Business context and reporting period
Realty Income Corporation, an equity REIT focused on long-term net leases, filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2010. It owned 2,350 properties across 49 states, with 96.2% occupancy and 118 tenants across 32 industries. Nearly all properties were single-tenant; 2,250 were leased under net leases, with an average remaining lease term of about 11.4 years.
Financial performance and position
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Total revenue | $83.5m | $81.3m | $166.7m | $163.8m |
| Income from continuing operations | $29.8m | $30.1m | $59.2m | $60.0m |
| Net income available to common stockholders | $25.0m | $26.5m | $49.1m | $50.5m |
| Diluted net income per share | $0.24 | $0.26 | $0.47 | $0.49 |
| FFO available to common stockholders | $46.8m | $47.2m | $93.4m | $93.9m |
| AFFO available to common stockholders | $47.7m | $47.9m | $95.3m | $95.6m |
Rental revenue increased 2.0% in Q2 and 1.8% for the half year. Same-store rents rose 0.1% in Q2 and 0.4% year to date. Continuing-operations income as a share of revenue was approximately 35.6% in Q2 (36.9% prior year) and 35.5% for the first half (36.6% prior year). General and administrative expense increased to $6.7m in Q2 and $13.4m year to date, primarily due to employee costs.
For the first six months, operating cash flow was $110.5m versus $106.8m; investing cash flow was $(284.7)m versus $3.3m, largely reflecting property acquisitions; financing cash flow was $165.0m versus $(121.1)m. Cash ended at $0.9m, down from $10.0m at year-end 2009. Common distributions paid were $89.7m, or 95.9% of reported FFO.
At June 30, total assets were $3.14bn, total liabilities $1.69bn and stockholders’ equity $1.45bn. Debt comprised $1.60bn of notes and $26.9m outstanding on a $355m revolving credit facility, with $328.1m available. Notes carried a 6.05% weighted-average rate; the facility rate was 1.35%. The company reported no mortgage debt, compliance with debt covenants, and investment-grade ratings with stable outlooks. Interest coverage was 3.4x for Q2 and 3.5x for the half year; fixed-charge coverage was 2.7x.
Material changes versus prior comparable periods
- Net income available to common stockholders declined 5.7% in Q2 and 2.8% for the first half; FFO fell 0.8% and 0.5%, respectively. AFFO per share remained $0.46 for Q2 and $0.92 for the half year.
- Acquisitions increased substantially: Realty Income invested $289.0m in 21 properties in the first half of 2010, compared with $1.3m in previously acquired properties in the first half of 2009. The portfolio included a roughly $258m sale-leaseback of Napa Valley winery and vineyard properties leased to Diageo under 20-year triple-net agreements and guaranteed by Diageo plc.
- The company issued $250m of 5.75% senior unsecured notes due 2021; net proceeds of approximately $246.3m repaid acquisition-facility borrowings. Total notes rose from $1.35bn at year-end 2009 to $1.60bn at June 30, 2010.
- Occupancy was 96.2%, compared with 79 vacant properties at June 30, 2009 and 75 at December 31, 2009; 90 properties were available for lease at June 30, 2010.
Outlook, commentary, risks and unusual items
- No specific earnings or FFO guidance was provided. Management said it expected cash, operating cash flow and available borrowing capacity to meet liquidity needs for the foreseeable future, while noting capital-market access cannot be assured.
- Management anticipated selling unidentified investment properties for $10m–$35m of proceeds over the next 12 months and generally intended to reinvest proceeds if attractive opportunities were available; neither sales nor reinvestment was assured.
- The July 2010 common distribution was raised to $0.143625 per share monthly, equivalent to $1.7235 annualized and an approximately 5.7% yield based on the June 30 share price. Management cautioned that future distribution levels and increases are not guaranteed.
- Key risks include tenant defaults, vacancies and re-leasing, property-value impairment, economic and real-estate-market conditions, interest-rate movements, volatility or disruption in credit markets, and access to debt and equity capital. A 1% rate change on the variable-rate facility balance would change annual interest cost by approximately $269,000.
- Restaurants and convenience stores represented 20.8% and 17.2% of rental revenue, respectively. Diageo became the company’s third-largest tenant, adding tenant exposure through the large winery transaction.
- Property sales generated $1.2m of Q2 gains versus $2.2m a year earlier. The company recorded $87,000 of first-half impairment charges on two sold properties; goodwill impairment was nil. Legal proceedings were described as routine and not expected to materially affect results. No material changes to previously disclosed risk factors were reported.
- Management stated disclosure controls were effective and reported no material internal-control weaknesses. The company reported no derivatives or unconsolidated variable-interest-entity investments.
Important facts for investors to verify
- Whether the Diageo lease and guarantee support the expected rent stream and how the transaction changes tenant concentration.
- Whether occupancy and same-store rent trends improve, and whether the 90 available properties can be leased or sold as anticipated.
- Whether FFO and AFFO continue to cover common distributions, given first-half common distributions were 95.9% of FFO and cash balances were low.
- Debt refinancing and liquidity needs, including the credit facility’s May 2011 expiration (subject to extension options), covenant headroom and exposure to variable rates.
- The execution and proceeds of the anticipated property sales and any reinvestment, alongside the effect of acquisition growth on returns and leverage.