REALTY INCOME CORP annual report, FY2015

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Realty Income Corporation — 2015 Form 10-K

Business context and reporting period. This annual filing covers the fiscal year ended December 31, 2015; the filing also reports fourth-quarter results. Realty Income is a REIT focused on freestanding commercial properties leased primarily under long-term net leases. At year-end, it owned 4,538 properties, was 98.4% occupied, and had an average remaining lease term of approximately 10 years on leased single-tenant properties. Its stated objective is to generate dependable monthly dividends from rental cash flow.

Financial and operating results

  • Revenue: Full-year total revenue was $1.023 billion, up 9.6% from $933.5 million in 2014. Rental revenue increased 9.3% to $976.9 million. Same-store rent grew 1.3%. Fourth-quarter revenue was $263.7 million, versus $247.6 million a year earlier.
  • Profit: Net income was $284.9 million, compared with $271.9 million in 2014. Net income available to common stockholders rose to $256.7 million from $227.6 million; diluted EPS was $1.09 versus $1.04. Fourth-quarter net income available to common stockholders was $76.2 million and diluted EPS was $0.31, compared with $71.0 million and $0.32 in fourth-quarter 2014.
  • REIT operating measures: FFO was $652.4 million, up 15.9%, or $2.77 per diluted share, up 7.4%. AFFO was $647.0 million, up 15.2%, or $2.74 per diluted share, up 6.6%. These are non-GAAP measures and are not substitutes for operating cash flow or liquidity.
  • Cash flow: Operating activities provided $692.3 million, versus $627.7 million in 2014. Investing activities used $1.179 billion, largely reflecting real estate investment; financing activities provided $523.2 million. Cash increased by $36.4 million to $40.3 million at year-end.
  • Margins and expenses: General and administrative expense was $49.3 million, or 5.0% of the filing’s specified revenue measure, down from 5.7% in 2014. Property expense net of tenant reimbursements was $13.3 million, or 1.4% of that measure, versus 1.9%. The filing does not present a single standard operating-margin measure.
  • Debt and coverage: Total debt was approximately $4.84 billion, about 26.6% of stated market capitalization. This included $3.65 billion of fixed-rate notes and bonds, $637.7 million of mortgages, $320 million of term loans, and $238 million drawn on the revolving facility. Debt-service coverage was 4.5x and fixed-charge coverage was 4.0x under the company’s covenant calculations; the company reported compliance with its covenants.
  • Liquidity: The $2.0 billion unsecured revolving facility had $1.76 billion available at year-end and matures initially in June 2019, with two optional six-month extensions. Management believed cash, operating cash flow and borrowing capacity were sufficient for the next 12 months. The filing identifies $275 million of notes and $170.1 million of mortgage principal due in 2016.
  • Dividends: Common dividends paid totaled approximately $2.271 per share in 2015, 3.6% above 2014. Common distributions were 82.4% of AFFO. The monthly common dividend reached $0.1985 in February 2016, an annualized $2.382 per share; future dividends remain at board discretion.

Material changes versus 2014

  • Portfolio growth drove revenue higher: 286 new properties or development/expansion projects received $1.26 billion of investment in 2015. Their initial weighted-average contractual lease rate was 6.6%, compared with 7.1% for 2014 acquisitions; the 2015 investments were reported as 100% leased with a 16.5-year weighted-average lease term.
  • Occupancy remained 98.4%, while the portfolio expanded from 4,327 to 4,538 properties. Rent recapture on 253 re-leased properties was 100.9%.
  • Operating cash flow increased by $64.6 million. Debt declined by about $89.5 million on the selected-data basis, while total assets increased to $11.87 billion from $11.01 billion.
  • Impairment provisions increased to $10.6 million from $4.6 million; gains on property sales decreased to $22.2 million from $42.1 million. The 2014 common-stockholder result included a $6.0 million non-cash preferred-stock redemption charge.
  • Common equity issuance and the dividend reinvestment plan raised substantial capital: public offerings generated $793.6 million net, the reinvestment plan raised approximately $363.0 million, and the ATM program raised $36.3 million. Shares outstanding increased to 250.4 million from 224.9 million.

Outlook, commentary, risks and unusual items

  • Management anticipated $50 million to $75 million of property sales during 2016, with proceeds intended for acquisitions if attractive opportunities were available. This is an estimate, not a guarantee. The filing does not provide a clear numeric earnings or FFO forecast.
  • Management described portfolio performance as solid and emphasized long-term net leases, tenant and industry diversification, and active portfolio management. Drug stores were the largest industry concentration at approximately 10.6% of 2015 annual rental revenue; Walgreens represented 6.9%.
  • Principal disclosed risks include tenant credit deterioration, defaults or bankruptcies; lease renewal and re-leasing conditions; acquisition competition and pricing; access to capital and refinancing; interest-rate exposure; real-estate illiquidity and impairment; environmental liabilities; and maintaining REIT qualification. Credit-market disruption, inflation, casualty losses, litigation and cybersecurity are also discussed.
  • Variable-rate exposure remains through the credit facility and certain debt, although swaps fixed the stated rates on the two term loans. Management estimated that a 1% rate change on the year-end credit-facility balance would change annual interest cost by $2.4 million.
  • The company adopted revised discontinued-operations guidance in 2014, changing which property disposals are reported as discontinued operations. The 2015 impairment charge includes properties classified as held for sale, held for investment, sold, or otherwise disposed of.
  • The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Management reported effective disclosure controls and no material internal-control weaknesses. Ordinary-course claims and lawsuits were disclosed; management did not expect them, in aggregate, to have a material adverse effect.

Most important facts for investors to verify

  1. Reconcile reported GAAP earnings with FFO and AFFO, including the effects of depreciation, property-sale gains, impairments and share issuance on per-share growth.
  2. Review the 2016 debt maturities and mortgage repayments, refinancing plans, facility availability and covenant headroom.
  3. Assess whether the 100.9% rent recapture rate and 98.4% occupancy can be sustained as leases expire and tenants’ credit conditions change.
  4. Evaluate tenant and industry exposure, particularly drug stores, and the credit quality underlying the reported rental revenue.
  5. Compare acquisition yields and investment costs with financing costs, and confirm the execution and pricing of the planned 2016 property dispositions.
  6. Confirm dividend coverage using cash flow and capital needs, not solely non-GAAP AFFO; the filing cautions that future dividend levels and increases are not guaranteed.