Baird Drops NNN Price Target 10% - Here's The Scoop

On Tuesday, Baird Equity Research issued a research note updating National Retail Properties, Inc. NNN, a leader in the triple-net lease REIT space, after NNN's Q1 earnings release and conference call.

The single-tenant, net-lease REIT business model is so solid and simple to understand that it is often viewed as being "bond-like," and that is essentially where Baird sees the potential headwinds for NNN shares coming into play.

These REITs lease well-located operational and key support facilities to credit-worthy customers – such as drugstores, auto supply, restaurants and dollar stores – on a long-term basis where, in addition to monthly rent, tenants pay the taxes, insurance and vast majority of property maintenance expenses.

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• Realty Income Corp O: Neutral, $10.9 billion cap, 4.84 percent yield.
• Spirit Realty Capital, Inc (New) SRC: Neutral, $$4.9 billion cap, 6.1 percent yield.
• Store Capital Corp STOR: Outperform, $2.5 billion cap, 4.65 percent yield.
• National Retail Properties: Neutral, $5.1 billion cap, 4.4 percent yield.

Tale Of The Tape – Past Year

Notably, NNN has increased its dividend for 24 consecutive years, and the current dividend remains well covered by a healthy mid-80s AFFO payout ratio.

Why REITs Are Not Like Bonds

Investors should keep in mind that as the economy improves, rents tend to rise – one of the reasons that commercial real estate has historically been a good hedge against inflation.

Many long-term leases contain contractual rent increases based upon CPI, or a fixed percentage vs. a bond fixed coupon rate. REITs are also able to grow accretively by purchasing future properties at cap rates that historically also increase in a rising rate environment.

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Retail Sharpshooter Approach

Baird–NNN: Maintain Neutral, Lower PT $44 To $40

The Baird's new $40 price target represents a potential 6.7 percent upside from the NNN close on Wednesday, or $37.48 per share.

The Baird $40 PT was derived from 17.2x its 2016E AFFO of $2.32 per share.

Baird–NNN: Q1 Earnings Takeaways

• NNN reported Q1 FFO of $0.54 per share, in line with Baird and consensus estimates.
• NNN raised the lower end of its FY 2015 FFO guidance a penny to $2.14 per share with high end remaining at $2.17 vs. consensus, which stands at $2.20 per share.
• NNN is ahead of schedule YTD on acquisitions and Q1 acquisition cap rates are also running higher than Baird's expected, coming in at 7.3 percent vs. NNN guidance of 7 percent and Baird's 6.9 percent estimate.
• Baird noted that NNN's "one-of" acquisition approach, which levers existing relationships, gives NNN a competitive advantage; NNN management feels it's an approximate 100 bps edge on cap rates vs. the premium paid for larger portfolios.

Baird–NNN: Risk Factors

While NNN appears to be hitting on all operational cylinders, Baird remains concerned about the macro risk of rising interest rates.

Baird noted that, "Since February, the 10-yr Treasury Bond yield has risen ~60bps, with the RMZ down 8 percent and shares of NNN down 11 percent."

The Bottom Line

Baird's top pick in the net-lease space remains Store Capital Corp.

The current Baird price target for Store Capital shares is $26, which represents a potential 21.3 percent upside from the Wednesday close of $21.43 per share, or a total return of approximately 26 percent, including the 4.65 dividend yield.

However, Baird expects the overall net-lease sector "to underperform the REIT index if rates continue to move higher in the short term."