. We have very few properties in urban cores. And most of our properties, many of those are in the suburban South and Mid-Atlantic and Southwest. And so our properties are primarily in states that have -- that are a little farther along the reopening curve and that have had less impact from shutdown. So I think we'd like to see a little bit more time pass to make sure that things continue to get -- to reopen. And our stock took a big hit when this first happened. Our stock is slowly working its way back toward a number that seems better. So once we get a better feel for kind of stability of cost of capital and stability of the retailers able to stay open, then I think what you'll see is us get back into the acquisition business. We are very much ready to play offense. We took that pause at the end of the first quarter in acquisitions, but we had some relationship deals in the pipeline that we just put on the shelf. We didn't cancel them. So you're likely to see us kind of take some of those deals off the shelf and start to close those as we get more comfortable that things aren't going to start going backwards again. And also, I think our tenants may be in a good position to do some consolidation. We do business with large operators, and they're going to be coming out of this. They're going to be in a better position to perhaps expand their market share by doing some M&A work with smaller operators that struggled more getting through this pandemic and out the other side.

How long would it take for like Steve's team to start re-cranking the engine here? I know you just talked about you have a couple of deals that you put on the shelf. Is it a matter of weeks? Is it a couple of months? I mean investors are now curious. Now that you have your cost of capital for the most part back to a decent spot, how -- if you get a go-ahead in the middle of this week, is it mid-July, is it early August? Like what will be that timing?

We did put pause on some deals. So those would be the first ones we would revisit. And the fortunate thing is, since NNN is a relationship-based company, the relationships we probably -- that's where we would kind of wade back into the water, without putting the exact timetable. I mean, it is acquisitions, it does take a period of time. Is it 30 days? Is it 60 days? I think we could be -- we're not going to be slower than any other group because we did hit pause. So when it's time to get back in, we'll get back in.

Yes. Yes, Simon, it doesn't feel like it would be a very long start-up.

Sure. And just lastly, on the dividends. You touched in your prepared remarks, you raised it 30 years in a row. Obviously, in April, you deferred a bunch of rents with your tenants. Historically, in mid-July is when you make that decision to raise. How are you feeling today about the upcoming decision? And so what are the factors that you look at to push that dividend forward for the 31st year?

Yes, Simon, it's Kevin. Yes, I mean, we're firmly committed to that. As Jay mentioned, we've got a long record in place. This team has been in place for virtually all those years. And so we're not inclined to make any knee-jerk reactions to 1 or 2 quarters of rough sailing as it relates to our dividend. It's why you go into -- why you carry a 72% dividend payout ratio, it's why you carry a balance sheet that's moderate leverage with lots of liquidity to let us kind of muddle through a soft patch and get to the other side and see how things shake out. Like in 2008, '09, when things got messy, we continued the dividend increasing, albeit not a lot, but some, and always the right direction and continue to pay it in cash. And so that's the track we remain on until we have a lot of evidence that tells us otherwise, which we don't see today. We just have a lot of capacity and in terms of our payout as well as our balance sheet to allow us to continue to pay the dividend.

We're coming up to the end of half hour here. I would like to thank management for your time, for all those on the line listening as well. So Jay, do you have any closing remarks here? And again, really, thank you again.

No, you're very welcome. Now I think what we want to leave investors with is that we are well positioned to get through to the other side of the effect of this pandemic. And we're really pleased with the approach that we're taking with our tenants. We think that at the end of this year, Simon, you and the analysts will have a better feel for how each of these approaches played itself out, but we're very pleased with the trajectory of ours. And I wouldn't want to tell it -- and I think, by law, I'm required to mention that we've raised the dividend for 30 years in a row, and I do believe our stock is on sale right now. Thank you much, pal.

Thank you, guys. Everybody, stay safe and enjoy the rest of your afternoon.