REALTY INCOME CORP quarterly report, Q2 FY2012

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Realty Income Corporation — Q2 2012 Form 10-Q

Business context and period. This unaudited filing covers the quarter and six months ended June 30, 2012. Realty Income is an equity REIT focused on freestanding commercial properties, primarily leased under long-term net leases. At quarter-end it owned 2,762 properties in 49 states, with 97.3% occupancy and an average remaining lease term of about 11.1 years for leased single-tenant properties.

Financial results and liquidity

  • Revenue: Q2 rental revenue was $115.0 million, up 13.4% year over year; total revenue was $115.6 million. For six months, rental revenue was $229.1 million, up 15.8%, and total revenue was $229.9 million.
  • Profit: Q2 net income was $43.4 million versus $39.2 million; income available to common stockholders was $33.0 million versus $33.2 million, and diluted EPS was $0.25 versus $0.26. Six-month net income was $82.7 million versus $75.2 million; common income was $59.0 million versus $63.1 million, and diluted EPS was $0.44 versus $0.51. The six-month 2012 common result includes a $3.7 million charge on redemption of Class D preferred stock.
  • REIT operating measures: Q2 FFO was $65.2 million, or $0.49 diluted per share, versus $60.9 million, or $0.48. Six-month FFO was $125.9 million, or $0.95 per share, versus $117.7 million, or $0.96. Q2 AFFO was $66.5 million, or $0.50 diluted per share, versus $62.4 million, or $0.49; six-month AFFO was $132.8 million, or $1.00 per share, versus $120.6 million, or $0.98. FFO and AFFO are non-GAAP measures.
  • Cash flow: Six-month operating cash flow was $155.9 million, versus $137.0 million. Investing cash outflow was $213.7 million, versus $304.7 million; financing cash inflow was $59.6 million, versus $305.8 million. Cash ended at $6.1 million, compared with $155.7 million a year earlier.
  • Debt and liquidity: Outstanding notes and bonds were $1.75 billion, mortgages were $56.7 million, and credit-facility borrowings were $183.6 million—about $1.99 billion total borrowings. The new unsecured facility provides $1 billion of capacity, with $816.4 million available at quarter-end. Total borrowings were approximately 24.3% of market capitalization. The company reported compliance with debt covenants; senior-note covenant debt-to-adjusted-assets was 37.8% against a 60% limit, and debt-service coverage was 3.7x against a 1.5x minimum.
  • Distributions: Six-month common distributions were $116.6 million, or 87.8% of AFFO. The monthly common dividend increased to $0.146125 in July 2012; management reported an annualized rate of $1.7535 per share. Preferred dividends were current.

Material changes versus prior period

  • Revenue growth primarily reflected properties acquired in 2011 and 2012. Same-store rents declined 1.1% in both Q2 and the first six months; excluding Friendly’s and Buffets leases, same-store rents increased 1.1% in both periods.
  • Six-month common income and diluted EPS fell despite higher total net income, reflecting increased preferred dividends and the $3.7 million Class D redemption charge. The weighted-average common share count also increased year over year.
  • Interest expense rose to $28.8 million in Q2 from $25.6 million and to $57.8 million for six months from $50.8 million, mainly due to higher average borrowings and mortgage interest, partly offset by lower average rates.
  • In May, the company replaced its $425 million acquisition facility with a $1 billion facility, reducing current all-in drawn pricing to 1.25% over LIBOR from 2.20% over LIBOR. In February and April it issued $395.4 million net of Class F preferred stock proceeds, used partly to redeem $127.5 million of higher-rate Class D preferred stock and partly to repay facility borrowings.
  • Six-month acquisitions were $221.5 million across 147 properties, versus $364.2 million across 36 properties in the prior-year period. The new properties were fully leased with a 15-year average lease term and a 7.2% initial weighted-average contractual lease rate.

Outlook, commentary and risks

  • Management continued to expect to meet or exceed its previously stated $650 million 2012 acquisition target, while noting that acquisitions would be weighted more toward year-end. About $316 million of previously announced purchase agreements were terminated.
  • The company planned more active property dispositions and anticipated $25 million to $70 million of sale proceeds over the next 12 months, subject to market conditions and available reinvestment opportunities.
  • Friendly’s emerged from bankruptcy in June; management estimated recovery of about 80% of its prior $16.1 million annualized rent. Buffets emerged in July; estimated recovery was about 65% of its prior $18.2 million annual rent.
  • Key risks include tenant defaults and bankruptcy, property vacancies and impairment, interest-rate movements, access to capital markets, real-estate and credit-market volatility, and the ability to sustain REIT qualification and distributions. A 1% rate change on quarter-end facility borrowings would change annual interest costs by approximately $1.8 million.
  • The company recorded no real-estate impairment in the first six months of 2012. It reported no material change in risk factors from its 2011 Form 10-K and concluded disclosure controls were effective.
  • Management cautioned that future dividends are not guaranteed. FFO and AFFO are supplemental non-GAAP measures and are not substitutes for operating cash flow or liquidity analysis.

Important facts for investors to verify

  • Whether acquisition closings support the $650 million 2012 target, given terminated agreements and back-loaded timing.
  • Actual rent collections and lease outcomes for Friendly’s and Buffets, and the effect on same-store rents.
  • Whether AFFO and operating cash flow continue to cover common distributions, while accounting for preferred dividends and capital spending.
  • Refinancing plans for the $100 million note maturity in March 2013 and the facility’s May 2016 expiration; also monitor covenant headroom and floating-rate exposure.
  • Execution and proceeds from planned property sales, and whether proceeds can be reinvested at attractive returns.