CA - Four Corners: A Look At This 5.6% Yielding REIT

2023-09-08 09:00:00 ET

Summary

• Four Corners Property Trust is a real estate investment trust with a portfolio of 1,077 restaurant and retail properties.
• FCPT's primary rental revenue comes from the sun belt region, with Texas and Florida being key contributors.
• FCPT has a strong financial health, with high rent collection and occupancy numbers, and is well-positioned in terms of lease maturities.
• We examine the setup and see if we can add this REIT to our portfolio.

The REIT

Four Corners Property Trust, Inc (FCPT) is a real estate investment trust that had a portfolio of 1,077 restaurant and retail properties at June 30. The property number is dynamic to say the least. This number increased by twenty in the time it took to release the Q2 results in the beginning of August.

Around 11% of the portfolio comprises of ground leases as opposed to the balance in which the own the building and the land. In case of the ground leases, the ownership of the building constructed by the tenant reverts to FCPT at the end of the lease. With an average lease term of 90+ years remaining at the end of Q2, we will contain our excitement at the prospects of the impending ownership for now. The sun belt region is the primary contributor to the rental revenue for this suburbia focused REIT, with Texas and Florida being in the forefront of this group.

This REIT started in July 2015 as a subsidiary of Darden Restaurants Inc. and was subsequently spun off at the end of that year. Darden started off as being the only tenant of FCPT and while it is still is the source of most of this REIT's revenue, the dependence has reduced to a good extent.

The properties are primarily single-tenant buildings and the leases are of the net lease kind. In the 10-Q , FCPT notes that its net lease arrangements call for the tenant to be "primarily responsible for ongoing costs relating to the properties, including utilities, property taxes, insurance, common area maintenance charges, and maintenance and repair costs". The REIT has an impressive roster of brands operating on its properties, with close to 60% of its tenants rated investment grade.

The REIT's rent collection and occupancy numbers are a strong indicator of its robust financial health and demand for its properties. We would note the resilience even during the pandemic where collections only briefly dipped below 99%.

FCPT is also well positioned in terms of lease maturities, with 2027 being the first year that any significant portion comes up for renewal.

The weighted average lease term of 8.1 years while decent, is on the lower side compared to some of the other net lease REITs we follow. Realty Income Corporation (O) had a 9.6 years weighted average lease term at the end of Q2, while NNN REIT Inc. (NNN) was even higher at 10.2 years . The properties that FCPT acquired subsequent to Q2 have an average term of over 12 years and while they will not move the needle drastically for the overall number of 8.1 years in the next quarter, we like direction of this move.

There is more to this REIT's business than acquiring and leasing out properties. As part of the 2015 spin off, FCPT entered into franchise agreements with Darden with respect to the operation of six LongHorn Steakhouse restaurants located in the San Antonio, Texas. So along with rental revenue from its close to 1,100 property portfolio, FCPT also earns a small amount of revenue from the six restaurants.

FCPT pays a 34 cents quarterly dividend, raised from 33.25 cents in Q4-2022. It has consistently raised its dividends on an annual basis and even 2020 was no exception.

All in all, this 5.5% yielding REIT has been a pretty solid choice for its investors over the years.

Q2-2023 Results

Acquisitions powered the 10.3% rental revenue growth with a net 117 properties added to the roster year over year.

The 14% increase in year over year operating expenses were primarily due to increase in the compensation related expenses, reflected under the higher general and administrative expenses. While over 90% of FCPT's borrowings have a fixed rate, in part due to hedges, the higher effective rates on the variable portion of the term loans and its revolving credit facility propelled the interest expense by 11% compared to Q2-2022. Excluding the impact of the hedges, the weighted average interest rate on the term loans was 6.13% at the end of Q2-2023, versus 5.10% at the end of 2022 (and just 2.19% at June 30, 2022 ). The credit facility's weighted average rate was not far behind at 6.00%, increased from 1.40% at June 20, 2022. Being informed about the rates excluding hedges is only fair, considering that the swaps mature on an ongoing basis and new agreements have to be entered into. About $250 million worth of hedges will mature by the end of 2024.

So although not a significant amount of the REIT's overall debt will come up for renewal until 2025, the ongoing hedge expiration, along with any incremental drawings from the credit facility will keep the pressure on the interest expenses.

Coming back to the Q2 numbers, the overall funds from operations or FFO increased compared to Q2-2022, however, the per unit amount remained flat.

This was the result of a higher share count compared to the prior period. Management also noted during the earnings call that equity funding is currently cheaper than debt funding, so that is the mode they will be tapping into for the next little while. The REIT has bought properties in the 6.85% capitalization rate zone in 2023, whereas its cost of equity is around 6.66% (using simple inverse of FFO multiple).

This in essence explains the flat FFO as the cost of capital is around their cap rates and they won't be moving the needle much.

Verdict

FCPT trades at close to 15X forward FFO. This is a fair number for this REIT. It has an investment grade rating ( BBB ) and everything we have seen so far suggests that the model is sound. It continues to diversify away from Darden. This reminds us of Granite REIT ( GRP.UN ), which was spun off from Magna International ( MGA ), and had MGA as its sole tenant. Currently MGA makes up less than 26% of Granite's revenue base. Restaurant dependency is still on the high side and likely could be a headache is a prolonged recession. This is despite high levels of rent coverage that are underwritten into new leases. We can look past that, but what we cannot look past is the relative valuation. NNN trades at near 12X FFO, and Realty Income is at 13.5X. Our favorite in the triple net sector W. P. Carey Inc. ( WPC ) is also at 12.0X. Agree Realty Corporation ( ADC ), arguably one of the most conservative triple-nets you can find, does reach the same lofty 15X (yeah in today's market 15X is lofty) multiple. So the valuation remains "meh". We are hard-pressed to give a buy here just because of the smorgasbord of choices you have for REITs in general and triple-nets in particular. We rate it a hold and might get interested if it traded 2-3 multiples lower.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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