Broadstone Net Lease, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Dollar amounts are in millions unless otherwise noted; financial statements are unaudited.
Business context
Broadstone is an externally managed REIT focused on long-term, predominantly triple-net commercial property leases. At quarter-end it owned 477 properties across 37 states, with approximately 14.1 million rentable square feet; the portfolio was 100% leased to 119 tenants. No tenant represented more than 5% of annual rental revenue. The company owned 92.3% of its Operating Company.
Financial performance and liquidity
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $46.2 | $37.0 | $132.1 | $103.4 |
| Operating income | $19.4 | $16.9 | $61.7 | $46.1 |
| Net income, including non-controlling interests | $13.0 | $15.4 | $42.7 | $26.5 |
| Net income attributable to Broadstone | $11.9 | $14.0 | $39.3 | $23.9 |
| GAAP diluted EPS | $0.68 | $1.02 | $2.36 | $1.87 |
| FFO per diluted share (non-GAAP) | $1.42 | $1.63 | $4.43 | $3.93 |
| AFFO per diluted share (non-GAAP) | $1.30 | $1.36 | $4.04 | $4.03 |
Nine-month revenue increased 27.7%, primarily from portfolio growth. Q3 net income declined 15.7%, reflecting a $2.6 million impairment charge, higher interest expense and debt-extinguishment costs; the diluted share count also rose. Nine-month net income benefited from portfolio growth, capitalization rather than expensing of acquisition costs under newly adopted accounting guidance, and higher gains on property sales. FFO and AFFO are company-defined non-GAAP measures and may not be comparable with other REITs.
- Cash flow: Nine-month operating cash flow was $72.4 million, versus $52.1 million a year earlier. Investing used $297.5 million and financing provided $217.2 million. Cash and equivalents ended at $13.7 million, down from $21.6 million at year-end 2016.
- Assets and debt: Total assets were $2.244 billion and total liabilities $1.011 billion. Debt was approximately $910.1 million before unamortized issuance costs, including $126.5 million drawn on the revolver, $250 million on the 5.5-year term loan and $150 million of 2027 senior notes. Weighted-average borrowing cost was 2.96%; $640 million of variable-rate borrowings was hedged with swaps.
- Leverage and covenants: Management reported leverage of approximately 36.5% of asset market value; all debt covenants were met. The new unsecured credit facility totals $800 million, with an accordion to $1 billion, and the 7-year $150 million delayed-draw tranche was undrawn at quarter-end.
- Distributions: Nine-month distributions totaled $66.0 million, including $28.1 million reinvested through the DRIP; the company reported they were funded from operating cash flow. The board subsequently declared monthly distributions of $0.415 per share/unit through January 2018.
Material changes and outlook
- Broadstone acquired 70 properties for $352.0 million during the first nine months, versus 71 properties for $381.0 million in the comparable 2016 period. Q3 acquisitions totaled $159.2 million, at a 7.7% weighted-average initial cash capitalization rate and 13.0-year weighted-average lease term.
- It sold 10 properties for $58.2 million during the nine months and recorded $10.3 million in gains, compared with four sales and $4.1 million in gains in 2016.
- A new $800 million unsecured credit facility closed in June 2017, refinancing prior facilities. The company also issued $150 million of fixed-rate senior notes at 4.84%, maturing in 2027. The refinancing generated $5.0 million of nine-month debt-extinguishment costs.
- ASU 2017-01 was adopted prospectively in 2017; $6.6 million of acquisition costs were capitalized rather than expensed. Management said it expected funding to be sufficient for operations and planned growth for the foreseeable future, subject to continued access to capital. No formal earnings or acquisition guidance was provided.
- Management revised its investment policy after quarter-end, including a 9.5% minimum average return-on-equity target across annual acquisitions and an 8.5% minimum for an individual transaction, net of fees. The determined share value was raised to $81.00 for subscriptions from November 1, 2017 through January 31, 2018.
Risks, contingencies and unusual items
- Interest-rate exposure, refinancing availability and the ability to maintain an investment-grade rating are key financial risks. The company relies on ongoing equity issuance and debt capacity to finance acquisitions; management noted adverse markets could constrain refinancing and potentially require property sales.
- Lease escalations averaged 2.1%; management cautioned that inflation could exceed contractual rent increases and could also weaken tenant credit quality. Restaurants represented 25.3% and healthcare facilities 20.8% of net next-twelve-month rent.
- A $2.6 million impairment was recorded on four properties using Level 3 valuation inputs, including capitalization rates of 7.25%–12% and an 8% weighted-average discount rate. Three properties suffered fire damage; $2.9 million of insurance receivables was recognized, and a possible additional gain depended on final insurance proceeds.
- Two tax-protection agreements could require up to approximately $12.3 million in damages under specified taxable dispositions or liability-allocation failures; management said triggering events were not believed likely in the foreseeable future. The filing reported no material pending litigation or known material environmental liability.
- Related-party management fees totaled $14.3 million for the nine months. Potential termination fees at quarter-end were stated as $14.1 million for the property management agreement and $41.6 million for the asset management agreement, subject to specified termination conditions.
Important facts for investors to verify
- Whether acquisition growth translates into per-share cash-flow growth: nine-month FFO per share rose, while Q3 FFO and AFFO per share declined year over year and nine-month AFFO per share was nearly flat.
- Debt maturity and refinancing plans, especially the $325 million term note due in 2019, floating-rate exposure, swap coverage, covenant headroom and the impact of any credit-rating change.
- Portfolio and tenant-credit trends, rent collections, lease escalations and concentration in restaurant and healthcare-related industries.
- Support for the $81.00 determined share value and NAV estimates; management estimated that a 0.25 percentage-point increase in the portfolio capitalization rate would reduce NAV per share to $76.03.
- Insurance recovery outcomes for fire-damaged properties, the four-property impairment assumptions, and the terms and potential consequences of related-party agreements and tax-protection commitments.