STIFEL: ADC ($47.80, Buy) - Takeaways From Management Meetings With Agree Realty Corporation

FULL REPORT

Takeaways From Management Meetings With Agree Realty Corporation

Hosted Management Meetings. We recently hosted meetings with Agree Realty Corporation's management.
Why ADC? Agree has a high-quality net-lease pure-play retail REIT portfolio that has been transformed over the last few years. The company's size and unique growth platform could result in some of the best AFFO growth of the next few years. The dividend is well-covered and should continue to grow. Additionally, ADC has one of the strongest balance sheets in the sector.

Main Message. Management's main message is that the company has created value and continues to create value across its three platforms.

Diversified Business Model. Agree has three growth platforms: acquisitions, development, and Partner Capital Solutions (PCS). Acquisitions yields are in the mid-7.0% range, development yields are in the 9.0% range, and PCS yields are somewhere in between.

How Is ADC Differentiated From Its Peers? Management believes it differentiates itself from the other net-lease peers in that it focuses strictly on retail, is a real estate focused company as opposed to being more of a finance company, and management believes its development capabilities also stand out.

Becoming More Relevant. Agree has become increasingly more relevant in the triple-net sector and among REIT investors as it has reached a certain mass and size. The company’s enterprise value is currently $1.5 billion.

Should Have Some of the Best AFFO Growth Among the Group. Our 2016, 2017, and 2018 AFFO estimates are $2.53, $2.84, and $3.05, respectively. On an AFFO basis, the company also has some of the highest expected CAGR from 2014-2017E of 8.5%, above the sector average of 6.2%. The cumulative growth is third behind Gramercy Property Trust (26.6%) and STORE Capital Corporation (10.1%).

Economies of Scale. The company today has 25 employees, up from only 12 just 36 months ago. The company has quadrupled over the last few years. Management believes it can double the size of the company by acquiring $250-$275 million/year of acquisitions with $50-$100 million of development with very little incremental SG&A. This could provide further earnings upside for the company. Management felt the optimal size for the enterprise is ~$3.0 billion.

Recent Value Creation Opportunities. Some recent and current value creation opportunities include a Starbucks turn-key lease at the strip center in Lakeland, FL, a ground-lease Chick-fil-A in Frankfort, KY, a ground-lease Texas Roadhouse in Mount Pleasant, MI, and the Family Fare Quick Stop in Marshall, MI. Another opportunity is the 20,745 sf Off Broadway lease in Boynton Beach, FL that expires next year. The lease was an original Borders location and accounts for half of the rent roll.in 2017. The property could be expanded by 15,500 sf and re-leased at higher rates.

YTD Acquisition Volume. YTD, Agree has purchased $192 million of acquisitions at a 7.8% cap rate. Acquisition volume included a $79.5 million, 11-property portfolio with a weighted average lease term of 11.4 year with assets primarily located in L.A. and S.F. as well as Seattle, Austin, Denver, and Orlando. Acquisition guidance is $250-$275 million, which was increased 40.0%. Additionally, the company's PCS division has completed or commenced nine projects.

Portfolio Statistics. The company’s portfolio is 99.6% leased, with a weighted average lease term of 11.0 years, one of the longest in the industry. Only 12.4% of revenue is rolling in the next five years. The company has the highest investment-grade concentration (46.1%) among its peers. Although non-investment grade, Hobby Lobby and Tractor Supply have solid balance sheets.

Has Pared Down Walgreens Exposure. Exposure to the company's top tenant Walgreens is currently 13.7%, down from 21.9% as of January 2015. Last quarter, ADC sold a Walgreens in Port St. John, Florida for $7.3 million, or a 5.5% cap rate. It hopes to sell $20-$50 million of Walgreens this year at very attractive cap rates. Overall pharmacy concentration has been reduced by over 1,100 bps over the same time-frame. Management would like to continue to reduce Walgreens concentration to below 10.0% by year-end 2017 and below 5.0% over the next 3-4 years.

Recently Added New Director. Last week, ADC appointed Merrie S. Frankel to its board of directors. She will replace outgoing board member Eugene Silverman, who has served for over 20 years on the board. Ms. Frankel most recently worked for Moody's Investors Service for the last 18 years in the Commercial Real Estate Finance Group as VP and senior credit officer.

Dividend. In early May, Agree raised its quarterly dividend 3.20% to $0.48 or annual yield of 4.02%. The current 2016E 76.0% FAD payout is below the group average by 200 bps and at the lower-end of management's payout range. This means the company has ample cushion to raise the dividend going forward.

Obtained $100 Million Of Unsecured Financings Earlier This Quarter. In early July, ADC obtained $100 million of unsecured financings with a weighted average lease term of 10 years at a blended interest rate of 3.87%. The financings consist of a seven-year $40 million unsecured term loan at 3.0% and a 12-year $60 million privately placed senior unsecured note at 4.42%. The company is likely eligible for an investment grade rating but does not feel it needs one at its current size.

Strong Balance Sheet. The company’s balance sheet remains strong, in our view, with net-debt+preferred/EV at a healthy 25.4%, one of the lowest in the sector, and net-debt+preferred to EBITDA at 5.1x, also among the lowest in the sector. No debt matures until 2018.

Valuation. Our 2Q16 NAV per share estimate of $42.00 reflects a 6.0% cap rate. Our value range of $47.50-$37.50 reflects cap rates of 5.5%-6.5%. Shares currently trade at an implied 5.5% cap rate and at a 13.8% premium to our NAV. Our estimated 2017 AFFO multiple is 16.9x, almost 3.5x below National Retail Properties (NNN, $49.42, Buy) and Realty Income (O, $65.54, Buy).

Target Price Methodology/Risks

Our target price of $54.00 reflects a 17.7x our 2018 AFFO estimate of $3.05. Risks to our target price include a prolonged economic downturn or recession, interest rate movements, and general market risk, including continued weakness in the mortgage-backed securities market and commercial real estate fundamentals.