Business context and reporting period
Realty Income Corporation filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. The REIT owns and leases primarily single-tenant commercial properties under long-term net leases. At quarter-end, it owned 4,703 properties across 49 states and Puerto Rico, with 98.3% occupancy and a 9.8-year weighted average remaining lease term for leased single-tenant properties.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $277.2m | $258.9m | $815.3m | $759.6m |
| Net income | $77.2m | $67.8m | $223.8m | $201.7m |
| Net income available to common stockholders | $70.3m | $60.7m | $202.8m | $180.5m |
| Diluted net income per share | $0.27 | $0.26 | $0.80 | $0.78 |
| FFO per diluted share | $0.73 | $0.69 | $2.11 | $2.05 |
| AFFO per diluted share | $0.72 | $0.70 | $2.14 | $2.06 |
FFO and AFFO are non-GAAP measures; the company cautions that they are not substitutes for GAAP results or cash flows. Approximate net income margin was 27.9% for Q3 2016 versus 26.2% a year earlier, and 27.4% for the nine-month period versus 26.6%.
- Cash flow, nine months: Operating activities provided $579.2m, versus $472.9m in 2015. Investing used $973.4m, primarily for real estate investment of $1.028bn. Financing provided $383.7m. Cash ended at $29.8m, down from $40.3m at year-end 2015.
- Assets and debt: Total assets were $12.54bn and total liabilities $5.77bn. Outstanding borrowings were approximately $5.27bn: $3.375bn notes and bonds, $1.082bn credit facility, $496.5m mortgages, and $320m term loans. The company reported debt equal to 22.9% of market capitalization and debt/annualized quarterly EBITDA of 5.3x.
- Liquidity: At September 30, $918m remained available on the $2.0bn revolving facility; the company reported covenant compliance and said liquidity sources were sufficient for the next 12 months. Following an October note offering and facility repayment, stated facility availability rose to $1.5bn.
- Distributions: Common distributions paid in the first nine months were $453.8m, 83.5% of AFFO. Monthly common dividends rose six times in 2016; the October rate was $0.202 per share. Class F preferred dividends were current.
Material changes versus the prior comparable period
- Q3 rental revenue rose 7.1% to $265.3m; nine-month rental revenue rose 8.0% to $782.2m. Same-store rents increased 1.1% for Q3 and 1.2% for the nine-month period.
- Common net income per diluted share increased 3.8% in Q3 and 2.6% year to date. FFO per diluted share rose 5.8% in Q3 and 2.9% year to date; AFFO per diluted share rose 2.9% and 3.9%, respectively.
- Interest expense declined to $171.0m for the first nine months from $181.1m, mainly reflecting lower average debt balances and debt repayments. Depreciation and amortization increased to $332.2m from $303.5m as the portfolio expanded.
- Impairment provisions increased to $17.0m from $9.2m for the first nine months. Property-sale gains declined to $15.3m from $17.1m.
- The company invested $1.1bn in 236 properties and development or expansion projects in the first nine months, compared with $1.1bn across 195 in 2015. New investments were 100% leased, at a 6.4% initial weighted average contractual lease rate and 15.0-year weighted average lease term.
- Common shares outstanding increased to 258.6m from 250.4m at December 31, 2015. The company raised $383.6m in a May share offering and $85.8m through its ATM program.
Outlook, commentary, risks and unusual items
- No specific earnings or FFO guidance is provided. Management anticipated $75m–$100m of property sales in 2016 and intended to reinvest proceeds if attractive acquisition opportunities were available; neither sales nor reinvestment was assured.
- Management described portfolio performance as sound and said operating cash flow, cash on hand and borrowing capacity were expected to meet near-term liquidity needs. It expects to use longer-term or permanent capital for acquisitions and to refinance facility borrowings.
- In October 2016, the company issued $600m of 3.000% senior unsecured notes due 2027, at an effective yield of 3.153%; net proceeds of approximately $587.2m were used to repay credit-facility borrowings.
- A Diageo lease-guarantee modification included $75m of additional rent in two installments. The first $37.5m was received in August and recorded as prepaid rent; the second was expected in January 2017, after which Treasury Wine Estates would become guarantor. The additional rent is to be recognized over approximately 15 years.
- Key risks include tenant defaults and credit deterioration, occupancy and re-leasing outcomes, property impairments, interest-rate changes, access to capital markets, real-estate and credit-market conditions, inflation outpacing contractual rent increases, environmental matters, and maintaining REIT qualification. A 1% change in interest rates on the quarter-end credit-facility balance would change annual interest costs by approximately $10.8m.
- Management reported routine legal proceedings without an expected material adverse effect, $14.6m of property and leasing commitments, and $6.6m under construction contracts. Disclosure controls were considered effective; no material internal-control changes or weaknesses were reported.
Important facts for investors to verify
- Review the composition and sustainability of AFFO and FFO growth, and compare distribution coverage with cash flow from operations and capital needs.
- Assess tenant and industry concentration, tenant credit quality, lease expirations, occupancy, and the effect of elevated restaurant-casual-dining impairments.
- Check refinancing needs and costs, variable-rate exposure, facility availability, debt covenants, and the subsequent use of the October note proceeds.
- Evaluate whether acquisition yields and lease terms support returns after financing costs, and whether the planned property sales and reinvestment occur as expected.
- Track the final Diageo/Treasury Wine Estates payment and guarantor transition, and confirm how the prepaid rent is recognized.