National Retail Properties

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

NNN REIT, Inc. is a Maryland corporation operating as a fully integrated real estate investment trust (REIT), primarily acquiring and owning single-tenant retail properties leased to national and regional retail tenants under long-term net leases.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

NNN operates as a real estate investment trust (REIT), focusing on single-tenant retail properties. Its core business involves acquiring and owning these properties, which are then leased to various national and regional retail tenants under long-term net leases. Here’s a breakdown of key aspects:

  • Property Portfolio: NNN’s portfolio primarily comprises freestanding retail locations, with a weighted average remaining lease term of 10.1 years. A wide variety of retail locations like Convenience stores, Full Service Restaurants, and Automotive service are a part of their tenant list.
  • Lease Structure: NNN uses net leases, under which tenants are responsible for all operating expenses related to the property, including maintenance, insurance, and taxes, allowing it to have low operating costs.
  • Tenant Base: NNN’s tenants are primarily national and regional retail brands. In the recent years, they have increased their efforts to lease properties to e-commerce resistant businesses and businesses focusing on the service sector.
  • Geographic Diversification: The properties are located in a wide range of states in the US. States like Texas, Florida, and Georgia constitutes a considerable part of their portfolio.
The management states that their investment approach is not based on geography and that they focus on credit worthiness and sustainability when looking at tenants. *   **Business Strategy:** NNN's strategy revolves around maintaining high occupancy rates, predictable cash flows, and stable rent.

Competitive Landscape

NNN faces competition from various sources, both domestically and internationally, including:

  • Other REITs: This is perhaps the main competition, other REITs which also lease properties under similar conditions.
  • Private Real Estate Investors: These are investors who compete with NNN for acquisitions and seek profits in the same industry.
  • Lenders: These lenders compete by providing their clients with more lucrative deals than NNN.
  • Public Retail Companies: These are companies that directly acquire and manage their properties rather than paying rent. The high competition for assets might lead to the risk of NNN buying overvalued properties that could become a drag on their ROIC.

It is important to understand that NNN’s market, retail real estate, is changing dramatically. In the past two decades, the growth of e-commerce players has impacted traditional retailers and many stores have had to reduce their footprint in the face of competition. Management, however, believes that their focus on high-quality tenants and e-commerce resistant businesses, that have a great credit-rating, insulates them from this.

Moat Analysis: 3/5

NNN does not possess a wide moat due to the limited differentiation within the REIT space and the competitive nature of its sector. However, it has a narrow moat based on some factors:

  • Size and Scale: Although other REITs of similar size exist, NNN’s considerable scale gives them access to good-quality properties and tenants. It gives them better access to capital and a better negotiating position with larger retail chains.
  • Net Lease Structure: The net lease structure is fairly unique in the sense that it allows the company to have predictable, recurring revenues while also putting the onus on expenses to the tenants.
  • Tenant Relationships: The company does not have the “network effect” as outlined in Dorsey’s “The Little Book that Builds Wealth”. The company’s relationship with its tenants allows the company to earn recurring revenue, and it has been able to retain many of the high-quality brands by giving them better offers and by having more sustainable properties than what is available in the market.

Based on these, I have rated the company a 3 out of 5 in moat. It is relatively durable, and it isn’t very easy for competitors to steal their tenants, but NNN isn’t in an area where they can exert substantial pricing power over their tenants.

Risks

Here are some of the key risks NNN faces:

  • Economic Slowdowns: Recessions and periods of low growth can have an adverse impact on businesses, and in turn, hurt the ability of tenants to pay NNN. If there is a substantial downturn, the number of vacant properties could go up and affect its ROIC.
  • Changes in Retail Industry: Shifts in consumer behavior, such as an increased focus on e-commerce, could weaken the long-term health of NNN’s tenant base. This could lead to reduced occupancy and increased defaults by the tenants.
  • Interest Rate Risk: Rising interest rates will increase NNN’s cost of capital and reduce the profitability of future investments. High interest rates may also squeeze some of its tenants, causing some to default or renegotiate their leases.
  • Tenant defaults: If tenants are unable to pay, then that will affect the overall earnings and might force NNN to sell at disadvantageous positions.
  • Overleveraging The debt that NNN takes to buy properties can become a liability if the economic cycle turns against the business.
The company has a history of relying on debt to fund acquisitions.

Business Resilience

Despite the risks outlined above, NNN has shown substantial resilience in the face of economic hardships. Here are a few aspects that might enable this resilience:

  • Long-Term Leases: The long-term, net lease structure of NNN’s properties provides a predictable income stream and protects them from some short-term market fluctuations.
  • Diversified Portfolio: NNN’s diversified portfolio limits the impact of a downturn in a specific region or by a specific tenant. Also, they have made efforts to move away from areas that are most likely to be affected by recession.
  • Low-Leverage: NNN has been working to bring down its debt-to-enterprise value ratio. While still relying on debt, it is likely to weather downturns better due to less reliance on debt.
  • High-Quality Tenants: The company’s focus on high-quality, e-commerce resistant tenants with strong credit ratings gives some confidence about its future viability.
The company's financial policy focuses on minimizing risk as well as maintaining a robust balance sheet.

Financials

Here is a look at NNN’s financial standing using the most recent financial information available:

  • Recent Performance: The Q3 2024 earnings release showed that the occupancy rates are consistent with previous quarters and rent collection was high at 99.8% from the properties. NNN has focused on maintaining a conservative balance sheet and a solid liquidity position.
  • Revenues: NNN primarily generates rental income, and it is fairly consistent over the years. A significant part of its revenue comes from the properties it owns.
  • Operating Profits: As a REIT, NNN has lower profit margins than most non-real estate companies. This is because, a lot of their earnings is used to fund property acquisitions.
  • Net Income: The company saw improvement in their net income in 2023, compared with 2022 due to improvements in operations. However, their net incomes are quite volatile as their real estate dispositions have an effect on them.
NNN has consistently increased its dividends over the past years. They have also increased their share buybacks, suggesting management is confident in future profitability and returns. *  **Balance Sheet**:  The company seems to have an adequately healthy balance sheet. It has limited short term debt and has a solid liquidity. NNN has reduced its leverage over the years, while still maintaining a solid credit rating from various rating agencies.

Understandability: 2 / 5

Although the company has several moving parts, the core business model is pretty straightforward: acquiring and leasing retail properties to various national retail chains. The challenges of valuing this business, however, and the nature of REITs makes the company have a slightly above-average complexity in its core functionality.

Balance Sheet Health: 4 / 5

While some points may be a concern, such as the level of debt it holds, on the whole NNN seems to be operating with a very healthy balance sheet that is stable and relatively low risk:

  • High-Quality Debt: The company makes use of high-quality, low-interest debt. They have also been refinancing older debt to bring down their interest rates, which have a positive impact.
  • High Liquidity: The company has a good reserve of cash and cash equivalents, which will help it in weathering downturns. They also have an investment-grade credit rating, which helps with access to loans.
  • Strong Financial Discipline: The company has historically been fiscally prudent, and the management continues to emphasize its focus on stability and the long-term value.