Q3 2023 Four Corners Property Trust Inc Earnings Call
Participants
Gerald R. Morgan; CFO; Four Corners Property Trust, Inc.
Joshua C. Zhang
Patrick L. Wernig; MD of Acquisitions; Four Corners Property Trust, Inc.
William Howard Lenehan; President, CEO & Director; Four Corners Property Trust, Inc.
Anthony Paolone; Senior Analyst; JPMorgan Chase & Co, Research Division
Connor Serge Siversky; Equity Analyst; Wells Fargo Securities, LLC, Research Division
James Hall Kammert; Research Analyst; Evercore ISI Institutional Equities, Research Division
Robert Chapman Stevenson; MD, Head of Real Estate Research & Senior Research Analyst; Janney Montgomery Scott LLC, Research Division
Unidentified Analyst
Presentation
Operator
Hello, and welcome to the FCPT Third Quarter 2023 Financial Results Conference Call. My name is Lauren, and I will be coordinating your call today.
(Operator Instructions)
I will now hand you over to your host, Gerry, to begin. Gerry, please go ahead.
Gerald R. Morgan
Thank you, Lauren. 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 inaccurate. For a more detailed description of some potential risks, please see our SEC filings, which can be found at fcpt.com. All the information presented on this call is current as of today, November 2.
In addition, reconciliations 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 it over to Bill.
William Howard Lenehan
Good morning. Thank you for joining us to discuss our third quarter results. I'm going to make introductory remarks, Patrick and Josh will comment further on the acquisition market, and then Gerry will discuss our financial results and capital position.
We reported third quarter AFFO of $0.42 per share, which is up $0.01 from our Q3 last year and in line with expectations. Our existing portfolio is performing exceptionally well with 99.9% rent collections for the quarter and 99.8% occupancy at quarter end.
FCPT has had a record acquisition year already with $322 million of capital deployed year-to-date. That is up 13% from the full year 2022, which was also a record acquisition year. We continue to see benefits of our investments in our people and the platforms capacity. These transactions were funded with equity raised in late 2022 and early 2023 at an average price above $27 per share and with our June debt offering where we benefited from hedge gains to lock in a 5.4% yield to maturity.
Year-over-year sales for the restaurant sector as a whole remained positive in the third quarter in the 3% range, according to Baird Research, although the casual dining sector is seeing small declines off of a strong 2022. Garden was a standout from that trend, reporting same-store sales growth of 6.1% and 8.1% for Olive Garden and LongHorn, respectively. Chili's saw same-store sales rise 6%.
As highlighted last quarter, restaurant margins are also improving as commodity and other inflation eases. Our EBITDA to rent coverage in the third quarter was 4.8x for the significant majority of our portfolio that reports this figure. This remains amongst the strongest coverage within the net lease industry and is a reflection of our underwriting standards.
Turning to capital sources, which Gerry will discuss in more detail. We issued $100 million of private notes in July and did not issue equity during the quarter. We now start the fourth quarter with $220 million of availability on our revolver and no near-term debt maturities and very attractive properties to sell if -- to 1031 buyers if we choose to access this liquidity source.
As we look ahead, the current capital market environment is making it challenging to deploy capital accretively. In this environment, we remain disciplined allocators of capital. And let me say that again. In this environment, we remain disciplined allocators of capital. Since our inception in 2015, we have established mental models and structured our teams' incentives that discoverages us from deploying capital just to grow the company's size without an increase in (inaudible) metrics of earnings or intrinsic value. Our compensation is not tied to acquisition volumes and we have never given acquisition or earnings guidance.
Finally, we benefit from low absolute and relative overhead costs and can be nimble and modulate investment activities up and down without negatively impacting the organization or employee morale. We believe that we are prepared to operate successfully in today's environment and expect to ratchet up activity when it is accretive to do so.
With that, I will turn it over to Patrick to further discuss the investment environment.
Patrick L. Wernig
Thanks, Bill. We had a busy quarter closing on $130.2 million across 31 properties. For 2023 year-to-date, we have acquired 90 properties for $322 million at a 6.7% cap rate, which is a record high volume for us. Year-to-date, our acquisitions have been roughly split between restaurant at 38% of volume, medical retail at 37% and auto service at 23%. We expect the mix to remain balanced based on the pipeline over the remainder of the year.
Remind ourselves often that our business is relatively simple. We do not focus on long-term covered land plays or trophy properties that come to market every 10 to 20 years. Our investment decisions are based on a consistently applied scoring model and yield spread. If a tire store or a restaurant does not pencil, we can be patient, pass on it and wait for the next one to come along that does.
The industry story remains similar to recent quarters, where we're seeing the effects of the tightening lending market, namely reduced private equity competition, fewer 1031 buyers and sellers who are much more accommodating on compressed closing schedules and other nonprice deal terms. Both developers and operators are more willing to engage with FCPT on portfolio opportunities than in prior years.
We've also seen cap rates improve a great deal over the past several months as a reaction to the higher interest rate environment. There are opportunities for some really interesting portfolios that would have been priced 100-plus basis points tighter a year ago. Pricing has not moved enough in our view but pressures building on sellers is institutional net lease investors are largely holding the line and passing at current cap rates. We expect cap rates to move up over the short term in the absence of meaningful interest rate movement.
We've been asked recently by some investors, what is the most interesting acquisition opportunity for Four Corners right now. The answer is the same, down the middle of the [fairway] deals we've been doing for years but at more attractive pricing and even stronger tenant credit than previously available in our cap rate range.
Josh, I will turn it over to you to discuss dispositions and re-leasing.
Joshua C. Zhang
Thank you, Patrick. We sold 3 Red Lobster properties in September and early October that were underperforming versus brand average for $15 million, representing a small gain. We had these dispositions in the works for several months, and it was just happened since that they lined up with the right buyers at similar closing time lines. These stores were underperforming relative to others in our portfolio, and we are maintaining our discipline of proactive portfolio management housekeeping to sell them at an attractive exit price, particularly when we have ample opportunities to redeploy the proceeds to further diversification at a positive spread.
Turning to leasing. Since inception and through the end of the third quarter, we've had 81 leases reached term expiration. Of these, 72 leases were almost 90% were renewed by the existing tenants and another 7 over 8%, were released to new tenants, many of with a positive rent spread and/or credit upgrade. Of the 81 only 2 remain vacant. The existing tenant is often the best candidate to continue on at a site, but in certain cases where there's a higher and better use or rents are well below market, we have been able to capture that positive rent spread and create meaningful value. We have no lease expirations in the portfolio for the remainder of 2023 and less than 2% of the rent stream is maturing in 2024.
Gerry, I'll turn it over back to you.
Gerald R. Morgan
Thanks, Josh. For the third quarter, our cash rental revenues grew 12.3% on a year-over-year basis, including the benefit of rental increases and $439 million of acquisitions in the last 12 months. We reported $56.1 million of cash rental income in the third quarter after excluding $1.2 million of straight-line and other noncash rental adjustments. And on a run rate basis, our current annual cash base rent for leases in place as of quarter end is $215.3 million, and our weighted average 5-year annual cash rent escalator remains at 1.4%.
We collected 99.9% of base rent for the third quarter and there are no material changes in our collectability or credit reserves, nor any balance sheet impairments. Cash G&A expense, excluding stock-based compensation, was $4 million, representing 7.2% of cash rental income for the quarter. We continue to expect cash G&A will be approximately $16 million for the year. And as a reminder, we take a very conservative approach to G&A and expense 100% of the costs associated with our internal investment program.
We generated AFFO of $0.42 per share. Results were in line with expectations but were impacted by higher interest expense on the $80 million of term loans that are unhedged and on the revolver balance. We also experienced a slight uptick in nonreimbursed property expenses from higher abandoned deal costs as we adjusted our deal pipeline to the rapid increase in treasury rates.
With respect to the balance sheet at quarter end, we held $6 million of unrestricted cash, $11 million of 1031 proceeds available to redeploy and have $220 million of undrawn revolver capacity. In total, that gives us $237 million of available capacity at the quarter -- as the fourth quarter begins.
In the third quarter, we funded the $130 million of acquisitions with cash on hand, the $100 million private note offering that funded in July and $15 million of net revolver borrowings. On overall leverage, our net debt to adjusted EBITDA in the third quarter was 5.6x and our fixed charge coverage ratio is a healthy 4.7x. We remain focused on maintaining a conservative balance sheet and extending and layering our debt maturities.
Our only debt maturity before November of 2025 is a $50 million private note due in June 2024. And otherwise, our net -- next debt obligation is $150 million of term debt due in November 2025.
And with that, we'll turn it back over to Lauren for investor Q&A.
Question and Answer Session
Operator
(Operator Instructions) Our first question comes from Rob Stevenson from Janney Montgomery Scott.
Robert Chapman Stevenson
Can you talk about what you're seeing in terms of the differential, if any, between cap rates for restaurant assets that you'd want to own and add to the portfolio in the non-restaurant, medical and auto assets? Any real gap there?
William Howard Lenehan
Not really. It's, I think, really being driven by rates and availability of credit and that affects not just all net lease but all real estate generally.
Robert Chapman Stevenson
Okay. So if those are on top of one another, how are you thinking about it today in terms of at the same return, whether or not you do the incremental restaurant asset or nonrestaurant assets to diversify the portfolio, given the scarcity of capital these days?
William Howard Lenehan
Yes. It's really about scoring the assets, Rob, which is a process and model that we've had in place now for years. And so we really look at properties, and we're thinking more of this one's an [80] and this one is [74], and the model really builds in our preferences for different building types and not to get too into the weeds but there tends to be more prevalent for double-net buildings or double net leases in auto service. So if anything, maybe a little bit of preference to stay away from that or ensure that we've got a brand-new roof.
Robert Chapman Stevenson
Okay. And then, Gerry, anything that we need to be thinking about in terms of FFO going from third quarter to fourth quarter beyond acquisitions and dispositions, the impact of higher rates and any capital raising you do, anything sticking out is that abnormal between either the third or fourth quarter that we need to take into consideration?
Gerald R. Morgan
No, not really. I think as you highlighted the one item that's variable and that is what is the interest rate on the unhedged portion of our debt, which is $80 million of term loans and whatever the revolver balance is. Otherwise, typically, the fourth quarter is a fairly normal quarter "from a G&A perspective". We don't have big proxy costs or other things like that. And generally, nothing that we see on the horizon with respect to property expenses that would be larger in the fourth quarter.
Operator
Our next question is comes from Anthony Paolone form JPMorgan.
Anthony Paolone
Maybe I'd like to start with just how you're thinking about where spreads need to be compared to your weighted average cost of capital? Because I know cap rates are expected to go up, your capital costs have gone up. But just trying to understand like if you're looking at this in terms of a target spread or just what would get you to do something or make sense?
William Howard Lenehan
Yes. We don't have specific number that is in the bullpen of our acquisition group that they know specifically. We're looking -- we're calculating our cost of capital, which really today is our cost of equity, frankly, because the debt markets are so dislocated. And then comparing how we think about the quality of our portfolio versus what we're buying. So we don't get into specifics for competitive reasons but I think our view is, we have this mental model that we've taken most people through of sort of the green zone, yellow zone, and red zone. Our stock is right now right at the bottom of the yellow zone. It's gone up a little bit in the last couple of days.
So we're pretty cautious and that's a mental model we've had, again, since inception. In preparing for this call, I went back and read transcripts our from 2016, our first handful of conference calls. And what I would say is our thought process about this business is remarkably similar to where it was then.
Anthony Paolone
Got it. I mean -- and so just to kind of push a lot just to understand your capital cost and how you're thinking about it, when you say your equity -- or should we be looking at just the inverse of your multiple, like a longer-term number and quite cap rate, like what's the most important to you on that front?
William Howard Lenehan
Yes. We triangulate different methods. We typically look at the inverse of the multiple adjusted for some cost to raise money. Unfortunately, raising money has some minor costs associated with it even if you use the ATM. So that would be a good way to look at it. Go check that with cap rate would be probably even better.
Anthony Paolone
Okay. And then in terms of thinking about the balance sheet capacity up in the high 5s right now, any appetite to push a bit above that? Or you really need to wait and see where cap rates at all?
William Howard Lenehan
Yes, I would say a different analysis than when you're borrowing your revolver was 3% or 2%. Now borrowing on your revolver is expensive. And so unless you have some crystal ball that says rates are going to dramatically decline, in the future. And frankly, if we had that crystal ball, we wouldn't be buying buildings for a living, we'd be trading derivatives. Is that borrowing on your revolver to buy buildings isn't the sort of artificially accretive game plan that REITs had in the past. So I think the way to look at it is cost to equity.
Gerald R. Morgan
And I would just add, I think we have been pretty consistent, Tony, that we want to keep our leverage below 6x. And that doesn't mean that it can't go up periodically above 6x for good reasons. I think what Bill is highlighting is, right now, I'm not sure there's good reasons to go above 6x this leverage.
Anthony Paolone
Okay. Got it. And then just if I can get one last one in here, just to follow up on Rob's questions. And you mentioned just no real difference between restaurant returns and some of the other product types. There's a lot of discussion around GLP-1 drugs and restaurants. Like if they're about the same, like do you find it's still worth taking the tail risk there? Or how do you think about that if at all at this point?
William Howard Lenehan
Yes. I'm certainly not an expert on the GLP-1 drugs but we've been doing our homework on the implications. Our current view is that the semi-regulated drugs may lead to some minor behavioral changes might have some minor effect on our tenants' businesses. But that's why we have conservatism in our underwriting model. I don't think it's a major concern. We're buying buildings with very long-term leases. It allows our tenants to adapt their business if there is some sort of behavioral shift. And I think we're going to own these buildings for decades.
So we want to look long term and not be knee jerk in our reactions based upon what's sort of trending. So we're not dismissive. I think it's a great question. We really put our head down on this issue. We've actually brought in experts to advise us on this. And at the current moment, even sort of adjusting for what will certainly be a lower cost, probably consumable versus injectable, probably with lower side effects in the future, we don't think it's a major concern. But we're monitoring.
Operator
Our next question comes from Jim Kammert from Evercore.
James Hall Kammert
I was noodling on your medical retail deck you put out this week. And I was just curious, as a general rule, obviously, emergency rooms, urgent care, have higher per square foot investments and rents. But how much of that improvement in those types of assets would Four Corners paying for versus the tenant? I just want to understand how that split if possible.
William Howard Lenehan
Yes, it's a mixed bag. I would say we reject the basic premise that some market participants hang their hat on, which is the tenant should be able to get out the entirety of their construction costs and the sale leaseback that, that's sort of a rule of thumb that some people follow that we don't. But I would reiterate what you said, which is that these are real costs. So this is -- these are improved buildings. They are expensive to improve. It's something that we watch closely. I would say the higher construction costs come back to us as rents. And we have a demonstrated track record of being very rent-sensitive. Our model is 25% to 30% rent-related factors and it's something that we're in particularly focused on in medical.
So I don't have a precise number because it's all across the board, everything from ground leases where you have none of the construction cost to some of the larger facilities that are brand new, where you're bearing a majority of the construction costs but not all. But it's something that we focus on in our underwriting. I would draw a distinction of medical retail to some other forms of net lease, where you're in at a substantial premium to any reuse scenario and sometimes maybe double what any reuse would be. And those are the kinds of transactions we've really stayed away from.
And maybe to circle back to Rob's question about the distinction between restaurant and other forms and at least we look at. What I would say is where we've seen the most cap rate move is in the kinds of buildings that we were not buying before, experiential retail, new concepts, brands, banking new brands with no track record, highly specialized use buildings, things of that nature.
James Hall Kammert
Okay. Very good. And just circling back a cleanup on the Red Lobsters, are you pretty much done on that sort of culling, and can you remind me, are there remaining assets largely under master lease?
William Howard Lenehan
They are and the ones that aren't are very well covered. We have a couple of properties still in the market, but I don't think it's a major item. We had success selling what we wanted to sell. There's a couple more out there. But again, what remains is a very high quality and mostly in a master lease. And Red Lobster is doing better.
Operator
Our next question comes from Connor Siversky from Wells Fargo.
Connor Serge Siversky
Maybe just another one on the medical retail presentation. I appreciate the detail in that presentation. So you described the scoring criteria you use for restaurant and other net lease assets. I'm wondering if you apply the same kind of scoring system to these assets, which might be a little more esoteric in nature. And then with that scoring system in play, is this potentially where you think you could find maybe higher yields on acquisition that would screen more favorably against the cost of capital as it sits today?
William Howard Lenehan
Yes. Great question. So I would say that our scoring model for restaurants has a north of 80% overlap with how we think about medical lease term credit, rent per square foot rent growth, is the lease truly triple net, et cetera, et cetera. Those are very similar between the different property types. The locations are similar between the property types. As far as finding higher yield, we're really not focused on thinking about the world that way. We are trying to find high-quality properties at a yield that pencils, not -- here's our cost of capital today, and Pat and Josh go find things that are north of that and we'll convince ourselves that the risk is acceptable. So we really look at the world a different way, which is focusing on quality and making sure that what we buy, we're very happy with because we're going to live with it for a long time.
Connor Serge Siversky
Got it. Understood. And I know it was touched on earlier, again, in the context of the cost of capital as it sits today but at the margin for any acquisition, how should we be looking at that funding mix or modeling that funding mix?
William Howard Lenehan
Well, I think for now, equity would be the primary. We have 1031 exchange proceeds as Gerry mentioned, sitting on our books. So those need to be used. We've obviously considered that and made appropriate high-quality acquisitions in our pipeline. But what I would say, as Patrick alluded to, this is the most target-rich acquisition environment that we've had since inception. There is very good stuff to do. Pricing is coming our way. It's just not there yet with the stock price that we have.
So to the extent that you see our stock price rebound, you will see us aggressively torque the business to take advantage of very attractive acquisitions. But today, if we acquired assets at our stock price, we would be buying buildings for practice. And we bought 700 buildings and since inception, we don't need to practice.
Operator
Our next question comes from [Alex Hogan] from Baird.
Unidentified Analyst
The first one is what's the baked in earnings growth for 2024 if Four Corners does nothing on the external front.
William Howard Lenehan
We don't give earnings guidance, but what I would say is that the primary factor in driving earnings growth in our business is the annualization of assets purchased in the year prior. We have 1.5% rent bumps -- 1.4% rent bumps. We're pretty conservative on G&A. We have a little bit of floating rate debt, but most of it is fixed. So the primary driver is the timing of acquisitions throughout the year. So we've tended to be back-end loaded. This year, we are front-end loaded.
But the primary is annualization. We don't give guidance. We try to stay away from that because it sets perverse incentives, but it's pretty easy to calculate where we stand. And what I would also say as given our disclosure regime of announcing every property bought or sold the day occurs, you can follow in almost real time what that progress looks like.
Unidentified Analyst
Okay. Helpful. Second one, kind of 2 parts but will you look to sell more assets over the near term? And is the spread between where you guys can buy and sell either widening or contracting?
William Howard Lenehan
Well, I would say it's probably widening a little bit because our existing portfolio is largely investment-grade, very high-quality properties. That's what's financeable in the world today, if anything is financeable. And so -- and we have properties in 47 states. So we get to meet the 1031 exchange buyer where he or she lives. We have sold assets in the past. It's never been a large portion of our business. I don't think today, it's a huge focus of ours. But if approached, we always are thoughtful in responding. And to the extent that we want to do some culling as you've seen with some of the Red Lobsters, we've been able to do that at pricing higher than what we purchased the properties for.
Unidentified Analyst
And the last one for me. You mentioned Red Lobster is doing better. Are there any other tenants on the watch list? And has it changed much since the beginning of the year?
William Howard Lenehan
No.
Operator
(Operator Instructions) And we have no further questions. So I'll now hand back over to Bill for closing remarks.
William Howard Lenehan
Great. Thank you, Lauren. Thanks for the robust questions. Specifically, thank you for being interested in our medical research report. A lot of good work went into that. If you have follow-up questions, please reach out. We'd love to continue the dialogue. Thank you.
Operator
This concludes today's call. Thank you for joining. You may now disconnect your lines.
