REIT Valuation Spirit Realty Capital, Inc. 5/17. Property Information. Corporate Data. Major Events

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David Cook
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1 REIT Valuation Spirit Realty Capital, Inc. 5/17 This month s REIT Review is on Spirit Realty Capital, Inc. ( SRC ), a publicly traded REIT that is engaged in the investment and management of single tenant net lease real estate assets located throughout the U.S. SRC owns 2,615 properties with 450 tenants, in 28 different industries and containing 52.8 million rentable sq. ft. Property Information SRC s properties are located in 49 states and as of Q1-17, portfolio occupancy was 98.2% and the weighted average lease term was 10.7 years. SRC s largest tenants include; Shopko (116 properties and 8.1% of rental revenue), Walgreens (49 properties and 2.7% of rental revenue), AMC Entertainment, Inc. (17 properties and 2.3% of rental revenue) and Church s Chicken (Cajun Global LLC) (192 properties and 2.2% of rental revenue). Corporate Data SRC was incorporated in Delaware, is traded on the NYSE, and located in Dallas, TX. SRC is rated Baa3 by Moody s, BBB- by Standard and Poor s and BBB- by Fitch. SRC has 484 million common shares outstanding and a market capitalization of approximately $3.58 billion. SRC owns a 99% limited partnership interest in its UpReit general partnership, Spirit Realty, L.P. Major Events May 8, 2017, Thomas H. Nolan, Jr., the CEO of SRC departed the company and resigned from the board. May 8, 2017, SRC reduced its full year AFFO guidance from $.89-$.91 per share to $.80-.$.84 per share. This was due to increased credit losses with some related tenant bankruptcies and the fact that SRC s largest tenant (Shopko) is a general merchandise retailer. SRC anticipates that it is not prudent to increase leverage in order to meet its previous net acquisition target for 2017 of $250 million.

2 Management Jackson Hsieh, 56, President and CEO Mr. Hsieh joined us in September 2016 and previously served as the Chief Operating Officer of Spirit, where he had oversight responsibility for credit underwriting, new investments, and portfolio and asset management. Prior to joining Spirit, Mr. Hsieh worked for Morgan Stanley, where he served as Managing Director and a Vice Chairman of Investment Banking, primarily focusing on the firm's real estate clients. Prior to rejoining Morgan Stanley, Jackson was Vice Chairman and Sole/Co-Global Head of UBS's Real Estate Investment Banking Group, managing a team of over 70 professionals in six offices worldwide. During his career, including a prior period at Morgan Stanley and tenures at Bankers Trust Company and Salomon Brothers, Inc., he served as senior lead banker on over $285 billion of real estate and lodging transactions. Mr. Hsieh is a graduate of the University of California at Berkeley, and earned a Master's degree from Harvard University. Phillip D. Joseph, Jr., 48, EVP and CFO Mr. Joseph joined us in April 2015 and oversees all aspects of Finance, Corporate Reporting, Tax and Investor Relations and focuses on the Company s capital markets and key stakeholder engagement activities. Mr. Joseph has over twenty years of real estate experience and has demonstrated expertise in developing, leading and executing capital markets and financial planning and analysis activities. Prior to joining us, Mr. Joseph spent more than 13 years at Prologis, as Managing Director and Global Treasurer. Mr. Joseph received his Bachelor s degree in Economics & Management from DePauw University and his Masters of Business Administration from the JL Kellogg Graduate School of Management at Northwestern University. Ownership Top Institutional Holders: Shares % Vanguard Group, Inc. 74,801, Cohen & Steers, Inc. 67,681,

3 Daiwa Securities Group, Inc. 24,814, JP Morgan Chase & Company 23,200, FMR LLC 21,545, Ownership Breakdown % of Shares Held by All Insiders and 5% Owners 49% % of Shares Held by Institutional & Mutual Fund Owners 94.7% Number of Institutions Holding Shares 285 All amounts above per Yahoo Finance Financial Analysis and Valuation Select financial data for SRC per the 2017, Q1 10Q, and supplemental information (in millions where applicable) Financial Data Amounts Real Estate Assets, Gross $7,445 Total Assets $7,588 Property Debt (at a weighted average interest rate of approximately 4.31%) $3,657 Common Stockholders Equity $3,608 Revenue $165 Net Income $12 Net Income Per Share.03 Cash Flow from Operations $96 Revolving Credit Facility ($800M with $129M used) $671 Market Capitalization $3,580

4 Property Debt to: Gross Real Estate Assets 48% Market Capitalization 98% Enterprise Value 50% Dividend and Yield ($.72/sh.) 9.49% Valuation Methodology Q1-17 Real Estate Revenue $165 Less: Q1-17 Real Estate Operating Expenses (excluding depreciation, amortization, interest expense and plus G&A expenses) 24 Q1-17 Net Operating Income $141 Projected Inflation Rate at 3.5% x1.035 Projected Forward Quarterly NOI $146 Annualized Forward NOI $584 Projected Average Cap Rate 8% Projected Value of Real Estate Assets $7,300 Add: Net Operating Working Capital (excluding goodwill and at book value) 533 Total Projected Asset Value of Company $7,833 Less: Total Debt Per Above (includes convertible debt with exercise price at $13.10/sh., as conversion is unlikely) (3,657) Projected Net Asset Value of the Company $4,176 Common Shares Outstanding-484M Shares (484M common shares)

5 Projected NAV Per Share 8 Market Price Per Share on 5/15/17 7 Premium (Discount) to NAV (12.5%) Financial Metrics The gross real estate assets, property debt, revenues, net income, funds from operations, return on invested capital and dividends per share for the years 2012 through Q1-17 are shown in the table below: (millions except per share amounts) Q1-17 Gross Real Estate Assets $3,365 $6,519 $7,193 $7,527 $7,479 $7,445 Property Debt $1,894 $3,778 $4,323 $4,092 $3,664 $3,657 Revenues $273 $419 $602 $667 $685 $165 Net Income (Loss) ($76) $1 ($33) $114 $97 $12 Funds from Operations (FFO) $52 $139 $236 $354 $394 $95 Return on Invested Capital (1) 8.7% 4.6% 5.9% 7.8% 7.6% NA Dividends Paid Per Share $.1748 $.6586 $.6689 $.685 $.705 $.18 (2) (1) This is the ratio of cash provided by operations plus interest expense divided by stockholder s equity plus property debt, less cash and measures the return the REIT is earning on its invested capital. (2) Dividend is currently $.18 per quarter. The total return of SRC year to date and through five years is show in the chart below per NAREIT:

6 SRC Total Return 4/ Yr 3-yr 5-Yr % % 1.83% NA As shown above, our net asset value per share for SRC is $8/sh., compared to a market price of $7/sh. Current average cap rates for net lease properties per our industry experience and CBRE s Cap Rate Survey are in the 6% to 9% range, depending on the location, lease term and credit of the tenant. We have used an average cap rate of 8% due to SRC s assets being a well-diversified national portfolio of net lease investments. Valuation Analysis SRC s strengths, concerns and recommendations are as follows: Strengths: Diversified portfolio of retail properties. Investment grade credit rating. High dividend yield at 9.49%. Attractive stock price at $7/sh., a 12.5% discount to NAV and 9.5 times current FFO. Strong occupancy at 98.2%. Concerns: Poor corporate strategy and management of company, lease portfolio and troubled tenants and nonexistent capital allocation plan. The management team has been reactive instead of proactive in dealing with problem tenants. Significant additional tenant risk with Shopko that accounts for 8.1% of revenue and other potential tenants. SRC is still subject to tenant event risk as there is increased potential for other tenant bankruptcies, lease defaults, etc. Projected increases in interest rates will raise cap rates and lower real estate values and REIT stock prices. Recommendation: SRC has a well-diversified portfolio of net lease assets and our recommendations are as follows:

We are very concerned that the management team at the company does not have the skill set necessary to properly deal with tenant issues and did not recognize and manage the negative tenant issues

7 We are very concerned that the management team at the company does not have the skill set necessary to properly deal with tenant issues and did not recognize and manage the negative tenant issues prior to the first quarter of Therefore, even though SRC is trading at a discount to NAV, we are not recommending purchase of the stock, due to the risk of additional tenant issues. The net lease investment business is really a bond spread business, by buying long term net leases at 7%+ returns and financing at 5%, thereby making the spread. However, if interest rates rise, these net lease assets are subject to significant interest rate risk and the values will decline precipitously. A five-year price chart of SRC is shown below:

A Publication of Paramount Capital Corporation. Strategy and Insight for the Commercial Real Estate Industry. Economic/Investment Focus:

Volume VI Issue 6 A Publication of Paramount Capital Corporation June 15, 2014 Strategy and Insight for the Commercial Real Estate Industry Inside This Issue: Real Estate Focus: Should Corporations Own