Four Corners Property Trust - Q1 2024

Executive Summary

• Q1 2024 was steady operationally with 99.6% occupancy and 99.7% rent collections; AFFO per diluted share was $0.43, up 4.9% YoY, supported by rental revenue growth and disciplined capital deployment.
• Total revenues rose to $66.47M (+10.9% YoY); GAAP diluted EPS was $0.26; AFFO per diluted share was $0.43; the dividend remained $0.345 per share.
• Management slowed acquisitions given cost of capital vs market cap rates; 4 properties were acquired for $15.9M at a 6.9% cap rate, all in medical retail, reflecting continued portfolio diversification and pricing discipline.
• Capital position strengthened with $85M term loans and interest rate swaps, fixing an effective rate of 4.89%; liquidity stood at $277M at quarter end—a key buffer to pursue selective deals or manage tenant events such as Red Lobster.

What Went Well and What Went Wrong

• What Went Well

  • AFFO per diluted share increased to $0.43, up $0.02 YoY, underpinned by solid collections and occupancy: “We reported first quarter AFFO of $0.43 per share, which is $0.02 or 4.9% up from Q1 last year”.
  • Lease renewals were strong: 13 expirations with 11 renewals at positive 12.5% spreads; occupancy remains 99.6% with limited 2024/2025 maturities (0.9% and 2.2% of ABR).
  • Portfolio risk management: proactive culling and selective Red Lobster exposure—15 of 18 sites below brand median rent; “We sold some of our highest rent and lower performing stores... dropped exposure from 2.9% ABR to 1.7% today”.

• What Went Wrong

  • External growth muted: only 4 acquisitions in Q1 as bid-ask spreads and seller reticence constrained accretive deployment at current cost of capital.
  • Capital markets backdrop still challenging: need slightly higher stock price, lower rates, or higher cap rates for robust accretive activity; “It’s darn close... slightly higher stock price, slightly lower 10-year or slightly higher cap rates, it begins to really work”.
  • Tenant-specific uncertainty: Red Lobster restructuring headlines created risk overhang; management views rejection unlikely, but acknowledged uncertainty and potential TIs if needed in a worst-case scenario.

Transcript

Operator (participant)

Welcome to the FCPT Q1 2024 financial results conference call. My name is Carla, and I will be coordinating your call today. During the presentation, you can register to ask a question by pressing Star followed by One on your telephone keypad. If you change your mind, it's by Star followed by Two. I will now like to hand you over to Patrick Wernig. Patrick, please go ahead.

Patrick Wernig (CFO)

Thank you, Carla. During the course of this call, we will make forward-looking statements which are based on our beliefs and assumptions. Actual results will be affected by known and unknown factors that are beyond our control or ability to predict. Our assumptions are not a guarantee of future performance, and some will prove to be incorrect.

For more detailed description of some potential risks, please refer to our SEC filings, which can be found at FCPT.com. All the information presented on this call is current as of today, 2, May 2024. In addition, reconciliation to non-GAAP financial measures presented on this call, such as FFO and AFFO, can be found in the company's supplemental report. With that, I'll turn the call over to Bill.

William Lenehan (President, and CEO)

Good morning. Thank you for joining us to discuss our Q1 results. I will make introductory remarks, and Patrick, Josh, and Gerry will comment further on the acquisition market and our financial results and capital position. We reported Q1 AFFO of $0.43 per share, which is $0.02 or 4.9% up from Q1 last year.

Our existing portfolio continues to perform very well, with 99.7% rent collections for the quarter and 99.6% occupancy at quarter end. Our EBITDA rent coverage in the Q1 was 4.9x for the significant majority of our portfolio that reports this figure. This remains among the strongest coverage within the net lease industry.

According to Baird Research, year-over-year sales for the restaurant sector as a whole remained positive in the Q1 in the 4% range after flat results in January, which was impacted by bad weather. Similar to last quarter, casual dining saw small declines off strong levels in the prior year period. Darden reported a 1.8% decline in same-store sales for Olive Garden and a 2.3% increase for LongHorn for the quarter ending February 25.

Overall, for Darden, restaurant-level EBITDA margin improved 70 basis points to 20.6%, reflecting commodity pricing and productivity improvements. We note that our second-largest tenant, Brinker, also announced positive results on Tuesday. Chili's same-store sales grew 3.5%, and their restaurant-level EBITDA margin improved 90 basis points to 14.1%.

FCPT acquired four properties in the quarter for $15.9 million at a 6.9% cap rate. All of the properties were in the medical retail sector, and we continue to benefit from establishing verticals in addition to restaurants, our historical core area of focus. Similar to the Q4 of 2023, we slowed down acquisition activity in the quarter to reflect the current cost of capital, of equity and debt in comparison to acquisition market pricing.

The current capital markets backdrop and seller reticence to accept higher cap rates has made it challenging to deploy capital accretively. In this environment, we remain disciplined allocators of capital. As we've stated in the past several quarters as well, we have established mental models and structured our team incentives to discourage deploying capital just to grow the company's size, without also increasing per share metrics of earnings or intrinsic value.

Turning to capital sources, we issued $6.9 million of equity early in the Q1 at an average offering price of $25.38. In March, we issued $85 million of term loans, utilizing the accordion feature of our credit facility to achieve favorable borrowing costs. $50 million of the offering was used to pay down a private note debt maturity that was due in June 2024. Our balance sheet is in great shape, with our next debt maturity not scheduled until November 2025. The remaining $35 million was used to fund acquisitions.

While we normally do not get into detail on individual tenants, we are aware that of the public reports that Thai Union is exploring options for Red Lobster, including selling the brand or restructuring alternatives. Before going into detail, it is important to note that we own a group of stores with below-average brand rents and above-average brand EBITDA to rent coverage. Now on to specifics.

First, I'll start with portfolio management. In 2022, we noticed a few stores beginning to show weaker performance through our monitoring of store-level sales and profitability. Over the next 18 months, we sold some of our highest rent and lower-performing stores at an average cap rate of 6.5% and a positive gain. This dropped our exposure from 2.9% of annual base rent to 1.7% today.

Today, we own 18 properties, of which 10 are in a master lease, with an average rent of $276,000. The remaining 8 are low rent ground leases and outparcels, with average rent of $117,000. Blended together, this equates to an average rent of $206,000 per property. In both the case of the master lease and the ground leases, we have good rent coverage.

Second, it's important to remember that we were highly selective in acquiring Red Lobsters in the first place. Over the years, we passed on a lot of Red Lobster locations where the rent was set very high or the underlying store performance was low. We recently reviewed nearly 200 Red Lobster rent comps to compare to our 18 locations. We found that 15 of our 18 restaurants have rents-... below the brand median for this comp set, and the remaining three were in the ballpark of brand median rent.

While we hope Red Lobster avoids restructuring, if it does come to that, we feel that we are well-positioned to manage the process. More importantly, in March, we announced Gerry's retirement from FCPT and Patrick's promotion to CFO. This transaction has been carefully planned over the last year and a half and will be completed tomorrow.

I would like to sincerely thank Gerry for his service and contributions in helping us grow from a spin-off, origin in 2015. Gerry was here day one as part of six employees, many years ago. Gerry has been a great financial steward and has been instrumental in helping make FCPT what it is today.

While Gerry will be around in the interim advisory role to support the team, we wish him all the best in the future. I'm also very excited to have Patrick step up in the CFO role. Patrick was working on the creation of Four Corners at J.P. Morgan even before Four Corners existed. He was one of our first hires and brings a deep understanding of our capital markets, our acquisition process, and our culture. With that, I'll hand it over to Patrick to further discuss the investment environment.

Patrick Wernig (CFO)

Thanks, Bill. Before I get into specifics on investments, I'd also like to just echo your comments about Gerry and his significant contribution to our company and culture. I'd be remiss if I also didn't take this moment to thank him personally for over eight years of mentorship and guidance over the last twelve months as we worked through the transition process.

Now, turning to our acquisitions outlook, we're seeing a lot of interesting opportunities that may be added to the pipeline. Said another way, there's no shortage of tenants seeking net lease capital, and there are fewer buyers out there pursuing them. What is missing, though, is a stable pricing environment where sellers are comfortable transacting at pricing that makes sense for Four Corners.

While we continue to see increases in seller cap rate expectations as interest rates remain elevated, we've also seen that net lease pricing adjust more slowly than capital markets. The bid-ask spread between buyers and sellers, while converging, still exists. That's resulted in transaction volume being down for the sector overall. It's worth pointing out that net lease can be lumpy, and while we had a slow start to the year in 2023, we also had a record acquisition year on the back of strong closings from April through July.

Overall, our portfolio now stands at 1,137 leases, with Darden at 51% of our annual base rents and restaurants at 80%. Non-restaurant is now 20% of our portfolio, with automotive as our largest non-restaurant sector at 9%, followed by medical retail at 8%.

On the disposition front, we did not sell any properties in Q1, but we frequently receive reverse inquiries on our properties and continue to consider strategic dispositions as a potential attractive alternative to issuing new debt and equity capital, as well as part of our active portfolio management strategy. We are fortunate that our portfolio continues to attract buyers, and we can utilize dispositions for creative capital recycling when needed or when capital markets are less attractive. Josh, I'll turn it over to you.

Joshua Zhang (Managing Director of Investments, and Head of the Investment Team)

Thanks, Patrick. Turning to leasing, we had 13 leases expire in Q1, with all but two tenants renewing. Those 11 leases had positive renewal spreads of 12.5%. We expect positive results on the two sites that did not renew, though we are early in the process there. These results reinforce our underwriting confidence that we are partnering with the right tenants and that the rents are set at attractive levels for the tenants in our portfolio.

Portfolio occupancy stands today at 99.6% and remains well positioned, with only 0.9% and 2.2% of annual base rent maturing in 2024 and 2025 respectively. This ticked up slightly for the quarter, but we already have strong leads on re-leasing at several locations.

To continue on Bill's statements on Red Lobster, we understand bankruptcy can be a complicated and uncertain process, but if the brand is unable to avoid it, we are prepared to respond. Any offer made for rent reduction would be weighed against what we expect to be strong demand to backfill the properties, given the real estate quality.

Fortunately, a lot of Red Lobsters are located adjacent to Olive Garden and LongHorn Steakhouse stores, which means at least one of our preferred tenants already knows these sites well. Before turning it over, I'd also like to thank Gerry for the past eight years of mentorship and service to FCPT. Gerry, I'll turn it over back to you.

Gerry Morgan (CFO)

Thanks, Josh. For the Q1, our cash rental revenues grew 12.9% on a year-over-year basis, including the benefit of rental increases and $329 million of acquisitions over the last twelve months. We reported $58.0 million of cash rental income in the Q1, after excluding $0.6 million of straight-line and other non-cash adjustments. On a run-rate basis, current annual cash base rent for leases in place as of quarter end is $219.6 million, and our weighted average five-year annual cash rent escalator remains at 1.4%.

We collected 99.7% of base rent in the quarter, and there were no material changes to our collectibility or credit reserves, nor any balance sheet impairments. Cash G&A expense, excluding stock-based compensation, was $4.6 million, representing 7.9% of cash rental income for the quarter and compares to 8.4% for the prior year quarter.

Overall leverage, our net debt to adjusted EBITDA in the Q1 was 5.6x and our fixed charge coverage ratio was a very healthy 4.3x. We have $277 million of liquidity, comprised of $27 million of cash and $250 million of full revolver capacity at the beginning of the quarter. We remain committed, and I know Patrick and the team will, will continue to maintain a conservative balance sheet and extend and layer our debt maturities as we can.

We issued $85 million of term in March, as we mentioned, and that did take care of our only debt maturity before November 2025. The loan matures in March 2027, with a 12-month extension exercisable by us. In conjunction with the offering, we entered into $85 million of interest rate swaps to fix the reference rate at 3.94% through maturity.

William Lenehan (President, and CEO)

Including the credit margin of 0.95%, determined by our current investment grade ratings, the effective interest rate is 4.89%. We are very appreciative of the support from our existing bank partners on the loan. As the others mentioned, this is my last quarter on earnings call at Four Corners. I, too, want to thank all of my colleagues here at Four Corners for their support and collaboration over the last 8+ years, and our board, which is an amazing board. FCPT is a special place, and I know it is in great hands going forward. With that, I'll turn it back over to Carla for investor Q&A.

Operator (participant)

Thank you. If you'd like to ask a question, please press star followed by one on your telephone keypad. If you change your mind, please press star followed by two. When preparing to ask your question, please ensure your device is unmuted locally. Our first question comes from Anthony Paolone from J.P. Morgan.

Anthony Paolone (Executive Director, and Co-head of US Real Estate Stock Research)

Thanks. First of all, thanks, Gerry, for all the help over the years. Good luck with everything. My first question is on just cost of capital versus yields. So if we think about just, like, your blended cost of capital right now, seems like maybe a high sixes thereabout, and you've been doing deals at seven. Like, do you think that's enough, or where do you think, you know, yields need to be for you to feel like you could lean into transactions more?

William Lenehan (President, and CEO)

It's a great question, Anthony. It's darn close. You know, we've been able to consistently acquire things with a 7 handle, you know, after 7-8 years of 6.5-6-7 cap rates. So it's quite close. We've been a little cautious. It's not super accretive where the market is, but you know, with a slightly higher stock price, a slightly lower 10-year or slightly higher cap rates, it begins to really work. So we're being patient. We're not lowering our credit quality on our acquisitions. We're playing for you know, for the long term.

Anthony Paolone (Executive Director, and Co-head of US Real Estate Stock Research)

All right. And do you see a sizable pipeline that you like right now, so that if your capital costs do line up a bit better, you can, you could turn it on a bit faster or more robustly, or-

William Lenehan (President, and CEO)

Yeah.

Anthony Paolone (Executive Director, and Co-head of US Real Estate Stock Research)

Or does the pipeline sort of-

William Lenehan (President, and CEO)

That's exactly right. And that informs our confidence to be patient. That to the extent that the numbers lined up a little bit better, we feel like there's a buildup in the market, and that we could be, you know, we could deploy capital creatively again, if the numbers were slightly different.

Anthony Paolone (Executive Director, and Co-head of US Real Estate Stock Research)

Okay. Thank you.

William Lenehan (President, and CEO)

Yep.

Operator (participant)

Our next question comes from Wes Golladay from Baird.

Wesley Golladay (Senior Research Analyst)

Hey, yeah, good morning, everyone, and congrats, Gerry and Patrick. I just want to go back to the comment about the strong demand for the Red Lobster units in a worst-case scenario. Just, if you can clear or just give us maybe some-- your views on how quickly you can turn a unit, maybe where you see the mark to market, and if you would, in this situation, happen to release it, would you look to put in TIs if you had the choice?

William Lenehan (President, and CEO)

You know, honestly, Wes, I don't think there's a high likelihood that we will be getting these buildings back i mean, eight of them are ground leases with $12 a foot rents. You know, we get percentage rent from those properties. They're healthy. The master lease is well covered. We sold the weaker properties, I don't think that that's likely.

But to directly answer your question, these are in good locations. As Pat mentioned, they're very often next to a LongHorn or an Olive Garden. Just to remind everyone, Red Lobster was a Darden brand a decade ago. I think it's unlikely i think if we get back the ground lease properties, we'd likely make money.

I think it's highly unlikely they'd reject the entire master lease, but if they did, I'm not concerned. As far as TIs, you know, TIs on a couple buildings in the context of a $3 billion company, you know, isn't terribly, terribly meaningful. It would be part of, you know, the whole, you know, bargain that you'd have with the new tenant.

I don't think we'd think about it, you know, as a hard no, it would be part of the negotiation. Again, I think it's pretty unlikely. As Josh mentioned, you know, restructurings, if it comes to that, you know, are uncertain. You know, I would just say that we have a lot of experience investing in distressed properties in my background and Jim's background. We're well equipped to handle it.

Wesley Golladay (Senior Research Analyst)

Okay. And then when we look at the pipeline, what are you seeing as far as deal volume goes? Is it—you're closing more deals on the medical retail is that just because of, you know, more realistic pricing? Is the volume just bigger there? And are you seeing more opportunities for sale-

William Lenehan (President, and CEO)

No, I think that's just-

Wesley Golladay (Senior Research Analyst)

-third-party transactions?

William Lenehan (President, and CEO)

Yeah, it's just-- That's just sort of law of small numbers and how it happened. We're looking at automotive service, we're looking at medical retail, we're looking at restaurants. I think the only thing that I would note on the acquisition pipeline is there seems to be more larger portfolios being discussed now, as it's been, you know, 9-12 months with a difficult acquisition environment. You know, people are starting to face debt maturities. Equity partners are, you know, on private deals, seeing higher cost of capital just like the public market. We're seeing more of that, but nothing that's hit pay dirt yet.

Wesley Golladay (Senior Research Analyst)

Okay, and then just last one for me you know, on the disposition front, you do have this, you know, a lot of assets that are in high demand in the private market. What type of spread, an initial spread, do you think you can get and redeploy the capital at? And then also another component of the value creation would be the annual escalators of the new properties. Do you think that'll be higher for what you buy versus what you're selling?

William Lenehan (President, and CEO)

It won't be lower to answer the last question first, it won't be lower. We have seen some higher escalations we've seen some more discipline on tenant-friendly lease extensions. As far as dispositions, you know, we get incoming inquiries, you know, almost daily, certainly weekly. You know, very often those are in the mid-fives.

You know, they're, you know, we like our existing portfolio, so to be incentivized to sell something, you know, needs to be compelling. I would also mention that, you know, very often the buyers they need to get financing they're part of a 1031 exchange, and so the closing rates are, you know, 50/50, and that means it's a bunch of work to do.

It's, it's an option, as you say we have, you know, you know, 100 of buildings leased to investment-grade tenants, that are, that are very desirable but it hasn't been, compelling mathematically for us just yet.

Wesley Golladay (Senior Research Analyst)

All right. Thanks for the time, everyone.

William Lenehan (President, and CEO)

Yep. Thank you, Wesley.

Operator (participant)

Our next question comes from RJ Milligan from Raymond James.

RJ Milligan (Senior Research Analyst)

Hey, good morning, guys. Actually, my questions have been answered, but I just wanted to stay in the queue, congratulate Patrick on the new role, and more importantly, thank you, Gerry, for the relationship over the past eight years. I really appreciate all of your help, and congratulations on your retirement.

Patrick Wernig (CFO)

Thank you, RJ.

Gerry Morgan (CFO)

Thanks, RJ.

Operator (participant)

As a reminder, to ask a question, please press star followed by one on your telephone keypad. Our next question comes from James Kammert from Evercore.

James Kammert (Managing Director, and Senior Equity Analyst)

Hi, good morning. Thank you. Bill, building on your comment that potentially there are some larger portfolios out there, which makes sense logically, right? Their, their pressures are magnified, given the scale of what they have to refinance or pay off, et cetera.

Does that mean, how would you think about that from Four Corners' perspective, if there is a $300 million portfolio out there, would you require a bigger, wider spread to your cost of capital at the time than, you know, a pipeline of one-offs because you're maybe precluding yourself from optionality to see the market evolve over time? I'm just curious how you think about a bigger transaction versus the, you've been a pretty steady cadence of one-offs.

William Lenehan (President, and CEO)

It's a, it's a really great question. The, the crux of it, though, is, is it $300 million of one tenant, or is it $300 million of a diversified pool that, for argument's sake, is analogous to our existing portfolio? What we've seen in the market is that the $300 million of one tenant trades at a discount, because you're buying tenant concentration when you buy that. A well-diversified pool, less.

I would look at a well-diversified pool that we're buying as very efficient, Iwouldn't demand a premium. $300 million of a sale-leaseback of one tenant in today's market would get, you know, discounted pricing or a premium cap rate, however you want to say it.

James Kammert (Managing Director, and Senior Equity Analyst)

That's great. I think the other thing that we've noticed in the market.

William Lenehan (President, and CEO)

Yeah, the other thing we've noticed in the market, just to close the loop, is that REITs generally, my feeling is, that if acquisitions require capital raises? there's a higher level of hesitancy because, you know, bank debt capital is more dear, capital markets are more fickle, and most people are a little bit where we are, where they'd like to see their stock price a little higher. A transaction that requires a capital raise, you know, three, four years ago, that was an advantage. You wanted a reason to go to the capital markets. Today, that causes pause.

James Kammert (Managing Director, and Senior Equity Analyst)

It's very good color. And just to close the loop, I know it's a fluid situation, but on those, let's just call them larger portfolios from your perspective, what, what's kind of dollar value that is in your, you know, shadow pipeline today, say, versus six or nine months ago? Just ballpark. Curious what, what you're looking at.

William Lenehan (President, and CEO)

These are more, you know, quite large transactions that we're kicking the tires on, but I want to just be very clear, nothing's imminent, or even probable. Just things that we're looking at we have, we've looked we've had a large transactions that we've been looking at, you know, since inception we've done a handful of them with Brinker, you know, with a bank that was selling some net lease a year ago, but nothing is imminent or probable. It's just an observation that they seem to be more prevalent than in the past.

James Kammert (Managing Director, and Senior Equity Analyst)

Okay, understood. Thank you.

William Lenehan (President, and CEO)

Yep.

Operator (participant)

That was our final question, We'll hand it back over to Bill for final remarks.

William Lenehan (President, and CEO)

Great. Thank you, everyone, and another efficient conference call. If anyone has any questions, please, reach out. Thank you.

Operator (participant)

This concludes today's call. Thank you for joining me, and now disconnect your line.