Spirit Realty Capital, Inc.

Greetings. Welcome to the second quarter 2021 Spirit Realty Capital Earnings Conference Call. At this time, all participants are in 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 zero from your telephone keypad. Please note this conference is being recorded. At this time, I'll now turn the conference over to Pierre Raval, Senior Vice President, Corporate Finance and Investor Relations. Pierre, you may now begin.

Thank you, operator, and thank you, everyone, for joining us for SPIRIT's second quarter 2021 earnings call. Presenting today's call will be President and Chief Executive Officer Jackson Hsieh and Chief Financial Officer Michael Hughes. Ken Heimlich, Chief Investment Officer, will be available for Q&A. Before we get started, I would like to remind everyone that this presentation contains forward-looking statements. Although the company believes these forward-looking statements are based upon reasonable assumptions, They are subject to known and unknown risk and uncertainties that can cause actual results that differ materially from those currently anticipated due to a number of factors. I'd refer you to the safe harbor statement in yesterday's earnings release, supplemental information, and Q2 investor presentation, as well as our most recent filing with the SEC for a detailed discussion of the risk factors relating to these forward-looking statements. This presentation also contains certain non-GAAP measures. Reconciliation of non-GAAP financial measures to most directly comparable GAAP measures are included in yesterday's release and supplemental information furnished to the SEC under Form 8K. Yesterday's earnings release, supplemental information, and Q2 investor presentation are available in the investor relations page of the company's website. For prepared remarks, I'm now pleased to introduce Mr. Jackson Shea. Jackson?

Thank you, Pierre, and good morning, everyone. As you saw in our results released this morning, we had another solid quarter and have once again substantially raised our 2021 earnings guidance with AFFO per share now forecasted to increase by 11% at the midpoint of our range compared to last year. In addition, we're raising our net capital deployment guidance as our acquisition volumes and weighted average cap rates have accelerated beyond our initial expectations. Most importantly, today marks SPIRIT's return to dividend growth with a third-quarter dividend increase of 2 percent. While these results might come as a surprise to many, they're actually the product of the methodical execution of SPIRIT's medium-term plan laid out at our investor day and the adherence to one of our core values that is best summarized by the words, Do what you say. While COVID took our operating results on a brief detour, it has not kept us from reaching our target destination. Given what we have and are set to accomplish this year, I'm confident that we can reach the 2022 AFFO per share range originally laid out at our investor day in 2019. So let's talk about how we're going to make that happen. One factor contributing to our performance is the success of our tenants. Lost rent across our entire portfolio was less than 1% during the second quarter, and cash rent collections, excluding theaters, improved to 99%. At the end of the quarter, less than 1% of annual base rent was accounted for on a cash basis, and we received 100% of deferred rent repayments owed during the quarter. The vast majority of our tenants in industries most severely impacted by COVID, such as casual dining, early childhood education, entertainment and fitness, have fully recovered and in some cases are growing and gaining market share. Theaters are also on the path to recovery. with recent box office successes like F9 and Black Widow. As you can see on page seven of our latest investor presentation, our rent collections from theaters continue to improve, and we expect this trend to accelerate as percentage rent agreements benefit from the strong release calendar and the remaining deferral agreements begin to expire. Given the trajectory of theater revenues, and recent balance sheet enhancements that many of our theater tenants have completed, either through equity raises or by accessing government programs, none of our theaters are currently being accounted for on a cash basis. In addition, we have signed leases with new operators on all the former California Studio Movie Grill locations and Goodrich Theaters that will add approximately 5.6 million in ABR after a period of percentage rent. As I mentioned earlier, because of the COVID-driven rent abatements and deferrals, our earnings took a brief detour. While I would have preferred our growth trajectory to remain in a straight line, it is important to reiterate that our tenants and our earnings are back on track, and the permanent disruption to our rents will be minimal. As it stands today, our total permanent rent degradation due to COVID equates to only 1% of our annual base rents. Our integrated credit and research-driven underwriting focus on large, sophisticated operators with good real estate and implementation of technology tools have enabled us to construct a highly durable and diversified portfolio that has endured through substantial economic volatility while continually improving in credit quality and value. We believe the tail of the tape has demonstrated that our strategy provides outside yields with very low default risk. Or said another way, superior risk-adjusted returns for our investors. Another factor is our accretive capital recycling. As you have seen with our disposition cap rates, we have effectively taken advantage of tighter market pricing for certain asset classes to further reshape our portfolio accretively. Over the quarter, we have disposed of $61.5 million in income-producing properties at a weighted average cash cap rate of 4%. While previous quarter's dispositions consisted of retail assets such as C-stores, grocery, and drugstores, and industrial asset sale drove the bulk of our disposition proceeds in the second quarter. Now, given that we get a lot of questions about our industrial portfolio and its underlying value, I want to give some color around the characteristics of this particular industrial asset and the sale execution, which is also included in our latest investor presentation, along with some good information about our industrial holdings. This particular asset was a 286,000 square foot beverage manufacturing and warehouse facility for one of the nation's leading independent beverage companies located in New Jersey. We bought this site in late 2016, and the building was well located with rail access, contained freezer and cooler space, and had excess land for future expansion. We initially paid $27.4 million for the building. which represented an initial cash cap rate of 7.7%. After receiving 10.2 million in rents over a little less than five years, we sold it for $59.4 million, representing a 3.89% cash cap rate on today's rent, and realized an unlevered IRR of 25.1%. While we like the property, there was less than six years remaining on the lease, and given the pricing we were able to achieve, it made sense to lock in this gain and redeploy the proceeds into other attractive opportunities. Now, obviously, this was a great investment for Spirit, but I can also say that this property only ranked in the middle of our industrial portfolio. The quality of our industrial assets can also be seen in some of our recent lease renewals, As you can see in our latest investor materials, our 2023 lease expirations as a percentage of ABR dropped from 6.1 percent at the end of the last quarter to 5.1 percent at the end of the second quarter. That reduction was driven by two early industrial property renewals with FedEx and Ferguson Partners, both which are investment grade. For FedEx, we added five years to the lease with a 5% base rent increase. And for Ferguson, we added 10 years to the lease with attractive 1.5% escalators. These early renewals, extensions, and enhancements were achieved with very minor concessions, mainly small TI allowances, and are good examples of the value that can be created with properties that are mission critical to tenants in healthy industries. Overall, we're very pleased with our industrial exposure and have benefited from our concerted effort, which began two years ago, to increase our portfolio weighting in this sector. The final factor that has kept Spirit on track to do what we say is our acquisition platform, which, since we rebooted the company post-spinoff, has delivered consistent acquisition volumes and yields. even in an environment of increasing competition and compressing cap rates. In fact, over the past few months, several of you have asked me, what is Spirit's secret sauce when it comes to acquisitions? The secret sauce resides in our unique platform, which is based on highly disciplined and transparent processes that utilize data and research to deep dive into tenant credits, industries, and the residual real estate value for every acquisition we make. Our technology tools allow us to immediately see the impact of any acquisition we consider on the overall portfolio, including how that acquisition affects diversification across geography, industry, credit risk, and benchmark the improvement to our exposure in each industry and asset type. This approach affords us the ability to pursue a wider breadth of opportunities with better risk-adjusted returns while maintaining proactive control over the portfolio. The way we apply our capabilities can be seen in what we buy. You may notice that each quarter we acquire what I call middle-of-the-fairway opportunities. These are simply the bread-and-butter assets for net lease, like a BJ's Wholesale Club, a dollar store, or a Kohl's store. They're not particularly time-intensive to underwrite or price. Then there are the opportunities that are less obvious, often mispriced, and take more time to understand and underwrite, but provide better risk-adjusted returns if you get them right. Sometimes this can be moving early into a tenant or industry where you develop deep conviction before the market sees it, like at-home or lifetimes. or seeing the upward trajectory of a credit before it has become fully realized, as we showed you with our credits on the move page a few quarters ago, or digging into a more complex situation like we sometimes see in the industrial space. We found that allocating some bandwidth to dig into the less obvious opportunities allows us to generate real alpha. An example of a less obvious opportunity was the 83 million, eight property Shiloh acquisition we made in the first quarter. We were able to secure 20 year leases with attractive fixed annual escalators at an 8.2% cash cap rate. Shiloh had recently emerged from bankruptcy with a PE sponsor, Middle Ground Capital as the new owner. Now on the surface, one might look at this situation and think, auto industry just emerged from bankruptcy, PE backed, and just move on. But we dug in. We looked at the importance of lightweighting cars, Shiloh's primary business, for increasing the gas mileage and range of traditional and electric vehicles. We spent time with the sponsor, who's an experienced B2B owner with a focus on industrial and distribution sectors, and the management team, who were former Toyota executives. In digging into the financials, we saw that the business was doing better now than before COVID, but with much lower leverage. And the real estate was well located in attractive submarkets across the Midwest with low rents per square foot, and the operations taking place within the properties were strong cash flow generators. We realized that this was a great business with substantial upside that was not being recognized by the market. This thesis proved out much faster than we anticipated. Early in the second quarter, two large strategic buyers purchased pieces of Shiloh's business. As part of those transactions, we agreed to sign the leases associated with those business units to the new owners. The net result is that three properties representing 51.5% of Shiloh's rent, were assigned to Worthington Industries, a 66-year-old company with a BBB credit rating, and three properties representing 17.6% of Shiloh's rent were assigned to Aludine, a global lightweighting solutions and components supplier. With the assignment of these leases and the continued improvement in Shiloh's business, I believe the cap rate compression on this portfolio today would be plus or minus 300 basis points, a meaningful increase in the value of our investment. We continue to find a mix of opportunities this quarter that kept our acquisition yields relatively high, investing $284 million across 18 properties at a weighted average cash cap rate of 7.07%, economic cap rate of 7.84%, and with rent escalators of 1.8%, at a waltz of 13 years. From an industry perspective, we added home improvement, building materials, dollar stores, and home decor, with an asset-type breakdown of 18% retail, 67% industrial, and 15% office. In total, 78% of our acquisitions consisted of public credits with increases to existing public tenants such as Home Depot, At Home, Dollar General, and Family Dollar. We also added four new public credits to our tenant roster, including Tupperware, Bluelinks, L3Harris, and Builders FirstSource. The acquisition of the three Bluelinks distribution facilities was one of our larger acquisitions this quarter. For those of you unfamiliar with Bluelinks, it's a leading wholesale distributor of residential and commercial building products, which has been delivering record operating results supported by the tailwinds driving single-family housing, remodeling activity, and commodity prices of wood. We like the Blue Wings transaction from the start, given the favorable secular trends supporting housing, the tenants improving credit trajectory, and the quality of the distribution facilities, which are all located in submarkets with strong absorption and low vacancy. So again, like other quarters we have posted, many acquisitions are squarely in the fairway and some are more unique and less obvious. Given the competitive landscape, I expect that this trend will continue as we utilize our platform to dig deeper and uncover new opportunities. As I mentioned last quarter, one new area that we have focused on is lifestyle. benefiting from the secular tailwinds of people moving to the suburbs, prioritizing recreation, and enjoying more work flexibility. And we have evaluated many new opportunities, ranging from marinas to ski resorts to RV parks. I'm pleased to announce that we closed on one of these opportunities in July, purchasing 22 golf clubs for $231 million. As you can see on page 16 of our investor presentation, We highlighted the many reasons we are attracted to the golf industry, including the rationalization of courses, increased participation, and the most rounds played since 2007. Our investment is under a master lease agreement with 19 years remaining, and at an initial mid-seven cash cap rate and 9% economic cap rate, which we believe will result in a great risk-adjusted return for our shareholders. From a real estate perspective, these properties are in attractive established communities with a weighted five mile population of 162,000. With a price per acre of only 47,000 and a price per club of only 10.5 million, our basis in this investment is a fraction of replacement costs. In addition, our tenant is Club Corp, the largest owner operator of private golf lifestyle clubs in North America. They have over 400,000 members and more than 218 whole golf courses. As we think about this investment going forward and the multiple tailwinds supporting this industry, we believe this will serve as another example where our early move into an underappreciated asset class will lead to significant value appreciation over time. Before I turn it over to Mike to run through the numbers, I just want to say that I'm extremely proud of the Spirit team and all that we've accomplished together. This was an outstanding quarter. The portfolio is performing, our acquisitions platform is delivering, and we are back to dividend growth. While we're certainly aware that COVID is not yet behind us and we must be thoughtful and vigilant in every step we take, we will continue to execute on the core mission that I highlighted to investors at the onset of COVID, to work with our tenants, to ensure their success, and in turn, success for our shareholders. In short, to do what we say. And with that, I'll turn the call over to Mike.