NetSTREIT Corp.

Ladies and gentlemen, good morning and welcome to the NetStreetCorp first quarter 2024 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star and zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Amy Ann, Investor Relations. Please go ahead.

We thank you for joining us for NetStreet's first quarter 2024 earnings conference call. In addition to the press release distributed yesterday after market close, we posted a supplemental package and an updated investor presentation. Both can be found in the Investor Relations section of the company's website at www.netstreet.com. On today's call, management's remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risk and uncertainties that may cause actual results to differ from those discussed today. For more information about these risk factors, we encourage you to review our Form 10-K for the year ended December 31, 2023, and our other SEC filings. All forward-looking statements are made as of the date hereof, and NetStreet assumes no obligation to update any forward-looking statements in the future. In addition, certain financial information presented on this call includes non-GAAP financial measures. Please refer to our earnings release and supplemental package for definitions of our non-GAAP measures, reconciliations to the most comparable GAAP measure, and an explanation of why we believe such non-GAAP financial measures are useful to investors. Today's conference call is hosted by NetStreet's Chief Executive Officer, Mark Manheimer, and Chief Financial Officer, Dan Donlan. They will make some prepared remarks, and then we will open the call for your questions. Now, I'll turn the call over to Mark. Mark?

Thank you, Amy, and thank you all for taking the time to join us this morning on our first quarter 2024 earnings call. First, I want to extend my thanks to the NetStreet team. Our strong start to the year would not have been possible without their fantastic work. We kicked off the year as one of only two REITs to raise follow-on equity in January while also remaining active on our ATM program. We have raised nearly $230 million of equity year-to-date, which gives the team ample dry powder to transact at our current investment pace through year-end. Due to a drastic decrease in competition, we are continuing to pursue investment opportunities at attractive prices. The team remains diligently focused on investing in properties with the strongest tenants in defensive retail sectors that heavily rely on their physical locations to make profit. We continue to see great opportunities with not only investment-grade tenants, which now make up a sector-leading 71.1% of our portfolio, but also with investment-grade profile tenants and low-risk, sub-investment-grade and unrated tenants. And while the buyer pool has thinned, we also continue to execute on strategic dispositions to lower our concentration in certain tenants and or recycle the capital into investments with longer leases and better rent escalations. In the first quarter, we completed over $129 million of gross investment activity at a blended cash yield of 7.5%, a 30 basis point sequential quarter-over-quarter increase. Acquisitions closed in the quarter were with strong nationally recognized tenants such as Tractor Supply, Dollar General, and Bridgestone Firestone, to name a few. From a tenant perspective, 84.8% of our investments completed in the quarter were with investment-grade tenants, which includes the completion of 10 new developments. Moving to our disposition activity, we sold 12 properties for $21.6 million at a 6.8% cash yield in the quarter. These properties were leased to tenants in the dollar store, drugstore pharmacy, discount retail, and convenience store industries. At quarter end, our portfolio consisted of 628 investments with an ABR of $140.3 million. Our 88 tenants operate in 26 industries across 45 states, with 84.4% of our portfolio leased to investment-grade or investment-grade profile tenants. Our focus on long-term leases and high-quality tenants has provided us with a favorable lease expiration schedule. For example, subsequent to quarter end, we renewed the one lease that was expiring in 2024 for a 12.5% increase in rent. Looking out to 2025, We have 1.8% of ABR expiring, which our team is actively addressing. We currently expect these expirations to have a positive impact on our cash flow and our portfolio weighted average lease term. We believe our high credit quality and minimal lease expiration risk in the near term provides stability of our cash flows. Turning to recent tenant headlines, I wanted to provide some commentary as it relates to Dollar Tree and their concentration within our portfolio. In March of this year, Dollar Tree, who acquired Family Dollar in 2015, announced that they intend to close several stores across the country, the bulk of which will be Family Dollar branded stores. This was not a surprise to us, as we have been addressing our Family Dollar locations via asset sales and proactive lease extensions over the past few years. With that in mind, we currently own 19 Family Dollar branded stores, which comprise 1.4% of our ABR. Two of those stores, or 13 basis points of our ABR, have a lease that expires within five years. We would also note that in the last 12 months, we extended the initial lease terms of 10 stores, with the seven remaining stores having leases that were already long-term in nature. As such, we are confident in the productivity of our stores, and we were pleased to see none of our locations among the 103 Family Dollar stores on the initial closure list. Our relationship with Dollar Tree is strong, and we plan to continue working with them to minimize risk and maximize cash flows for our investors. Before I turn the call over to Dan, I wanted to reiterate a couple points as it pertains to our balance sheet portfolio and tenancy. While there are multiple reported cross-currents as it pertains to the health of the economy and the U.S. consumer, we believe our portfolio and tenant focus are well positioned to weather a prolonged negative impact in consumer spending, as well as provide a robust opportunity set from which to grow should economic growth remain stable. Similarly, our low leverage and well-capitalized balance sheet provides us with sufficient capacity to grow externally should the capital markets remain volatile, while also allowing us to remain highly competitive and opportunistic on the investment front should the environment for spread investing improve from current levels. With that, I'm going to turn the call over to Dan to discuss our key financial highlights for the quarter.

Thanks, Mark. Looking at our first quarter earnings results, we reported net income of $1 million, or $0.01 per diluted share. Core FFO for the first quarter was $22.5 million, or $0.30 per diluted share, and AFFO was $22.9 million, or $0.31 per diluted share, which was a 3.3% increase over last year. Turning to the expense front, we saw total G&A x one-time severance payments decline 1% year-over-year to $4.85 million. while our cash G&A X one-time severance payments declined 11% year-over-year to $13.4 million. In addition, with our total quarterly G&A X one-time severance payments representing 13% of total revenues in the quarter versus 17% of total revenues in the prior year quarter, our G&A continues to steadily rationalize relative to our revenue base. Turning to the balance sheet, our total adjusted net debt, which includes the impact of all forward equity as of quarter end, was $395.1 million. Our weighted average debt maturity is 3.9 years, and our weighted average interest rate is 4.36%. Including extension options, which can be exercised at our discretion, we have no debt maturing until January 2027. During the quarter, please note that we drew the remaining $100 million on our 2029 term loan. As Mark mentioned, we were active on the capital markets front this quarter. Utilizing the constructive match for backdrop that existed in early January, we sold over $198 million of forward equity at $18 per share in a follow-on offering. Additionally, we have remained optimistic with our ATM program with the year-to-date forward sales of $31 million through the end of April, including $2 million sold in March. At quarter end, our liquidity was $638.1 million, which consisted of $22.3 million of cash on hand, $324.9 million available on a revolving credit facility, and $290.9 million of unsettled forward equity. Including the $28.7 million of unsettled equity from our April ATM activity, our pro forma liquidity at quarter end was $666.8 million. Turning to leverage, our adjusted net debt to annualized adjusted EBITDA RE was 3.1 times at quarter end, which remains well below our targeted leverage range of 4.5 to 5.5 times. Furthermore, Adjusting for our April ATM activity, our pro forma leverage declines to $2.9 million. Given this forward equity cushion, we can modestly exceed our 2023 net investment activity level and still end the year below the low end of our targeted leverage range with no additional equity required this year. Moving on to guidance, we're increasing the low end of our 2024 AFO per share guidance to a new range of $1.25 to $1.28. In addition, we continue to expect cash G&A to range between $13.5 and $14.5 million, which is exclusive of transaction costs and one-time severance payments. Lastly, on April 23rd, the Board declared a quarterly cash dividend of $0.205 per share. The dividend will be payable on June 14th to shareholders or record as of June 3rd. Based on the dividend amount, our AFFO payout ratio for the first quarter was 66%.

With that, Operator, we will now open the line for questions. Thank you.

Ladies and gentlemen, we will now be conducting a question and answer session. If you would like to ask a question, please press star and 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star and 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Ladies and gentlemen, we will wait for a moment while we poll for questions. Our first question is from the line of Handel Shrain Just with Missouri Securities. Please go ahead.

Hey, good morning to you guys. Morning. So my first question, I guess, is on how should we interpret or what should we extrapolate from the first quarter activity and what it means for your capital deployments? over the near term. You've mentioned a few times that you can continue to buy at a sustainable pace without getting above your leverage metrics. But I'm curious how we should be thinking about cap rates and spreads here. Are they indicative of where your cost of capital allows you to buy high grades in the current market? Thanks.

Yeah, sure. I mean, I think with our current cost of capital and the opportunity set that we're seeing, I think you can expect us to continue to deploy at a pretty similar pace as far as what to interpolate out of what we've acquired. So far this year, I think it looks a lot like what we've acquired over the past several quarters. Investment grade spreads and non-investment grade spreads have certainly gotten a lot more attractive than what they were Historically, you know, on the non-investment grade side, you know, we've really focused on the very healthy non-investment grade tenants and industries that aren't facing a lot of headwinds with real estate that we think is fungible and rents that we think are replaceable, whether they be non-investment grade or just an investment grade profile. I think you may see, you know, some more opportunities on the Southeast back side for the remainder of the year. Certainly in the second quarter, you know, we see a few of those. that we think are pretty attractive. We'll see if we get there in pricing, but I think you could see up to, you know, as much as half of what we do in the second quarter kind of fit some of that bucket. But, you know, really seeing a lot more attractive opportunities on the investment grade side and the, you know, what I call kind of the healthy non-investment grade side.

Yeah, and Handel, it's Dan. As we think about kind of future equity raising or debt raising, look, we've raised what we want to do for the year and, frankly, through the first quarter. So we can afford to be fairly patient and see if the market comes to us, whether it's on the capital side or if the opportunity set gets more attractive in terms of higher yields. So, you know, that's why we are where we are with the capital position is we want to be able to be opportunistic if something comes available and we've got plenty of time to write out, you know, whatever, you know, this capital markets environment may be over the next, you know, three to four quarters. Got it. Appreciate that.

Maybe the follow-up. just a bit more on how you're thinking about your ability to achieve your target, you know, 75 or 100 basis points of spread here. Should we, I guess, expect you to continue using maybe more term loan versus, you know, kind of given where the spot cost of a 10-year unsecured debt here is?

Yeah, I mean, look, right now at just north of $2 billion in gross assets, you know, looking to the 10-year market is not nearly as efficient as doing is looking to the bank term loan market. That being said, where we are today with all the forward equity that we have, $320 million, you think about the pace that we're on, our near-term capital needs will easily be able to be covered by the forward equity as well as our credit facility. We're really not looking to do anything longer term in nature until we get out to early to mid-2025 and We'll just have to see where the market is for term loans, for seven-year private placements, 10-year private placements, whatever it may be. Thankfully, we have the capital right now not to have to concern ourselves with that right now. Got it, got it.

My second question is on big lots. I just wanted to check in. They're not in your top 10 tenant list anymore. I'm curious if you're selling what the market is and just generally where you'd like that exposure to get to. Thanks.

Yeah, sure. Thanks, Andel. Yeah, no, like, I mean, you know, we continue to monitor what's going on with Big Lots. You know, they closed 48 stores last year, none of, you know, which are ours. They also opened another 15. You know, it looks like they've, you know, finally right-sized inventories, starting to now finally see improvement in margins. Their cost-cutting appears to be helping, but at the end of the day, we really need to kind of see the sales bottom out and hopefully start to increase versus the you know, have full confidence in their turnaround. So, you know, we're really relying on, you know, the strong real estate that we've got left after, you know, selling off, you know, a handful of those locations. You know, now we've got locations with below market rents and attractive infill retail corridors. And so that's really our ultimate, ultimate backstop. But we're, you know, we're open to potentially selling some more. We just don't feel like we have to be price takers, you know, with how attractive the real estate is that we're left with. There continues to be a market for those assets. I think, you know, we'd really like to see, you know, cap rates be a little bit more aggressive for us to pull the trigger. But we've got, you know, a couple of feelers out in the market. So I would not be shocked to see us, you know, move a couple more.

Great. Appreciate the call, guys. Thank you. Thank you. Our next question is from Smithers Rose with Citibank.

Please go ahead.

Hi, thank you. I think since your last call with investors, you know, there's this narrative of kind of just, you know, higher for longer has taken hold. And I was just wondering if you could talk about what you're seeing in terms of seller pricing. Do you think there's more people just retreating at this point, given what I assume is an upward bias in cap rates, or maybe just talk a little bit about the landscape of what you're seeing?

Yeah, sure. No, it's certainly an interesting market. It does feel like the expectations have been muted on a lot of cuts coming. We started the year with the expectation, at least from the market, that we'd see six or seven cuts during the year, which is largely why we raised some equity, because we kind of didn't see the macro quite the same way. But the seller market at that point in time was still, you know, really kind of banking on, you know, those rate cuts coming. Now, obviously, I think the, you know, the consensus is that, you know, we might get one in December or nothing at all. And so I think there's been a little bit more of an acceptance that, you know, we could be in a higher for longer market. We've seen a lot more actually opportunities than I would have expected. And that really keeps a lot of our competition on the sidelines. It allows us to be very selective, allows us to really negotiate terms the way we like to see them, where we're not really competing against other people that are trying to buy the assets that we are. So, yeah, I mean, cap rates have continued to move up. What we're seeing in the second quarter, I think, will likely look a lot like the first quarter. But, yeah, I think there has been a little bit more of an acceptance that you know, the Fed's not going to turn around and just start cutting rates and bring us back to 2021.

So, sorry, you said second quarter cap rates should be kind of in line with what you saw in the first quarter, or you think it'll be, or you meant the sequential increase will be similar?

You know, I think the rates will be similar in the second quarter than the first. You know, we still haven't, you know, depending on what closes, you know, we're still sourcing a few more opportunities in the second quarter, but kind of what we have in the pipeline today looks pretty similar. Although the lease term, we're getting much longer lease terms with better rental increases.

Okay, thank you. Thank you.

Our next question is from Greg McGinnis with Scotiabank. Please go ahead.

Hey, good morning. On the acquisition side, I'm just curious, do we kind of expect to see more the same in terms of what you're looking to target from a concept and industry standpoint, or are there any kind of new concept industries out there that, given your cost of capital, maybe you're now able to address, or where cap rates have changed, you're now able to address, or I guess just any changes in terms of industries that you're targeting?

Yeah, sure. And so, I mean, you've seen, you know, specific mostly to dollar generally, you've seen that concentration increase. move up quite a bit. A lot of that was funding developers that we committed to, you know, last year. So I think we've got maybe another, you know, call it four or five months left of kind of funding some of that. But that's going to be a little bit less than what you've seen, you know, in the past. You will see a few new tenants, you know, come into the portfolio. We do think it's important for us to increase the diversification, not only in the top 20, just, you know, just broadly across the portfolio. And we are seeing some attractive sale effects and other opportunities that we had in the past. There's a few that we've been active with on the development side that maybe haven't popped into our top 20, but are kind of getting close there in the collision space. So I think you will see a few new tenants pop into the portfolio that I think we find to be very attractive and cap rates would have been much lower, call it 18, 24 months ago, that we would not have been able to put in the portfolio.

Okay. And then on that development side, I believe you previously mentioned that you've been able to negotiate escalators into some of those development deals that previously didn't have them. Have there been any other changes on the leasing side in terms of being able to build in escalators or different terms as the financing market has changed?

Yeah, I mean, I think, you know, not much of a change quarter over quarter, but, yeah, I mean, we're getting, you know, better rent escalators in leases that historically had been flat. So that's driven a lot of our capital recycling program, you know, bringing in some of those tenants with now longer leases with better rent bumps and then turn around and selling, you know, some of the flat leases with less term, you know, out of the portfolio and being able to do that, you know, slightly accretively has been something that we've focused on. But no real big change quarter over quarter.

Okay, thanks. And final for me, apologies if you already addressed this, but have you guys talked about bad debt expectations built into guidance for the year?

Yeah, we did on the last call. I think as we sit here today, you know, we're still on an annualized basis. We're still modeling somewhere between 20 to 25 basis points at the high end of our AFFO guidance range.

Okay, thank you. Thank you. Our next question is from the line of Alec Fagan with Baird.

Please go ahead.

Hi, thank you for taking my question this morning. First one for me is, can you just talk about what are the categories that are in the assets held for sale?

Yeah, it's a pretty big mix. We've got some of the big lots are in there and a lot of the dollar stores that I mentioned where we're kind of recycling through to improve the escalators, but it's a pretty broad mix of property type.

Got it. Thank you. Second one is may provide some color on the current in-place rents for the 19 family dollar stores in the portfolio and where you think the market is at for those properties if you did need to release them.

Yes, I mean, you're talking about, you know, $90,000 to $100,000 per property, so in annual rent, so very inexpensive rents that we think are largely replaceable. That being said, you know, we've worked very closely with the tenant there in understanding the profitability and their commitment to our site, so we still feel good that there's, you know, you know, They could always close, you know, a couple, you know, if they're going to close as many stores as they're talking about. But, you know, certainly pleased to see, you know, their first list of 103 locations that none of ours were on that list. But that being said, you know, we do think that, you know, a lot of ours are pretty infill locations and we would have a lot of interest from, you know, various different tenants to take those assets at similar rents or potentially even higher rents.

Got it. That's helpful. Thank you. Thank you.

Ladies and gentlemen, a reminder, if you wish to ask a question, please press star and 1. Our next question is from the line of Joshua Dennelang with Bank of America. Please go ahead.

Hi, this is on behalf of Josh. I wanted to know if you could touch on what you're seeing in investment spreads relative to where you can deploy capital today.

Yeah, sure. I mean, you know, I'll take the first piece, which is, you know, we, you know, most recent quarter, we're at, you know, seven and a half. I think you're going to kind of expect that to be similar in the second quarter. You know, we really only have visibility going out, you know, into the second quarter and, you know, not as far as, you know, getting into the third. So tough to project, you know, beyond that. But, you know, certainly gives us a pretty healthy spread off of where we raised capital earlier this year.

Great. And I know you already touched on big lots and family dollar. I was curious if there's any other color on tenant watch list.

Yeah, sure. I mean, nothing on the watch list, but to give you a little bit more color than that, I mean, we are focused on the product mix of our tenants, how discretionary that product mix is and who their customer is and if they're kind of on the lower income you know, type consumer, that's really where we're seeing pressure. You know, the consumer overall is healthy. And so you see a lot of those, you know, government numbers come out that look pretty healthy, but it's, you know, kind of been a tale of two cities, you know, where the kind of, you know, middle and upper, you know, consumer is doing well, but the lower end consumer is certainly struggling. And you see that with, you know, some tenants having trouble passing on, you know, inflation, inflationary costs onto the consumers. I mean, Walgreens is, you know, has been topical. That's why you've really seen their gross margins, you know, kind of come in and, you know, from kind of 22, 23% to 18 plus percent. So that's, you know, really impacting their cash flow. And so we're really making sure that we're getting out ahead of those types of risks. And then looking at, you know, the balance sheets of our tenants. Fortunately, there's really not much in there that, you know, is of concern. But, you know, when a lot of these tenants have to refinance their debt, it's going to be a lot more expensive than it was if they, you know, financed themselves a few years ago. And even just the ability to access debt is likely to be more challenged for some of these tenants. So those are the things that we're focused on. But yet nothing really is popping up that rises to the level of getting on our watch list at this point.

Okay. And I was also curious, is there anything in the market that you're waiting to see or what's maybe leading to some hesitancy on providing a net investment guidance?

Yeah, I mean, I just think there's been a lot of volatility in the markets over the past couple of years, obviously. And then we really wanted to see cap rates move up. Obviously, we're making some progress there. Early in the year, we really didn't think it made a lot of sense to come out with a number and then potentially change it one or two times over the year. But I think just overall for acquisitions, which we haven't given guidance on that, but I think a good way to think about that is in a If the environment persists in a similar manner, you can expect us to deploy capital at a similar quantum that we did last year.

Okay. Thank you so much. Thank you.

Our next question is from the line of Todd Thomas with KeyBank Capital Markets. Please go ahead.

Hi. Good morning. This is Antara Naktaduri on for Todd Thomas. Apologies if you discussed this already, but Could you discuss your current investment pipeline and where it stands, just thinking about 2Q and 3Q volumes?

Yeah, sure. I mean, I think the volumes will probably, you know, continue to be spread fairly evenly over the year if market conditions continue to be similar. And so I don't think you'll see much of a change in yield or, you know, or how much we deploy in the second quarter, third quarter, probably a little bit too far out for us to to figure out, but you may see a couple of, you know, chunky deals that are in the sales spec category and some that we're developing a little bit more or funding development for a little bit more than we have in the past.

Okay. Got it. And on disposition pricing, are you still able to achieve a sub seven cap rate or are disposition cap rates trending higher?

They're trending higher a little bit on the margin. And I think, you know, depending on what we sell is going to drive that a little bit. but cap rates have moved up a little bit. I think really what the issue has been on the disposition side and us getting kind of figuring out how we want to approach dispositions is there just aren't as many buyers. And so that helps us on the acquisition side where we're not really competing with anybody for acquiring the properties that we want to acquire. But then on the disposition side, it takes a little bit longer and the buyers have been a little bit flakier than they've been in the past. So that's something that we're just making sure that we're staying on top of costs and not incurring a bunch of dead deal costs. But cap rates have moved up a little bit on dispositions, but I think what we're looking at potentially selling in this quarter very likely could be below 7%. Okay, got it.

Thank you.

Thank you.

As there are no further questions, I now hand the conference over to Mark Mannheimer for his closing comments. Mark?

Well, thank you everyone for joining.

Really appreciate the support and have a great day. Thank you.

The conference of NetStreetCorp has now concluded. Thank you for your participation. You may now disconnect your lines.