Value Investors Club / NATIONAL RETAIL PROPERTIES (NNN)

Description

Investment Thesis

 Macro factors, exacerbated by last month’s Brexit, have driven the stock to a really

expensive level.

 A properly hedged bearish position in NNN should provide attractive upside with

limited downside.

Company Description

National Retail Properties (NNN) is a triple-net lease REIT that is exclusively retail focus.

The real estate portfolio is about 25.4m sf and spans 47 States.

Triple-Net Lease REIT Overview

 Long term lease with fixed or CPI-linked rent escalators. Lease term often exceeds

10 years.

 Tenants are responsible for operating expense, real estate tax and insurance. The

risk for the landlord is credit risk.

 All else being equal, properties leased to investment grade (IG) tenants trade at a

lower cap rate than non-IG tenant properties.

 Bond-like cash flow, hence triple-net REITs trade on dividend yield or FFO multiples,

not NAV

 Excluding acquisition, organic, same store growth is 0 – 2%.

Company Overview

100% Retail Focus

 Other triple-net REITs are diversified by property type (office, industrial, retail).

NNN is retail only

Leverage

 Strong balance sheet metric: Net Debt/EBITDA = 4.2x, Net Debt/TEV = 21% relative

to peer avg of 5.4x and 31% respectively. Peer group consists of O, SRC, GPT,

STOR and VER

 Negligible 2016 debt maturities:$6mm

Unique Underwriting

 Favor non-IG tenants. Management believes the higher cap rate outweighs the

incremental credit risk

 Focus on small investment: $2 – 4mm/property. They believe there is less

competition because institutional capital is uninterested to underwrite small deals.

Strong Fundamentals

 Occupancy is at 99.1%

 Despite the company retail focus, it is only exposed to Sports Authority which

represents 0.5% of annualized base rent.

 Chains like PacSun, Aeropostale, Sports Chalet, Tailored Brands, Sears have

announced bankruptcies or store closures. It has so far avoided store with the

exception of Sports Authority. This is strong evidence that NNN’s underwriting

is sound.

Recent Acquisition

 Bob Evans Farms transaction exemplifies NNN acquisition

 Direct, non-marketed deal leads to above market cap rate 6.8%.

 $160.8mm, $1.4mm/box. Initial lease term is 20 years, with 5 year renewal option.

 Accretive deal as the stock is trading at 5% implied cap rate.

 Non-rated credit with established franchise.

Bullish Thesis

 Great fundamentals, great strategy.

 Management team is capable and above average, in my opinion

 Favorable macro tailwind: the market expected the Fed to hike rates multiple times

at the start of this year and now some participants expect a rate cut. 10 year US

treasury has declined to 1.35%, a historic low.

 The company can continue to issue new stock as currency to make accretive

acquisitions. NAV is $34 – 36 and stock is at $52. Issuing equity at 5% cap rate

and buying properties is highly accretive and fun, until the music stops.

 Accretive refinancing potential: the preferred D and $250mm of unsecured debt is

due next year and could likely be refinanced at lower rates that may provide some

upside to earnings.

Bearish Thesis

Macro factors completely out of management’s control has driven the stock to a very

expensive level. How do I know this?

 Several sovereign government bonds have negative yield

 How much would you pay for a stock that has organic growth of 1 – 2%? If you

require 10% returns, dividend yield should be 8 – 9%. If your required return is

high single digit, it should yield 5 – 6%. NNN is yielding 3.3%.

 The 5 yr avg spread between NNN dividend yield and the yield of an index of US BBB

REIT 10 yr bonds is 62.5 bps, it’s now negative 11.4 bps. NNN is BBB rated. The

dividend yield should always be above a diversified basket of BBB REIT bonds.

Pair Trade Suggestion

1. Long a basket of BBB US REIT bonds and short NNN.

 The least riskiest with 70 bps of correction.

 If bond price don’t move, this means NNN would trade down to $43.5.

2. Long SIR and short NNN.

 the spread in dividend should compressed to negative 2% from the current

4.2%.

 SIR introduces company specific risk. It is highly levered and has external

manager issues (RMR).

 Both are triple-net REITs. Equity market risk and interest rate risk are

hedged.

3. Long a basket of Apartment (AVB, PPS, UDR) and Self-Storage (SSS, PSA, EXR)

REITs and short NNN

 This trade is also a spread trade. You are taking on sector risk. (i.e. new

supply risk in Apartments)

 Equity market risk and interest rate risk are hedged.

 Fundamentally, similar to NNN, apartments and self-storage are both

insulated from the global economy.

 Duration risk. Apartment and self-storage have short lease terms, thus are

much more sensitive to the domestic economy. If you believe the U.S.

economy will continue to do well in the next 2 years, this is the suitable trade

because dividend growth in the long basket will be much higher than NNN.

 The long basket has a dividend yield of low 3%, similar to NNN. Organic,

dividend growth for the long basket should be 3 – 5% vs 1 – 2%

I am against a pure short of NNN (see above bullish thesis).

 There is no immediate catalyst for the short case.

 I am not comfortable making a call in interest rate

 I have learned painfully that the market can stay irrational than one can stay

solvent.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Passage of time.

show sort by

			2016	2017
Price:	52.80	EPS	1.46	1.4
Shares Out. (in M):	144	P/E	36.2	37.7
Market Cap (in $M):	7,587	P/FCF	0	0
Net Debt (in $M):	2,516	EBIT	324	346
TEV (in $M):	10,103	TEV/EBIT	31.2	29.2
Borrow Cost:	General Collateral