Four Corners Property Trust - Q2 2024

Executive Summary

• Q2 2024 was steady and clean: AFFO per diluted share rose 2.4% YoY to $0.43; rental revenue grew 10.8% YoY to $58.5M; total revenue was $66.5M; rent collections were 99.8% and occupancy 99.6%.
• External growth remained disciplined but accretive: FCPT acquired 17 properties for $45.5M at a 7.2% cash yield (roughly 30 bps better than last quarter); management expects to “add to the pipeline in a meaningful way in the second half” while maintaining quality thresholds.
• Balance sheet is conservative and flexible: $240M liquidity (cash $17M + $223M undrawn revolver), net debt/Adj EBITDAre 5.7x, no maturities until Nov 2025; fixed charge coverage 4.3x.
• Credit watch: Management reiterated confidence in Red Lobster exposure (18 stores) through its restructuring—expects “very minimal or no disruption from a rent perspective” and all sites to remain open; portfolio franchise exposure remains small and specific Pizza Hut franchisee issues are contained and current on rent.
• Near-term catalyst: If equity multiples and debt costs remain favorable, FCPT intends to lean into higher-yielding (>7%) acquisition opportunities without sacrificing credit/real estate quality—potential for accelerated accretive deployment in 2H.

What Went Well and What Went Wrong

• What Went Well

  • Durable internal/portfolio performance: 99.8% rent collections; 99.6% occupancy; run-rate ABR $223.6M; WALT ~7.4 years.
  • High-quality, accretive acquisitions: 17 assets at 7.2% initial cash yield; management: “we will continue to look to add to the pipeline in a meaningful way in the second half of the year while maintaining our quality standards”.
  • Leasing/retention: Of 2024 expirations, ~95% renewed or swapped; minimal near-term lease roll (0.7% of ABR in 2024, ~2% in 2025).

• What Went Wrong

  • Higher operating and interest costs: G&A rose to $6.0M (vs $5.6M YoY) and interest expense to $12.3M (vs $10.1M YoY), modestly damping earnings leverage despite rent growth.
  • Mixed tenant comps backdrop: Darden same-store sales were +4% at LongHorn but -1.5% at Olive Garden for its latest quarter; industry casual dining trends remained slightly soft off strong comps, albeit with improving margins.
  • External market friction persists: Although narrowing, bid-ask remains in parts of net lease; some sellers previously held out for lower cap rates; FCPT stayed patient to protect per-share accretion.

Transcript

Operator (participant)

Good morning, all, and thank you for joining us for the FCPT Second Quarter 2024 Financial Results Conference Call. My name is Carley, and I'll be the Call Coordinator for today. During the presentation, you can register a question by pressing Star followed by One on your telephone keypad, and to remove yourself from that line of questioning, you can press Star followed by Two. I'll now hand over to Patrick Wernig to begin. Please go ahead.

Patrick Wernig (CFO)

Thank you, Carley. 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 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, August 1st, 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 will turn the call over to Bill.

Bill Lenehan (President and CEO)

Good morning. Thank you for joining us to discuss our second quarter results. I will make introductory remarks. Josh will comment further on the investment market, and Patrick will discuss our financial results and capital position. We reported second quarter AFFO of $0.43 per share, which is up one cent, or 2.4%, from Q2 last year. Our existing portfolio continues to perform very well, with high rent collections and occupancy. Our EBITDA to rent coverage in the second quarter was 4.9 times for the majority of our portfolio that reports this figure. This remains among the strongest coverage within the industry. As an update on the restaurant industry performance, we are seeing overall positive performance. According to Baird Research, year-over-year sales for the restaurant sector as a whole improved in the second quarter in the 5% range after 2% results in the first quarter.

Similar to last quarter, casual dining saw small but improving declines off strong levels from the prior year. We note this broad view on the industry includes local restaurants and small regional chains. FCPT's casual dining operators are national brands and sector leaders that generally outperform the industry. For example, Darden reported a 4% increase for LongHorn and a modest 1.5% decline in same-store sales for Olive Garden for the quarter ending May 26th, with an overall increase of 1.6% for fiscal year 2024. Overall, for Darden-operated brands, restaurant-level EBITDA margins improved 20 basis points to 20.9%, reflecting commodity pricing and productivity improvements. Our second-largest tenant, Brinker, reported Chili's same-store growth of 3.5%, and their restaurant-level EBITDA margin improved 90 basis points to 14.1% for their latest quarter ended March 27th. We also note Darden continues to see external growth opportunities.

The company recently announced the acquisition of casual dining Tex-Mex brand Chuy's. Chuy's has 101 locations and will be the 10th brand under the Darden umbrella. I would imagine the key intent would be to grow this brand's store count in the near term. Importantly, we remain disciplined allocators of capital. As we've stated the past several quarters, 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. Our investment team compensation goals are not tied to acquisition volumes, and we've never given acquisitions or earnings guidance. These mental models and team structure have allowed us to remain nimble, and we believe that we have operated successfully through today's environment.

As such, we are seeing a lot of interesting opportunities that fit both our quality guidelines and are priced in a manner that makes sense for FCPT, by which I mean accretive. We will continue to look to add to the pipeline in a meaningful way in the second half of the year while maintaining our quality standards. Regarding Red Lobster, we have been in communication with the management, Fortress, and external advisors since they entered into bankruptcy. As we stated last quarter, our 18 stores are well covered and profitable, and after reviewing the store's latest updated financials as of May, they continue to be. Importantly, our conversations with Red Lobster have also confirmed our belief that our stores are performing well and in strong locations.

While negotiations and proceedings are ongoing, we expect all of our Red Lobster locations to remain open for there to be very minimal or no disruption from a rent perspective. We think this speaks to the quality of FCPT's underwriting and asset selection process. That said, we note that the bankruptcy process is still ongoing, and we, along with their other landlords, are awaiting official confirmation. We expect them to exit the restructuring process before the end of Q3. On the issue of potential credit issues, we wanted to remind investors that FCPT's medical retail portfolio specifically avoids all pharmacy and medical office buildings. We have a great advantage in that our portfolio was formed after the advent of the cell phone, online shopping, and other new trends. We take a cautious approach to general retail merchandise, dollar stores, car wash, and large-box retail, including theater and gyms.

While a potential softening in consumer spending will ripple through the entire economy, we believe our portfolio is very well positioned. With that, I'll turn it over to Josh to further discuss the investment environment.

Josh Zhang (Director of Investors)

Thank you, Bill. During the quarter, FCPT acquired 17 properties for $45.5 million at a 7.2% cap rate, roughly 30 basis point improvement from last quarter. The acquisitions this quarter were roughly split between auto service and medical retail properties at 49% and 47% of our volume, respectively, the balance being a single casual dining restaurant. For the year, we've been more weighted to medical retail with 61% of our volume coming in that category. As we stated before, these sectors all have similar pricing and quality, but the opportunities we close can vary from quarter to quarter. We still expect that we will be roughly even between these categories over the long term. Our largest single transaction this quarter was a $20 million sale-leaseback of eight properties with Mavis Tire. Mavis is a large consolidator in the auto service space with over 1,800 locations nationally.

We had acquired some properties of Mavis from other landlords in the past, but this was our first direct sale-leaseback with them. This is a case where we have been interested in this brand for some time and had to wait for pricing to meet our return thresholds. Mavis has a long-running program of selling sites one at a time at tighter cap rates, but there's a niche for FCPT to provide optionality to tenants like Mavis to also utilize mid-size portfolio sales. As Bill mentioned, we are remaining disciplined on pricing and consistent with our established quality thresholds for new acquisitions. As a higher-for-longer rate dynamic continues, we are seeing the bid-ask spread between buyers and sellers narrow. The supply of net lease inventory continues to build up, and our team is well positioned to take advantage of these opportunities.

Increasingly, we are finding attractive opportunities over a 7% cap rate with quality tenants and real estate. We also note that all acquisitions this quarter were with investment-grade or large corporate tenants and a weighted average lease term of 13 years. We have momentum in the pipeline building today, and we expect that will continue into Q3. Overall, our portfolio now stands at 1,154 leases and Darden now at 51% of our annual base rent and restaurants at 79%. Non-restaurants is now 21% of our portfolio, with automotive as our largest non-restaurant sector at 10%, followed by medical retail at 8%. On the disposition front, we did not sell any properties in Q2 of this year. However, we frequently receive reverse inquiries on our properties and continue to consider strategic dispositions, both as a potential alternative to issuing new capital and as part of our active portfolio management strategy.

Patrick Wernig (CFO)

We are fortunate that our portfolio continues to attract buyers, and we can utilize dispositions for accretive capital recycling when needed or when capital markets are less attractive. Turning to leasing, we had 45 leases come due between January and December 2024. Almost all of these are now resolved with a very strong result of 95% being renewed or swapped for new brands. These results reinforce our underwriting confidence that we are partnering with the right tenants and that rents are set at appropriate levels for the tenants in our portfolio. Patrick, I'll turn it back over to you.

Thanks, Josh. For Q2, our cash rental revenues grew 11.4% on a year-over-year basis, including the benefit of rental increases and $204 million of acquisitions in the last 12 months.

We reported $57.9 million of cash rental income in the second quarter after excluding $0.6 million of straight-line and other non-cash rental adjustments. On a run-rate basis, current annual cash-based rent for the leases in place as of June 30th, 2024, is $223.6 million, and our weighted average five-year annual cash rent escalator remains at 1.4%. Portfolio occupancy stands today at 99.6% and remains well positioned with only 0.7% and 2% of annual base rent maturing in 2024 and 2025, respectively. As mentioned earlier, most of these 2024 lease maturities have already confirmed their extension. We collected 99.8% of base rent for the second quarter, and there were no material changes to our collectibility or credit reserves, nor any balance sheet impairments. Our high occupancy in collections is directly tied to the efforts of our asset management and accounting teams.

In particular, FCPT has dedicated resources so that we can remain in tight communication with our tenants and be proactive on upcoming lease maturities. Cash G&A expense, excluding stock-based compensation, was $4.3 million, representing 7.4% of cash rental income for the quarter in comparison to 7.8% for Q2 2023. We continue to expect cash G&A will be approximately $17 million for 2024. As a reminder, we take a conservative approach and do not capitalize any of the compensation costs related to our investment team. Turning to capital sources, we issued $2.4 million of equity in the second quarter at an average offering price of $25.14. As a reminder, in March, we issued $85 million of term loans under our existing credit facility to refinance a June 2024 debt maturity.

With respect to overall leverage, our net debt to adjusted EBITDA in the second quarter was 5.7 times, and our fixed charge coverage ratio was a healthy 4.3 times. We have $240 million of liquidity, comprised of $17 million of cash and $223 million of undrawn revolver capacity. We are committed to maintaining a conservative balance sheet and laddering our debt maturity profile. Our balance sheet remains in great shape today, with our next debt maturity not scheduled until November 2025. Taking a step back to think about our overall cost of capital, we've been pleased to see sector equity multiples improve, including FCPT's. We've also seen some relief in treasury yields and the all-in rates for new debt issuance. Today, our cost of capital is looking much more attractive than last quarter, which gives us some good optionality for match-funding new acquisitions.

That said, we have the liquidity and revolver capacity to meet our needs without new external capital. With that, we'll turn it back over to Carley 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 now. If you'd like to remove yourself from that line of questioning, please press star followed by two. First question comes from Anthony Paolone. Your line is now open.

Anthony Paolone (Analyst)

Thank you. So I guess just first one, just wanted to confirm on the Red Lobster point. I guess they had just put out a bunch of new closures, and I guess you guys didn't have anything on that list either.

Josh Zhang (Director of Investors)

Yeah, we're not aware of any of our stores are going to close, and our conversations with them have been very productive. The stores are doing well.

Anthony Paolone (Analyst)

Okay, thanks. And then the other credit that has come up is, I guess, one of the larger Pizza Hut franchisees went bankrupt, EYM, I think. And do you all have any exposure there that we should be thinking about?

Josh Zhang (Director of Investors)

Yeah, we have a couple of stores. Best of my knowledge, they're paying, and we have a personal guarantee from the founder of the company.

Anthony Paolone (Analyst)

Okay, thanks. And then just last one for me. In terms of the cap rates, have been pretty steady here in the low sevens, and it seems like, if anything, interest rates are stabilizing, and there's some expectations of rates starting to come down. Do you think we've seen sort of the end of cap rates backing up, or how should we think about where the pipeline looks like today?

Josh Zhang (Director of Investors)

Yeah, hard to tell. There was obviously a substantial 6-9 month delay in cap rates going up. Hard to know what will happen going forward. Our focus has really been high-grading our pipeline to make sure we have very high-quality properties that we're closing on.

Anthony Paolone (Analyst)

Okay, thank you.

Josh Zhang (Director of Investors)

Yep, thanks.

Bill Lenehan (President and CEO)

Our next question comes from John Kilichowski of Wells Fargo. John, your line is now open.

John Kilichowski (Analyst)

Thank you. I guess first, could you talk about what drove the increased acquisitions quarter-over-quarter? Was that a result of an improving cost of capital or just greater seller willingness?

Josh Zhang (Director of Investors)

Yeah, I think really for the second half of the year, it'll be a combination of both. Our equity cost of capital has improved, rates have come down, credit spreads have narrowed, so our sources of funds are much more attractive, and there's still a buildup in supply in the market, which we can take advantage of. And so we have been thoughtfully conservative when our cost of capital wasn't there, and now we are very much in the green zone and looking to grow.

John Kilichowski (Analyst)

Got it. And then an interesting question here, just kind of looking forward, as I look at your lease maturity schedule, obviously it inflects from 2027-2033. Is there any desire on your part to have conversations with those tenants about amending those leases and maybe flattening that role? Or do you see that as an opportunity to reprice?

Josh Zhang (Director of Investors)

I would expect the vast, vast majority of those leases, which are predominantly the Darden leases from Spin that are 5.5-6 times covered, that those will be extended according to their contractual terms. So very, very well covered, not something that's a big concern for us at all.

John Kilichowski (Analyst)

Got it. Thank you.

Josh Zhang (Director of Investors)

Yep, thanks.

Operator (participant)

Our next question comes from Mitch Germain of Citizens JMP. Your line is now open. Sorry, Mitch, your line is not quite clear.

Patrick Wernig (CFO)

Hey, Carley, we're having some trouble hearing you.

Bill Lenehan (President and CEO)

Yeah, maybe on Mitch's line. Mitch, if I could ask you to raise a question again to see if that improves the line, that would be great. We'll move on to the next question.

Operator (participant)

Our next question comes from Alec Fagan of Baird. Your line is now open.

Speaker 8

Hi, good morning, and thank you for taking our questions. So to go back on the franchises, with some large franchises going bankrupt, may you provide some details about the health of franchises in the Four Corners portfolio, as well as the percentage of the restaurant exposure is from franchises versus corporates?

Josh Zhang (Director of Investors)

Yeah, we have very little franchise exposure overall, and the portfolio is 99.8% occupied. So we're in terrific shape there. And again, we're talking about a couple of properties on a 1,150 property portfolio.

Speaker 8

Got it. And overall, how is the watch list looking like? We've talked about Red Lobster. Anything else that we should that you're aware of? Any changes?

Josh Zhang (Director of Investors)

No.

Speaker 8

Got it. And the last one for me is, have you looked at Chuy's and/or talked with Darden about potentially partnering up for a sale leaseback or a different way to grow their store count?

Josh Zhang (Director of Investors)

Yeah, they don't have a lot of owned real estate on their books, but we're in constant conversation with Darden and a number of other tenants all the time about supporting their growth. But I think that brand has a really strong brand proposition and a lot of white space to grow. If you think about Darden's other brands that are several hundred properties, that would be a multiple of the hundred or so properties in the Chuy's brand today.

Speaker 8

Got it. That's it for me. Thank you.

Bill Lenehan (President and CEO)

Our next question comes from Jim Kammert of Epicor. Jim, your line is now open.

Speaker 9

Thank you. Good morning. Both Josh and Patrick touched on the strong sort of releasing or addressing all the lease exposure for 2024. I'm curious, can you share anything about the economics? I'm sure a fair bit were maybe fixed option exercise and whatnot, but what sort of recapture rates, I guess, did you get on rents that moved to market, if you will?

Josh Zhang (Director of Investors)

Yeah, it was positive, but I would really caution that it's a very small sample size because the vast majority took down their contractual options, which is typically 1.5% per year. Occasionally, it's a 10% every five years, but economically, think about it as 1.5% per year, but the vast majority were the contractual extensions. Just a very small sample size, but a positive number if you were to look at that very small sample size.

Speaker 9

Okay, but then thinking about, obviously, it builds. We talked about most of it's Darden in the out years, but is that pretty representative then? Most of your deals have that fixed 1.5% type increment in the new lease rent from the prior expiring rent. Is that a good answer for the next question?

Josh Zhang (Director of Investors)

Yeah, it does match the vast majority.

Speaker 9

Okay, very helpful. Thank you.

Operator (participant)

As a reminder, if you'd like to raise a question, please press star followed by one on your telephone keypad, and if you'd like to remove yourself from that line of questioning, please press star followed by two. Our next question comes from RJ Milligan of Raymond James. RJ, your line is now open.

R.J. Milligan (Analyst)

Thanks, and good morning, guys. Bill, you gave some restaurant same-store sales numbers at the beginning of the call, and I'm just curious, if we do see or start to see a downtrend in those numbers, does that create more buying opportunity? Does that reduce the buyer pool for those types of assets?

Josh Zhang (Director of Investors)

I don't think that that will happen, would be my guess. The performance of the restaurant net lease at a high level has been very strong, especially the kind of brands that we focus on, the large public companies. Hopefully, it will provide an opportunity, but I don't think I'd count on that.

Anthony Paolone (Analyst)

Okay, that was it for me, guys. I appreciate it.

Josh Zhang (Director of Investors)

Great. Yep, thanks, RJ.

Operator (participant)

Thank you. Our next question comes from Mitch Germain of Citizens JMP. Mitch, your line's now open.

Mitch Germain (Managing Director of Real Estate Research)

I will try this again. How does a math of a one-off Mavis look versus the portfolio? I know that Josh indicated pricing was a little bit tighter.

Bill Lenehan (President and CEO)

Josh?

Patrick Wernig (CFO)

Yeah. Well, this is Patrick. I'd say that there might be a 75 basis point portfolio discount. The cap rates throughout net lease have moved significantly in the last 12 months, but you are seeing the return of a portfolio discount for buyers like ourselves that can take down more than one at a time.

Josh Zhang (Director of Investors)

Yeah, Mitch, I'd just elaborate. For a number of years, there wasn't a ton of value in providing certainty of being a professional buyer of assets. Folks understood that if a 1031 exchange fell out, they'd be able to put it back under contract in no time, potentially at a tighter cap rate. Now, because of the capital markets uncertainty, I think a trend that we're seeing is perhaps people trying to get deals closed before the election, a little bit more value in being a large, established professional buyer of buildings.

Mitch Germain (Managing Director of Real Estate Research)

That's super helpful. But to that point, though, you're not seeing any buyers sorry, sellers pull back to wait for the potential rate cut to see if that changes the pricing dynamic?

Josh Zhang (Director of Investors)

We had seen some portfolios that had been on the market, call it late last year, early this year, not transact. And so always hard to read the minds of sellers, but I think that that was a dynamic. But as the forward SOFR curve would be a place that I would look for data indicates rates will be relatively elevated for the next 12-18 months. That's the borrowing reference rate that a lot of sellers have of floating rate debt that's more flexible for prepayment.

Mitch Germain (Managing Director of Real Estate Research)

That's super helpful. Last one for me. Obviously, deal flow was centered away from the restaurant sector this quarter. Was that by choice, or was that just a function of the assets that were available that met your underwriting criteria?

Josh Zhang (Director of Investors)

The latter, for sure. The latter. 13 weeks is too short of a time to draw any conclusions. Other than we are excited to be buying assets in the auto service and medical sector, but we're always looking at restaurants. There's plenty in our pipeline. You'll see that percentage go up and down by quarter.

Mitch Germain (Managing Director of Real Estate Research)

Thank you. Have a good rest of the summer.

Josh Zhang (Director of Investors)

Great. Thanks, Mitch.

Mitch Germain (Managing Director of Real Estate Research)

Thanks so much.

Bill Lenehan (President and CEO)

Thank you. We currently have no further questions, so hand back to Bill Lenehan.

Terrific. Well, exciting quarter. We're very excited for the second half of the year. Again, the combination of lower borrowing costs, a higher stock price, and an attractive acquisition market bodes well for the next six months. Thanks, everyone.