Four Corners Property Trust: Fortress Balance Sheet, Growth Prospects

Introduction

Four Corners Property Trust (NYSE:FCPT) has performed in line with the sector Vanguard Real Estate Index Fund ETF (VNQ) so far in 2024, resulting in a 10% stock decline so far in the year:

I think the company’s current valuation with a 6% market cap rate, solid fixed-rate financial profile, and ample growth ahead creates a compelling risk-reward investment opportunity, and rank the shares a buy, with a high single-digit return potential to shareholders with moderate leverage.

Company Overview

You can access all company results here. Four Corners Property Trust is a net lease REIT boasting an exceptional occupancy of 99.8%. The company specializes in acquiring and leasing restaurant and food-related properties across 47 states. As of the end of 2023, Four Corners owned 1,111 properties and continues to add more locations into 2024. The portfolio has an average rent escalation of 1.4% annually:

From a geographic perspective, Texas, Florida, and Ohio are the REIT’s three largest markets, accounting for 26.4% of 2023 annual base rent:

More recently, the company has been diversifying in non-restaurant properties, such as auto service and medical retail which account for a combined 17% of annualized base rent. Still, Olive Garden is the largest single exposure of the Group, at 37% of annualized base rent:

In addition to the net lease business, the REIT has a taxable REIT subsidiary involved in restaurant operations, which accounted for 0.5% of 2023 net income.

Operational Overview

In Q4 2023, Four Corners Property Trust grew its FFO per share by 2.5% Y/Y, marginally ahead of the 1.3% full-year growth rate. Being a net lease REIT with a 1.4% average rent escalator, we can expect the trend to continue into 2024.

Debt and Financing

The company ended 2023 with a net debt of around $1.1 billion, implying debt makes up 34% of the company’s enterprise value.

The average cost of debt, accounting for interest rate hedges, stood at about 4% in 2023. 97% of the debt is fixed rate (with the use of interest rate swaps) while floating rate borrowing costs for the remaining 3% of debt stood at 6.46% at the end of 2023.

From a maturity perspective, the company has just $50 million in debt maturing in 2024 (which has already been refinanced) and $150 million in 2025, as shown in the breakdown below for the term loan (39% of the fixed rate debt after swaps) and the fixed rate notes (61% of the fixed rate debt):

Overall, I think Four Corners Property Trust has done a great job locking in lower rates, with limited near-term maturities, allowing the company to capture the spread from its cost of debt of around 4% and the market interest rate of circa 6.5% on the revolver.

Indeed, looking at the maturity profile of the notes above, we observe some $350 million of notes mature between 2029 and 2032 with interest rates around 3%. This amounts to 32% of the company’s net debt fixed at low rates for 5+ years.

FED easing delayed, but still on the table

In a recent note by ABN AMRO, the bank sees the recent upside surprises in US inflation as a challenge to a June rate cut, with markets now predicting a 0.25% move in September this year (ABN AMRO predicts a July move). Nevertheless, odds are rates move materially lower from current levels, with markets predicting a FED funds rate of about 4.25-4.75% in July 2025.

As a result, the increase in interest expenses for Four Corners Property Trust for its first material maturities in 2025 should be rather limited.

Market implied cap rate

I think Four Corners Property Trust should produce an FFO of about $152 million in 2024, which together with the $44 million interest expense results in a circa $196 million cash flow to enterprise value. Against its current enterprise value of about $3.2 billion, the market cap rate stands at a respectable 6%.

In 2023, the average cap rate on acquisitions stood at about 6.7%, with management citing a number closer to 7% for current acquisitions on the company’s Q4 2023 conference call:

Indeed, some of the latest acquisitions closed at cap rates between 7.3% and 7.7%. Given the market cap rate of 6% and investment opportunities on the market, you should expect the company to continue issuing shares to pursue value-creative opportunities.

Risks

The main risk in my investment thesis is that the company’s valuation falls closer to that of private markets, where cap rates closer to 7% are the norm. This would result in a circa 19% drop in the company’s market capitalization. While certainly a possibility, the company benefits from fixed long-term financing, boosting returns to shareholders, which would be a mitigating factor.

Conclusion

Four Corners Property Trust offers a 6% cap rate with a low single-digit growth of about 1.4% driven by rent escalators. Returns to shareholders will be enhanced by smart hedging of interest rate debt at around 4%, allowing the REIT to pass the current elevated interest rate environment with flying colors. I expect the company to continue issuing stock, funding growth opportunities in private markets closer to a 7% cap rate. Looking further ahead, the company may even be able to gradually renegotiate its rent escalators to be in line with the 2% inflation target of the FED, boosting returns even further. As such, given expectations for falling rates and robust operating performance, I rank the shares a buy.

Thank you for reading.