STORE Capital Corporation
Q1 2017 Earnings Call Transcript

Published: 8 May 2017

[Operator:]

Good day, and welcome to the STORE Capital First Quarter 2017 Earnings Conference Call. All participants will be listen only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Moira Conlon, Investor Relations for STORE Capital.

[Moira Conlon:]

Thank you, Allison, and welcome to all of you for joining us for today's call to discuss STORE Capital's first quarter 2017 financial results. Our earnings release, which we issued this morning, along with a packet of supplemental information, is available on our investor website at ir.storecapital.com under News & Market Data, Quarterly Results. I'm here today with Chris Volk, President and Chief Executive Officer of STORE; Cathy Long, Chief Financial Officer; and Mary Fedewa, Executive Vice President of Acquisitions. On today's call, management will provide prepared remarks, and then we will open the call up to your questions. In order to maximize participation while keeping our call to one hour, we will be observing a two-question limit during the Q&A portion of the call. Participants can then reenter the queue if you have follow up questions. Before we begin, I would like to remind you that comments on today's call will include forward-looking statements under the federal securities laws. Forward-looking statements are identified by words such as will be, intend, believe, expect, anticipate or other comparable words and phrases. Statements that are not historical facts such as statements about our expected acquisitions or our AFFO and AFFO performance share guidance for 2017 are also forward-looking statements. Our actual financial condition and results of operations may vary materially from those contemplated by such forward-looking statements. Discussion of the factors that could cause our actual results to differ materially from these forward-looking statements are contained in our SEC filings, including our reports on Form 10-K and 10-Q. With that, I would now like to turn the call over to Chris Volk. Chris, please go ahead.

[Chris Volk:]

Moira, thank you. And good morning, everyone, and welcome to STORE Capital's First Quarter 2017 Earnings Call. With me today are Cathy Long, our CFO; and Mary Fedewa, our Executive Vice President of Acquisitions. We continued to be active on the acquisition front during the first quarter. Net of approximately $30 million in gross asset sales, our investment activity for the quarter totaled over $391 million. Our portfolio remained healthy with an occupancy rate of 99.5%, and approximately 75% of the net-lease contracts rated investment-grade quality based upon our STORE Score methodology. Our dividend payout ratio for the quarter approximated 57% of our adjusted funds from operations, serving to provide our shareholders with a well-protected dividend and a company that's extremely well protected that is positioned for long-term internal growth based upon anticipated rent increases from our tenants and the reinvestment of our surplus cash flows. Our funded debt to EBITDA on a run rate basis continued to approximate 6 times at the end of the quarter with all of our investments during the quarter added to our unencumbered assets, which stood at around $2.6 billion or 46% of our total gross investments, providing us with flexibility in our financing options. During the quarter, Fitch Ratings raised our rating outlook to positive, which is in line with our BBB- credit rating with a positive outlook from Standard & Poor's. We continue to target unencumbered asset ratio of over 50% of our total portfolio during the year 2017. And during the first quarter, STORE raised more than $270 million in new equity with most of that from a $220 million overnight sale and the remainder from our ATM. Now here are some specifics that are relevant to our first quarter investment activity. Our weighted average lease rate stood at approximately 7.74%, which is down slightly from the 7.85% last quarter. The average annual contractual lease escalation approximated 1.9%, which is up from 1.8% last quarter, which provides us with a growth rate of return, which is what you get by adding lease escalations and the initial lease rate that was virtually unchanged from quarter to quarter. The weighted average primary lease term was long at approximately 17.4 years. The median new tenant Moody's RiskCalc credit rating profile was consistent at Ba2. The median post-overhead unit-level fixed charge coverage ratio was higher than historical or portfolio medians at approximately 3.35

[Mary Fedewa:]

Thank you, Chris, and good morning, everyone. Our first quarter acquisition volume was strong at $421 million at an average lease rate of 7.74%. As of the quarter ended March 31, 85% of our investments were in consumer-facing industries. 67% of our investments were in real estate leased to service sector tenants such as restaurants, movie theaters and health clubs. 18% of our portfolio is in experiential retail such as furniture stores, home goods stores, hunting, fishing and camping outfitters stores. These are goods that consumers generally prefer to see, touch and interact with before committing to buy. For example, during the first quarter, we invested in 17 Art Van Furniture locations in concert with the acquisition of Art Van Furniture by Thomas H. Lee Partners, a well-known Boston-based private equity firm. Founded in 1959, Art Van has had a long and successful history. Today, it is the number one furniture and mattress retailer across the Midwest. Art Van now leads our top 10 concepts. Furniture is a great example of an experiential retail segment that is thriving in a post-Amazon world. Art Van has two key strategies that we believe will help it continue to thrive. Number one, Art Van's private label brands account for approximately 90% of their sales; and number two, more than 95% of Art Van's physical store guests pre-shop on their website prior to coming into the store. We are excited to have Art Van in our portfolio. You may have also noticed another new tenant in our top 10, Automotive Remarketing Group, which is the third-largest wholesale auto auction service company in the U.S. We began a relationship with them when they had just six units. And today, they have 21 auction centers. This is a great example of our direct origination approach and how our solutions help our customers grow. We are also excited to see them in our top 10. The remaining 15% of our portfolio is manufacturing facilities that serve a broad array of industries that make everyday necessities such as playground equipment, medical devices, aerospace components, memory foam products, just to name a few. These facilities are primarily located in industrial parks and are strategically close to their customers and suppliers. We continue to see a strong flow of new opportunities in our target market of established middle-market and larger companies with strong cash flows. This gives us plenty of room to be selective in making investment decisions while staying on course to meet our expected 2017 acquisition volume of $900 million net of property sales. To date in 2017, we have funded nearly $500 million in gross acquisitions. With that, I'll turn the call to Cathy to talk about financial results and guidance.

[Cathy Long:]

Thank you, Mary. I'll start by discussing our capital markets activity and balance sheet, followed by our financial performance for the first quarter and then review our 2017 guidance. Please note that all comparisons are year-over-year, unless otherwise noted. In the first quarter, we continued to capitalize on our financing flexibility to access both the equity and debt markets, raising over $500 million in capital. We raised a total of $270 million in net equity proceeds through a $221 million follow-on offering in March and $50 million through our ATM program during the quarter. We also raised $235 million of attractively priced debt during the quarter. As we discussed last fall, the unique structure of our seventh series of Master Funding notes allowed us to retain $135 million of debt for future sale. In March, we sold these notes to a group of qualified institutional investors at a coupon of 4.32%. We also raised $100 million through an unsecured two year variable-rate term note that has three one year extension options. The variable rate on this note has been effectively converted to a fixed rate of 2.77% through an interest rate swap. The net proceeds from these capital markets activities were used to pay down all outstanding amounts on our unsecured credit facility and to additional cash to our balance sheet. As a result, we now have the full $500 million of borrowing capacity on our credit facility, which can be expanded to $800 million by accessing the accordion feature. We closed the quarter with cash of $103 million, up from $54 million at year-end, giving us plenty of liquidity for continued acquisition activity. At March 31, our total long-term debt outstanding was $2.6 billion with a weighted average maturity of 6.2 years and a weighted average interest rate of 4.5%. All of our borrowings are long term and fixed rate. In addition, our debt maturities are intentionally well laddered with no meaningful near-term debt maturities. At quarter end, gross investment in our real estate portfolio totaled $5.5 billion, of which approximately $2.9 billion had been pledged as collateral for our secured debt. The remaining $2.6 billion of real estate assets are unencumbered. This growing pool of unencumbered properties provides us with increased financial flexibility, which adds to our overall financial strength. And as Chris mentioned, Fitch upgraded their outlook on our investment-grade rating from stable to positive. At the end of the first quarter, our leverage was right in line with our target at a conservative 6x net debt to EBITDA on a run rate basis or roughly 45% on a debt-to-cost basis. In summary, we're building the company on a very conservative capital structure. We have a strong balance sheet with low leverage, ample liquidity and access to a variety of attractive equity and debt options to fund a strong pipeline of investment opportunities. Now turning to our financial performance, our first quarter results reflect the strong cash flow and earnings power of our business as well as the continued growth of our real estate portfolio. In the first quarter, revenues increased 27% year-over-year to 108 million. Our consistently strong revenue growth reflects the broad-based demand for our real estate capital from our target market of established middle-market and larger companies. Our portfolio grew from 5.1 billion in gross investment, representing 1,660 properties at the beginning of the year to 5.5 billion, representing 1,750 properties at March 31. The annualized base rent and interest generated by the portfolio at March 31 increased 25% to 448 million as compared to 356 million a year ago. For the first quarter, total expenses increased 34% to $80 million compared to $60 million a year ago. Over 40% of this increase is attributable to higher depreciation and amortization expense, simply reflecting the growth of the portfolio. Our interest expense increased about 26% for the quarter as we continued to finance a portion of our acquisition activity with attractively priced long-term fixed-rate debt, locking in healthy spreads for the long term. Property costs were $800,000 for the first quarter as compared to approximately $500,000 a year ago. These costs are primarily related to property taxes, insurance and maintenance costs on properties that were vacant during the quarter as well as the properties where we determined that our tenant was unlikely to pay those obligations. As of March 31, nine of our properties were vacant and not subject to a lease. These properties represent a very small amount, less than 0.7% of the annualized base rent and interest generated by our portfolio. Property costs can vary quarter to quarter based on the timing of vacancies and the level of underperforming properties but are generally not significant to our operations. G&A expenses for the first quarter were 10.2 million or less than 75 basis points on an annualized basis as a percentage of our total portfolio assets. This compares to $8.6 million or about 80 basis points as a percentage of portfolio assets a year ago. Net income increased to $31 million or $0.19 per basic and diluted share for the quarter compared to $25 million or $0.18 per basic and diluted share a year ago. Our net income for the first quarter included a gain of $3.7 million on the sale of five properties, offset by an impairment of $4.3 million recognized on a vacant property sold subsequent to March 31. This compares to a loss of about $300,000 on the sale of one property in the first quarter 2016. We delivered another strong quarter of AFFO and AFFO per share growth. For the quarter, AFFO increased 25% to $70 million or $0.43 per basic and diluted share from $55.8 million or $0.40 per basic and diluted share last year. This represents an increase of 7.5% on a per-share basis. Our dividend is an important component of our overall stock return. And since our IPO, we've increased our dividend per share by 16% while maintaining a low dividend payout ratio. For the first quarter, we declared a cash dividend of $0.29 per common share, representing approximately 67% of our AFFO per share. Our low payout ratio and attractive lease escalators generate excess cash flow that we can invest in new acquisition opportunities to generate strong internal growth. Now turning to our guidance for 2017. Today, we're affirming our 2017 AFFO per share guidance in the range of $1.74 to $1.76. As with prior years, AFFO per share in any period is sensitive to the timing of acquisitions. We had a particularly strong acquisition volume in the first quarter, while property sale volume was light compared to expected sales activity of up to $200 million for the year. As a result, we're-purchases affirming our acquisition volume guidance for the year of $900 million, which is net of anticipated property sales. The remainder of our acquisitions and property sales activity are expected to be spread throughout the year and weighted towards the end of each quarter. Our AFFO guidance is based on a weighted average cap rate on new acquisitions of 7.75%. Our AFFO per share guidance for 2017 assumes net income of $0.78 to $0.79 per share plus $0.87 to $0.88 per share of real estate depreciation and amortization plus about $0.09 per share related to items such as equity compensation, the amortization of deferred financing costs and straight-line rent. While we don't give guidance on capital markets activities, we are targeting leverage based on a run rate net debt to EBITDA of approximately 6x, plus or minus 25 basis points. Estimated interest expense on new long-term debt for 2017 is based on a weighted average interest rate of 5%, which assumes a 10-year treasury rate of 3%. And now I'll turn the call back to Chris.

[Chris Volk:]

Thank you, Cathy. As is usual for me to do and before I turn the call over to the operator for questions, I'd just like to make a few comments about the composition of our investment portfolio. From the inception of STORE, a substantial majority of our real estate investments have been centered on tenants who are involved in providing services. In fact, our exposure to service-centric real estate investments is averaged in the area of 70% of our portfolio for the better part of our existence. This is fully intentional. Service providers that require human interaction are less likely to be disrupted by alternate modes of delivery. And surely, the Internet comes to mind. This is why retail, which has such exposure, has generally been in the area of 15% the o 20% of our average exposure. And we have kept our distance from retail concepts where consumers benefit simply for the convenience of multiple brands or commodity products beneath a single roof. The Internet can and does compete ably with us. Key retailers are vulnerable to this threat as are service providers that do not require material human interaction. With this in mind, we've avoided such retail and even some service-center investments. We started this company in 2011, so had the benefit of seeing much of the handwriting on the wall. And the handwriting on the wall. And the handwriting includes other secular changes on the forefront such as driverless and alternative fuel vehicles. After all, we're writing 15 to 20 year leases in a world where most pundits see the inception of driverless cars within 5 years. At the same time, we're believers in certain bricks-and-mortar retailers. Hunting and fishing retailers come to mind where retailers are more experiential, where service component is important, where shopping patterns are driven often by an immediacy and where certain merchandise is regulated and less generally available through parcel post. So at 2%, a hunting and fishing tenant of ours, Gander Mountain, recently filed for bankruptcy. And as it turns out, another of our customers, Camping World, won a bid to acquire the assets and the intellectual property of Gander Mountain last Friday. Camping World operates a highly successful chain of recreational vehicle parts and services and dealership establishments from coast to coast. Their publicly stated aim is to keep open as many stores as they possibly can and have a clear path to profitability. In our case, we have 13 locations, which generated potent revenues for the 12 months through February 1, 2017 and which posted 4-Wall rank coverage approximately -- approaching two times. Given that the auction was just recently held, it's too early for us to speculate on an outcome. But as in all potential vacancy matters, we were aware of options and are certainly in discussions with Marcus Lemonis and Camping World. In the meantime, our Gander Mountain stores are open and continuing to pay their rents as due. Now I should make a few more comments, too, about retail. First, apart from Gander Mountain, we have no retailers today that concern us. Second, since we are so dominated by service sector real estate investments and since our retail investments include experiential stand-alone hobby stores, furniture stores, home furnishing stores, hunting and fishing and full-service home and farm supply retailers, we actually have few locations that we hold that are in proximity to those retailers that are experiencing closures. So for example, out of our 1,750 properties, just around 3% are within a 0.25 mile in any direction of any Sears, J.C. Penney's, Macy's, Kmart or hhgregg store. In other words, STORE has, by design, virtually no exposure to these retailers or to the malls associated with them. I want to turn for a moment to tenant revenue growth. What you'll see from our investor presentations that our contract quality and median unit-level coverages have shown stability since 2015. That does not actually tell the whole story. In an economy having a nominal GDP growth averaging around 3.75% annually since we started STORE in 2011 and ranging from an annual high of 4.8% to an annual low of 2.8% over the past 6 years, our weighted tenant has realized revenue growth averaging 8.9% annually as a result of same-store sales increases and also as a result of new unit acquisition or development. That growth exceeds the recent approximate 7% growth of -- growth rate of middle-market companies in the United States. Taken together, the middle market is the most formidable creator of employment and economic growth in the country. And actually if you took the middle-market companies in the U.S. as a whole, it would be viewed as the third-largest economy in the world. I'll end my comments on this note, which some of you have heard me say in the past. Most real estate investment companies achieve success based upon the quality of the real estate they hold, and that's because they're generally developers of property that speculatively build and is dependent upon its quality to solicit tenants. For a net-lease investment and management company like STORE, this is not the case. The real estate that we hold is already successful, causing profitable operations and operated by tenants who are so devoted to the locations we hold that they're willing to execute 15 to 20 year leases with approximately 80% of our portfolios are properties held as master leases. Therefore, the benchmark of STORE's success, just like the successful predecessor companies that we've run going back to 1980, is dependent upon the success of our tenants. Two of us are making a bet on the relevance and quality of the real estate that we hold; the tenant who's willing to execute a long-term lease and our investment committees. So if our tenants succeed, we will succeed. And this is precisely why we devote so much of our strategy on tenant and sector diversity and so much of our disclosure on tenant and contracting metrics. Such very meaningful disclosure helps to make certain that we maintain our investment and management discipline in order to keep up our sustained, long-term track record of outperformance. And outperformance comes from a powerful combination of realizing high investment rates of return with low investment of portfolio risk. And with that, operator, I'm going to turn the call over for any questions that you may have.

[Operator:]

[Operator Instructions] Our first question will come from Collin Mings of Raymond James. Please go ahead.

[Collin Mings:]

I guess first question for me, it just doesn't look like there is a big move in kind of your charts as far as on the EDF or the STORE Score. But maybe just -- obviously a lot of concerns out there about underlying tenant quality and recognizing the comments that you made in prepared remarks about being kind of customer-facing and experiential retail, just update us on kind of what it is as far as you're seeing from your tenants and the health? Anything that might have popped up on the watch list for you guys?

[Chris Volk:]

Yes. I would say -- and by the way, I should say as we're answering questions, I'm surrounded by our whole leadership team. So I've got Chris Burbach here, Mike Zieg and Michael Bennett and Cathy and Mary and me, so we will probably pass this around for some answers to if we need to. But I would say that from a portfolio perspective, as I said in my prepared comments, we have no retailers that are on any form of a watch list or concern, and we don't maintain a formal watch list. So you can look at the left tail of our STORE Scores and kind of -- that's kind of where you start, and that's really totally quantitative. And then you sort of drill down from there in terms of what you're looking at. So you won't see any meaningful changes in the left tail of the sheet from quarter to quarter or from year to year. And from a portfolio perspective and the business that we're in, you always expect, and we bake into our projections every year and have for decades, portfolio vacancies that will come up. Right today, we're seeing nothing in our portfolio that causes us to want to alter those projections.

[Collin Mings:]

Okay. And then I guess shifting gears just as far as the guidance and recognizing some of the prepared remarks Mary and Cathy made. But just as far as -- clearly strong start as far as deal flow. Is there anything else, whether it be maybe some higher operating costs because of potential vacancies or things like that, that are holding you back from maybe getting more aggressive on terms of the guidance for the year?

[Cathy Long:]

Collin, this is Cathy. The first quarter volume was strong, but we didn't have very much of what we would anticipate to be sales activity hitting Q1. And that sales activity will occur and as early as Q2. So you can't really look at Q1 and assume that you can just multiply that times four and that will be the annual volume. It was a great start to the year, and we're happy to have that volume and that start. But we will have sales, and I think it's a little too early to be considering changing any guidance at this point.

[Chris Volk:]

And it's obviously too early to do this, I mean after the first quarter conference call. You don't want to do it -- it would be sort of exceptional to want to up your guidance. And our guidance range, of course, is incredibly tight as it is. So we don't have a wide range to move with. So we're not -- but we wanted to up the bottom range of our guidance, and I saw National Retail do that, which is great. Our guidance range is so tight, we couldn't really do that.

[Operator:]

And our next question will come from Ki Bin Kim of SunTrust. Please go ahead.

[Ki Bin Kim:]

Could you talk about your new top tenant, Art Van, and how the deal metrics look like in terms of unit coverage, how well the company is doing, things like that? And also what percent of their sales is mattresses?

[Chris Volk:]

Well, the company is a privately held company. So I think that we can't get into specifics about what percentage of their retail mix is. It is a company that has been based in Michigan and is -- you're talking about a generational transfer. So it's being run by the same leadership team today that's been running it for a long period of time. And if you look at our median unit-level coverage for this quarter, which is north of three, in most quarters where the coverages are two and knowing that's the largest transaction, that should give you a pretty big clue that these stores do exceptionally well and are well north of the coverages that we otherwise have. And we think that the company is diversified across multiple markets. It's -- from a leadership perspective, and they've been a leader for a very long period of time. And they're being acquired by a very good quality firm, and there were other -- many other firms that were -- had an interest in buying them, and they elected to select Thomas Lee, which is great. And that's the best I can tell you.

[Ki Bin Kim:]

I see. I mean, how do you underwrite the kind of growing world of mattresses that are sold online?

[Chris Volk:]

Well, I mean, part of them -- Ki Bin, this is Chris Volk. Part of their business model is across the entire furniture spectrum. So they have a pretty big mattress component, but they also have their own kind of online piece as well for mattresses. So they're a pretty nimble retailer. And if you've ever been to the Midwest, you know who Art Van is.

[Ki Bin Kim:]

Okay. And I want to go back to your comments, Chris, about the watch list. I know you guys have a very quantitative way of looking and evaluating risk, probably one of the better ones in the industry. But I think it was a little concerning that you don't have like a more of a kind of old-school watch list, right? So maybe you can talk a little bit about that and with your size and [indiscernible] I'd imagine there would be at least always a bottom 5%. And tied to that, what was Gander's STORE Score?

[Chris Volk:]

Well, so Gander's corporate credit rating is going to be sort of in the single B-ish range. Their STORE Score would be kind of in the BB-ish range because the stores make money. Actually, the STORE Score is B1, yes. So nothing to write home about. So it's -- and they had gravitated. They -- when we started doing Gander, they were in an investment-grade territory. You go back to -- from a contract basis, you go back to 2013, 2014, end of 2015, they started having issues. If you ask us to be self-critical about things we could have done with Gander, I think we would all told you that we probably could have sold some assets a little bit sooner than we did. And so there were some lessons that we've taken to heart on that. And certainly, we have some ability in hindsight. I mean, it's -- if you're-purchases looking backwards, you can see that. You couldn't see it quite so easily at the time for different reasons. When you say, why don't we have an old-school watch list, I would ask you what an old-school watch list is. So I find that there are a lot of people in this business and no one calculates their watch lists the same way. And if you could make them comparable, if there were metrics that were comparable, we'd be happy to do that. But otherwise, you'll find yourself comparing yourself with other companies and you can't even make a comparison. And I think the best thing to do -- that's why when companies report they all have their ways of reporting. And the best thing you can do with your analysis is to sort of look at them relative to what they've been reporting in the past. In our case, we stand alone as the only company out there that's actually disclosing the entire array of credit quality of our full tenant base of 370-some-odd tenants. There's no one that comes close to that. We are the only people that come close to reporting contract credit ratings which incorporates unit-level coverages, which we can do, because we get 97% reporting, which the next highest company out there is at 75% financial reporting from their portfolio. So the portfolio we give you, the exposure or the disclosure we've given you is like insanely meaningful and is stuff that we look at internally. And then the thing to keep in mind is it's pure quantitative reporting. So for example, you're missing in there the entire notion of capital stacks. So you have somebody who is a B pre-tenant, but they have a lot of mezzanine debt or unsecured debt in front of you, then basically you have a much stronger position. If on the other hand, they're B3 and the only guy in front of you is an ABL provider, totally different issue. So as you're looking through these trends, these curves that we give you from EDF scores, the Store Scores, understand it's fully quantitative. We're not messing with any of the numbers. It's basically third-party derived because you're starting off with Moody's RiskCalc and then you're overlaying a very simplistic algorithm that we deploy. And then from that, then you have to start focusing on the qualitative issues to come up with what would be a watch list, and that's going to be on your left tail. So that's what we're going to be focusing on. If you look from time to time and you're looking at how big the left tail, it's basically been sort of flat to the unchanged for like the better part of several years.

[Operator:]

And our next question will come from Vikram Malhotra of Morgan Stanley. Please go ahead.

[Vikram Malhotra:]

So just going back to Gander, in terms of what you know as of date, 13 stores. What's your sense, do stores as we talked about were going to be shut, what's your sense of what happens to the balance and over what time frame?

[Chris Volk:]

Well, I would say that at the time that Gander was filing for bankruptcy, they announced certain closures. To my understanding is that Camping World has the right to enter into the lease agreement or to negotiate exclusive rights to negotiate with landlords across the platform. And the stores that they announced from a closure perspective may not close, and the stores they announced that would stay and not be close, and they closed. So you should take nothing that you've heard, or again, you shouldn't look at the 17 stores they announced that they were assuming or whatever assume it's 17 stores. There's nothing you can see in the press release. So this is a process. It's dynamic. It's ongoing. It's going to take a month or two or three. In the meantime, as the stores liquidate through and as Mr. Lemonis and Camping World figure out what they want to do and -- with their landlords and how much they want to work with their landlords, then we'll have clear answers going forward. But I don't want to speculate at this time.

[Vikram Malhotra:]

Okay. And just given -- I mean, obviously today, the -- all of net lease is somewhat pressured. But just given what you've seen with one of your peers in terms of maybe you could characterize this as surprises and certain tenant weakness, does this make you -- can you sort of supplement the way you monitor tenants? Is there anything you would like to change? You sort of cited Gander and one of the lessons learned is maybe you could have sold earlier and you did see the credit deteriorate. Is there something additive? Or can you change something to sort of maybe have different early warning system that would help you tackle these issues earlier?

[Chris Volk:]

Well, I mean, first of all, I'd like to say to you, Vikram, that in doing this for 30 years, we've made boatloads of mistakes, and yet we still outperform the broader R&V and virtually every other broad net-lease core real estate sector. And not only outperformed them, we've outperformed them by a mile, and we've done it with less risk and less volatility. So in other words, any mistakes that we've made have -- the portfolios we've run have been able to tolerate those mistakes. I mean, it's really important to have margins of error in the business that you're having. And -- or to be the inverse, having margins of safety. And those are almost too numerous for me to go in to you on this call. I would say that there is nothing that I learned from the peer yesterday that would cause us to change what we do.

[Operator:]

Our next question will come from Michael Knott of Green Street Advisors. Please go ahead.

[Michael Knott:]

Chris, just sort of along that same -- along the lines of that same topic, I think they cited yesterday restaurant weakness and some movie theater weakness, and those are both important categories for you. And just wanted to give you a chance to say whether you've seen anything there that concerns you or not. I know earlier, you said you didn't see anything outside of Gander that concerned you but just wanted to ask that question directly.

[Chris Volk:]

So first of all, I would say that we don't -- we do see things outside of Gander that bother us, but it's nothing systemic. I mean, we always have assets of the portfolio that you're bond trigger are having issues with from time to time. That's part of what we do. But to put a broad brush on theaters, which we've actually had record box-office years, is not true. I mean, the theater tenants that we have been doing very well, or the childhood education operators have been doing very well. One of the things I wanted to point out to you is just sort of how broad the growth is of the tenants that we have for -- at the company level. And if you look at our restaurant tenants, they've been growing also pretty substantially. And if you break down casual dining and you're looking at certain chains like Applebee's, where there are issues, our largest Applebee's -- most of our Applebee's is centered in the second-largest Applebee's franchisee and is doing pretty well. If you look beyond that, say, regional dining chains, they're doing actually quite well. I mean, their same-store sales numbers are doing fine. So we're seeing nothing broadly systemic. I've obviously came to work this morning seeing the cascade of values in wake of a call yesterday and wonder, you think the whole world is falling apart, or somehow there's an economic cataclysm out there. And there's nothing. I mean, you could see from our numbers, I mean, the contract scores are flat. The corporate EDF scores are flat. I mean, these are third-party algorithms. So I mean -- so there's nothing that we're seeing in that respect at all that would suggest that there are any issues. And of course, the other thing is grades. We're getting like 80% of our revenues from people we have less than 1% exposure to. So the amount of diversity that we have and the amount of -- the lack of correlation that we have with our tenant base is extraordinary compared to virtually anybody else.

[Michael Knott:]

I appreciate it. Then last question for me would just be on your growth strategy, external growth. Today, it's obviously just 1 day. But the share price change for you and your peers is pretty significant. I'm just curious how you think about a 1-day shock like this in terms of how you think about your cost of equity, capital and how that impacts -- how you think about external growth going forward.

[Chris Volk:]

Well, I would tell you that even at today's this moment's stock price, it's accretive. And that comes from having huge margins of errors/margin safety in what we do, in terms of making investments at prices that exceed our cost of capital. I mean, I'm a big EVA person. Now I think it's important for you and the investors that are on this call to note that this space is a great business. I know of no better business. I've been doing this for 30 years on the finance side. It is a place where you can just achieve risk-adjusted returns in a world that's real estate-backed and with tenants that you can really create value for. I mean we've made many companies so successful over the years and likewise done the same thing for our investors. It deserves and demands confidence from shareholders because it's vital to the economy in terms of being able to help support these companies growing. To have REITs that trade at values that are less than where properties can be sold out in a marketplace, despite the fact that those REITs have diversified portfolios, and therefore, less risk in the properties individually sold in marketplace makes actually no sense at all. And would be not a smart thing for either investors to do or for the economy to do because it would change people's long-term thinking about how you actually capitalize these companies.

[Operator:]

And our next question will come from Dan Donlan of Ladenburg

[Dan Donlan:]

Yes. Just kind of want to follow up on that question, Chris. The shopping center space is trading at a 20% discount to net asset value that the malls are at a 28%. So what happens if your discount really starts to get disconnected from where you think the property should trade and your company should trade based upon your growth profile, the credit of your tenants, the diversity, what then happens? Do you stop growing? Like how should we think about that, just given the carnage that's happened in other sectors from a valuation perspective?

[Chris Volk:]

Thanks, Dan, for that tricky question. I would say that in our space when you're looking at -- because first of all, the question basically talks about the other areas of real estate where investors are rightly concerned about some very secular changes that are happening and spaces which will have and are having an impact on some old and very-storied companies, and I understand that concern. We have no such concerns. And I pointed out to you that we have a whopping total of 3% of our properties that are anywhere near any Sears, any Penneys, any Kmart, any Macy's stores, any hhgregg store. I mean, so we're not even in the same ZIP code practically. And I think that's important in a world where people are looking how to short-stuff. And if I compare -- when I look at our stock sometimes, some of you who are analysts covering us will have us as a retail net-lease REIT. And people confuse property type with what business people are actually in. So if you look at us, we're probably the only net-lease company that actually discloses our portfolio based upon the business sectors that our tenants are in and not what the real estate physically looks like. Now if you look over time and you take a look at a nice company like Realty Income, who's been -- that went public in 1994, there were times when they were probably trading at or below or close to net asset value. And so there were times in their history where they grew slower and then grew -- and times when they grew faster. And I think that those of us who are in this business should take a lesson from that in terms of being long-term thinkers on this. And of course, Realty Income shareholders over time have been rewarded by their business. And so being simply reactive in a marketplace from day to day, I think, is nice, but not the right answer for us or for shareholders.

[Daniel Donlan:]

Okay. I appreciate the thoughts. You've been around a long time, so I know it's a difficult question. But -- and just kind of maybe switching to your tenants. Given what happened to one of your peers, a lot of their credit risk came out of the tenants that were in the top 20. I'm looking at the STORE Score here. I can see where your most problematic properties are from a risk-out perspective. But just curious if this gives you any thoughts to maybe provide additional clarity or additional disclosure on all of your tenants or at least 50% to 60% of your tenants. I'm just kind of curious if that's something that you're now thinking about or it's something you think that -- because it's just hard to figure out sometimes exactly what's going on, other than just looking at the STORE Scores.

[Chris Volk:]

Okay. Well, the first thing is that we -- the amount of disclosure that we give you is more pervasive and more far-reaching than anyone. I mean, if you look at our corporate presentation, we broke it down into foundational distinction piece of it in the front. And at the end of the foundational distinction piece is a page on corporate governance. And corporate governance is more than just opting out of MUTA, corporate governance -- or not having a staggered board and whatnot. Corporate governance to me is very much about disclosure. So for example, if I disclose to you what our same-store rent increases was this last year, it is really not that meaningful a disclosure. However, if I disclose to you what our embedded rent increases in -- are in our portfolio going forward, much more meaningful from a growth rate of return perspective for you to be able to add up what the lease rate is, the escalators. And we're one of the few, maybe the only that does this from quarter to quarter. And we don't just tell you the cap rate. We tell you what the escalators are on the transactions that we do. We are the only people that give you a full spread of credit reporting. There is no one that comes close. If you're asking me to give you more disclosure, I don't know what more I could give you, except for to give you the actual STORE Scores by tenant, which I don't think I really want to do. These are private companies. And we get their financial statements, so we can't really disclose individual information at the corporate level. And of course, no bank or finance company would ever do that. So you're asking a company to give more in-depth disclosure when frankly nobody gives the disclosure that we give. Now I should point out to you that one of the key components to STORE is the internal growth piece that we have. And so if you have, for example, 67% payout ratio and you roll that cash, that gets you basically 2.5 points of growth. And it actually gives you more than that, like 2.8 or something like that worth of growth. If you have 1.8% tenant lease month, which we do, that gets you another 2.6% or 2.7% worth of growth. I mean you're talking about a company, because we give you the disclosure, you can start to map out that growth, and you know where it's coming from. And that's really important because let's say someday we are a $20 billion equity cap REIT, then your denominator impact of growing starts to -- the external growth doesn't really do a lot for the game. So the internal growth comes exceptionally important over time. And you have to build that stuff in up front. I mean, you cannot wait for it and build it later on. And so this company has eons more of internal growth than any other company that we've been associated with and I believe at least the entire net-lease space in that accord. And of course, internal growth, by the way, helps cover a lot of sense. So if we have default or tenant vacancies, that's a cushion that you have that nobody else has, I mean in terms of what you can do I mean. So from a portfolio performance and a risk-adjusted performance perspective, it's just not even close. I mean, our goal here, if you look at all the foundational things that we've done with this company, is to generate really extraordinary returns with the lowest risk that you can take, I mean -- period. And you do that with underwriting, with disclosure. And in a way, when we give you that disclosure that we give you, which is a wide array of disclosure and you could go through on the foundational distinction slide and walk through various disclosures that we give that are unique to us, when you go through that disclosure, in a way, it institutionalizes performance because you as shareholders or you as analysts look at it and say, "Oh, these guys are giving disclosure." So if Chris Volk is no longer there running the company, you're going to expect whoever my successor is to be able to deliver that kind of disclosure going forward. And that forces people to behave because when you're running a company and you're out there, if you don't have this kind of disclosure, then it's very easy to misbehave.

[Operator:]

And our next question will come from Craig Mailman of KeyBanc. Please go ahead.

[Craig Mailman:]

Just curious. Have you guys look to kind of decide between doing unsecured and Master Funding in the future? I know unsecured has had better terms here. But with concerns about tenant credit and Master Funding having substitution rights or unsecureds don't. I mean, how much do you weigh just the flat kind of cost of the debt versus the flexibility that's embedded in the Master Funding to do stuff if you run into tenant credit issues?

[Chris Volk:]

Well, I think that for us, they're interchangeable. And when you look at our latter debt maturities, again going through the foundational piece of our company, one of the things that we're trying to do here is make it so that our debt maturities in any given year are no more than 2% to 2.5% of total assets. And then we have such an amount of free cash flow that we can reinvest to basically end up in a position where your debt maturities are no more than a 1% to 1.5% of total assets if you net the cash flows, the free cash flows that you retain. So basically, on an interest rate sensitivity basis, interest rate sensitivity on the existing portfolio is almost an afterthought, which I'm going to point out to you in a world where they think that net-lease REITs are so interest-rate sensitive, which we're not. So then the question is as you're deciding which tool for long-term financing to use, whether you use ABS or whether you use unsecured debt, I think that the advantage to having two tools is unquestionable. The barriers to entry to doing a Master Funding conduit are significantly higher than doing an unsecured debt deal, just so you know, much harder. It requires very potent IT systems to be able to pull off. And you're -- today, we're accessing A-rated debt. Now it so happens that A-rated debt tends to, in today's marketplace, trade sort of in line with BBB minus unsecured debt. So our debt costs are almost a push, whether we're going from unsecured to Master Funding. But my guess is that, over time, that's going to change. It will not always be at par. So having the diversity and being able to select which instrument you want to use is always important. The other thing is that having Master Funding gives the unsecured note holders of STORE a real boost. So that when our funded debt to EBITDA is six times and somebody else's funded debt is six times, but they're using, for example, only unsecured debt, it's not even an equivalent. You can't compare the leverage equivalence. From a shareholder perspective, you might say yes. From an unsecured note holder, no, because our leverage efficiency in Master Funding is so extraordinary that our unencumbered asset coverage at the company level ends up being ballistically better for unsecured note holders. And so I think over a long term, unsecured note holders will understand this and we will end up being favored with the lower cost of capital by virtue of having both these instruments to be able to use.

[Craig Mailman:]

That's helpful, I guess. But what I was getting at is how much value do you put in the substitution right given potential tenant credit issues versus having...

[Chris Volk:]

Well, I mean, Craig, we haven't substituted a single asset out of Master Funding at this point. I mean, we've been doing this -- I mean, the first deal we did was in 2012. We can do some. But frankly, we can substitute assets in unsecured, right? I mean, so -- I mean, the issue is can we sell assets out and put new -- we occasionally sell assets out of Master Funding. We take the cash and we reinvest it. I mean, it's -- I think that the value of Master Funding is that unlike using CMBS, we are the servicer. We control the entire conduit. So we -- so in a way, it is the closest flexibility that you can have and probably it's on par from a flexibility standpoint with unsecured borrowings and doing it in a structure finance framework, which is very unusual.

[Operator:]

And our next question will come from Todd Stender of Wells Fargo. Please go ahead.

[Todd Stender:]

Just a couple of quick ones. Back to the Art Van Furniture deal. Can I just hear about how the lease was structured? I know there are 17 properties that you've got, but I know the company itself has about 100. And did you get to cherry-pick those? And what kind of risks should we assume now that the Thomas Lee Partners is the private equity owner?

[Chris Volk:]

Well, I think I could say to you that all the stores they had were really attractive. I mean, they were all making money. And we don't go into companies cherry-picking. We work with a company, I mean, to finance the asset. If we start just cherry-picking real estate, if that's all we do, then we've become a -- not a value-added provider. Whenever I hear somebody say that they're going out and targeting markets, I know they're doing nothing but broker-deal. Because the only way you can target an actual market is to do nothing but broker business. We are doing the reverse. We're starting with tenants, and we have a list of 10,000 companies that we're going after. And today, we have 370 of those 10,000 tenants that are in our customer base. And we're getting about 30% of our business from -- repeat business from those same tenants every single year. So Art Van, I would classify just like that. I mean, it's a company that we are in business with directly. We have a relationship with them. And we arrived at a price point that we thought -- for the real estate that we thought made sense. So you're making 2 decisions, one is how much am I willing to pay for the real estate, and the second one is what's the lease rate supposed to be. And so we have, I think, multiple master leases with Art Van, and we had a nice price point with the real estate, and our capabilities rate was good.

[Todd Stender:]

What was the cap rate?

[Chris Volk:]

I didn't say. Nor will I say it to costar anybody else that calls us up and ask this. Sometimes they'll find out, but we don't say it.

[Operator:]

And our next question will come from Nick Yulico of UBS. Please go ahead.

[Frank Lee:]

This is Frank Lee with Nick. Just got a quick question. Can you guys quantify how much you set aside for Gander reserves in guidance?

[Cathy Long:]

This is Cathy. I do a general reserve for every year based on sort of looking at the contract-level quality of investment grade and so I assume an investment-grade loss rate. And I don't particularly look at who I think it is. I just look at history over time, and the investment-grade loss rate is what I bake in.

[Chris Volk:]

And so when you say reserves, just you know, I mean, real estate accounting is a is lot different from bank and financial institutional accounting. So you don't actually book a reserve in any single quarter when you're doing this. You can book impairments on the -- on property sales, but you don't actually book a technical reserve. So what we're doing every year when we budget for guidance is we assume that some of our tenants aren't going to pay, and we assume some of our tenants are not going to -- are going to have lost rents. And we assume that we're going to have also property tax and direct property costs associated with those tenants, and we assume a period of time it's going to take to retail [ph] those properties and so on. So -- and all that's based upon historical numbers, and we try to build in some cushion on that every year when we do our budgets. And sometimes we are well under that. And sometimes, we're over that number. And so we have to make up the number somewhere else.

[Operator:]

And our next question is a follow-up from Collin Mings with Raymond James. Please go ahead.

[Collin Mings:]

I just want to follow up on two fronts. I wasn't sure if you were going to provide some additional color on just the impairment on the property that got -- that you sold subsequent to the end of the quarter. Any information on the tenant or kind of the situation that drove to the impairment?

[Chris Volk:]

Sure. Well, since Dan Donlan didn't ask the question. He asked last for it. The asset, Dan, was Wright Career College in Overland Park, Kansas. And we had options to relet the property. We ultimately decided that selling it at a loss was a better part of valor, so we did that. So the recovery was not like exciting, but it was okay. In total, if you look -- if you were to assume that -- I hate impairments like this that we took in the first quarter because it's just a timing difference. And sometimes from a finance perspective, analysts sort of miss what's really happening. So if we had sold that property during the first quarter, our loss is -- there would be no -- there would have been no impairment, and our loss on the sale of assets would have simply been higher. In the second quarter of course, since they close -- sold in second quarter, you'll see no loss on the sale of the Wright Career College because we already impaired it in the first quarter. So if you were to like take a true finance approach to it and say, okay, what's really going on here? What's really going on is that year-to-date through April, we lost about $2 million on the sale of real estate, which is not in the scheme of life a lot of money. And when I say $2 million, I'm talking about at cost because I don't like using depreciated book. I mean, I want to sort of tell you what we're disclosing. And I'm not sure that many people disclose this either. We're talking about like what did we actually pay for it? What did we sell it for? How much do we lose? The number is like $2 million net-net. So we had several -- we had two or three opportunistic property sales that basically covered the sins mostly of some vacant properties, three vacant assets that we sold, including the Wright Career College asset. And during the course of the year, if you look at our pipeline for property sales, and Cathy alluded to the notion that the property sales were light in the first quarter, which is just timing. I think that you'll see us book some gains on that stuff over time, and the gains will outstrip the losses, and so -- which is one of the reasons this business is so sweet because you can make a mistake like Wright Career College. You lose some money, and then opportunistically, you can actually cover that entire sin for making money on other properties that you have. I mean, how many businesses are that good? So I mean, this is an exciting thing.

[Collin Mings:]

Well, I guess I'll follow up to that, just along those lines. Chris, just remind us. I know we've spoken about it in the past. But as far as -- just when you have a tenant default, what type of recovery ratios do you get? And how long does it typically take for that to be realized?

[Chris Volk:]

The average recovery tends to be in the 60% to 70% range, and the time frame tends to be 6 to 9 months.

[Operator:]

And our next question will come from Haendel St. Juste of Mizuho. Please go ahead.

[Haendel St. Juste:]

I wanted to go back and clarify some comments you made earlier in the call in response to funding your growth. You responded that issuing equity here would still be accretive. Are you saying that -- should your stock continue to persist at these levels that perhaps the volume is not at risk, perhaps the spread, the accretion? So signaling that you'd be comfortable, if you had to, issuing at these levels to meet your acquisition goals?

[Chris Volk:]

I'm not saying we do it forever, and I'm not saying we do it like in huge quantities. But I mean, the answer is it's accretive. So I mean, if it is accretive. We have a fiduciary obligation to do it. And on top of which, the shareholders benefit from more than just the accretion. They benefit from the fact that you have diversity and that you have a better laddered capital stack from a maturity perspective. You end up with less interest rate sensitivity. There's like a whole host of things that you benefit from when you make acquisitions.

[Haendel St. Juste:]

Okay. And then curious on third-party management. Do you -- how many or how significant of your assets are managed by third parties like, say, Midland?

[Chris Volk:]

Well, understand Midland is a CMBS servicer, and they are based in Overland Park, Kansas. They are part of PNC Bank. And CMBS servicers do four basic things. They collect the rent payments. They actually scan the documents, and so a lot of our stuff is digitally scanned by them. They collect the rent payments. They monitor property taxes. They monitor insurance. They actually typically spread financial statements, although we're now getting that done by India. So we're sending most of the financial stuff over to India. But if you think about this company, we have 70 employees here at Scottsdale, Arizona. And our first company that we operated at about this size had 200 employees and including a phalanx of computer programmers. And we did everything that Midland does, at that company. We've collected the financial statements. We monitor property taxes, monitor insurance. So by using Midland, what we're doing is we're turning a very large fixed cost into a really, really small variable cost, and they do it incredibly well. And on top of that because we access the -- because we have an ABS conduit, so because we have Master Funding, we can then use Midland as a backup servicer, which is also very good. And then finally from a control perspective, all of our money, when it comes in, there's nobody here that actually puts their fingers on it. I mean, it comes right into Midland, and it gets swept out to -- for all the debt payments that we have. And then the residual essentially comes in to STORE. So from a corporate control perspective, anything you can do it's brilliant to use them. And we couldn't begin to duplicate what they do for any amount of money. I mean, it would cost you, as a shareholder, a lot if we were to take on that administrative burden. And it is just administrative. So when you say managing properties, you make it sound like they're actually going and doing something. I mean, they're basically like a back office that is dealing with certain very administrative things. We site-inspect some of our portfolio properties every year. They do that for us. Again, it is just a site inspection report that we get out of them. So by outsourcing things like that, it's important. I mean, we have like five really key core competencies here. I mean, we can acquire properties. We're buying properties at lease rates that you can't get, with lease contracts you can't get, with tenants you won't find. So we're originating in the acquisitions. Our second core competency is that we're underwriting this stuff incredibly well. Our average credit writeup, 30 to 40 pages long, and I'm happy to show some to people. Our third is the ability to close properties and close deals. Our fourth is the ability to manage the assets that we have. And the fifth is the financial reporting and treasury management. Anything we do that's apart from that is a waste of time. And I would tell you that having a bunch of administrative service people doing that is a waste of time. And just like having, by the way, a phalanx of lawyers or phalanx of computer programmers would be not really in our best interest, right. In terms of having like a general counselor that does lots of lawyers, we've tried not to do that as well. So we focus on really what our core competencies are. And everything else we've done, we've outsourced.

[Operator:]

And ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to Christopher Volk for closing remarks.

[Chris Volk:]

Perfect. So in closing, I want to refer you to our recently posted audiovisual corporate presentation, which is available on our Investor page or website. Our presentation approach is also reflected in my annual stockholder letter this year, which is also paired with a video that's available on the website. For the first quarter presentation, you're going to see a few improvements. For example, we're now charting the median unit-level fixed charge coverage ratios for the operations of the properties we hold over time, so you can see trends. Likewise, you could see the stability of the high proportion of investment-grade contracts over time, so you can see how that's moved from time to time. Given the fact that we're entitled to corporate and unit-level financial statements from substantially all of our tenants, which go under these computations, these disclosures are highly meaningful. We added to the disclosure of our top 10 tenants to include descriptions of their businesses, and we also included in our presentation the appendix disclosure related to our historic ability to outperform broader REIT sector and with much less risk over time. We've also put that historic performance into context, illustrating the average 10-year treasury rates, occupancy rates, lease rates and our corporate capitalization strategies and our private company and public companies that we've run. Outperformance through various economic and interest rate environment over three decades is what we've historically done and like the center of our foundational strategies and many margins of safety, they are delivered -- designed to deliver attractive rates of return, coupled with a low amount of investment risk, period. So thank you so much. We look forward to next quarter's call. If you need to ask any further, to follow-up questions, we are around. Bye.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.