NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB+' credit rating to the $350 million aggregate principal amount 3.875% coupon senior unsecured notes due 2024 issued by Realty Income Corporation (NYSE: O, Realty Income). The notes were priced at 99.956% of par to yield 3.88% to maturity, or 125 basis points over the benchmark treasury rate.
Net proceeds from the offering of $347.6 million are expected to be used to repay a portion of borrowings outstanding under the company's unsecured credit facility and for other general corporate purposes and working capital, which may include acquisitions.
In addition to the 2024 notes, Fitch currently rates Realty Income as follows:
--Issuer Default Rating (IDR) 'BBB+';
--$1.5 billion unsecured revolving credit facility 'BBB+';
--$3.2 billion of senior unsecured notes 'BBB+';
--$609.4 million of preferred stock 'BBB-'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
Realty Income's IDR of 'BBB+' is supported by the geographic diversity of the company's predominantly net leased retail property portfolio, limited tenant concentration and moderate tenant credit risk. Fixed charge coverage is appropriate for the 'BBB+' rating, and Realty Income's management team has been and remains cognizant of maintaining consistent credit metrics despite fluctuations attributable to mergers and acquisitions. Liquidity and access to capital are strong for the rating. Leverage has been elevated for the 'BBB+' rating, though declined following the company's April 2014 $528.5 million equity issuance. In addition, the company's recent focus on investing outside of net lease retail has less of a track record within the context of Realty Income's long history.
Diverse Net Lease Portfolio
As of March 31, 2014, Realty Income's portfolio consisted of 4,208 properties across 49 U.S. states and Puerto Rico, protecting bondholders from possible regional supply-and-demand imbalances. The most significant portfolio transaction over the past two years was the acquisition of American Realty Capital Trust, Inc. (ARCT) that closed in January 2013, totaling 501 properties for $3.2 billion.
Fitch views the portfolio's tenant industry diversification favorably. The portfolio includes 47 tenant industries, and top segments based on 1Q'14 revenues were convenience stores (10.3%), drug stores (9.5%), dollar stores (9.1%), casual dining and quick service restaurants (8.5%) and health and fitness (6.9%). Industry expansion is consistent with Realty Income's strategic plan to be less concentrated in net lease retail and more focused on improving tenant credit quality.
Improving Tenant Credit
The company has 211 tenants and its top 15 tenants comprised 46.4% of 1Q'14 rent, which is somewhat concentrated. The top three tenants at March 31, 2014 were Walgreens at 5.4%, FedEx at 5.2% of rent, and L.A. Fitness at 5%. The company has materially reduced the percentage of annualized rental revenue derived from properties leased to speculative-grade companies since 2010 and, somewhat relatedly, property-level cash flow coverage has also improved in recent years. In addition, the company's weighted average lease duration is long at 10.8 years, signaling durability in the cash flow that supports the ratings, absent tenant bankruptcies.
Solid Fixed-Charge Coverage
Fixed charge coverage is solid for the rating at 3.1x in 1Q'14 pro forma for the April 2014 equity offering, recent acquisitions and proceeds from the senior unsecured notes due 2024 (also 3.1x actual for the TTM ended March 31, 2014) compared with 2.6x in 2012 and 2.8x in 2011. EBITDA growth from acquisitions as well as contractual rent increases and occupancy gains in the same-store portfolio, partially offset by increased fixed charges associated with debt incurred to fund a portion of those acquisitions, drove the increase. Fitch defines fixed charge coverage as recurring operating EBITDA less straight-line rent adjustments less recurring capital expenditures divided by total interest incurred and preferred dividends.
Fitch's base case projection is predicated on contractual base rent increases (1.5% same-store rent growth) and additional acquisitions (assumed to be $1.2 billion in 2014), which should result in coverage sustaining around 3.0x over the next 12 to 24 months, which remains consistent with the 'BBB+' rating. In a stress case not anticipated by Fitch in which tenant bankruptcies similar to the Friendly's and Buffets bankruptcies in 2011-2012 reduce annual rent by approximately 5%, fixed charge coverage would remain above 2.5x and remain appropriate for a 'BBB+' rating.
Forward-Looking Strategic Planning
Realty Income has a long track record of growth since its formation in 1969, having increased the portfolio to 4,208 properties across 47 tenant industries in 1Q'14 from 630 properties across five industries in 1994. The original initiatives of generating monthly income from retail properties leased on a long-term triple-net basis (1969 to 1994) evolved towards being attuned to portfolio diversity as well as focusing on cash flow coverage and underwriting (1997 to 2007). Following the recession, the company has concentrated on improving tenant credit and pursued new industries while re-underwriting and ranking the portfolio.
Realty Income's strategy centers on owning real estate net leased to stronger credit tenants, with a preference for services over goods. The company owns both discretionary and non-discretionary retail as well as non-retail. However, its experience owning non-retail such as industrial and distribution (10.7% of 1Q'14 revenue), office (6.5%), manufacturing (2.5%) and agriculture (2.4%) properties is somewhat limited.
Strong Liquidity and Access to Capital
Liquidity coverage pro forma is strong at 5.0x for the period April 1, 2014 to Dec. 31, 2015. Fitch defines liquidity coverage as sources of liquidity (unrestricted cash, availability under the unsecured revolving credit facility pro forma for the equity and bond offerings, and projected retained cash flows from operating activities after dividends and distributions) divided by uses of liquidity (debt maturities and projected recurring capital expenditures).
Longer-term, debt maturities are manageable with 1.1% maturing during the remainder of 2014 followed by 6.1% in 2014 and 13.2% in 2016 pro forma. Contingent liquidity is adequate for the rating with unencumbered asset coverage of net unsecured debt of 2.8x at March 31, 2014 pro forma (assuming a stressed 8% capitalization rate). The company intends to further unencumber the portfolio when prepayment penalties on secured debt assumed as part of the ARCT become less onerous.
Fitch anticipates that the company's adjusted funds from operations (AFFO) payout ratio will remain in the mid-to-high 80% range (85.5% in 1Q2014 2012, although this ratio increased to 88.4% in 2013 as a result of the dividend increase associated with the ARCT acquisition). Recent AFFO payout levels indicate the company's ability to generate a modest amount of internal liquidity.
Decline in Recently Elevated Leverage
Net debt to recurring operating EBITDA was 6.1x at 1Q'14 but improves to 5.5x pro forma compared with 6.6x in 2012 and 5.3x in 2011. Leverage was skewed upward in 2012 due to the incurrence of debt prior to the close of the ARCT transaction. Under Fitch's base case, leverage is forecast to remain around 5.5x in 2014-2015, which would remain appropriate for the rating. In a stress case (principally a material tenant bankruptcy) scenario not anticipated by Fitch, leverage could sustain above 6.0x, which would be weak for the rating.
Preferred Stock Notching
The two-notch differential between Realty Income's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB+'. Based on Fitch research titled 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', available on Fitch's web site at 'www.fitchratings.com', these preferred securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default.
The following factors may result in positive momentum in the ratings and/or Rating Outlook:
--Fitch's expectation of fixed-charge coverage sustaining above 3.0x (pro forma fixed charge coverage is 3.1x);
--Fitch's expectation of leverage sustaining below 4.0x (pro forma leverage is 5.5x);
--Fitch's expectation of unencumbered assets-to-unsecured debt sustaining above 3.0x pro forma coverage is 2.8x).
The following factors may result in negative momentum in the ratings and/or Rating Outlook:
--Fitch's expectation of fixed-charge coverage sustaining below 2.5x;
--Fitch's expectation of leverage sustaining above 6.0x;
--Tenant bankruptcies resulting in a weakening of the company's credit metrics.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014);
--'Rating U.S. Equity REITs and REOCs (Sector Credit Factors) (Feb. 26, 2014);
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 23, 2013);
--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 19, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Criteria for Rating U.S. Equity REITs and REOCs
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Recovery Ratings and Notching Criteria for Equity REITs