Fitch Upgrades National Retail Properties' IDR to 'BBB+'; Outlook Stable
Fitch Ratings has upgraded the credit ratings of National Retail Properties, Inc. (NYSE: NNN) as follows:
--Issuer Default Rating (IDR) to 'BBB+' from 'BBB';
--$500 million unsecured revolving credit facility to 'BBB+' from 'BBB';
--$1.2 billion senior unsecured notes to 'BBB+' from 'BBB';
--$223 million senior unsecured convertible notes to 'BBB+' from 'BBB';
--$288 million preferred stock to 'BBB-' from 'BB+'.
The Rating Outlook is Stable.
The upgrade is driven by Fitch's expectation of leverage sustaining at a level consistent with a 'BBB+' rating, coupled with growth in the overall size of the triple net leased retail portfolio that has contributed to declines in tenant and industry concentration. The upgrade also reflects the company's flexible funding profile, laddered debt maturity schedule, and strong access to capital. NNN also has a strong management team. The rating takes into account credit concerns including exposure to non-necessity-based retailers that may be adversely affected through retail demand cycles, as well as tenant credit risk.
In Fitch's view, NNN's leverage metrics are consistent with a 'BBB+' rating. Net debt-to-last 12 months recurring operating EBITDA was 5.0x as of Sept. 30, 2012, down from 5.9x as of Dec. 31, 2011, and 5.7x as of Dec. 31, 2010. Leverage in 2011 and 2010 was skewed higher by the timing of acquisitions toward the latter half of the year. Adjusting for this timing, leverage in both periods would be approximately 5.0x. Leverage at Sept. 30, 2012 based on annualized 3Q'12 EBITDA was 4.7x and management targets leverage on a normalized basis in the high 4.0x range.
Fitch expects leverage to remain in the 4.7x-5.0x range through 2014, which is consistent with the 'BBB+' IDR. In a more adverse operating environment than currently anticipated by Fitch wherein net operating income (NOI) declines by 3% in each of 2013 and 2014, leverage would decline to 5.5x in 2014, which would be at the upper end of the range appropriate for the 'BBB+' rating.
PORTFOLIO GROWTH ENHANCES DIVERSIFICATION
NNN's asset base has grown significantly over the past few years, enhancing an already granular triple net leased retail property portfolio. Recurring operating EBITDA grew to $277.4 million for the TTM ended Sept. 30, 2012, from $205.7 million in 2009. As of Sept. 30, 2012 the portfolio consisted of 1,530 properties totaling 18.3 million square feet, up from 1,015 properties with 11.4 million square feet at Dec. 31, 2009.
Tenant diversification has improved, with the largest tenant representing just 6.0% of annualized base rent (ABR), and the top 10 tenants representing 38.8% of ABR at Sept. 30, 2012. This is a decline from 9.1% and 45.9%, respectively, as of Dec. 31, 2009. The largest industry segment (convenience stores) represents 21.6% of ABR as of Sept. 30, 2012, and is down from 26.7% at Dec. 31, 2009.
STABLE OPERATING PERFORMANCE
Occupancy was 97.9% as of Sept. 30, 2012, up from 97.2% as of Sept. 30, 2011. NNN's fixed-charge coverage ratio (defined as recurring operating EBITDA less recurring capital expenditures and straight-line rents, divided by total interest incurred and preferred stock distributions) was solid at 2.9x for the 12 months ended Sept. 30, 2012, up from 2.8x for full year 2011. Fitch expects fixed charge coverage to improve to just above 3.0x through 2014 due to recent acquisitions at attractive spreads (capitalization rates averaging 8.5%, approximately 450 basis points (bps)over recent bond issuance), combined with long average remaining lease terms of 12 years, stable occupancy and fixed charges. In a more adverse operating environment than currently anticipated by Fitch wherein NOI declines by 3% in each of 2013 and 2014, fixed charge coverage would decline to 2.7x in 2014, which would be at the low end of the range appropriate for the 'BBB+' rating.
The company also has an Adjusted Funds from Operations (AFFO) payout ratio of approximately 88% for the TTM ended Sept. 30, 2012. Fitch projects that the AFFO payout ratio will remain in the mid-to-high 80% range, which is appropriate for the rating.
STRONG MANAGEMENT TEAM
NNN has a long-term track record of astute implementation of its business strategy that entails acquiring, owning, and investing in single-tenant retail properties, generally under long-term triple net leases.
Fitch views positively NNN's laddered debt maturity schedule, which contributes to a liquidity coverage ratio of 1.6x for the period Oct. 1, 2012 through Dec. 31, 2014. Fitch defines liquidity coverage as liquidity sources divided by liquidity uses. Liquidity sources include unrestricted cash, availability under the company's unsecured revolving credit facility and expected retained cash flow after dividends. Liquidity uses include debt maturities, development expenditures and expected recurring capital expenditures.
ACCESS TO MULTIPLE CAPITAL SOURCES
NNN's recent issuances include a $325 million 3.8% 10-year unsecured notes offering in August 2012 at a yield of 3.98% and a $287.5 million 6.625% series D preferred stock issuance which refinanced the series C preferred that had a coupon of 7.375%. Additionally, the company amended its unsecured revolving line of credit, increasing the capacity by $50 million to $500 million, expandable to $1 billion, with a borrowing rate of L + 117.5bps (down from L + 150bps), and extended the maturity to 2016, with a one-year extension option to 2017. Finally, the company established an at-the-market (ATM) equity offering program in May 2012, with a total capacity to sell 9 million shares. YTD as of Sept. 30, 2012, NNN has sold 2.3 million shares for net proceeds of $65.4 million. These transactions highlight NNN's robust access to various sources of capital on increasingly favorable terms.
NNN's unencumbered asset coverage of unsecured debt (based on a 9.0% capitalization rate on 3Q'12 annualized unencumbered NOI) was 2.6x as of Sept. 30, 2012. This level is adequate for the rating and provides ample contingent liquidity for NNN.
MODERATE GEOGRAPHIC CONCENTRATION
Texas represents 21.8% of ABR, with the next largest concentration in Florida (9.2% of ABR). However, within both of these large states, NNN's properties are well-distributed, mitigating the geographic concentration risk.
HIGHER RISK TENANTS
NNN's tenants include non-necessity-based retailers (e.g. electronics, full-service restaurants, movie theatres, sporting goods) and NNN may continue to experience tenant bankruptcies due to the nature of the retail business. It is possible that some of the locations leased to these tenants will be vacated in bankruptcy, leading to lost revenue until a property is re-tenanted, or a potential decline in value if the property is sold vacant.
Notably, only two of the top 15 tenants are rated by Fitch, and those tenants have speculative-grade ratings (AMC Entertainment - IDR 'B'; Best Buy - IDR 'BB-'). The lower credit quality highlights the risk of potential revenue losses.
PREFERRED STOCK NOTCHING
The two-notch differential between NNN's IDR and its preferred stock rating is consistent with Fitch's criteria for corporate entities with a 'BBB+' IDR. Based on Fitch's report '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 Stable Outlook centers on Fitch's expectation that NNN's credit metrics will remain consistent with a 'BBB+' rating over the next 12-24 months. In addition, NNN's long-term triple net leases (typically 15-20 years in term) and manageable lease expiration schedule contribute to the stable cash flows of the portfolio.
WHAT COULD TRIGGER A RATING ACTION
Fitch does not anticipate additional positive rating momentum in the near term; however, the following factors may have a positive impact on NNN's ratings and/or Outlook:
--Fitch's expectation of fixed charge coverage sustaining above 3.5x (coverage was 2.9x for the 12 months ended Sept. 30, 2012);
--Fitch's expectation of leverage sustaining below 4.0x (leverage was 5.0x as of Sept. 30, 2012);
--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 2.6x as of Sept. 30, 2012).
The following factors may have a negative impact on NNN's ratings and/or Outlook:
--Fitch's expectation of fixed-charge coverage sustaining below 2.7x;
--Fitch's expectation of leverage sustaining above 5.5x;
--Fitch's expectation of unencumbered asset-to-unsecured debt ratio sustaining below 2.4x;
--A liquidity coverage ratio sustaining below 1.0x.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 13, 2012);
--'Recovery Rating and Notching Criteria for REITs' (Nov. 12, 2012);
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Parent and Subsidiary Rating Linkage' (Aug. 8, 2012);
--'Criteria for Rating U.S. Equity REITs and REOCs' (Feb. 27, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Parent and Subsidiary Rating Linkage
Criteria for Rating U.S. Equity REITs and REOCs
Recovery Ratings and Notching Criteria for Equity REITs
George Hoglund, CFA
One State Street Plaza
New York, NY 10004