Realty Income Corporation (O) Earnings Call Transcript & Summary

Hi, and good afternoon, everyone. I'd like to thank you all for joining us for the Realty Income 2020 REITweek presentation. So joining us from management is CEO and President, Sumit Roy. Realty Income, ticker O, is an S&P 500 net lease company with an enterprise value of over $28 billion that has a strong and consistent business model and management that has consistently outperformed the major markets in its over 25 years history as a public company. Last year, it was added to the S&P 500 Dividend Aristocrats Index as Realty Income is known as a monthly dividend company with a 4.6% dividend yield. With that, I would like to turn over to CEO and President, Sumit Roy, to give us a quick introduction.

Thanks, Simon, and thanks, everyone, for joining us. Realty Income was founded in 1969 and was listed on the New York Stock Exchange in 1994 under the ticker O. Today, we are an S&P 500 company with a total market capitalization of over $28 billion. Our real estate portfolio of over 6,500 properties is well diversified by tenant, industry, geography and property type. Our primary property type is retail, specifically single-tenant freestanding net lease retail. Our largest industry is convenience stores at 11.9% of rental revenue. Our largest tenant is Walgreens at 6% of rental revenue. Our portfolio is leased to approximately 630 tenants operating across 51 different industries in 49 states, Puerto Rico and the U.K. We target properties leased to tenants with a service nondiscretionary and/or low price point component to their business. We believe these characteristics allow our tenants to operate effectively in a variety of economic environments and to compete effectively with e-commerce. Approximately half our rental revenue is generated from investment grade-rated tenants. Industrial is our second largest property type, representing approximately 11% of rental revenue. We have a very strong track record of performance over our 50-year history as a company and our 25 years as a public company. Since our public listing, we have delivered a 14.6% compound average annual total shareholder return. We have generated positive earnings growth in 23 out of 24 years, and we have increased our dividend every year. As a result, earlier this year, we were added to the S&P 500 Dividend Aristocrats Index for having increased our dividend every year for the last 25 consecutive years. Additionally, we are proud to be one of only a handful of REITs with at least 2 A credit ratings by major rating agencies. We have a very conservative balance sheet, and we ended the first quarter of 2020 with a net debt-to-adjusted EBITDAR ratio of 5.0x, and our fixed charge coverage ratio of 5.5 is the highest in our company's history. Additionally, we were pleased to raise approximately $752 million in well-priced equity at the end of February. We entered a period of economic uncertainty driven by the COVID-19 pandemic well positioned, and we continue to have strong liquidity and financial flexibility. The impact of the COVID-19 pandemic has been and continues to be felt across geographies, economies and industries, and our thoughts remain with all who have been impacted. We continue to manage the business with a focus on all stakeholders, our shareholders, clients, colleagues and community. Accordingly, we have leveraged technology to ensure seamless business continuity with our employees working safely from their homes. Our real estate portfolio is deliberately designed to generate predictable cash flow through a variety of economic environments, but our portfolio is not immune to the economic shutdown that resulted from COVID-19. After all, our tenants operate across 51 different industries. We've always maintained stringent investment parameters targeting high-quality tenants who are leaders in their respective industries. As previously mentioned, approximately half our rental revenue is generated from investment grade-rated tenants. While we have not historically pursued properties leased to investment grade-rated tenants as a primary objective, during periods of economic uncertainty, high-grade credit tenants do tend to provide more reliable streams of income, all else equal. In April, we collected 99.9% of rent from investment grade-rated tenants. And in May, we collected 98.1% of rent from investment grade-rated tenants. Certain tenants have requested rent relief, and these requests have primarily been for rent deferral rather than rent abatement. We're reviewing rent deferral requests on a case-by-case basis. We view our tenants as partners and clients and the relationship is symbiotic. However, the approach we have taken is to independently review the individual financial and business positions of our tenants, and we have not and will not accept rent deferral requests that we believe are solely opportunistic in nature. As of June 1, we have collected 84.2% of contractual rent for April and 81.9% of contractual rent for May. On Tuesday, we uploaded an Investor Presentation to our website, which further details our rent collection. Our top 4 industries, convenience stores, drug stores, dollar stores and grocery stores, each sell essential goods and represent approximately 37% of rental revenue. And we have received almost all of the contractual rent due to us from tenants in these industries. Other industries such as theaters, health and fitness, restaurants and child care have been more challenged due to store closures and social distancing requirements. We are actively monitoring these industries, but we are pleased to partner with top operators in these industries. We've always managed the business conservatively with a focus on generating predictable cash flow and delivering favorable long-term risk-adjusted returns for our shareholders through a variety of economic environments, and we continue to do so. During the Great Recession, we were 1 of only 11 S&P 500 REITs with positive earnings growth, 1 of only 9 S&P 500 REITs without a dividend cut and 1 of only 5 S&P 500 REITs with positive total shareholder return. Finally, we believe we are well positioned to capitalize on opportunities going forward once we receive additional clarity regarding the current crisis, and we remain optimistic that cities and states slowly begin to reopen. The COVID-19 pandemic has resulted in an economic environment largely unprecedented, but I'm confident of the resiliency of our tenant credit profile, the quality of our real estate and the talent of our team members. And with that, I'll return it back to Simon.

Thank you, Sumit, for that introduction here. [Operator Instructions] Sumit, you touched on your April rent collection of over 84%, your May rent collection of about 82%. Maybe if you could just touch on why you've been successful towards the upper end of your peer set. And what's unique and special about your portfolio that you've had a lot of success relative to your peers?

Sure. That's a great question, Simon. And we pride ourselves in trying to construct a portfolio that can withstand the economic vagaries that one experiences going through the various different cycles. And even with that construction in mind, I don't think any of us ever anticipated a pandemic-induced downturn, where businesses could go to 0 revenues literally overnight. Part of the reason for our success is our very conservative mindset. We have chosen to partner with operators that tend to be in businesses that have a defensive slant to them. Businesses in the retail side tend to be nondiscretionary in nature, tend to have a low price point component or have a service orientation. What is now being deemed as essential retail constitutes almost 80% of all of our retail exposure. And this is one of the main drivers of why we have been so successful in being able to collect 84% -- north of 84% for April and 82% for May. Because a large portion of our portfolio actually experienced positive tailwinds going -- coming through this pandemic-induced downturn and have continued to perform well. But like I said in my prepared remarks, we are not immune to this downturn. There are certain businesses, though they have a service orientation to them and would have done well in a downturn that was anything but orchestrated by a pandemic and therefore instituted social distancing, I would have argued that businesses like the theater business as well as the health and fitness business would have continued to do well. And in fact, we saw that play out during the last great financial recession, but those businesses have been impacted because of the unique nature of this downturn. But as a week goes by, the data is tending to be more and more positive. The capital markets have opened up both for high-grade tenants as well as investment-grade tenants. The high-yield market stabilizing has certainly helped some of our operators who've been able to tap into that market to create a better liquidity profile than what they were going into this pandemic-induced downturn with. And therefore, their ability to pay rent has improved. And so despite the fact that some of the businesses have been impaired, given the capital market situation, given the aggressive nature of the openings that were adopted by the governors and given how quickly some of these businesses have been allowed to open, I think all of these have sort of been more positive than what we had anticipated and therefore, has resulted in better collection than what we had anticipated. And the fact that we also diversify across real estate asset types, we are in industrial, we're in office, we are in agriculture, that, too, has certainly helped continue to drive our collections north of our peers.

Sure. Just a follow-up on that from the question on the audience here. Do you feel that we're sort of bottomed in terms of rent collections? Do you think that if everything stays status quo, we don't have a second relapse that you feel pretty confident that's sort of the [ bottom onward ] here?

I think there is a lot more clarity, Simon, in terms of defining the distressed area of our business and of our portfolio. So from that perspective, is this 82%, 80% the ZIP Code that we should see ourselves in? All else being equal, the answer is yes. Now clearly, we have gone through, and with certain of our clients, we have orchestrated amendments to rent collections, et cetera, where there are certain percentages that could be higher for the month of May than for the month of June, so you might see some nuanced differences around the edges. But by and large, the businesses that were impacted have been very clearly identified, and we have to put bookends around that part of our business. And as long as we don't see contraction rates going up, mortality rates going up and -- which results in shutdowns of businesses across the board, I do think that this is sort of the ZIP Code that we will -- we should see in terms of rent collection. And then I think it will take a little bit of time, though, for these businesses to sort of arch back up to not necessarily precrisis revenue and profitability levels, but to levels which will allow them to support paying 100% of their rent and then as their businesses continue to improve, be able to pay back some of the deferred rent. So that will be very much unique to the operators and to the businesses themselves. But I do think that if you were to ask us, "Have you sort of put a fence around the area of your business that has been impacted by COVID-19?" The answer is yes.

Sure. Segueing into your dividend. You're known as a monthly dividend company. You're on the S&P 500 Dividend Aristocrats list with a very few REITs that's even anywhere near there. What's your dividend policy today? Thinking about where rent has been collected in April, May, where you think June is going to shake out? Can you touch on the safety of your dividend? What's your philosophy in the near term?

So even at the very beginning of this downturn, which was -- when the gravity of the situation was being assessed, this was in the middle of March, end of March, beginning of April, we obviously drew out many different scenarios and stress-tested our models to figure out what are the levers that we will need to utilize to make sure that we are very well positioned to withstand this downturn. And clearly, managing the dividend is one of the levers that's available to REITs but the strength of our portfolio, the leverage ratio, the coverage ratio, when we started to think about our business and put -- ring-fenced the area of our business we thought would be impacted, the questions that we were asking ourselves is how long, how long would it take these businesses to recover, et cetera. We felt very comfortable in not having to touch our dividend policy, as we have articulated to the market. We are -- it's taken us a long time, over 50 years of our existence as a company and 26 years as a public company, to get to a point where we are part of the Dividend Aristocrat Index, we are -- we have trademarked the name the monthly dividend company, and so it is certainly a level that is available to us. If we run into a situation where contraction rates go up, if gradual U-shaped recovery starts to look more like a W-shaped recovery and there are mass shutdowns again, that is a lever that we might have to revisit. But based on everything we're seeing today, based on how things have moved positively faster than what we had anticipated, our dividend is not one that we need to pull on. And this is a testament to how we run our business so far and the portfolio we've constructed. So as far as we are concerned, the dividend policy is not one that we need to touch on at this point.

Sure. I mean a large reason why you can keep the dividend in place is because of your solid balance sheet, your 2 A- ratings, only 1 of the 8 REITs to have that. So maybe you can just touch on your -- the strength of your balance sheet, your liquidity position despite all what's going on.

Yes. I mentioned this in my prepared remarks. We ended the first quarter at 5.0x debt-to-EBITDAR. Our coverage ratio was at 5.5x which is an all-time high for Realty Income. We are sitting on about $600 million of cash. We were able to tap into the unsecured market literally 3 weeks ago, where we were able to price -- we were the first retail REIT to tap into the market. We raised about $600 million, which was upsized from $500 million, for an all-in cost of 3.37. And so we feel very good about where we are sitting today with regards to liquidity. And if you even look at our maturity schedule on the debt side of the equation, we have $250 million of term loan that's coming due at the end of this month, but that's it essentially for the month of -- for the year of 2020. And then we have a similar amount next year. So even from a debt maturity perspective, over the next 18 months, we are in very good shape. And so given the capacity we have undrawn on our credit facility, which is a $3 billion credit facility, given the cash on hand, given where our leverage was at the end of the first quarter, given our coverage ratios, we feel like from a liquidity perspective, we are very well positioned to withstand whatever comes our way.

Sure. In terms of shaping your portfolio going forward coming out of this pandemic, any thoughts as to some of the lessons you've learned over the last couple of months for your portfolio and how that will carry forward over the next couple of years as you continue to grow your sector-leading portfolio?

Yes. Look, there are a lot of thoughts being put around what are the macro shifts that we see being precipitated by this pandemic-driven downturn. Will suburbanization take on a different slant? Will people start to be more inclined to buy cars and not use public transportation? Will office usage be less than what it was pre-crisis? Will omnichannel strategies get accelerated because people have learned the value of having click-and-collect or delivery services which does require alterations to the business flows? And how does all of this sort of translate to our portfolio, into our real estate are questions that we are absolutely focused on and discussing. To balance that thought process, we are also very focused on not overindexing to this pandemic-induced downturn because it could lead to answers that perhaps is not the right answer across the board. And so what we mean by that is should health and fitness be businesses that are less attractive going forward? Should theater businesses be less attractive going forward? And I would argue that had this been a downturn that was precipitated any other way, those businesses would have done well. But we do have to look at not just the business, but the operators within those businesses to see how are they running their business. And I do think that from a fundamental perspective, the theater business remains down, but operators within this business have overleveraged balance sheets and so don't have the capacity to withstand situations like this even if it is temporary in nature. And so could we see some rationalization from a real estate perspective on the theater side? Yes. Does that make us more inclined to perhaps be focused on diminishing this area of our business post-pandemic? The answer is probably yes. But the corollary is also true when there are businesses that clearly stood out, and they tend to be in the defensive areas and businesses like grocery business, which was the primary industry that we focused in the U.K. and it turned out to be quite prescient in retrospect, are businesses that we'll continue to invest in. I talked about from a macro perspective distribution centers are going to take on, last-mile distribution especially, will take on a life all its own. And that is an area that we want to focus on, so you could see the industrial component of our businesses -- business becoming a bigger portion of our overall portfolio. So those are things that we feel will be how we alter the portfolio going forward. But by and large, we -- these are not new thoughts that have just come about because of this downturn that we are faced with. These are alterations that we are making around the edges to make sure that we continue to craft a portfolio that remains very resilient.

Sure. A question from the audience here is, have you seen any change in sourcing? Or will you -- obviously, you source tens of billions of dollars a quarter a year, has there been any change there in the funnel where stuff is coming through your door? And have you seen any change in cap rates yet?

And so again, there are 2 -- there isn't an answer that sort of encapsulates all the product that is out there. I would say grocery stores and dollar stores and drugstores, those assets, there has been no change on cap rate. They continue to be in demand, and they continue to have buyers that are willing to pay dollars and cap rates that existed pre-pandemic. Other -- on the other end of the spectrum, you have no transactions occurring in the health and fitness side of the equation or the movie theater business, as you would expect, because even though that might have been in the market, trying to sell some of these assets have pulled back because they recognize that they would be selling into a market that is in free fall. And potentially, there won't be buyers of this product in this market. So if you were to sort of think of it as pre-pandemic and post-pandemic or -- clearly, the volume is less today than it was in the first quarter, but that doesn't mean it has -- that all the products across all the various industries have sort of dried up. That's on the retail side of the equation. On the industrial side, we continue to see product, and cap rates really haven't moved that much there. In fact, continues to be incredibly aggressive especially for product that is part of the omnichannel supply chain. And even 1 year forward, industrial assets are trading at cap rates with deltas to available product today at some of the smallest levels that we've seen, and that phenomena has continued from the first quarter. So it's -- it really is a product-by-product and an operator-by-operator discussion in terms of cap rate movements.

Thanks. Another question coming in here is production rate has been below 80%. You've obviously identified some of the categories that have struggled somewhat. They want to get a little bit more granular here. What do you think is the opening trajectory for that 15-ish percent of your portfolio that's sort of not paying right now in terms of the assets reopening?

The expectation is -- and let's just touch on the 2 that have been most impacted. It's basically theaters and health and fitness. Health and fitness today, I would say, about 60% to 70% of those assets are open -- or at least they have the ability to be opened. Based on some conversations we've had with some of our operators, one of them had said that we were expecting 75% of our membership to return. That's trending in the low 80s. 82% was the number that was shared. So that is more positive than the expected and now that's a very unique concept, and so it may be very unique to them. We do expect that the theater business is going to bounce back quicker than the -- I mean, sorry, the health and fitness business is going to bounce back quicker than the theater business. Theaters today remain closed, but the expectation is tenant is expected to be re-leased mid-July, I think, July 17, if I remember correctly. And by then, we should expect to have 70% to 80% of our theaters open. And by early August, potentially all of the theaters should be open. But that is, of course, predicated on infection rates and mortality rates continuing the trend that we have seen occurring over the last few weeks.

Sure. We have about a minute left to go here. So I'll throw it back over to you to make like that closing elevator pitch for why investors should be buying Realty Income now.

Thank you very much, Simon, for having me and for asking all these questions. Look, we are very positive based on where we sit today. The variables that we are tracking internally have trended positive. We hope that this trend continues, and we look forward to a nice summer, and we look forward to seeing you guys in person at some point. But until then, please stay safe, and thank you.

Thank you, Sumit, and the team at Realty Income. Thank you for everybody listening. Stay safe, and have a great summer.

Bye-bye.