Business context and reporting period
Realty Income Corporation is a REIT focused on freestanding commercial properties leased primarily to single tenants under long-term net leases. This Form 10-K reports the fiscal year ended December 31, 2012; quarterly figures are unaudited. The company’s objective is to generate dependable monthly distributions from rental cash flow.
At year-end, the portfolio comprised 3,013 properties across 49 states, leased to 150 enterprises in 44 industries. Occupancy was 97.2%; the weighted average remaining lease term on leased single-tenant properties was approximately 11.0 years.
Financial performance and position
| Metric | 2012 | 2011 | Change or context |
|---|---|---|---|
| Total revenue | $475.5 million | $410.3 million | Up 15.9% |
| Rental revenue | $473.7 million | $408.6 million | Up $65.1 million |
| Income from continuing operations | $146.0 million | $144.6 million | Continuing-income margin was approximately 30.7% versus 35.3%, calculated as continuing income divided by total revenue |
| Net income | $159.2 million | $157.0 million | Includes discontinued operations |
| Net income available to common stockholders | $114.5 million; $0.86 per diluted share | $132.8 million; $1.05 per diluted share | Down $18.3 million; per-share income also affected by higher preferred dividends and share count |
| FFO available to common stockholders | $260.9 million; $1.96 per diluted share | $249.4 million; $1.98 per diluted share | FFO up 4.6%; per share down 1.0% |
| Normalized FFO | $268.8 million; $2.02 per diluted share | $249.4 million; $1.98 per diluted share | Up 7.8%; excludes 2012 ARCT merger costs |
| AFFO | $274.2 million; $2.06 per diluted share | $253.4 million; $2.01 per diluted share | Up 8.2%; non-GAAP measure |
| Net cash provided by operating activities | $326.5 million | $299.0 million | Up 9.2% |
| Cash and cash equivalents | $5.2 million | $4.2 million | Year-end balance |
Operating costs rose: depreciation and amortization was $149.6 million (2011: $118.9 million), interest expense $122.5 million (2011: $108.3 million), and general and administrative expense $38.0 million (2011: $31.0 million). The filing does not present a conventional gross margin measure. Interest coverage was 3.6 times, versus 3.5 times in 2011; fixed-charge coverage was 2.7 times, versus 2.9 times.
Cash distributions paid to common stockholders were $236.3 million, or $1.771625 per share, in 2012. That was 86.2% of AFFO; AFFO exceeded common distributions by $37.8 million. Cash distributions to common and preferred holders totaled $275.8 million, approximately 131.4% of estimated taxable income. The company says FFO was sufficient to support current distributions but gives no assurance that dividend levels or increases will continue.
Year-end total assets were $5.44 billion, total liabilities $3.03 billion, and stockholders’ equity $2.41 billion. Total borrowings were $2.88 billion: $2.55 billion of senior unsecured notes and bonds, $175.9 million of mortgage debt, and $158.0 million drawn on the credit facility. Borrowings were approximately 32.5% of the company’s stated $8.88 billion market capitalization. The $1 billion unsecured credit facility had $842 million of available capacity; the company reported covenant compliance. The combined weighted average interest rate on outstanding debt was 4.75% at year-end.
Cash used in investing activities was $1.01 billion, principally reflecting property acquisitions. Financing activities provided $683.0 million, including $800 million of note issuance proceeds and $395.4 million of preferred stock proceeds, partly offset by distributions, debt repayments, and redemption of Class D preferred stock.
Material changes versus prior comparable period
- Revenue increased 15.9%, driven chiefly by acquisitions; same-store rents rose only 0.1% to $360.4 million.
- Despite higher revenue and net income, net income available to common stockholders fell 13.7%, reflecting increased preferred dividends, acquisition-related expenses, and the $3.7 million charge on redemption of Class D preferred shares.
- FFO increased in total but declined slightly per share; normalized FFO and AFFO increased both in total and per share.
- Occupancy improved to 97.2% from 96.7% at year-end 2011. For 124 expiring leases renewed or re-leased during 2012, rent was $10.6 million versus $10.9 million previously.
- Debt increased from $2.06 billion to $2.88 billion, while total assets increased from $4.42 billion to $5.44 billion. Preferred shares issued in 2012 funded redemption of higher-rate Class D preferred shares and repayment of credit-facility borrowings.
Outlook, commentary, risks and unusual items
- Acquisitions: In 2012, the company invested $1.16 billion in 423 properties and properties under development, at an initial weighted average contractual lease rate of 7.2%. The company cautions that actual returns may differ if tenants default.
- ARCT acquisition: Completed January 22, 2013, after year-end, in a transaction valued at approximately $3.1 billion. Realty Income added 515 properties, repaid approximately $552.9 million of ARCT credit-facility and term-loan borrowings, and assumed approximately $516.3 million of mortgage debt. The company estimated total merger costs of approximately $19 million, of which $7.9 million was incurred in 2012. Purchase-price allocation was preliminary.
- Portfolio dispositions: Management anticipated $50 million to $125 million of property-sale proceeds over the following 12 months, with proceeds to be reinvested if attractive acquisitions were available. These sales and proceeds were not assured.
- Dividends: The February 2013 monthly common dividend of $0.1809167 represented an annualized $2.171 per share. Management stated that future distributions remain subject to Board discretion and operating, financing, and other conditions.
- Risks: Key exposures include tenant default or bankruptcy, economic and retail-sector weakness, acquisition integration and higher leverage following ARCT, interest-rate and capital-market access, property impairments, environmental liability, insurance shortfalls, and continued qualification as a REIT. Convenience stores generated 14.9% of fourth-quarter rental revenue, the largest industry concentration disclosed.
- Legal matters: Eight lawsuits were filed in connection with the ARCT transaction. Realty Income said it believed the actions lacked merit. A Maryland state-action settlement was contemplated subject to final documentation and court approval; the Maryland federal action was dismissed in January 2013, while the New York action was stayed pending the Maryland state action. Ordinary-course claims were not expected by management to have a material aggregate effect.
- Other unusual items: Realty Income recorded $5.1 million of property impairment provisions in 2012, compared with $0.4 million in 2011. KPMG issued unqualified opinions on the financial statements and internal controls; management reported effective disclosure controls and no material internal-control weaknesses.
Important facts for investors to verify
- Reconcile the annual common distribution figures and payout ratios, and assess cash-flow coverage after preferred dividends, property investment, and debt service.
- Review ARCT’s final purchase-price allocation, integration progress, realized synergies, total transaction costs, and the combined company’s post-acquisition debt and coverage.
- Examine tenant and industry concentration, especially convenience stores and casual dining, alongside tenant credit quality and lease-expiration exposure.
- Assess whether acquisition yields and same-store rent growth support per-share FFO/AFFO growth after financing costs and share issuance.
- Confirm the status and financial implications of ARCT-related litigation and any environmental, impairment, or other contingencies.