Four Corners Property Trust - Q2 2023

Transcript

Operator (participant)

Good morning. Welcome to the FCPT second quarter 2023 financial results conference call. My name is Carla. I will be the operator of today's call. If you would like to register a question of the Q&A portion of the call, please press star followed by one on your telephone keypad. When asking your question, please ensure your telephone is unmuted locally. To revoke a question, you can press star followed by two. I would now like to pass the conference over to our host, Gerry, to begin. Please go ahead when you're ready.

Gerald Morgan (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 a more detailed description of potential risks, please refer to our SEC filings, which can be found on our website at fcpt.com. All the information presented on this call is current as of today, August 2nd, 2023. 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 (CEO)

Thank you, Gerry. Good morning. Thank you for joining us to discuss our second quarter results. I'm going to make introductory remarks, Patrick and Josh will give more details on acquisitions, then Gerry will discuss the financial and capital raising results. While commercial real estate as a whole is facing challenges, FCPT specifically is very well positioned. Our portfolio continues to perform exceptionally well, with 99.7% collections for the quarter and occupancy at 99.9%. We reported second quarter AFFO of $0.42 per share, which is up $0.01 from Q2 last year and the first quarter of this year. Our casual dining and quick service tenants continue to perform very well, which, along with our low rent levels, provides us ample support to continue growing our dividend.

Our EBITDA to rent coverage in the second quarter was 4.8x for the significant majority of our portfolio that reports this figure. This is amongst the strongest coverage within the net lease industry. Olive Garden, LongHorn Steakhouse, and Chili's, three of our most prominent brands, saw same-store sales rise 4%, 7%, and 10%, respectively. In all three cases, margins improved as commodity and labor inflation eased. For Q2, our cash rental revenues grew 11.1% on a year-over-year basis, including the benefit of rental increases and $379 million of acquisitions in the last 12 months. This included the acquisition of 48 properties in the second quarter for $170 million at an initial cash yield of 6.85%, reflecting rents in place as of June 30th.

We have continued to be quite busy in July with the closing of the previously announced Darden transaction for $80 million and an $18 million acquisition of recently constructed developer portfolio with high quality and diversified corporate credit. Including the deals closed in July, for 2023 year to date, we have acquired 79 properties for $301 million at a 6.7% cap rate, which is more than our acquisitions for the full 12 months of 2022, or any prior year for that matter. I'd be remiss if I didn't acknowledge our incredibly talented and dedicated legal and accounting teams, led by our COO, Jim Brat, and our Chief Accounting Officer, Niccole Stewart. Without their efforts, we would not have been able to seize these acquisition opportunities over the past quarter.

We have invested more time and energy over the years to build out our capabilities as a larger and more capable organization. Now, taking a step back, when speaking with investors, we sometimes get the feedback that they have come to know FCPT as a stable and predictable story. As a REIT, we take great compliment to have earned that, that conservative reputation. We will continue to carve out our niche for quality in the competitive field of net lease. However, we also believe that 2023 has been, and may continue to be, a differentiated breakout acquisition year for the company. In Q2, we saw FCPT continue to benefit both from an accretive cost of capital and reduced competition for acquisitions overall, particularly in the higher quality brands and credit opportunities we focus on.

We are planning to continue to press our advantage, and we are working on a attractive pipeline. With that, I'll turn it over to Patrick.

Patrick Werning (Managing Director of Acquisitions)

Thanks, Bill. During our Q1 earnings call in early May, we discussed the shifting market dynamics and increasing seller receptivity to more buyer-friendly pricing. This dynamic really gained steam following the collapse of the Silicon Valley Bank in March and continued as other lenders faced challenges. We're still seeing the aftereffects of a tighter lending market, namely reduced private equity competition, fewer 1031 buyers, and higher borrowing costs paired with lower debt proceeds. For both developers and operators, parties are more willing to engage with FCPT on portfolio opportunities. Now, seven months into 2023, our numbers show that effect, with FCPT already at a record acquisitions year. We've hired new team members to help manage the increased workflow. Our acquisitions team now has eight full-time members focused on sourcing new opportunities. We also recently welcomed Justin Peters, who is leading our asset management and lease extension negotiations.

Shifting to the pipeline, we continue to see a strong set of opportunities in line with recent closings. Year to date, our acquisitions have been roughly split among restaurant at 40%, medical retail at 36%, and auto service and other at 23%. We'd expect the mix to remain balanced based on the pipeline over the course of the year, barring an unforeseen large sale lease back or portfolio sale opportunity. Of those three core sectors, we wanted to spend a moment on medical retail, which now represents 7% of our portfolio, and reference several slides we've included in our investor presentation posted to the website yesterday. Much of the net lease investment opportunity for medical retail comes as operators seek to meet new consumer demand and to bring down overall medical costs, particularly around outpatient care.

10 years ago, the urgent care sector was virtually nonexistent, and today those facilities are a fixture of many retail corridors. We've also seen CVS, Walgreens, and Amazon enter the primary care space with the acquisition of Oak Street, VillageMD, and One Medical, respectively. Real estate is still catching up with demand from these medical operators for prime retail corridors. This trend within healthcare to move services out of hospitals and office buildings and closer to the end consumers in retail areas is going to be impactful to net lease for years to come. Importantly, for FCPT's strategy, these properties often utilize smaller footprint, fungible buildings, similar to the traditional net lease properties we've been acquiring for years. This distinction is important as FCPT is not currently pursuing investment in traditional medical office, nursing, hospitals, or other specialty/large box use. With that, I'll turn it over to you, Josh.

Josh Zhang (VP of Acquisitions)

Thanks, Patrick. In addition to the improving buying environment we've touched on, we have also been able to purchase properties, tenants, and brands that were historically too expensive on a cap rate basis for FCPT. We have three examples of larger transactions we recently closed, which highlight these types of opportunities. First, in June, we acquired a portfolio of nine car wash properties via sale leaseback for $40 million. The portfolio is geographically diversified across six states and under a long-term master lease with annual rent increases to one of the largest national operators. While FCPT has been actively underwriting car wash properties for several years, the industry typically had properties selling well above replacement costs and at a low 6% or high 5% cap rate range.

We were able to negotiate reasonable rents, resulting in an average basis of $4.4 million per property, much lower than the other car wash sale leasebacks we have previously seen. Second, in July, we closed on a portfolio of Darden properties comprised of 12 Cheddars and one Olive Garden for $80 million. As Bill highlighted, Darden continues to outperform and is one of the strongest credits in net lease. The properties had an average term of 13 years, a corporate guarantee from Darden, and an annual rent increase of 1.5%. The quality and markets of these properties are very similar to our original spin portfolio and allowed us to acquire the portfolio at attractive pricing.

While the cap rate here was a bit tighter than more recent deals due to the strong credit, markets, and lease structure, it was matched with pre-raised funds such that it was accretive from day one. The last example is the first tranche of a large developer portfolio for $18 million that we also closed in July. This portfolio included four newly constructed properties leased to eight different brands. The credit in this portfolio is very strong. seven of the nine leases are with corporate operators, including Starbucks, Aspen Dental, Oak Street Health, and WellNow Urgent Care. The transaction is part of our larger strategy to utilize a reputation for handling complex deals and providing surety of execution to work more actively with developers of high-quality projects in this challenging lending environment.

For avoidance of doubt, FCPT did not fund the construction of these assets, but instead provided a takeout commitment once construction was complete. Turning to dispositions, we sold one Burger King property that was underperforming versus brand average at a 6.6% cap rate, representing a small gain. In prior years, we've been opportunistic on selling properties at low cap rates as a source of funding for new acquisitions, and it remains a viable capital source option for us still. We'll now turn it back over to Gerry.

Gerald Morgan (CFO)

Thanks, Josh. We generated $51.9 million of cash rental income in the second quarter, after excluding $0.8 million of straight line and other non-cash rental adjustments. On a run rate basis, current annual cash base rent for leases in place as of June 30th, 2023, is $207.6 million, and our weighted average five-year annual cash rent escalator is 1.4%. As Bill mentioned, we collected 99.7% of base rent for 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 $4.1 million, representing 7.8% of cash rental income for the quarter. We continue to expect cash G&A will be approximately $16 million for the year in total.

On June 30th, we held $11 million of cash and $235 million of undrawn revolver capacity. In the second quarter, we funded the $170 million of acquisitions with cash on hand and equity. The equity consisted of $9 million raised in the second quarter at $26.11 per share, and $110 million of equity forwards initiated in prior quarters at an average execution price of $27.25 per share. In July, we issued $100 million of 10-year senior unsecured notes, which were used to fund July acquisitions. The notes have a coupon of 6.44%, but priced at a 5.39% yield to maturity, including the benefit of an $8.1 million gain on the termination of pre-occurrence treasury hedges.

The debt markets are more challenging than in recent memory, but we received strong investor support in this offering, given the quality of our credit story. With respect to overall leverage, our net debt to adjusted EBITDAre in the second quarter was 5.5x, and our fixed charge coverage was a very healthy 4.8x. Pro forma for the July debt offering, our leverage is approximately 5.8x prior to any third quarter equity activity, which we will announce in our third quarter earnings release in October. We remain focused on maintaining a conservative balance sheet and extending and layering our debt maturities and repayment obligations. Our only debt maturity before November 2025 is a $50 million private note due in June of next year.

With that, I'll turn the call back over to Carla for investor Q&A.

Operator (participant)

Thank you. If you would like to ask a question, you may do so by pressing star, followed by one on your telephone keypad. To revoke your question, please press star, followed by two. When preparing for your question, please ensure your phone is unmuted locally. Our first question comes from Anthony Paolone from JPMorgan. Your line is now open. Please go ahead.

Anthony Paolone (Executive Director)

Great. Thank you. The first one, relates to just the pipeline and whether you can talk about, what you're seeing out there beyond, you know, what was pretty strong level of activity in July, and also, you know, kind of what the, the yield picture looks like in terms of, cap rates right now.

William Lenehan (CEO)

Sure. I would say that, consistent with Pat's comments, you know, pipeline's robust, opportunity set is as good as we've seen, in our history. My direction to the team is to quality sort, what's available for us to work on, to be in the very high sixs or seven cap. We think that that's the sweet spot of the risk-return spectrum at the moment, given our cost of capital.

Anthony Paolone (Executive Director)

You did the, the debt deal, and you had some hedges to apply to that. Where do, where do you see, you know, your incremental capital costs from here? I'm trying to understand just kind of what the spread would thus look like if, you know, your deals are in the high sixes.

William Lenehan (CEO)

Right. What's really interesting now, is for the first time, our equity cost of capital is advantaged over our debt cost of capital or blended cost of capital. I think, as mentioned, a terrific job from Gerry hedging, the debt that we, we closed, a few weeks ago, funded a few weeks ago. We are sort of did our debt deal for the year, so to speak, equity is a more attractive source of funds. You know, I think pretty straightforward, that, you know, we don't need to be in the debt markets right now, the equity markets are a more favorable source of funds.

Anthony Paolone (Executive Director)

Great. Thanks for the time.

William Lenehan (CEO)

Yep, thanks.

Operator (participant)

Thanks, Anthony. Our next question comes from Rob Stevenson from Janney. Your line is now open. Please go ahead.

Rob Stevenson (Managing Director and Head of Real Estate Research)

Good morning. Bill, what are the any areas beyond auto and healthcare that you're targeting for any significant investments beyond restaurants?

William Lenehan (CEO)

Yeah, great question. We, we have a formal process with our board, where we review new sectors, tenants, every quarter, and then we retroactively review all the rocks we've turned over in the past. We try to be very thorough about it. To answer a slightly different question, we're, we're really happy with many of the sectors that we didn't enter when times were very frothy. You know, we always are trying to better understand the medical ecosystem. I think over time, you'll see us expand into different sectors there. You know, really a lot of white space with auto service and medical, and, and then just overall, the acquisition environment is much more favorable.

Properties that historically really wouldn't even been shown to the REIT market, would have, would have been sold to, to the 1031 exchange market one by one, are, are showing up. And obviously, a lot of the, the folks that we have built relationships with over the last seven, eight years, at a high level now understand that lease capital is much more attractive compared to high-yield debt or loans from banks or CMBS.

Rob Stevenson (Managing Director and Head of Real Estate Research)

I guess accordingly, do you guys have any desire to go to the next level and be a loan-to-own partner for some of these merchant developers, given the market conditions and, you know, that have opportunities but not access to cost-effective capital these days?

William Lenehan (CEO)

Yeah. Loans have been the topic du jour. For many of our competitors, it was the hot topic at the Palm Springs ICSC meeting, and, and, and we received a lot of questions about it at Nareit. I think we have the capability to do loans. Jim and I worked on loans when I worked at a hedge fund, you know, very substantially. I would say that we feel like we have just a really attractive opportunity set with the down-the-middle acquisitions that we have evidenced in Q2. I think that we'd never say never, but that certainly is keeping us very busy.

Rob Stevenson (Managing Director and Head of Real Estate Research)

Okay. Last one for me.

William Lenehan (CEO)

Just as you know, loans can be challenging around setting dividend policy because they can be repaid. They can be challenging, because they're short-term, so you have asset liability mismatches. They can be document-intensive. Typically, the developer deal that we announced, this was someone who was within six months of all the properties, being a certificate of occupancy. So we were able to come up with pricing that was fair, and then we closed when the properties are, are open.

Rob Stevenson (Managing Director and Head of Real Estate Research)

Okay, and then last one for me. I think you mentioned, LongHorn did, like, 7% same-store. How is Caro doing relative to that?

William Lenehan (CEO)

Caro is doing great. We, we post the Caro results. They had a good quarter, extremely well managed. Make sure that you're adjusting for the, the seventh property that we, we opened. Yeah, they're doing great.

Rob Stevenson (Managing Director and Head of Real Estate Research)

Okay, thank you.

William Lenehan (CEO)

A little, you know, a little different, seven sample size versus 700. But, yeah, they're doing terrific for the market they're in.

Operator (participant)

Thanks, Rob. As a reminder, if you'd like to ask a question, please press star followed by one. Our next question comes from Wes Golladay from Baird. Your line is now open. Please go ahead.

Wes Golladay (Senior Research Analyst)

Hey, good morning, everyone. Can you maybe talk about the car wash deal? I guess, will this be a big part, or is this a unique one-off? I believe in the past, you did not like having a high basis in an asset, and I get that for a car wash, it's low, but maybe it's still a little higher than a traditional space you'd go for.

William Lenehan (CEO)

Yeah. Oh, we've looked at so many car wash deals. As you said, you know, very often you're seeing $7 million-$9 million bases. You know, they can cover because the car wash business is very profitable. It's a, it's a recurring revenue business now with subscription, but we have, you know, turned down 90+% of the car wash deals we've looked at. This one really lined up with, with the lower basis with the top operator. It's not a thing against car washes specifically, just we're nervous with that level of basis.

These companies are typically pretty aggressively growing, and I'm not sure we really understand or anyone really understands what the through the cycle performance of these businesses are with a new model, and that level of rent. We, we, we're happy with the one that we did. We continue to look at them, but I would expect us to be selective.

Wes Golladay (Senior Research Analyst)

Okay. Then when you look at your pipeline, will that, you know, be constrained at all from your cost of equity where it is? I get that it's still relatively high, but it's, you know, it's come in a little bit, and maybe conversely, you do have this alternative, form of equity where you have your low cap rate dispositions. Would you dial those up?

William Lenehan (CEO)

Yeah, we, we receive offers for our properties in the 5.5 cap and below pricing very regularly. They're very high quality Darden assets, typically, great locations, investment grade, long-term leases. We've sold properties in the past, as you said, it's a, it's a terrific option to have. But we've always been sensitive to our cost of capital when we make acquisitions, and because our acquisitions are small, it allows us, and our pipeline is, is, is very crystal clear, it allows us to modulate. But, you know, our, our hope is that with the elevated level of acquisitions that we've evidenced, frankly, having a, a full year of acquisitions already completed by the beginning of August is, is quite advantageous, that our equity valuation will respond to that.

Wes Golladay (Senior Research Analyst)

Great. Thanks for the time, everyone.

William Lenehan (CEO)

Yep.

Operator (participant)

Thanks, Wes. Our next question comes from Jim Kammert from Evercore. Your line is now open. Please go ahead.

James Kammert (Managing Director)

Thank you. Good morning. You noted, team, that you've had about an $18 million acquisition in the quarter from, you know, sort of take out with a developer. Would you be willing to share, you said it was the first tranche, how large that ultimately could be in terms of dollars?

William Lenehan (CEO)

Yeah, so, so we're, we're not gonna get into things that could relate to guidance, but we've done two or three tranches with this developer in the past. It's a great relationship that Josh has nurtured. We're not gonna give guidance, but just maybe more generally on developers. You know, historically, at the ICSC meeting in Las Vegas, every year we'd meet with, you know, two or three developers, and, and frankly, rarely did that lead to an acquisition. This year that we met with dozens. We think that that's a fertile opportunity to buy newly constructed, high credit quality tenants with long-term leases because the buildings are, are relatively new.

I think, our reputation as someone who can perform in a difficult market, we don't need property financing, we're well capitalized, is, is an advantage.

James Kammert (Managing Director)

Great. Well, that was my second question: How many of these relationships are you cultivating? It sounds like it's a proliferation from 12 to 18 months ago.

William Lenehan (CEO)

Yeah, I mean, I, I would just- Jim, I'd say 12 to 18 months ago, the business model of the developer was almost certainly to capture the widest possible spread, selling into a 1031 exchange market, one by one. Frankly, timing wasn't that much of a concern because they were borrowing at, you know, 3%. Well, now, even personal- personally guaranteed loans might start with an eight, and so timing is very important, and banks are trying to shrink their balance sheets. Our purchase and sale agreement, e- even prior to close, I think is something that's of value that they can evidence to their financial partners, that liquidity is coming.

James Kammert (Managing Director)

Great. That's useful color. Thank you very much.

Operator (participant)

Thanks, Jim. We have no further questions at this time. With that, I will hand back to Bill for final remarks.

William Lenehan (CEO)

Excellent. Thank you, Carla. Well, it's been an exciting year so far for FCPT, and we are very excited for the second half of the year as well. If you have any questions, please reach out to myself or Gerry, or Drake, and we can set up follow-up. Thanks so much. Cheers.

Operator (participant)

This concludes today's call. Thank you for your participation. You may now disconnect your line.