National Retail Properties (NNN) gave a glimpse as to what to expect in the months following COVID-19. NNN collected only 52% of April rent, and noted that there are a sizable amount of tenants choosing not to pay rent. NNN does not anticipate any change to their investment strategy or leverage profile as a result of COVID-19. Its dividend policy now faces a dilemma between preserving the 30 consecutive years of growth versus financial flexibility. I rate shares a buy on account of its strong balance sheet and valuation.
National Retail In The Age Of COVID-19
Adjusted FFO grew 4.4% to $0.71 per share, but I don’t think anyone really cares about pre-coronavirus numbers. NNN announced that it has collected 52% of April rent, and tenants representing 37% of rent have requested rent deferrals of 1-3 months which would be repaid between 2020 and the end of 2021. NNN noted that they have for the most part been able to collect rent from their 19% investment grade roster. NNN estimates that for the number of open tenants, “it’s probably around close to maybe half, half, fully open and another 30% or so percent maybe partially open and quarter maybe fully closed but that’s anecdotal. Those are very rough numbers.” I now discuss some key takeaways from their earnings call.
Expect A Legal Fight
As mentioned above, NNN is already working on deferred rent agreements with a significant amount of its tenant base. NNN noted that the vast majority of non-paying tenants that haven’t reached deferred rent agreements seem to be able to pay rent, but are choosing not to. Some of their language surrounding these tenants suggested some uncertainty as to whether or not they will eventually be paid:
“But we’re still in dialog with those folks and optimistic maybe too good or too strong of a word at the moment but certainly hopeful, probably optimistic that a lot of that will get turned into a payment at some point.”
It appears that there are many tenants who not only want to defer rents, but also want to avoid paying rent altogether. I do not expect NNN to forgive rent so easily, and investors should expect extended legal battles across the retail REIT space for many months following COVID-19. It is very possible that landlords like NNN decide to settle and accept partial payment of rent. The takeaway is that AFFO per share is almost guaranteed to decline in 2020.
Don’t Expect Tenant Concessions For Rent Deferrals
Many investors may have hoped that in exchange for deferred rent, NNN (and other retail REITs for that matter) would be able to get something in return, such as lease extensions or even some interest income. In the case of NNN, that doesn’t seem to be the case. Management specifically said: “What we wanted to do at this moment, while things are moving so fast, is to just deal simply with short term rent deferrals that, as Kevin talked about, get paid back relatively soon and relatively fast. And so we did not look at this initial situation as something that we wanted to, again, try to push more onto our tenants. We just wanted to work with them at the moment and deal with these short term deferrals.”
Management also repeatedly stated that they “are not looking to punch anybody in the nose in the middle of this unexpected unforeseen disruption.” It does not appear that NNN has much leverage nor any desire to impose such leverage on its tenants during these difficult times.
No Change To Investment Strategy Or Leverage Profile
It’s become clear that investment grade tenants have proven to be more dependable rent payers during these times. That said, management stated that “it so far hasn’t changed our view that we should migrate to more of those properties, which have a lower initial yield, lower growth and lower price per property.”
Management was also asked if they would maintain a lower leverage profile coming out of COVID-19. Management indicated that while lower debt and higher liquidity is always good, they feel “comfortable” about their current leverage profile.
I was surprised by the lack of motivation to change either the investment strategy or leverage profile – perhaps NNN doesn’t think that we’ll see another pandemic, or doesn’t think that the economy will behave in the same way in the future. I anticipate many peers like Realty Income (O) to seek a lower leverage profile and higher investment grade tenant roster moving forward.
Is The Dividend At Risk?
Dividend investors love dividend growth track records. That is to say, if NNN were to cut the dividend this year then raise it next year far and above prior levels, some investors would view this as inferior in comparison to consistent increases. NNN acknowledged that they would like to maintain their track record and that one or two quarters of cash flow deficit wouldn’t cause them to cut the dividend:
“Our dividend policy is not set on the basis of one or two quarters but rather on what we think is reasonably sustainable over the longer term.”
Perhaps a key caveat was their stating that the dividend is “not sacrosanct,” which contrasts from Realty Income’s dividend policy. I personally would not mind a dividend cut, as I view dividend track records as being backward-looking judgment of business model quality and not reflective of forward dividend safety.
Valuation And Price Target
NNN trades at 11 times 2019 AFFO and a 6.6% yield. I’ve already mentioned that AFFO is very likely to dip in 2020 due to inability to collect all rents. That said, NNN has no near-term debt maturities and over $1 billion in liquidity. I am confident that NNN has the financial capacity to survive through this pandemic. My fair value estimate is $51, representing a 4% yield. At that price, shares would be priced for 7-8% total returns assuming no multiple expansion or contraction. Shares have 70% total return upside to that target.
Risks
I’ve already mentioned the likely risk that NNN will not be able to collect rent from non-payers. NNN may also decide to cut its dividend if collected rents lead to too steep of a cash flow deficit moving forward. I am optimistic on NNN due to their strong balance sheet, but this pandemic has proven to be highly disruptive on the economy – if the pandemic worsens, leading to further economic damage, then NNN may see widespread vacancies. NNN is likely to need to dispose of vacant properties at high cap rates, which will be dilutive to its bottom line.
Conclusion
NNN reported a solid quarter and management appeared to be very candid on the earnings call. It is clear that past dividend track records do not matter in light of COVID-19, as the ability to collect rent is not guaranteed. NNN has not indicated that they intend to maintain a lower leverage profile or higher investment grade tenant roster moving forward. In spite of the unclear near-term trajectory, I remain bullish on NNN due to the lack of near-term debt maturities and ample liquidity. I rate shares a buy.
(Tipranks: Buy NNN)
25 Stocks I Like More Than NNN
NNN is only rated a buy – the Best of Breed portfolio features over 25 stocks rated strong buy or even conviction buy.
Some investors start by looking at valuation with a stock screener, and from these cheap companies try to find any that they can justify buying. I instead start with an assessment of quality, and only from the highest quality companies do I begin to search for value. My goal is to not only beat the market but to also do so with a high success rate.
Disclosure: I am/we are long NNN, O. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: DISCLAIMER: Julian Lin is not a Registered Investment Advisor or Financial Planner. While the information in his articles and his comments on SeekingAlpha.com or elsewhere may seem like financial advice, it is not, and it is provided for information purposes only. Do your own research or seek the advice of a qualified professional. You are responsible for your own investment decisions.
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