Business Context and Reporting Period
National Retail Properties, Inc. (NNN), a fully integrated REIT, filed this unaudited Form 10-Q for the quarter ended March 31, 2014. NNN acquires, owns, develops and invests in primarily retail properties leased under long-term net leases. At quarter-end, the portfolio included 1,903 properties totaling approximately 20.6 million square feet across 47 states, with approximately 98% of properties leased and a weighted-average remaining lease term of 12 years.
Key Financial Metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Total revenues from continuing operations | $104.1 million | $92.5 million | 12.5% increase |
| Earnings from operations | $62.2 million | $53.7 million | 15.9% increase |
| Net earnings attributable to NNN | $43.3 million | $34.1 million | 27.2% increase |
| Net earnings available to common stockholders | $34.5 million | $29.3 million | 17.7% increase |
| Basic net earnings per common share | $0.28 | $0.26 | Increase |
| Cash flow from operating activities | $78.6 million | $68.8 million | 14.2% increase |
| Comprehensive income attributable to NNN | $40.9 million | $34.9 million | 17.2% increase |
Rental income increased 12.6% to $99.6 million, primarily from property acquisitions. The operating margin, calculated from earnings from operations divided by continuing-operations revenue, was approximately 59.8%, compared with approximately 58.1% in the prior-year quarter. Net earnings attributable to NNN represented approximately 41.6% of continuing-operations revenue, compared with approximately 36.8% in Q1 2013.
At March 31, 2014, total assets were $4.52 billion and total equity was $2.78 billion. Total outstanding debt was $1.62 billion, consisting primarily of $1.51 billion of notes payable, $91.5 million outstanding under the revolving credit facility and $9.2 million of mortgages. Cash and cash equivalents were $5.9 million, and $408.5 million remained available under the $500 million credit facility.
Cash used in investing activities was $81.7 million, including $89.9 million of additions to operating real estate, partly offset by $12.3 million of disposition proceeds. Financing activities provided $7.5 million, including net credit-facility borrowings and common-stock issuance proceeds, after common and preferred dividends.
Material Changes Versus the Prior Comparable Period
- NNN acquired 47 properties totaling approximately 309,000 square feet for $94.0 million, compared with 17 properties and $42.6 million in Q1 2013. The initial cash yield declined to 7.7% from 8.7%.
- The portfolio increased from 1,636 properties at March 31, 2013 to 1,903 properties at March 31, 2014; gross leasable area increased from 19.3 million to 20.6 million square feet.
- Operating expenses increased 7.8% to $41.8 million, primarily due to higher depreciation and amortization from acquired properties. Depreciation and amortization increased 18.1% to $28.0 million.
- Interest expense decreased 7.7% to $20.3 million, primarily reflecting the settlement of the convertible notes in 2013, lower weighted-average credit-facility borrowings and a slightly lower average interest rate.
- Continuing-operations impairment charges declined to $396,000 from $2.9 million. NNN also recorded a $158,000 valuation impairment on commercial mortgage residual interests.
- NNN sold four properties for net proceeds of $11.2 million and recognized a net gain of $1.8 million, compared with two properties sold and a $505,000 gain in Q1 2013.
- Common dividends increased to $0.405 per share from $0.395 per share. The quarter included $4.1 million of Series E preferred dividends, which were not present in the prior-year period.
- NNN issued 432,000 common shares under its 2013 at-the-market program for net proceeds of $15.1 million and issued 184,503 shares under its dividend reinvestment plan for net proceeds of $6.1 million.
Outlook, Commentary, Risks and Unusual Items
Management expects rental-income growth to continue primarily through additional acquisitions and contractual rent increases. Management stated that operating cash flow has been sufficient to fund distributions and expects obligations to be met through operating cash flow, existing resources, the credit facility, debt or equity financing and property dispositions.
NNN had construction commitments for 28 properties totaling $97.3 million, of which $50.4 million had been funded and $46.9 million remained. Eleven properties were classified as held for sale, with anticipated dispositions within 12 months. NNN also had 35 vacant, unleased properties, approximately 2% of the portfolio.
The company early adopted ASU 2014-08 regarding discontinued operations. No additional properties were classified as discontinued operations after December 31, 2013, and the adoption did not have a significant impact on financial position or results of operations.
Principal risks include tenant defaults or bankruptcies, concentration in convenience stores and restaurants and in the South and Southeast, property illiquidity, acquisition and disposition execution, access to capital, leverage and debt covenants, interest-rate changes, valuation changes in commercial mortgage residual interests, environmental liabilities, cybersecurity incidents and the ability to maintain REIT qualification and dividend payments. NNN had three interest-rate hedges with a total notional amount of $225 million; a 1% increase in variable interest rates would have increased quarterly interest expense by less than 1%, according to the filing.
Management concluded that disclosure controls and procedures were effective as of March 31, 2014, and reported no material change in internal control over financial reporting. No material legal proceedings or reportable subsequent events were disclosed.
Investor Verification Items
- Verify the sustainability of acquisition-driven rental growth and the reported approximately 98% portfolio leasing rate.
- Review debt maturities, credit-facility availability, interest-rate exposure and compliance with debt covenants.
- Assess funding for the remaining $46.9 million of construction commitments and the planned disposition of held-for-sale properties.
- Evaluate dividend coverage using the company’s non-GAAP operating measures, including funds from operations, which are not provided in the supplied filing text.
- Monitor tenant, industry and geographic concentration, particularly convenience stores, restaurants and the South and Southeast.
- Review valuation assumptions and sensitivity for the $12.0 million commercial mortgage residual-interest portfolio and related Level 3 measurements.