Realty Income Corporation (O) Earnings Call Transcript & Summary

Okay. I'm Josh Dennerlein, Bank of America's senior analyst covering the net lease REITs. I'm pleased to be joined by Sumit Roy, Realty Income's President and Chief Executive Officer. Sumit has served as Realty income CEO since October 2018 and President since 2015. Previously, during his tenure at Realty income, Sumit has served as the firm's Chief Investment Officer and Chief Operating Officer. With that, I would like to hand it over to Sumit to provide a brief overview of Realty income.

Thank you, Josh, and thank you to everyone for joining us. Realty income is the largest net lease REIT with a total market capitalization of nearly $30 billion and a real estate portfolio of over 6,500 properties across 49 states, Puerto Rico and the U.K. Our portfolio is approximately 85% retail and 10% industrial. Our retail exposure is all single-tenant net lease retail, and we target properties leased to tenants with a service, nondiscretionary and/or low price point component to their business. We believe that these characteristics allow our tenants to operate successfully in a variety of economic environments and to compete effectively with e-commerce. Exposure to nondiscretionary retail has been especially important through the current environment driven by COVID-19. Approximately half of our rental revenue is generated from investment-grade rated tenants, and our top industry is convenience stores at approximately 12% of revenue, and our largest tenant is Walgreens at 5.8% of revenues. We've had 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 15.3% compound average annual total shareholder return. We have generated positive earnings growth in 23 out of 24 years, and we've increased our dividend every year. As a result, earlier this year, we were added to the S&P 500 Dividend Aristocrat 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 the major rating agencies. We have a very conservative balance sheet, and we ended the third quarter of 2020 with a net debt to adjusted EBITDA ratio of 5.3x and a fixed charge coverage ratio of 5.2x. During 2020, we have raised over $2.6 billion of capital, including approximately $1.2 billion of well-priced equity. Additionally, last month, we were pleased to issue our inaugural sterling-denominated unsecured notes due 2030. We raised GBP 400 million at 1.71% effective annual yield. Our conservative capital structure and stringent investment guidelines positions us favorably at the start of the current recession and helped our company remain resilient during these uncertain times. While the COVID-19 pandemic has impacted our real estate portfolio, the business continues to perform well. After all, our tenants operate across 51 different industries. Our top 4 industries, convenience stores, drug stores, dollar stores and grocery stores, each sell essential goods and represent approximately 37% of rent. Other industries such as theaters, and health and fitness have been challenged due to the mandatory closures and social distancing requirements. For the third quarter, we collected 93.1% of contractual rent; and in October, we collected 92.9% of contractual rents due. Our rent collection, which compares favorably relative to the broader peer group, highlights the resiliency of our higher-quality real estate portfolio leased to operators who are leaders in their respective industries. We've always managed the business conservatively with a focus on generating predictable cash flow and delivering favorable long-term adjusted returns for our shareholders through a variety of economic environments, and we continue to do so. Looking ahead, our outlook remains positive as our high-quality real estate portfolio continues to perform well, ending the third quarter with a portfolio occupancy of 98.6%. And we recently increased our 2020 acquisition guidance to approximately $2 billion. Consistent with our acquisition guidance, we are seeing very strong transaction flow in the market, and we remain very well positioned to capitalize on these opportunities going forward. With that, I'll turn it back to you, Josh.

Thank you, Sumit. Appreciate all that. Maybe we could talk about rent collection trends. What are the recent trends you're seeing regarding rent collection across your portfolio and occupancy as well?

Sure. So in October, like I said, we had a rent collection of 92.9%. For the third quarter, we had a rent collection of 93.1%, and I'll break that down for you. In September, it was 94.1%. August was 93.3%, and July was 91.8%. The third quarter 2020 occupancy number was 98.6%, which was up 10 basis points sequentially. The majority, which is 96% of our portfolio, is open for business although at a decreased capacity in some sectors, and they are the ones that you would guess, restaurants and childcare. Our rent collection across the portfolio continues to highlight the resiliency of our portfolio and tenants. In the third quarter 2020, we collected 100% of rent from investment-grade rated tenants. Our top 4 industries, which I've mentioned before, convenience stores, drug stores, grocery stores and dollar stores, each sell essential goods and represent approximately 37% of rental revenue, and we have received nearly all rents due to us from tenants in these industries. Performance of our high-quality net lease portfolio continues to demonstrate the difference between our net lease retail portfolio and traditional retail real estate. Further improvement in rent collection is primarily dependent upon improvements in the theater industry. In October, theaters accounted for 74% of unpaid rent. We are pleased to partner with the top operators in the theater industry, but we do recognize the near-term challenges facing this particular industry, as we believe that, in the long term, rationalization of the industry means low-performing locations may not survive. Although the industry is still expected to downsize in the future, we continue to believe it'll remain a viable industry in a post-pandemic world, especially for high-budget blockbuster movies. While there might be a more permanent switch to a streaming for some of the smaller budget movies, streaming businesses require significant scale to break even, especially if they are building content libraries to attract subscribers. And this continues to be an obstacle that we view as very difficult to overcome. The theatrical experience is still superior to in-home viewing and drives ancillary revenue streams like merchandising and theme parks. From 2015 to 2019, blockbuster films represented approximately 60% of box office and ticket sales, and the studio's take was 50% to 60% of the box office sale. Outside of the theater industry, rent collection across the portfolio have continued to trend positive, demonstrating the resilience of a high-quality net lease portfolio leased to operators who are leaders in their respective industries.

You recently increased your acquisition guidance. What gave you the confidence to do that? And what trends do you see on the acquisition front?

That's right, Josh. We recently increased our 2020 acquisition guidance to approximately $2 billion. The key reasons we are comfortable with the increased guidance are the following: One, our pipeline is very strong, both here in the U.S. as well as the U.K. Across our industry relationships, we are consistently seeing strong transaction volume for the net lease product. Year-to-date, we have sourced approximately $47 billion in potential transaction opportunities. The acquisitions market remains very active, and the volume has picked up over the recent months. We believe this is partially driven by higher demand for the type of products we pursue as investors continue to recognize a favorable risk return profile of quality net lease products. Number two, we continue to enjoy a favorable cost of capital. Given our consistent appetite for acquisitions, our cost of capital is supremely important, the low interest rate environment, our 2a credit ratings afford us a very favorable pricing. Our $3 billion revolving credit facility accrues interest at LIBOR plus 77.5 basis points. We recently established a commercial paper program, which allows us to borrow at approximately 60 basis points cheaper than borrowing under our revolving credit facility. As I previously mentioned, in October, we priced our debut sterling debt offering of 2030 notes for an effective yield of 1.71%. Our acquisition team remains very active, and we have certainly seen an increase in volume coming through investment committee. And we remain comfortable with our increased acquisition guidance. Josh?

Great. Given the need for capital because of COVID, do you think we see more sale leasebacks -- sale leaseback transactions over the next year? Could you also provide some color on cap rates in the market?

Sure. So as we discussed, the investment pipeline is very strong. The larger sale leaseback transactions we typically pursue, as evidenced by our historical acquisitions, are generally with strong operators who are not reliant on sale leaseback as a form of capital, but rather, they understand the merits of sale leaseback financing versus traditional financing. That being said, yes, we are seeing an increase in sale leaseback activity, particularly for large-scale portfolios. As a reminder, our size and scale are key competitive advantages as we are the only net lease company that could complete very large-scale sale leaseback transactions without necessarily creating tenant or industry concentration issues. We have a very strong relationship with our existing clients and expect to continue to partner with them and help them grow their businesses coming out of this recession. You also asked about cap rates. So not surprisingly, cap rates for very high-quality assets leased to tenants selling essential goods, such as grocery, c-stores, dollar stores and home improvement, are trending downwards due to a low interest rate and increased demand for these types of assets. However, thankfully, our cost of capital has improved since the early stages of the pandemic, and we continue to generate attractive investment spreads for our acquisitions. So on the industrial front, demand remains strong for high-quality, single-tenant industrial assets in the good markets that we typically pursue, but we are also seeing cap rates are trending lower in this particular sector of real estate as well. Josh?

So the pandemic, it's not quite over yet but curious if you have any early takeaways on how really income will allocate capital in the future. Do you think differently about your portfolio mix going forward?