On Thursday, VEREIT (NYSE:VER), formerly American Realty Capital Properties, conducted its second quarter conference call and CEO Glenn Rufrano discussed the four pillars to rebuild the company's foundation for the future.
- Enhance the portfolio
- Improve the balance sheet
- Re-establish Cole Capital
- Pay a sustainable dividend
VEREIT has been battling back from an accounting scandal and cover up that was announced on October 29th of last year. However, the release of the new business plan gives the company a clear focus, and it is an important step in the right direction to establish itself among the REIT elite.
1. Enhancing the portfolio
According to Rufrano, the company is expecting to dispose of $1.8 to $2.2 billion in real estate assets by the end of 2016. That is a daunting figure, and amounts to 12% of the company's real estate assets, but the good news is that VEREIT has a good start with $960 million already in the books.
Of the $1 billion or so in remaining assets sales, Rufrano said the company will focus on minimizing four key property types:
- Non-controlled joint ventures
- Flat leases
- Non-core assets
In particular, flat leases and restaurants caught my attention. First, flat leases – which, like it sounds, are leases where rent does not increase over time – account for 20% of the company's net operating income, and in a potential rising interest rate environment, this provides no protection and little long-term upside. And second, accounting for 12% of annual rent, Red Lobster is overwhelmingly VEREIT's largest tenant, and Rufrano wants to diversify away from this to limit the risk exposure of relying too heavily on one business.
Overall, it is hard to get excited about selling assets, but the process should diversify and improve the quality of the company's portfolio, which is ultimately what is best for the business long-term.
2. Improving the balance sheet
The sale of assets also allows VEREIT to pay down debt in the hope of regaining its investment grade credit rating, which would give the company better access to capital at lower borrowing costs.
According to Rufrano, "We believe we are not far from investment grade based on the majority of our quantitative metrics." One of those quantitative metrics is "net debt to EBITDA," which gives investors and creditors an idea of how easily a company can pay down its debt, and like golf, a lower number is better. Shown below is how VEREIT stacks up against its credit-worthy competition.
|Company||Net debt to EBITDA|
|National Retail Properties||4.4|
VEREIT's figure uses a "normalized EBITDA," which pulls out one-time charges, and, even with the leg up this gives VEREIT, it is still far and away the loser among its peers. However, Rufrano's goal for the company is only a net debt to EBITDA ratio between six and seven, and if VEREIT follows through on the sale of $1 billion in assets, it should have ample cash to begin to cut that figure down and put the company is a better position to regain its investment grade rating.
3. Re-establishing Cole Capital
The third piece to the puzzle is restoring the brand value of VEREIT's asset management arm, Cole Capital. The business currently has $6.3 billion in assets under management, generates 7% of VEREIT's revenue, and is responsible for raising capital and managing investments for four non-listed REITs.
Following the accounting scandal last year, which tainted Cole Capital's reputation, several of the broker-dealers suspended selling shares of Cole Capital's managed REITs, which stunted the company's ability to raise capital.
In a nutshell, Rufrano's plan is to do things the right way (i.e. no more accounting scandals) to win back brokers and investors. It's not fancy, but it is just might to work.
4. A sustainable dividend policy
The final pillar comes with the announcement that VEREIT is reinstating its dividend starting in the third quarter of this year. This will be the first dividend payment since December of 2014.
The company expects full-year adjusted funds from operation, or AFFO – which for REITs is akin to earnings from core operations – to fall between $0.80 and $0.83 per share, and to pay an annualized dividend of $0.55.
Based on those figures, VEREIT would have a payout ratio of roughly 67%. This is well below its peers group that averages payouts in the upper 70% range. However, the lower payout gives the company wiggle room during a challenging time that I believe will allow VEREIT to accomplish the goal of paying a sustainable dividend.
Time to execute
VEREIT has established a clear business plan, begun improving the quality of its portfolio by selling assets, and reestablish its dividend, so there is no question the company has made strides to improve its foundation.
Looking forward, I think investors should be keeping an eye on VEREIT's balance sheet and their credit rating. The lower borrowing costs that come with the investment grade rating that VEREIT is aiming for provide a significant competitive advantage. I would also like to see the company make meaningful progress in paying down its $9 billion debt pile before I consider hitting that buy button.