Agree Realty Corporation s Second Quarter 2014 Earnings Conference Call Tuesday, July 29, 2014; 9:00AM ET

Transcription

1 EDITED TRANSCRIPT Agree Realty Corporation s Second Quarter 2014 Earnings Conference Call Tuesday, July 29, 2014; 9:00AM ET NYSE: ADC

2 CORPORATE PARTICIPANTS CONFERENCE CALL PARTICIPANTS Paul Adornato; BMO Capital Markets; Analyst Wilkes Graham; Compass Point Research & Trading; Analyst Daniel Donlan; Ladenburg Thalmann & Company; Analyst PRESENTATION Good morning, and welcome to the Agree Realty Corporation's second quarter 2014 conference call. All participants will be in listen-only mode. ( Instructions) After today's presentation, there will be an opportunity to ask questions. ( Instructions) Please note this event is being recorded. I now would like to turn the conference over to Joey Agree. Mr. Agree, please go ahead. Thank you, Keith. Good morning, everyone, and thank you for joining us for Agree Realty's second quarter 2014 conference call. With me today is Brian Dickman, our Chief Financial Officer. Overall, the second quarter of 2014 was another strong quarter for the Company. In addition to producing another quarter of year-over-year earnings growth, we saw significant activity across all three of our external growth platforms, and expect to capitalize on a number of investment opportunities throughout the second half of the year. As Brian will touch on shortly, on a year-over-year basis, both FFO and AFFO per share were up approximately 6%, and, at approximately 28% debt to total market capitalization and 4.5x debt to EBITDA, these results were achieved while preserving our strong balance sheet. The recent announcement of our new, more robust credit facility will only further enhance our balance sheet capacity and flexibility. At the end of the quarter, our portfolio consisted of 142 properties spread across 34 states and encompassed approximately 3.9 million square feet of gross leasable area. The portfolio was at 99% occupancy at quarter-end and consisted of 134 net lease assets, which generated over 86% of our annualized rent, and 8 community shopping centers which generated the remainder. As of June 30, the Company's portfolio had a weighted average lease term remaining of approximately 11.3 years, which increases to 12.4 years specifically for the net lease portfolio. Investment-grade retailers generated approximately 59.4% of annualized rent across the portfolio, and approximately 67.3% when looking only at the net lease portfolio. On the acquisition front, we closed on two properties for $12.5 million in the second quarter, including the portfolio's first Academy Sports, as well as a Michaels Craft Store in Wausau, Wisconsin. Subsequent to quarter-end, we announced two additional acquisitions for an aggregate purchase price of $24.7 million, including a 13-property Taco Bell portfolio and a Giant Eagle Grocery Store. The weighted average cap rate and lease term on these four transactions was approximately 8% and 14.4 years respectively. 2

3 These acquisitions all represent retail sectors that we believe to be e-commerce and recession resistant, as well as tenants that are among the leading operators within their respective sectors. Academy Sports, Giant Eagle and Charter Foods, the operator of the Taco Bell portfolio, are all new tenants for us. The Taco Bell Restaurants represent the introduction of one of the country's leading fast-food brands to our portfolio. As we look ahead to the second half of the year, we think the Company has an attractive pipeline, particularly in light of an environment that remains supply-constrained and seller-friendly. Our acquisition team continues to do a great job of sourcing unique, off-market, accretive investment opportunities. Moving on to development and joint venture capital solutions, in the second quarter, we announced the commencement of a redevelopment project for Buffalo Wild Wings in St. Augustine, Florida, as well as our third JVCS project, a Cash & Carry Store in Burlington, Washington. We are excited about both projects as we continue to expand our relationship with Buffalo Wild Wings, and welcome Cash & Carry to our portfolio. Our McDonald's in East Palatka, Florida and our project in New Lenox, Illinois are both on track to be delivered during the fourth quarter. As a reminder, East Palatka is preleased to McDonald's under a 20- year ground lease and the New Lenox project is preleased to TJ Maxx, Ross Dress for Less and Petco. Lastly, we had quite a bit of leasing activity in the portfolio this quarter. Kmart and Rite Aid each exercised 5-year extension options at Marshall Plaza, Kmart exercised a 3-year extension option at a freestanding store in Grayling, Michigan and we executed new leases or extensions for approximately 9,000 square feet of small shop space within the portfolio. On the other hand, Kmart declined to exercise extension options at Chippewa Commons, Ferris Commons and Petoskey Town Center. The Company will continue to receive full rent through the end of these respective leases as we pursue our disposition or redevelopment plans, all of which have been in process. Additionally, we've executed a letter of intent with an industry-leading fast-food operator for the ground lease of anoutparcel at our shopping center in Frankfort, Kentucky. The potential rent from the contemplated ground lease is half of the NOI currently generated by the 80,000 square foot anchor tenant, and is representative of the value creation potential we believe is embedded in a number of the remaining assets in the shopping center portfolio. And finally, the previously announced Hobby Lobby at Petoskey Town Center celebrated its grand opening at the end of June. We understand that the store has gotten off to a strong start and we think it's a great addition to our portfolio and certainly to Petoskey Town Center. With that, I'll turn it over to Brian to discuss our financial results. Thanks, Joey. Good morning, everyone. As a reminder, please note that during this call, the Company will make certain statements that may be considered forward-looking under federal securities law. Our actual results may differ significantly from the matters discussed in any forward-looking statements. In addition, we'll be discussing non-gaap financial measures, including funds from operations, or FFO, and adjusted funds from operations, or AFFO. Reconciliations of these non-gaap financial measures to the most directly comparable GAAP measures can be found in the Company's earnings release. 3

4 As announced yesterday, for the second quarter of 2014, the Company reported FFO per share of $0.54, which represents an increase of 5.9% over Q2 2013, and AFFO per share of $0.55, which represents an increase of 5.8% over Q These per share results were driven by a 19% year-over-year increase in total rental revenue as we continue to grow the Company through accretive investments. The Company paid a dividend of $0.43 per share for the second quarter, or $1.72 on an annualized basis. This represents the Company's 81st consecutive cash dividend. Our payout ratios, currently at 80% of FFO and 78% of AFFO, remain well within the Company's target ranges. As Joey mentioned, Kmart declined to exercise lease extensions at three of our properties, which resulted in the Company taking a non-cash impairment of $2.8 million on our Chippewa Commons shopping center. Impairment analyses were run on the other affected properties and did not result in additional write-down. The Company has worked diligently over the past few years to reduce our Kmart and shopping center exposure and we are confident in our plans to realize the remaining value in these assets. The Company's balance sheet continues to provide a strong foundation for our growth efforts. Total debt to total market capitalization at June 30 was approximately 28% and debt to EBITDA was approximately 4.5x. These metrics compare to our targeted leverage levels of 30% to 40% and 4.5x to 5.5x respectively, and imply a balance sheet that continues to have additional capacity for growth. Fixed charge coverage was robust at 3.6x and our debt maturities continue to be well staggered. The Company has no remaining debt maturities in 2014 or As Joey mentioned, subsequent to quarter end we replaced our existing $85 million unsecured revolver with a new $150 million unsecured revolving credit facility. As part of that transaction, we also entered into a $65 million, 7-year unsecured term loan. Proceeds from the new term loan were used to repay the $43.4 million balance on our existing revolver at June 30, as well as to fund our July investment activity. The Company entered into interest rate swap agreements to effectively fix the all-in interest rate on the new term loan at 3.74% for the duration of its term, subject to adjustments based on the Company's leverage ratio. The new revolver provides the Company with increased borrowing capacity, lower rates and additional flexibility and will further enable our growth and diversification efforts. Meanwhile, the 7-year term loan allows us to lock in attractively priced, unsecured debt capital for a meaningful term. With that, I'd like to turn the call back to Joey. Joey Agree, Agree Realty Corporation - President & CEO Thank you for the update, Brian. In conclusion, it was another strong quarter of significant progress on our operating strategy. We delivered material year-over-year earnings growth, continued to expand and diversify the portfolio, and not only maintained our strong balance sheet, but significantly improved our credit profile through our new unsecured bank facilities. We look forward to continuing to execute in a disciplined and strategic manner as the year progresses. At this time we'll open it up for questions. QUESTIONS AND ANSWERS 4

5 Yes, thank you. We will now begin the question-and-answer session. Paul Adornato, BMO Capital Markets - Analyst On the shopping center portfolio, I was wondering if you could just talk about that for a little bit. You said you had some leasing activity, both on the anchor side, and then some of the small shop space. What were some of the leasing metrics there? That is, what was the rent growth or maybe you could provide a little color on what the leasing environment is like? Yes, I'll talk just generally about the shopping center portfolio and the leasing activity. It was predominantly small shop-based within the shopping center portfolio for an aggregate, during the quarter, of approximately 9,000 feet. That was really scattered throughout the remainder of the shopping center portfolio. In terms of rent growth, we're looking at nominal rent growth, nothing overly significantly material that will impact the bottom line. But most importantly, we're continuing to see the demand for small tenant space continue to increase. Paul, just to put a little bit more detail around it for you, we had activity at six primary units. You had the two extensions from Kmart, those were contractual extensions, as well as the Rite Aid extension in Marshall. Those were the big ones. As Joey mentioned, the others were small shop space. There was one contractual extension at our Lakeland property and then we had two new leases, one at Chippewa and one at Petoskey, on previously vacant spaces, so no real comparison in terms of previous rent on those boxes. Paul Adornato, BMO Capital Markets - Analyst Okay. And what milestone should we look for with respect to potential sale of those portfolios? In terms of the shopping center assets, what we've always talked about -- we'll continue to monetize existing assets potentially in the portfolio. The LOI for the outlot at our Frankfort, Kentucky, Capital Plaza shopping center is emblematic of those opportunities which we think we can harvest from the existing portfolio. Our goal, over the long term, is to continue to focus on net lease and dispose of non-core assets. And again, over the long term, shopping centers will all be deemed non-core. Paul Adornato BMO Capital Markets Okay. Thank you. Wilkes Graham, Compass Point. Wilkes Graham Compass Point - Analyst Just one question on the balance sheet in light of what was a pretty attractive debt financing and refinancing that you alluded to, and that you just did recently. Does it increase your appetite for leverage maybe to the higher end of that 30% to 40% range? 5

6 As you continue to build the portfolio out, as you get larger, are you more comfortable with having a little bit higher leverage, given the attractive financing you just got? Wilkes, this is Brian. I don't think it changes our view on leverage broadly. Within those bands, 30% to 40% on a debt to asset level and 4.5x to 5.5x, I think that gives us plenty of room to operate. Obviously, we have to look at various factors at any given time with regards to the balance sheet, what the pipeline looks like, where are the equity markets and what debt capital is available to us. So I think we're comfortable operating, for the most part, anywhere within that band. That's why those are the ranges we've set. And I'd say broadly, no, I don't think it changes our view on leverage, nor do we anticipate operating any differently than we've articulated. Joey Agree Agree Realty Corporation President & CEO Wilkes, this is Joey. I think when you look at the recent balance sheet activity and the increased capacity of the revolver, plus the increased size of the accordion; it gives us the opportunity to execute on larger price point transactions. It gives us the ability to execute from a perspective where we can execute on multiple transactions on a simultaneous basis, which frankly, the $85 million previous revolver really didn't enable us in that regard. Wilkes Graham Compass Point - Analyst Can I read into that that maybe you're seeing some attractive pricing in either smaller portfolios or larger assets? I would say we are finding opportunities to execute on, that we find attractively priced. I wouldn't want to speak to the broader market, thinking that there is cap rate compression or that the stabilized cap rate environment that we've seen has let up. But I'll tell you, similar to the Taco Bell sale-leaseback for the $19 million there, we're seeing larger price point opportunities across multiple different sectors that we're both looking at and frankly, have in our pipeline. So I think the $85 million revolver just didn't comport with our ability long term to execute and continue to scale and diversify the portfolio there. Wilkes, we always talk about the balance sheet as being a facilitator of growth, as opposed to an inhibitor. And that is everything from your leverage and coverage metrics to your debt maturities. But also certainly, liquidity and making sure that we have the capital and the capacity to act on opportunities as we see them. So I think this really, as the Company's grown and as we increase our appetite, to some degree, for growth through the right opportunities, we certainly now have the capacity to act on those as they come around. Wilkes Graham Compass Pointe Great, all right. Thanks. Daniel Donlan, Ladenburg Thalmann. Joey, sorry, I had a little snafu on the conference call. So I'm sorry if this was asked. 6

7 That's okay. With the Buffalo Wild Wings project in St. Augustine, what's the expected cost of that redevelopment? About $1.75 million total cost. Okay. And that is predominantly the acquisition of the existing building. Okay. So I'm not going to ask you for a cap rate per se, but what type of value should we base an estimated cap rate off of, that $1.7 million number? That's an interesting project and it's almost a hybrid between a development and an acquisition. We've actually called it a redevelopment. So we're acquiring a former restaurant there and Buffalo Wild Wings is actually doing all the work. But it's fair to assume that it has fallen within our typical band of, call it, 8% to 9% on a straight line, as well as a cash basis. Dan Donlan Ladenburg Thalmann Okay. And just use the $1.7 million on that? Yes. Dan Donlan Ladenburg Thalmann Okay. Buffalo Wild Wings, obviously a pretty well-known tenant is growing fairly quickly. Is this a sign of some other things to come? Or is this just a one-off thing that you hope to duplicate, but may not necessarily possible per se? We think Buffalo Wild Wings is a fantastic flag and a great operator. Their same-store sales continue to be at the top of the industry. So we are continuing to work with Buffalo Wild Wings on both the corporate as well as the franchise level on new stores. Both the acquisitions and development, frankly. And hopefully, we can get some other opportunities across the goal line with them. Okay. And then with regards to Kmart -- again, I'm not sure if you talked about this -- what is the expected loss in NOI from the non-renewals? And when does that hit exactly? Dan, this is Brian. So a few things there, a little bit of detail. Those leases, there are three of them. They expire, the earliest one is November of this year, another one is July of next year, 2015, and then 7

8 November of And as Joey mentioned in our earlier remarks, all those rents will be paid in full through the end of those leases. So as we look out over the next, call it, 18 months, year and a half, on an all-in basis, NOI, we're estimating, depending on some co-tenancies, how they're triggered, how they're not, call it $600,000 to upwards of maybe $900,000, very worst-case scenario, of NOI reduction over the next 18 months. And of course, that doesn't assume any sales, redevelopment or re-tenanting. So that's kind of the baseline analysis that we've looked at. Okay. And then Joey, I think you had talked about you were hoping that this might happen at some of your centers, just given that you'd be able to bring tenants in potentially at a significantly higher rent. Is that the case in any of these locations? On an asset-specific basis, we think there's an opportunity to redevelop Ferris Commons. And we've been working on those redevelopment plans for upwards of 12 to 18 months. Um-hum. So there, we anticipate potentially being able to create some upside or additional outlots that could be created there as well as redevelopment of the Kmart box. Specific to Petoskey Town Center, after we executed the lease with Hobby Lobby, that asset has been previously marketed for sale. And we anticipate disposing of that asset by the end of this year here in And frankly, we're close to entering into an agreement for that disposition. Chippewa Commons, we're still evaluating. We'll look at the opportunities there in the market. We've been evaluating it for some time. If we don't see the opportunity to re-tenant or redevelop that parcel, we could potentially look to dispose of that by early 2015 as well. Dan Donlan Ladenburg Thalmann _ Analyst Okay. All right. Then as far as leverage is concerned, you have always maintained, I would say, a highly conservative balance sheet. But given now that you've got 60% or plus exposure to investment-grade rated tenants, much less dependence on the shopping centers. Do you feel like you might be able to run the Company with slightly higher leverage than you have in years past? Or should we continue to expect you to really maintain a sector low leverage versus your peers? Dan, this is Brian. It's a good question. And building off my previous answer, I think that if you look at those bands, at any given point in time, you could be on the low end; you could be on the high end. There are obviously a lot of factors that impact where your leverage is, again, at a point in time. I think we're comfortable anywhere within that band. Obviously, it depends on the environment out there. We've stated throughout the year that we've been on the low end. And I think that you've obviously seen us finance this year's investment activity with debt, which makes sense, given that profile. So again, I just don't see a material change in terms of how we think about the balance sheet. Keeping in mind that long term here, and hopefully, more like medium term, but in the foreseeable future, we do aim to be an investment-grade rated company ourselves to give us access to additional capital, additional attractively priced capital. 8

9 And having seen a number of companies make that transition and have to take some, not necessarily punitive measures, but whether it's prepayment penalties or a material equity raise, to put themselves in a position to get that rating at some additional cost to them. We think that keeping that mindset today in preparation for that will make that transition as easy and at as low of a cost to us as possible when we get there. Okay. Makes sense. Thanks. Thank you. ( Instructions) All right. Well, there is nothing more at the present time. So I would like to turn the call back over to management for any closing comments. Joey Agree Agree Realty Corporation President & CEO Great, thank you. Well, that about wraps it up. Again, I'd like to thank everyone for joining us this morning. And we look forward to speaking with you all again next quarter. Thank you. Thank you. The conference call has now concluded. Thank you for attending today's presentation. You may now disconnect. Have a nice day. 9