Realty Income Corporation — Q3 2010 Form 10-Q
Business context and reporting period
Quarter ended September 30, 2010; comparisons are with Q3 and the first nine months of 2009. Realty Income is an equity REIT focused on long-term, primarily net-leased commercial properties and monthly distributions. At quarter-end, it owned 2,342 properties across 49 states, with 96.4% occupancy and 118 tenants across 32 industries.
Financial and operating performance
- Revenue: Q3 total revenue was $87.2 million, up from $81.5 million; rental revenue rose 7.5% to $87.1 million. Nine-month total revenue was $253.2 million, up from $244.5 million. Same-store rents grew 0.3% in Q3 and 0.4% for the nine months.
- Earnings: Q3 net income available to common stockholders was $25.6 million, or $0.25 per diluted share, versus $27.1 million and $0.26. Nine-month results were $74.7 million, or $0.72 per diluted share, versus $77.6 million and $0.75. Net income includes property-sale gains, which vary by period.
- REIT performance measures: Q3 FFO was $47.8 million ($0.46 diluted share), versus $48.2 million ($0.47); nine-month FFO was $141.2 million ($1.36), versus $142.1 million ($1.37). AFFO was $48.6 million in Q3 and $143.9 million for nine months; per-share AFFO was unchanged year over year at $0.47 and $1.39, respectively. FFO and AFFO are non-GAAP measures.
- Cash flow and distributions: Nine-month operating cash flow was $156.8 million, versus $148.8 million. Investing used $295.0 million, largely for acquisitions; financing provided $283.8 million. Ending cash was $155.6 million, compared with $10.0 million at year-end 2009. Common distributions paid were $134.7 million, or 95.4% of nine-month FFO; AFFO exceeded common distributions by $9.2 million.
- Margins and expenses: The filing does not present a conventional operating-margin measure. G&A was 7.1% of revenue in Q3 versus 6.0%, and 7.7% for nine months versus 6.5%. Interest expense rose to $25.1 million in Q3 and $68.1 million for nine months. Nine-month interest and fixed-charge coverage were 3.3x and 2.6x, respectively, versus 3.5x and 2.7x.
- Debt and liquidity: Notes payable totaled $1.60 billion, up from $1.35 billion at year-end; no credit-facility borrowings were outstanding, with $355 million available. Debt was 28.2% of stated market capitalization; the company reported no mortgage debt. Notes carried a 6.05% weighted-average rate and had estimated fair value of $1.74 billion. The company reported compliance with debt covenants and investment-grade ratings with stable outlooks.
Material changes and significant transactions
- Acquired 23 properties for $302.9 million in the first nine months, at a 7.6% initial weighted-average contractual lease rate; the properties were fully leased, with an average 18.3-year lease term. This compares with $11.9 million invested in three properties in the prior-year period.
- The largest acquisition was a $269.2 million sale-leaseback of Napa Valley winery and vineyard properties leased for 20 years to Diageo under triple-net agreements and guaranteed by Diageo plc. Diageo became the company’s largest tenant by rental revenue.
- Issued $250 million of 5.75% senior unsecured notes due 2021 and 6.20 million common shares at $33.40, receiving approximately $246.1 million and $196.9 million net, respectively. The equity issuance increased outstanding shares.
- Q3 G&A increased primarily due to employee costs, particularly in acquisitions and research. Depreciation also increased with acquisitions; interest expense rose with additional borrowing, partly offset by lower average rates.
- Sold 19 investment properties for $16.1 million in the first nine months, recognizing $3.8 million in gains, versus 17 properties, $10.8 million of proceeds, and $4.2 million in gains in 2009. Recorded $171,000 of impairments on three properties sold during 2010.
Outlook, risks and contingencies
- Management said available cash, operating cash flow, and borrowing capacity should meet foreseeable liquidity needs. It anticipated investing property-sale proceeds of $10 million to $35 million over the next 12 months if attractive acquisitions were available; neither sales nor reinvestment was assured.
- After quarter-end, the company acquired 23 properties for about $126.5 million, funded with September equity proceeds. It also signed an agreement to acquire 136 properties for about $250 million, subject to conditions, with completion anticipated within 90 days; funding could include cash, credit-facility borrowings, or public securities.
- The monthly common distribution rose to $0.1439375 per share in October, an annualized $1.72725. Management stated it intended to continue monthly distributions but could not assure their level or continued increases; future distributions remain subject to board discretion and financial condition.
- Key risks identified include tenant defaults, economic and real-estate-market conditions, interest-rate changes, access to capital markets, asset impairments, environmental matters, natural disasters, and maintaining REIT qualification. Management reported no material change in risk factors from the 2009 Form 10-K.
- Ordinary-course legal matters were not expected to have a material adverse effect. At quarter-end, contingent tenant-improvement and leasing payments were $934,000, with $966,000 of construction-contract commitments expected to be paid within 12 months.
Most important facts for investors to verify
- Diageo tenant concentration and the credit support, lease terms, and performance of the winery and vineyard properties.
- Whether the proposed 136-property acquisition closed, its final price and financing, and the returns relative to funding costs.
- Occupancy, tenant credit quality, and the trend in available-for-lease properties, which rose to 84 from 75 a year earlier.
- Dividend sustainability against AFFO and cash flow, including the effect of ongoing capital spending and preferred dividends.
- Debt maturities, covenant headroom, interest coverage, and refinancing access as the $355 million facility approaches its May 2011 expiry.
- Drivers of declining GAAP earnings and per-share FFO despite higher rental revenue, including expense growth, dilution, and property-sale timing.