NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB-' rating to the expected Series F preferred stock to be issued by National Retail Properties, Inc. (NYSE:NNN). Fitch expects the net proceeds will be used for general corporate purposes. A full list of Fitch's current ratings for NNN follows at the end of the release.
KEY RATING DRIVERS
The ratings reflect NNN's disciplined investment focus on single-tenant retail real estate and predictable cash flow in excess of fixed charges generated from a granular triple-net leased property portfolio. Credit strengths also include strong financial flexibility as measured by above-average liquidity coverage and appropriate contingent liquidity as measured by unencumbered asset coverage of unsecured debt, and minimal secured debt. Balancing these strengths is some tenant concentration and exposure to predominantly below investment-grade rated tenants. While specific tenant credit profiles have improved via M&A over the past few years, this could be negated in part should defaults in the high-yield market flow through to NNN's portfolio.
Fitch anticipates that leverage will sustain around current levels and remain appropriate for the 'BBB+' rating. NNN has prudently funded its recent acquisitions primarily with common and preferred equity but also with proceeds from asset sales and long-term debt; a more aggressive approach toward funding acquisitions predominantly with debt would be a credit concern.
Disciplined Investment Focus
NNN invests in a fragmented but competitive industry (i.e. unrated net lease retail real estate). The company's portfolio generates predictable cash flow, as evidenced by annual rent bumps of 1.5% to 2% over 15-20-year lease terms and consistent occupancy despite the focus on unrated and lower rated tenants. From 2003 through 2015, occupancy did not fall below 96.4% and stood at 99.1% as of June 30, 2016.
NNN's weighted average remaining lease term is long at 11.4 years, signaling durability in cash flows, absent tenant bankruptcies and lease rejections. Overall, average tenant rent coverage was solid at 3.7x as of June 30, 2016, with only 8.5% of leases set to expire through 2018. Combined, these factors provide a buffer for NNN's credit metrics against the cyclicality of tenant businesses and real estate markets.
As of June 30, 2016, the company owned 2,452 properties leased to over 400 tenants across 48 states. Top states included Texas (18.9% of average base rent [ABR]), Florida (9.3%), Ohio (5.8%), Illinois (5.1%), and North Carolina (4.9%). NNN's largest exposure is in Texas and Florida; however, the portfolio is spread across numerous metropolitan statistical areas in these states, including Dallas, Houston, Brownsville, Austin and San Antonio in Texas, and Tampa, Orlando, Miami and Jacksonville in Florida.
The company's top lines of trade as of June 30, 2016 were convenience stores (c-stores, 16.7% of ABR), full-service restaurants (12.6%), limited-service restaurants (7.7%), automotive service (6.7%), and family entertainment centers (5.7%).
Strong Fixed Charge Coverage for 'BBB+'
The company's fixed charge coverage (FCC) ratio was strong for the 'BBB+' rating at 3.5x for the trailing 12 months (TTM) ended June 30, 2016, compared with 3.4x and 3.2x in 2015 and 2014, respectively. Contractual rent escalators on existing properties and recently acquired assets are the primary drivers behind the slight improvement in FCC. Fitch defines FCC as recurring operating EBITDA less straight-line rent adjustments divided by total cash interest incurred and preferred stock dividends.
Fitch's base case anticipates that 2% same-store net operating income (SSNOI) growth along with additional acquisition-related NOI at capitalization rates in the low 7% range will result in coverage sustaining near 3.5x through 2018. In a stress case not anticipated by Fitch in which the company experiences tenant bankruptcies resulting in a 5% decline in SSNOI, FCC would remain above 3x. In both cases, this ratio would be appropriate for the 'BBB+' rating.
Good Liquidity Position and Access to Capital
Liquidity coverage is strong for the rating at 2.5x for the period July 1, 2016 through Dec. 31, 2018. NNN's primary source of liquidity is its $650 million revolving credit facility due 2019. Fitch calculates liquidity coverage as sources of liquidity (unrestricted cash, availability under the company's unsecured credit facility, and projected retained cash flows from operating activities after dividends) divided by uses of liquidity (debt maturities and projected development costs).
Liquidity coverage benefits from high availability under the unsecured line, lack of recurring capital expenditures, and laddered near-term debt maturities. As of June 30, 2016, the company has only 11.9% of debt maturing between July 1, 2016 and Dec. 31, 2018. In addition, Fitch views NNN as having strong access to capital, which further supports its liquidity position.
NNN had limited secured debt (0.8% of total debt as of June 30, 2016), improving its financial flexibility. Contingent liquidity is strong, as unencumbered assets (2Q16 unencumbered NOI divided by a stressed capitalization rate of 9%) covered net unsecured debt by 2.7x as of June 30, 2016, which is strong for the 'BBB+' rating. This ratio has been between 2.4x and 3x since 2012.
Leverage Remains Appropriate
NNN's net debt-to-recurring operating EBITDA was strong for the 'BBB+' rating at 4.6x for the TTM and 4.4x for the quarter ended June 30, 2016, compared with 4.5x in 2015 and 4.4x in 2014. When including 50% of preferred stock in total debt, NNN's leverage was 4.9x for the quarter and 5.2x for the TTM ended June 30, 2016, still appropriate for the 'BBB+' rating.
Fitch anticipates that NNN will fund its growth with more debt than equity on a go-forward basis, which, combined with retained cash flow after dividends, would result in leverage (including 50% preferred stock) sustaining in the low 5x range.
Dividend Trend Highlights Growth Focus
Fitch expects NNN will continue to increase its dividend going forward due to shareholder expectations but the pay-out ratio will remain appropriate and allow the company to retain approximately $75 million of operating cash flow per year. NNN has raised its dividend annually for the past 26 years as a result of increases in adjusted funds from operations (AFFO) and taxable net income arising from both internal and external growth. NNN's AFFO pay-out ratio was 72.2% for the quarter ended June 30, 2016, down from 75% in 2015 and 77.3% in 2014.
Preferred Stock Notching
The two-notch differential between NNN'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', 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.
Fitch's key assumptions within our rating case for the issuer include:
--SSNOI growth of 2% for 2016-2018;
--Acquisitions of $400 million in 2016, $450 million in 2017, and $500 million in 2018;
--Dispositions of $100 million in 2016, $50 million in 2017 and 2018;
--$400 million unsecured bond offerings in both 2017 and 2018;
--Equity issuance of $150 million in 2016, $225 million in 2017 and none in 2018. If NNN's share price reaches the level where it would not be willing to issue equity, Fitch assumes the company would reduce net acquisitions to maintain leverage at current levels.
The following factors may have a positive impact on NNN's ratings and/or Outlook:
--Fitch's expectation of leverage sustaining below 4.5x (leverage was 4.6x for the TTM ended June 30, 2016);
--Fitch's expectation of fixed charge coverage sustaining above 3.5x (coverage was 3.5x for the TTM ended June 30, 2016);
--Fitch's expectation of the ratio of unencumbered assets to unsecured debt based on a 9% capitalization rate, sustaining above 3.0x (this ratio was 2.7x for the TTM ended June 30, 2016).
The following factors may have a negative impact on NNN's ratings and/or Outlook:
--Fitch's expectation of leverage sustaining above 5.5x;
--Fitch's expectation of fixed-charge coverage sustaining below 2.7x;
--Fitch's expectation of the ratio of unencumbered assets to unsecured debt, based on a 9% capitalization rate, sustaining below 2.5x.
FULL LIST OF RATING ACTIONS
Fitch currently rates NNN as follows:
--Issuer Default Rating (IDR) 'BBB+';
--Unsecured revolving credit facility 'BBB+';
--Senior unsecured notes 'BBB+';
--Preferred stock 'BBB-'.
The Rating Outlook is Stable.
Relevant Committee Date: April 21, 2016
Additional information is available on www.fitchratings.com
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
Recovery Ratings and Notching Criteria for Equity REITs (pub. 03 Dec 2015)
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 29 Feb 2016)
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