Fewer than 100 of the more than 10,000 publicly-traded companies have increased annual dividends for at least 26 consecutive years. National Retail Properties (NNN) is one of them.

Perhaps more impressively, National Retail’s average annual total return for the past 25 years has been 14.8%, significantly outpacing the market to provide meaningful value for shareholders.

The company is conservatively managed and generates a stream of highly predictable operating income, making it an appropriate income investment for our Conservative Retirees dividend portfolio.

National Retail Properties – Business Overview

National Retail Propertieswas formed in 1984 and is a real estate investment trust (REIT) with more than 2,200 properties over 47 states. The company’s retail properties are leased to more than 400 tenants across 38 industry classifications such as convenience stores and restaurants, providing nice diversification.

Furthermore, National Retail only originates single-tenant triple-net leases, which shift property operating expenses such as maintenance, taxes, and utilities to the tenant. In other words, the rental revenue received by National Retail has substantially fewer expenses and more stable net cash flow than other REITs with a smaller mix of triple-net leases.

National Retail Properties – Business Analysis

We believe National Retail has a strong moat and plenty of opportunities for long-term profitable growth. The company’s strengths really begin with management’s focus on generating consistent annual funds from operations (FFO) per share growth, increasing the dividend annually, and assuming below average balance sheet and portfolio risk.

These objectives have resulted in a conservatively managed, well-diversified business that is not susceptible to any single industry, customer, or geography, which results in very reliable cash flows.

Convenience stores are the company’s largest exposure at about 17% of annual rent, followed by full-service restaurants (11%), limited service restaurants (7.2%), auto service (7%), family entertainment centers (5.6%), and theaters (5.2%).

National Retail’s largest tenant is Sunoco, which generated 5.9% of NNN’s total rent last fiscal year. The company’s top 25 tenants account for 60% of rent, which is a healthy level of diversification. Many of them are in very stable lines of business, too. This prevents National Retail from being overly exposed to the fate of any one customer, reducing its risk profile.

Its top tenants are also in good financial shape with a weighted average rent coverage ratio of 3.6x. By spreading its properties across nearly 40 different industries and hundreds of tenants, National Retail diversifies away a significant amount of fundamental risk.

Furthermore, National Retail owns well-placed retail locations. The company finished 2015 with an occupancy rate of 99.1%, and its occupancy rate has never dipped below 96.4% over the last 13 years. As seen below, National Retail enjoys significantly higher occupancy rates than the broader REIT industry, which results in lower earnings volatility.

National Retail Properties Dividend

Source: National Retail Properties Investor Presentation

Importantly, National Retail has not had to discount its leases or make substantial improvements to its properties to get tenants to stay. The chart below shows the company’s lease renewals by year. From 2007-2015, National Retail renewed 86% of its leases, and 58% of renewals were at rates about the prior rent (14% were at the prior rent, and 28% were below the prior rent).

Importantly, National Retail only invested $338k in capital expenditures on these properties while renewing nearly $40 million in rent over this time period, highlighting the benefits of its triple-net leases (the company doesn’t have to “buy” higher rent with capital investments because tenants are on the hook for maintenance).

National Retail Properties Dividend

Source: National Retail Properties Investor Presentation

We believe National Retail has achieved these strong results for several reasons. First, the company intentionally owns properties with no anchor or co-tenancy issues. By owning single-tenant properties, tenants are unable to pool their bargaining power together to try and reduce their rent. National Retail’s main street locations also provide a strong market for replacement tenants and rent growth over time.

Finally, consumer-focused retailers also face more switching costs than an office or industrial customer because they are more location-driven; they don’t want to risk disrupting their established customer base to save a bit on rent, resulting in stronger renewal rates.

The company has also done a great job managing its lease renewal schedule. As seen below, over 60% of leases are not up for renewal before 2025, and fewer than 10% of leases are due for renewal any single year until then. This protects National Retail from being forced to renew a substantial portion of its leases during a down market. The company’s average remaining lease term is also 11.4 years, providing good cash flow visibility.

National Retail Properties Dividend

Source: National Retail Properties Investor Presentation

By now, it might not come as a surprise to learn that the company generates a strong capitalization rate on its properties. As seen below, National Retail has enjoyed an average cap rate of 8.1% since 2010. While the cost of debt for all REITs is currently cheap, National Retail appears to be very well positioned to continue earning a positive spread on its acquisitions if interest rates begin to rise thanks to its healthy cap rate.

National Retail Properties Dividend

Source: National Retail Properties Investor Presentation

One of the reasons why National Retail earns a strong cap rate is the nature of its market. According to National Retail’s 2014 annual report, the total size of the single tenant retail property market is estimated to be in the $1 trillion range, but the company generated just $483 million in revenue last year, providing plenty of room for future growth via acquisitions.

The market is extremely fragmented. Most of the company’s properties are $2-4 million in size, resulting in less buyer competition because it’s harder to scale in this market. The company also seemingly maintains strong relationships with its tenants, which positions it well for acquisitions and sale-leaseback transactions. All of these factors combine to help National Retail enjoy higher initial cap rates and built in rent growth.

Finally, it’s worth highlighting management’s financial conservatism with the company’s balance sheet. Since REITs are required to pay out at least 90% of their taxable income as a dividend, they are left with little capital to grow their business. As a result, they usually depend more heavily on capital markets for raising debt and issuing equity to keep operations growing.

As seen below, National Retail’s diluted shares outstanding have more than doubled from 55 million in 2005 to 134 million last year in order to fund acquisitions and grow FFO.

National Retail Properties DividendSource: Simply Safe Dividends

Despite the dilution, National Retail has still managed to consistently grow its FFO per share, highlighting management’s ability to make accretive acquisitions. Importantly, National Retail maintains one of the lowest leverage ratios relative to other REITs. As seen below, the company’s long-term debt to capital ratio stood at 37% at the end of 2015. Most REITs in our coverage have a ratio greater than 50%. While credit markets are loose and cheap today, highly levered REITs are more likely to cut their dividends if conditions

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