AGREE REALTY CORP annual report, FY2013

Agree Realty Corporation: FY2013 Form 10-K Summary

Business context and reporting period

Agree Realty Corporation is a self-administered, self-managed Maryland REIT focused on developing, acquiring, owning and managing retail properties primarily net leased to national tenants. The filing covers the fiscal year ended December 31, 2013, including fourth-quarter results.

At year-end, the portfolio comprised approximately 130 properties in 33 states, totaling 3.7 million square feet and approximately 98% leased, with a weighted average remaining lease term of 11.7 years. The filing’s notes refer to 131 properties, including one held for sale; investors should reconcile this presentation difference.

Financial performance and key metrics

Metric	FY2013	FY2012	Change
Total revenues	$43.5 million	$34.6 million	Up 25.7%
Income from operations	$25.4 million	$19.4 million	Up 31.2%
Income from continuing operations	$18.9 million	$14.2 million	Up 33.0%
Net income	$20.2 million	$18.6 million	Up 8.5%
Net income attributable to Agree Realty	$19.7 million	$18.0 million	Up 9.0%
Diluted EPS	$1.50	$1.62	Down $0.12
FFO	$28.4 million	$23.4 million	Up 21.4%
Adjusted FFO	$28.8 million	$23.9 million	Up 20.4%
Cash flow from operations	$29.6 million	$21.2 million	Up 39.5%

Minimum rents increased 26% to $40.9 million, primarily from 18 property acquisitions, the full-year contribution from 25 properties acquired in 2012, and six development projects placed in service during 2013. Operating cost reimbursements increased 30% to $2.6 million.

Income from operations represented approximately 58.4% of revenue, while net income represented approximately 46.4% of revenue. These are calculated from reported GAAP amounts and should not be interpreted as REIT operating margins or property-level NOI margins.

Fourth-quarter 2013 revenue was $11.7 million versus $9.3 million in the fourth quarter of 2012. Fourth-quarter net income was $5.6 million versus $4.7 million, and diluted EPS was $0.38 versus $0.40.

Cash flow, liquidity and capitalization

Cash and cash equivalents increased to $14.5 million from $1.3 million at December 31, 2012.
Cash used in investing activities was $85.3 million, including $75.9 million for acquisitions and $14.6 million for development and other investments.
Cash provided by financing activities was $68.9 million, supported primarily by two 2013 equity offerings that generated aggregate net proceeds of approximately $93.7 million and by a $35.0 million term loan.
Total debt was approximately $158.4 million at year-end, compared with $160.9 million in 2012.
Mortgage debt was $113.9 million, with a weighted average maturity of 5.5 years and a weighted average interest rate of approximately 4.4%.
The $85.0 million unsecured revolving credit facility had $9.5 million outstanding and $75.5 million available, subject to customary borrowing conditions. It matures in October 2015, with extension options to October 2017.
The $35.0 million unsecured term loan matures in September 2020 and was effectively fixed at 3.85% through an interest-rate swap.
Debt represented approximately 26.4% of total market capitalization, compared with 33.8% at December 31, 2012. Management intends to maintain this ratio at 65% or less, although the policy is not a contractual limitation.
Annual cash dividends increased to $1.64 per share from $1.60. The quarterly dividend was $0.41 per share during 2013; a $0.43 dividend was declared for the quarter ending March 31, 2014.

Material changes versus the prior comparable period

The portfolio expanded from 109 to 130 reported properties, and total assets increased from $370.1 million to $462.7 million.
The company acquired 18 retail assets for approximately $74 million at a weighted average capitalization rate of approximately 8.0%, compared with 25 assets acquired for approximately $82.3 million at an 8.6% rate in 2012.
Seven development or redevelopment projects were listed as completed in 2013, compared with three in 2012.
Interest expense increased 26% to $6.5 million due to higher borrowings supporting acquisitions and development.
Depreciation and amortization increased 36% to $8.5 million, also reflecting portfolio growth.
General and administrative expense increased 5% to $6.0 million, while G&A as a percentage of rental income declined to 14.2% from 16.0%.
Net income growth was slower than operating and FFO growth because of increased depreciation, amortization and interest expense, as well as a lower contribution from discontinued operations.
The company completed a $44.9 million net equity offering in January 2013 and a $48.8 million net equity offering in November 2013, increasing shares outstanding and contributing to lower diluted EPS despite higher total earnings.
One non-core Kmart-anchored shopping center in Ironwood, Michigan, was classified as held for sale at year-end and sold for approximately $5.0 million on January 15, 2014.

Guidance, outlook, commentary and unusual items

Management expects to continue growing through acquisitions and development of long-term, pre-leased net retail properties. It stated that operating cash flow and the credit facility should provide adequate liquidity for operations, dividends and short-term capital needs for at least the next 12 months, while noting that market conditions could limit financing availability for future development.

Management expects to continue quarterly distributions, but future distributions remain subject to board approval, operating cash flow, capital requirements, debt restrictions and REIT distribution requirements. The company believes it qualified as a REIT for the three years ended December 31, 2013.

Approximately 47.8% of annualized base rent came from five tenants: Walgreen 27.4%, CVS 5.5%, Kmart 5.3%, Wawa 5.0% and Walmart 4.6%.
Approximately 35.9% of annualized base rent was concentrated in Michigan.
Approximately 90% of annualized base rent was attributable to national tenants.
2013 included a $450,000 impairment charge in discontinued operations; 2012 had no impairment charge.
2013 included a $946,000 gain on the sale of the Ypsilanti, Michigan property. The filing reports $298,000 of income from discontinued operations, versus $2.3 million in 2012.
Interest-rate swaps hedged approximately $82.0 million of notional debt at year-end. A 100-basis-point increase in variable-rate interest costs would have increased annual interest expense by approximately $95,000 based on the disclosed exposure.
The company had no material litigation identified beyond routine matters and reported effective disclosure controls and internal control over financial reporting.

Key risks and contingencies

Tenant concentration, particularly Walgreen, creates material exposure to tenant defaults, bankruptcies, store closures and lease non-renewals.
Single-tenant net leases may produce significant cash-flow and property-value declines if a tenant defaults, and re-leasing may require substantial capital expenditures.
Michigan geographic concentration increases exposure to local economic conditions, natural disasters and other regional disruptions.
Debt maturities, refinancing risk, variable interest rates, credit-facility covenants, cross-default provisions and cross-collateralization could pressure liquidity or result in foreclosure if cash flows are insufficient.
Approximately $12.7 million of principal repayments were scheduled for 2014, including a mortgage balance with a June 2014 balloon maturity; the filing indicates refinancing or repayment would be required.
Development and acquisition activity is exposed to construction delays, cost overruns, permitting issues, unfavorable financing and underperformance of acquired assets.
Environmental liabilities may be imposed on the property owner even when contamination is caused by tenants; the company states it carries no environmental-risk insurance.
REIT qualification requires compliance with complex income, asset, ownership and distribution tests. Failure to qualify could result in corporate-level taxation and reduce funds available for distributions.
Future equity issuance may dilute existing holders, while additional debt may increase leverage and interest-rate exposure.

Most important facts for investors to verify

Reconcile the reported portfolio count of 130 properties with the notes’ reference to 131 properties, including the held-for-sale asset.
Review tenant credit quality and lease rollover, especially the 2014 and 2015 expirations and the concentration of rent from Walgreen and other major tenants.
Verify refinancing plans for 2014 and 2015 maturities, the October 2015 revolving facility maturity, and the company’s ability to maintain covenant compliance.
Assess whether acquisition and development growth can continue without excessive equity dilution or increased leverage.
Compare dividend coverage using adjusted FFO, cash flow from operations and recurring capital requirements; 2013 distributions included 16.34% classified as return of capital for tax purposes.
Evaluate the effect of discontinued operations, property sales and the $450,000 impairment on the sustainability of reported GAAP earnings.
Review the filing’s non-GAAP FFO and AFFO reconciliations, including the company’s warning that these measures may not be comparable with those of other REITs.