Business Context and Reporting Period
National Retail Properties, Inc. (NNN) is a fully integrated REIT that acquires, owns, develops and invests in primarily retail properties leased under long-term net leases. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2017.
- Portfolio: 2,675 properties totaling approximately 28.1 million square feet across 48 states.
- Occupancy: approximately 99%; weighted-average remaining lease term of 11.5 years.
- Common shares outstanding: 149.2 million as of July 28, 2017.
Financial Performance and Position
| Metric | Q2 2017 | Q2 2016 | Change |
|---|---|---|---|
| Total revenue | $145.6 million | $130.9 million | +11.2% |
| Rental income | $141.7 million | $126.9 million | +11.7% |
| Earnings from operations | $82.6 million | $75.0 million | +10.1% |
| Net earnings attributable to NNN | $58.0 million | $51.9 million | +11.7% |
| Net earnings attributable to common stockholders | $49.4 million | $43.1 million | +14.8% |
| Basic and diluted EPS | $0.33 | $0.30 | +10.0% |
Revenue increased primarily from property acquisitions and contractual rent increases. Net earnings attributable to common stockholders benefited from higher operating earnings and the absence of Series D preferred dividends during the quarter, partly offset by Series E and Series F preferred dividends.
| Six-month metric | 2017 | 2016 |
|---|---|---|
| Total revenue | $287.0 million | $257.9 million |
| Net cash provided by operating activities | $215.1 million | $187.6 million |
| Net earnings attributable to NNN | $131.7 million | $122.6 million |
| Net earnings attributable to common stockholders | $101.1 million | $104.9 million |
| Basic EPS | $0.68 | $0.74 |
- Q2 operating-expense margin was approximately 43.3%, compared with 42.7% in the prior-year quarter; earnings-from-operations margin was approximately 56.7%, compared with 57.3%.
- Q2 interest expense increased 13.3% to $27.3 million, primarily due to the December 2016 issuance of $350 million of notes and higher Credit Facility borrowings.
- Six-month investing cash use was $350.8 million, including $399.0 million of additions to real estate, partly offset by $48.6 million of disposition proceeds.
- Six-month financing cash use was $154.4 million, including $287.5 million to redeem Series D preferred stock and $134.4 million of common dividends.
- Cash and cash equivalents declined to $4.5 million at June 30, 2017, from $294.5 million at December 31, 2016.
- Total debt was $2.529 billion at June 30, 2017, compared with $2.312 billion at year-end 2016. Debt consisted primarily of $2.300 billion of notes payable and $215.5 million drawn on the revolving Credit Facility.
- The $650 million Credit Facility had $434.5 million available at quarter-end, excluding $0.2 million of undrawn letters of credit, and matures in January 2019 with a potential extension to January 2020.
Material Changes Versus the Prior Comparable Period
- NNN acquired 140 properties in Q2 and 164 properties during the first six months, investing $299.5 million and $407.4 million, respectively. The initial cash yield was 6.9% for both periods.
- Property acquisitions increased the portfolio to 2,675 properties from 2,452 at June 30, 2016, while gross leasable area increased from 26.3 million to 28.1 million square feet.
- NNN sold eight properties in Q2 and 25 during the first six months, generating total gains of $3.1 million and $17.7 million, respectively.
- Q2 operating expenses increased 12.7%, driven by higher depreciation and real estate expenses and $7.4 million of retirement severance costs related primarily to former CEO Craig Macnab’s retirement.
- Real estate impairment and other charges were a net recovery of $39,000 in Q2 2017, compared with $5.5 million of charges in Q2 2016. Six-month impairment charges declined to $1.2 million from $6.0 million.
- NNN redeemed all $287.5 million of Series D preferred stock in February 2017. Series E and Series F preferred stock remained outstanding.
- Common dividends increased to $0.455 per share in Q2 2017 from $0.435 in Q2 2016. In July 2017, NNN declared a $0.475 per-share dividend payable in August 2017.
- Common equity issuance declined: six-month ATM proceeds were $72.1 million in 2017 versus $209.7 million in 2016.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management did not provide quantified earnings or acquisition guidance in the filing. Management expects rental income to continue to benefit from additional acquisitions and contractual rent increases and expects operating obligations to be funded through operating cash flow, available capital, the Credit Facility, debt or equity offerings and property dispositions.
- Construction commitments totaled $126.6 million on 22 properties, of which $48.3 million had been funded and $78.3 million remained.
- Approximately 3% of the portfolio was leased to four tenants, including Gander Mountain, that had filed for Chapter 11 bankruptcy protection; those tenants could reject or affirm their leases.
- NNN reported 18 vacant, unleased properties, representing less than 1% of the portfolio.
- Key risks include tenant defaults or bankruptcies, rent loss, tenant and geographic concentration, illiquidity of real estate, acquisition and disposition execution, access to capital, leverage and debt covenants, interest-rate movements, environmental liabilities, REIT qualification, regulatory changes and cybersecurity incidents.
- NNN had two forward-starting interest-rate swaps with a total notional amount of $250 million. Management stated that a 1% increase in rates on variable-rate debt would have increased six-month interest expense by less than 1%.
- NNN plans to adopt the revenue recognition guidance in ASU 2014-09 and related amendments on January 1, 2018, using the cumulative catch-up transition method; the potential impact was still under evaluation.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting. No material changes to previously disclosed risk factors or reportable legal proceedings were identified.
Investor Verification Checklist
- Verify whether acquisition volume, 6.9% initial yields and approximately 99% occupancy were sustained after June 30, 2017.
- Assess liquidity after the decline in cash to $4.5 million and monitor utilization, pricing and maturity-extension options under the Credit Facility.
- Review debt maturities, refinancing needs and exposure to interest-rate changes, including the forward-starting swaps.
- Monitor bankrupt or financially stressed tenants, particularly the four tenants representing approximately 3% of annual base rent.
- Evaluate the effect of the $7.4 million retirement severance charge and any further management-transition costs.
- Confirm the impact of the 2018 revenue and lease accounting standards on reported results and disclosures.
- Reconcile dividend growth and preferred-stock obligations with recurring operating cash flow and future capital requirements.