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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning ladies and gentlemen, and welcome to your Essential Properties Realty Trust Second Quarter 2019 Earnings Conference Call. All lines have been placed in a listen-only mode, and the floor will be open for questions and comments following the presentation. [Operator Instructions].
This conference call is being recorded and a replay of the call will be available two hours after the completion of the call for the next two weeks. The dial-in details for the replay can be found in today's press release. Additionally, there will be an audio webcast available on Essential Properties' website at www.essentialproperties.com an archive of which will be available for 90 days.
It is now my pleasure to turn the call over to Dan Donlan, Senior Vice President and Head of Capital Markets at Essential Properties.
Thank you operator and good morning everyone. We appreciate you joining us today for Essential Properties' second quarter 2019 conference call. Here with me today to discuss our second quarter results are Pete Mavoides, our President and CEO; Gregg Seibert, our COO; and Hillary Hai, our CFO.
During this call we will make certain statements that may be considered forward-looking statements on our federal securities law. The company's actual future results may differ significantly from these matters discussed in these forward-looking statements, and we may not release revisions to those forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time-to-time in greater detail in the company's filings with the SEC and in yesterday's earnings press release.
Before I turn the call over to Pete, I would note that our 10-Q and second quarter supplemental are available on the Investor Relations section of our website.
Pete, please go ahead.
Thank you Dan, and thank you to everyone who has joined us today for your interest in Essential Properties. We are pleased to report our second quarter results, which include passing the one-year anniversary of our initial public offering. In the past four quarters since coming public, we have invested $546 million into 243 properties and sold 47 properties for $76 million, which equates to nearly 40% growth in assets over the last 12 months.
In addition, our 100% leased portfolio has performed exceptionally well with same-store contractual cash rents increasing between 1.8% and 1.9% since coming public. Similarly, our rent coverage ratio, which represents 98% of our cash ABR has averaged between 2.8 times and 2.9 times since coming public, which speaks to the profitability of our properties and their value to the operations of our tenants. Coupling the strong internal growth with consistent external growth has resulted in improved diversity, rationalization of our G&A, and most importantly dividends and earnings growth.
Turning to the second quarter and starting with the portfolio. As of June 30, we owned 789 properties that were 100% leased to 184 tenants operating in 16 distinct industries. Our weighted average lease term was 14.5 years, with only 3.6% of our ABR expiring through 2023.
Our same-store portfolio, which represents 55% of our total portfolio at quarter end, experienced contractual cash rent growth of 1.9% quarter-over-quarter and contractual NOI growth of 1.7% quarter-over-quarter. As we have mentioned in the past, we expect our same-store portfolio to grow at approximately 1.5% per annum. So we were pleased to exceed that threshold again this quarter through proactive asset management.
From a tenant health perspective, our portfolio has weighted average rent coverage ratio of 2.9 times, which is up modestly from 2.8 times last quarter. And 73.3% of our cash ABR has rent -- has a rent coverage ratio of two times or better. With that in mind, less than 1% of our leases that expire over the next eight years have unit level rent coverage below 1.5 times, which we believe indicates a high likelihood of lease renewal at expiration. Similarly, 2.1% of our tenants have both an implied credit rating lower than B per Moody's Risk Analytics and a unit-level coverage rent ratio below 1.5 times, which represents a very manageable number of tenants and properties with elevated risk characteristics.
Turning to our second quarter investment activity, we invested $190 million at a weighted average initial cap rate of 7.3%. This level of investment activity was above our trailing four-quarter average of $136 million, and represents our second most active quarter since inception.
Approximately 65% of our second quarter investments came via sale-leaseback transactions, 67% were subject to master-lease provisions and 100% are required to provide us with corporate and unit-level financial reporting on a regular basis.
On the disposition front in an effort to proactively mitigate risks and exposures, we sold 11 assets in the quarter, including one vacant property for $26.8 million in net proceeds. Subsequent to quarter-end, we completed a secondary offering of common shares for $519 million for Eldridge Industries, our initial capital partner.
As a result, Eldridge no longer owns any shares or OP units in EPRT. The Eldridge team was integral in growing this company from a business plan to a well-capitalized public company that it is today. We would like to thank the Eldridge’s team for their trust, support and guidance over these past three years.
As we look out to the balance of the year, we remain focused on growing our portfolio through the origination of sale-leaseback transactions with middle market tenants in service-oriented and experience-based industries. And we anticipate our level of investment activity to be consistent with our historical averages with cap rates in the mid-7% range.
Overall, this was a great quarter for the company and has paved the way for us to continue to scale our portfolio accretively and generate attractive risk-adjusted returns for shareholders.
With that, I'd like to turn it over to Hillary Hai, our CFO, who will take you through the financials for the second quarter. Hillary?
Thank you, Pete, and good morning, everyone. Starting with the balance sheet, we ended the quarter with $1.6 billion in total assets, and $579 million of total debt including $312 million of outstanding master funding notes, $200 million of unsecured term loan and $67 million outstanding under $400 million unsecured revolving credit facility.
We have no major debt maturities coming due until 2024, and our net debt to annualized adjusted EBITDAre was 4.7 times at quarter end, which gives us capacity to execute on our external growth plan while managing within our targeted leverage range.
Turning to the income statement, our second quarter net income was $10.6 million or $0.14 per diluted share. NAREIT defined funds from operations or FFO was $17.7 million or $0.23 per diluted share.
Core funds from operations or Core FFO was $22 million or $0.29 per diluted share, and adjusted funds from operation or AFFO was $21.1 million or $0.27 per diluted share.
Of note, in the quarter, we recognized a loss of $4.4 million related to the partial repurchase of our 2016-1 ABS Notes, which included $1.4 million in premium paid, a $2.9 million write-off of deferred financing costs and $100,000 of legal costs.
Given the one-time nature of these items, we added new disclosure to this quarter to our income statement called Core FFO, which adds back these items to NAREIT-defined FFO.
While we continue to increase our operating efficiencies, G&A for the second quarter was 14.5% of total revenues. We expect this metric to moderate as our portfolio grows and scale.
Subsequent to quarter end, we paid a dividend of $0.22 per share for the second quarter, which equated to an 81.5% payout of our second quarter AFFO per share. We also filed a shelf registration statement, which gives us the ability to raise various forms of equity and debt capital on an overnight basis.
Turning to guidance, we are reiterating our 2019 AFFO per share guidance range of $1.11 to $1.15.
With that, I'll turn the call over to Gregg.
Thanks, Hillary. During the quarter, we invested $190 million in 32 transactions and 91 properties at a weighted average cash cap rate of 7.3%. These investments were made within 10 of our 16 targeted industries with convenience stores and early childhood education, representing half of our investment activity in the quarter.
The weighted average lease term of the properties was 15.3 years. The weighted average annual rent escalation was 1.5%. The weighted average unit-level coverage was 3.2 times and our average investment per property was $2 million.
Consistent with our investment strategy, approximately 65% of our second quarter investments were originated through direct sale-leaseback transactions, which are subject to our lease form with ongoing financial reporting requirements and master lease provisions in most cases.
In addition, 87% of our second quarter investment activity was relationship based, which we define as transactions completed with operators, sponsors, advisers or brokers that senior management has done business with in the past.
From an industry perspective, quick service restaurants or QSRs remain our largest industry at 12.8% of cash ABR, followed by early childhood education at 11.7%, convenience stores at 10.8%, car washes at 10.7%, and medical dental at 9.4%.
Conversely, due to property sales and portfolio growth in other industries, our home furnishings concentration declined 120 basis points quarter-over-quarter and is down 250 basis points year-over-year which is a trend that should persist as we continue to seek better risk-adjusted returns in other industries.
In addition, we continue to proactively manage our casual dining concentration through selective dispositions of underperforming locations in order to free-up capacity to invest in higher-performing brands and properties.
From a tenant perspective, no tenant represented more than 4% of our cash ABR. Our top 10 tenancy represented 28% of our cash ABR at quarter end, which was down 270 basis points quarter-over-quarter.
We expect our top 10 concentration to further decline over the coming quarters as we continue to grow our exposures with existing tenants outside of our top 10 and capitalize on newly developed tenant relationships.
Of note we added 34 Circle K branded convenience stores to the portfolio in the second quarter which resulted in a subsidiary of Alimentation Couche-Tard entering our top 10 tenancy.
Looking at the portfolio more broadly approximately 93% of our cash ABR is derived from tenants that operate service-oriented and experience-based businesses which has been a deliberate focus for Essential since we have started investing over three years ago.
We believe tenants in these industries and more importantly, real estate occupied by these tenants, are more recession-resistant and heavily insulated against e-commerce pressures.
Moving on to asset management, our portfolio remains healthy with a weighted average coverage ratio of 2.9 times and approximately 73.3% of our cash ABR having a rent coverage ratio of two times or better.
In addition with approximately 98% of our tenants required to report unit-level financials to us we have near real-time transparency into the health of our tenancy which is an important component to managing risk in our portfolio. With an average investment per property of $2.1 million, our portfolio remains highly liquid from a sales perspective and readily fungible from a leasing standpoint.
Turning to dispositions, we sold 11 properties from seven different industries this quarter for $26.8 million in net proceeds. The 10 of these properties were leased and sold for a blended cash cap rate of 7% which was slightly elevated given the higher prevalence of portfolio repositioning this quarter.
With that, I will turn it back to Pete for the closing remarks.
Thanks Gregg. Our portfolio remains in excellent shape with no vacancies, healthy coverage, coupled with strong transparency, good property level liquidity, and limited near-term lease expirations. Our investment pipeline is full, our balance sheet is well-positioned to fund continued growth, and we look forward to continuing to execute on our business plans.
With that, operator, please open the call up for questions.
Thank you. The call is now open for questions. [Operator Instructions] We'll go first to Christy McElroy with Citigroup.
Hey, good morning everyone. Just wonder if you could provide some additional color on your acquisition strategy with the pace of -- in Q2 accelerating recognizing that you had like more dry powder that you deal following the equity raise this spring and also your cost of capital position is more favorable. What drove the accelerated pace? And how should we be thinking about the rest of the year?
Great Christy and thank you. We certainly came into the quarter with a fully-charged balance sheet and an attractive cost of capital as we went about investing. That said we've been more focused on transacting around our historical average. We had a large transaction that you see in our top 10, a $52 million deal that we bought during the quarter and that really drove kind of the outsized performance in the quarter and that we would expect to be transacting more consistent with our historical average.
Okay, got it. And then can you comment on your Perkins exposure and provide an update on where that stands today? How are you feeling about that credit?
Sure. And I think Perkins is a great example of the benefits of coupling great unit level of visibility with asset fungibility. And so we acquired 21 Perkins properties when we bought the GE portfolio three years ago. We've been monitoring that credit and managing our exposure to the point today, we sit where we have 12 properties representing about 1.8% of our cash ABR. We sold or repositioned nine properties and really reduced that exposure to a point where we feel comfortable with the assets that we hold. We think this Chapter 11 restructuring will be a good thing for our tenant and will come out with our lease intact and a stronger tenant going forward.
Pete, its Michael Bilerman. Now that Eldridge is completely out of the stock, what is going to be the process and timing for their two Board seats that they have the nomination rights and also used to sit on the Board? You obviously have a very small Board given the size of the company and when you went public and were a controlled company. So can you talk a little bit about improvements that you want to make in corporate governance and the timing that that's going to occur?
Yes. I think it's logical to assume the two Board members -- the two Eldridge Board members who will transition off in a reasonable time frame. And I think that would be over the next quarter or so and that we would replace those seats in an orderly manner to bring more diversity and broader perspective to the Board. And so I think that's something that was discussed at the our last Board meeting and really would happen over the back half of the year here.
You already engaged advisers to -- so the search is already underway and that will occur in the next three to six months?
We have not engaged the search. But the discussions are ongoing. And once we have something to announce we will announce it.
But you're committed to do it?
I think the Eldridge Board members want to come off the Board given they have no economic interest in the company any longer. And I think that's the logical transition.
Thank you.
Thank you.
Our next question comes from Sheila McGrath with Evercore. Please go ahead.
Yes, good morning. Pete the coverage for the portfolio did increase to 2.9 times. Just wondering if that was driven by the mix of new acquisition? Or is some tenant segment performing well boosting the portfolio coverage higher?
Yes. There's a lot going on in that number Sheila and obviously if we bought $190 million representing just about 10% or 11% of our total assets of $1.6 billion. I think it's going to be a combination of factors. Our coverage on investments for the quarter were 3.2 times. And so it's slightly accretive to that 2.8 times. But I guess if you just did the pure math, you can figure out how much that is from new investments and how much is from movements within the portfolio.
Okay. And then the sales, it was a fairly active quarter for you and a historical perspective. Can you just give us your thoughts on -- or what were the characteristics of the sale of assets? And why you chose those assets to dispose off?
Yes, really it tends to be derisking sales and that could be derisking a specific asset where we don't see coverage or tenant credit that we like or it can be in the case of this last quarter derisking a specific industry sector where we sold down some of our furnishing and casual dining exposure. And so I think the quarter represented a good mix of both specific asset motivations as well industry and tenant motivations.
Okay, great. One last question. You did reduce secured borrowings related to that Master Trust Funding. Should we expect that will be continued -- you'll continue to pay that down over time?
Yes. So we had our 2016 notes. We have the opportunity to purchase those notes using unsecured term loan that we put in place in connection with our recasted revolver. We have another chunk of those 16 that become prepayable in November. And I think in general, you should expect us to transition our balance sheet to a more unsecured borrowing strategy.
Okay. Thank you.
Thank you, Sheila.
And next we'll go to Sam Choe with Credit Suisse. Please go ahead.
Hi, guys. So you guys cited the debt-to-EBITDA of 4.7% which is kind of close to your preference of low to mid 5%. Just wondering how you intend to manage that along with the expected investment pacing in the second half of the year?
Yes. I think we'll manage that by raising equity. Obviously, we filed a universal shelf subsequent to quarter end. And I think it's logical that you could expect us to get an ATM program in place in the near future and be in the market to raise equity to help fund our investments and manage our leverage within our leverage targets, as we look at the back half of the year here.
Okay. That's what I thought. And then the property operating expenses were a little lighter this quarter. Could you give some color on that?
Yes. Hillary, why don't you give some color on that?
So last quarter was higher because we had some onetime reimbursable property tax charges that was due to a tax reassessment. So going forward, this quarter should be a better run rate for the last half of the year.
Okay, perfect. Thank you so much.
Thank you.
And next we'll go to Brian Hawthorne with RBC Capital.
Can you talk about which industries you're seeing the best or the most expansion plans? And then kind of give us your -- any color you can on the close rates of investments by industry?
Sure. Listen we're pretty focused in 16 industries and we're originating across all those industries. We're conducting sourcing activity across all those industries. And generically, I would expect our exposure is to grow ratably in any given quarter, you'll see ebbs and flows across those industries.
But this past quarter was 30% C-stores and 20% child care. Next quarter could be 30% QSRs and 20% car washes. But overall, I think you'll see us grow kind of ratably with the exception, we are cautiously kind of managing down our home furnishing exposure and trying to stay more neutral on our casual dining and family dining exposure.
Okay. Thanks.
Thank you, Brian.
Our next question comes from Nate Crossett with Berenberg.
Hi, good morning guys. Kind of similar to the Perkins question. Can you touch on your exposure to Pizza Hut, as I think they've announced a bunch of store closures?
Yes. It's stand-down. We have 40 basis points roughly of exposure to Pizza Hut as we stand.
Yes. 40 basis points of ABR spread across a good number of properties that are fungible and liquid and so we don't see any heightened risk there for our portfolio.
Okay. And then on just Art Van, I know you talked about reducing home furnishings and I think Dave -- they're trying to change the CEO. And I see you kind of sold one of the Art Vans in the quarter. Just wanted to get a sense of how you feel about the other four locations?
Yes. Listen, we made that investment not that long ago and we felt it was a good concept, a good brand. We had good assets subject to a strong master lease. And that really hasn't changed.
I think a management change there will be well received. I think the founding family has come -- taken more active role in the Board which I see is a positive and we think that's a good company that should continue to grow.
And so we're comfortable with our exposure there. Should we see an opportunity to reduce it accretively and opportunistically, we would, but we feel good about our exposure to Art Van.
Okay, that's helpful. And then just one more, can you remind us the size of the sales team? Do you guys feel that that's enough? Or are there going to be more ads in the coming months?
No. Listen I've often said, we built this company and staffed this company when we were private to be able to transact predictably in its public form. And hopefully over the past 12 months, you guys have come to appreciate that. And our teams in place, the infrastructure is in place to execute. And so the key seats are filled and we're transacting at a high level.
Generically about 1/3 of our 22 employees are focused on originations and closing another 1/3 on asset management, 1/3 on financial -- finance and accounting and that's not going to change materially.
Okay. Thanks guys.
Thank you.
And our next question comes from John Massocca with Ladenburg Thalmann.
Good morning.
Good morning, John.
So if you look at kind of Page 11 of the sub, you talked about 6% of the kind of portfolio move into the kind of B minus category for the tenant credit, breakout you give there in that bar chart? Maybe just any kind of color around that, what drove that move? Was any of that Perkins? Just anything you provide would be helpful?
Yes. I mean, I don't have the specific breakdown on the tenancy there. You will see ebbs and flows in any given quarter. We certainly take comfort in the fact that a good chunk of that movement is – has healthy coverage and really doesn't give us any concern.
Okay. And then on the home furnishing side, can you guys provide any color maybe on what tenants are in that sub-segment besides Art Van?
We have a couple of Ashley Furnitures besides that. And really, it's – if you think about Art Van and the overall exposure, I think the entire balance is Ashley. Is that right Gregg?
That's right.
Okay. And then, one more detailed question on the Perkins exposure. Are any of those branded Marie Callender's or are they all Perkins branded locations?
Yeah. And so all 12 of our Perkins sites are Perkins and they're all corporate stores and they all are currently operating.
Okay. That's it for me. Thank you very much,
Thanks John, appreciate the questions.
And next we'll go to Caitlin Burrows with Goldman Sachs.
Hey. This is Julian on for Caitlin. Earlier, this week another net lease REIT mentioned that non-investment-grade properties were trading at cash cap rates in the range of high five’s to low eight’s. I know you mentioned you're expecting mid seven’s for the rest of the year which would be at the high end of that range. I guess, what do you believe is driving your ability to achieve cap rates at the high end and how sustainable is that?
Yeah, I would say, quite simply I think we're good at what we do. If you look at the stats in our investor deck, a high percentage of the deals are deals we're doing with people we've dealt with in the past into the 90%. So we have a good reputation and people trust us as a counterparty. We're also structuring sale leasebacks. A high percentage of our deals are direct sale leasebacks, where we're delivering capital into a capital need for a tenant. And so we're not competing in the brokered market for existing lease – net lease deals, which – that whoever that was is probably referring to. We're moving upstream to work with relationships and counterparties that we know and trust us to structure deals in the context of sale-leasebacks, and we've been doing this for 20 years. And you look in our disclosure we've consistently been in that mid-7% range. So we believe it to be very sustainable.
Got it. And I guess related to that, I know the release mentioned about 70% of the transactions year-to-date are sale leasebacks. I guess, when we look at that other 30% is that mostly made up of the brokerage market? Or what kind of other selling entities are we talking about?
Yeah. And we think about sale leaseback, where we're structuring a new lease at inception and that could be in the broker market or it can be a direct deal. Outside of the sale leaseback kind of the inverse of the sale leaseback is an existing lease deal, where we're buying a property subject to an existing lease. We generally focus on doing that only when we can create value, either through restructuring that lease, with the tenant or having unique insight into the tenant performance, or relationship there, but generally trying to find inefficiencies where we're getting paid an attractive risk-adjusted return. A great example of that is the Questar transaction that we transacted with $52 million in the second quarter here. That was an existing lease deal, but it happened to be a deal that my partner had originated, 20 years ago. And so, we had great insight into the structure, the nature of the lease. We had worked, with and for the seller in the past. And so, we look for opportunities, where we can deliver shareholder value, in those existing lease buckets.
Awesome. Thanks for that.
Thank you.
Our next question comes from Kevin Kim with SunTrust.
Hey! Good morning. Just a quick, accounting question, the G&A was a little bit higher this quarter. I know, you've addressed some of that, but just curious about longer term. What is the right annualized G&A run rate?
Hillary, what do you get there?
So this quarter is a little bit higher. We had a few onetime expenses that came through. But looking forward to next two quarters, we should be around the 13% range, of total revenues.
Okay. How about in hard dollars? Just because the total revenues can change based on acquisitions?
Yeah. So, we're looking at, roughly per quarter. I would model as $4.6 million to $5 million each quarter. Depending -- also depending on the volume that we're doing, we do have certain variable costs.
So the transaction expenses are in the G&A line item. Is that correct?
Not transaction, but we do have servicing costs that are very dependent on how many properties we have.
Okay. And just one last question, on your AFFO calculation, that you add back transaction costs, which is fully fine. But there seems to be no add-back this quarter. Just curious, why that is?
We -- the transaction cost is actually for our investments, that's already in our investment total. So it's not in our AFFO calculation. So, that's why, you don't see any.
Okay, all right. Thank you.
Thanks, Kevin.
And, another question is from John Massocca with Ladenburg Thalmann.
Actually, I was going to ask about the Questar transaction. But I think you covered it pretty well. So, I'm just pulling out of the queue. Thanks.
Great, thanks John.
[Operator Instructions] And there appear to be no questions, at this time. So I'll turn it back over to management for any closing remarks.
Great, I think, we're proud of the quarter, we just reported. As you see, in our 10-Q filed yesterday, we've had good progress into the quarter -- into the third quarter here as we continue to execute.
And so, we look forward to engaging with you all, conferences in September. And I hope you enjoy the rest of the summer. Thank you.
And that does conclude today's teleconference. We appreciate your connection. You may disconnect your lines at this time. And have a great day.