Business context and reporting period
Broadstone Net Lease, Inc. is an externally managed REIT focused on long-term net-leased commercial properties. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018; comparative figures are for 2017. At quarter-end, the company owned 583 properties in 42 states, with 100% leased and 99.4% occupied. Its weighted-average remaining lease term was approximately 12.8 years, and no tenant represented more than 4% of annual rent.
Financial and operating metrics
Amounts below are in millions, except per-share data and percentages.
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $61.8 | $46.2 | $174.4 | $132.1 |
| Operating income | $27.0 | $19.4 | $79.9 | $61.7 |
| Net income | $23.1 | $13.0 | $60.4 | $42.7 |
| Net income attributable to Broadstone | $21.3 | $11.9 | $55.8 | $39.3 |
| GAAP diluted EPS | $1.03 | $0.68 | $2.81 | $2.36 |
| FFO per diluted share* | $2.02 | $1.42 | $5.31 | $4.43 |
| AFFO per diluted share* | $1.40 | $1.30 | $4.26 | $4.04 |
Q3 revenue grew 33.6% year over year and operating margin was approximately 43.7%, compared with 42.0%. Nine-month revenue grew 32.0%; operating margin was approximately 45.8%, compared with 46.7%. Growth primarily reflected acquisitions and portfolio expansion. *FFO and AFFO are non-GAAP measures; the company cautions they are not substitutes for GAAP earnings or operating cash flow.
- Cash flow: Nine-month operating cash flow was $93.5 million, versus $72.4 million in 2017. Investing used $274.6 million and financing provided $199.0 million. Cash and restricted cash totaled $28.0 million at September 30, 2018.
- Debt and liquidity: Total debt carrying amount was approximately $1.31 billion; cash and cash equivalents were $17.3 million, with $10.7 million restricted. The $425 million revolving facility was undrawn, leaving $425 million available. Debt-to-approximate-market-value leverage was 40.3%; the company reported compliance with financial covenants. Weighted-average borrowing cost was 4.17%, up from 3.03% at year-end 2017.
- Capital and distributions: The company issued $325 million of fixed-rate senior notes in 2018: Series B at 5.09% due 2028 and Series C at 5.19% due 2030. Monthly distributions declared for November 2018 through January 2019 were $0.43 per share or unit. Nine-month distributions totaled $81.7 million, including reinvested distributions of $37.1 million.
- Acquisitions and dispositions: The company acquired 70 properties for $365.3 million and sold 15 properties for $43.9 million in aggregate, recognizing $9.6 million in gains on sale of real estate.
Material changes versus the prior comparable period
- Q3 net income increased 77.6%, while diluted EPS increased 51.5%; nine-month net income increased 41.5% and diluted EPS 19.1%. Share issuance increased diluted weighted-average shares by 16.4% in Q3 and 19.0% year to date, tempering per-share growth.
- Interest expense rose 54.4% in Q3 and 51.4% year to date, reflecting higher debt balances and financing of portfolio growth. The weighted-average interest rate also increased.
- Q3 results included an $8.5 million gain from selling the company’s investment in its Manager to an existing owner of the Manager. This related-party transaction contributed to GAAP net income; the gain is excluded from AFFO.
- FFO per diluted share rose faster than AFFO per diluted share: 42.3% versus 7.7% in Q3, and 19.9% versus 5.4% year to date. The company cites the related-party gain being excluded from AFFO, lower debt-extinguishment add-backs, and higher straight-line rent adjustments.
- At September 30, 2018, $300 million of the 2015 unsecured term loan was scheduled to mature in February 2019, subject to two one-year extension options. The company issued longer-term notes in 2018 and said it intended to extend, refinance, or replace maturities.
Outlook, risks, contingencies, and unusual items
- The filing provides no formal earnings or acquisition guidance. Management said existing operating cash flow, private-offering proceeds, cash, available revolver capacity, and access to long-term debt were expected to fund operations and planned growth for the foreseeable future.
- Management targets leverage of 35%–45% of approximate asset market value and seeks to keep floating-rate exposure below 5% of that value. Interest-rate swaps had aggregate notional value of $760.1 million; the company reported a $35.5 million swap asset. Higher rates could still increase borrowing costs.
- Management reported rent collections above 99% and a fully leased portfolio. Risks include tenant financial deterioration, vacancies, real-estate market and valuation changes, acquisition and capital-raising conditions, and inflation exceeding contractual rent increases. Five properties were impaired in Q3, resulting in a $2.1 million charge; tenant nonpayment and viability concerns were cited among impairment triggers.
- Potential damages under three tax-protection agreements were capped at approximately $12.3 million; management said triggering events had not occurred and were not considered likely in the foreseeable future. Management reported no material pending litigation or known material environmental liability.
- Related-party management agreements were amended to three-year terms and are scheduled to renew January 1, 2019. Conditional termination fees, if applicable at September 30, were estimated at $18.4 million for the property management agreement and $51.6 million for the asset management agreement.
- The company planned to adopt the new lease-accounting standard on January 1, 2019 and was still evaluating its effects, including possible gross presentation of certain tenant-paid costs. It expected no material impact from its lessee arrangements.
Important facts for investors to verify
- How the company will address the $300 million February 2019 term-loan maturity, including whether it will use the extension options or refinance.
- Whether portfolio growth translates into durable AFFO and operating cash flow per share, given higher interest expense and increased share issuance.
- The sustainability of the $0.43 monthly distribution relative to cash generation, and the role of DRIP proceeds in reported distribution totals.
- The impact of the $8.5 million related-party investment-sale gain and the terms, governance, and renewal provisions of the Manager agreements.
- Tenant credit trends, impairment developments, interest-rate exposure, and sensitivity of stated NAV to valuation assumptions; management estimated a 0.25 percentage-point increase in the portfolio cap rate would reduce NAV per diluted share to $80.64 from $85.66.