November 29, 2017 / 3:41 PM / in a year

Fitch Rates Realty Income's Senior Notes 'BBB+'

(The following statement was released by the rating agency) NEW YORK, November 29 (Fitch) Fitch Ratings has assigned a 'BBB+' rating to the senior unsecured notes issued by Realty Income Corporation (NYSE: O). A full list of Fitch's current ratings on O follows at the end of this release. KEY RATING DRIVERS The ratings and Stable Outlook reflect consistent financial policies and metrics that Fitch does not expect to change over the ratings horizon. The company's credit strengths include good leverage and fixed-charge coverage (FCC) for the current rating, improvements in the company's portfolio quality, good access to capital, the granularity of its predominantly retail net lease portfolio, and management's track record in acquisitions and balance sheet management. These strengths are balanced by elevated tenant concentration relative to select net lease peers, the company's shorter track record of owning non-retail assets, and ownership of assets with less mortgage-financeable assets than higher-rated REITs. Consistent Performance: Realty Income's consistent and generally conservative track record underwriting investments and managing the balance sheet is a credit positive. The company has a 48-year operating history and began trading on the New York Stock Exchange in 1994. Since 2013, the current management team has maintained leverage and coverage ratios, produced same store NOI growth of 1%-2% and produced consistent adjusted funds from operations (AFFO) growth. Good Leverage and FCC: Fitch expects that leverage will remain in the 5.0x-5.25x range over the next 6 to 18 months. As a result of a large equity issuance in February 2017, leverage decreased to the low 5.0x range for the third quarter ended Sept. 30, 2017 (3Q17), compared to 5.9x at year-end 2016. Fitch anticipates that Realty Income will maintain its current financial policies, which include maintaining the company's leverage (as measured by net debt/EBITDA) below 5.5x and its FCC above 4.0x. FCC was in the mid-4.0x range for the TTM ended Sept. 30, 2017, up from 4.0x in 2016 and 3.5x in 2015. Driving the improvement was EBITDA growth from acquisitions, as well as contractual rent increases, partially offset by increased fixed charges associated with debt incurred to fund a portion of those acquisitions,. Walgreens Concentration: Walgreens (BBB/Stable) is O's largest tenant, representing 6.6% of annualized 3Q17 rental revenue. Walgreens recently announced it will acquire a large portfolio of stores from Rite Aid, which is also a large tenant of O's. The details of the transaction are still emerging, and the company has announced that Walgreens will assume a portion of O's Rite Aid stores.. O's exposure to Walgreens and Rite Aid combined is 8.4% of annualized rental revenue. Granular Portfolio Diversified by Store Count and Concept: Fitch expects Realty Income's portfolio will exhibit durable and stable operating cash flows through the cycle as a result of the granularity of its portfolio. Realty Income owns over 5,000 properties located in 49 states and Puerto Rico, with over 80 million square feet of leasable space. In addition, Fitch views the portfolio's tenant industry diversification favorably; O's properties are leased to 251 different commercial tenants in 47 industries. Moreover, O's underwriting focuses on non-discretionary and discount retail segments that are both resilient through economic cycles and mostly insulated from e-commerce pressures. The portfolio's top segments for 3Q17 were drug stores (10.8%), convenience stores (9.5%), restaurants (8.7%, including 5.0% in the Quick Service subcategory), dollar stores (7.8%), and health and fitness (7.6%). The credit quality of O's tenants in its portfolio has improved in recent years and is stronger compared to most of the company's net lease REIT peers. Offsetting this is some tenant concentration. At Sept. 30, 2017, the company's top tenants were Walgreens at 6.6% and FedEx at 5.2% of rental revenue; O's top 10 tenants represent approximately 36% of the company's revenues, which is more concentrated on average than the REIT net lease peer group. Ample Liquidity & Strong Access to Capital: Realty Income has ample liquidity due largely to the $1.3 billion of availability under its line of credit due 2019 and relatively modest near-term debt maturities. Near-term debt maturities are manageable with negligible maturities for the remainder of 2017 and 7.6% of outstanding debt in 2018; O has $1.2 billion of maturities (including its credit facility) in 2019 representing 21% of outstanding debt. Fitch anticipates Realty Income will generate approximately $150 million to $200 million of FCF annually. Realty Income's dividends comprised 81.7% of adjusted funds from operations in 3Q17; the company has steadily decreased its AFFO payout ratio from 88.4% in 2013. O has strong access to the capital markets as demonstrated by the issuance of nearly $1.5 billion in unsecured debt and equity in 1Q17; since 2013 the company has raised over $6 billion in proceeds from the public capital markets. The Stable Outlook reflects Fitch's expectation that O will operate within its targeted metrics through the rating horizon and the issuer will have sufficient capacity to address any potential tenant credit issues. DERIVATION SUMMARY O's closest net lease peer is National Retail Properties (NNN; BBB+/Stable); O is comparable to NNN based on leverage ratio, FCC, portfolio diversification and historical profitability. Other net lease peers include STOR (BBB/Stable), VEREIT, Inc. (BBB-/Stable), EPR Properties (BBB-/Stable) and SRC (BBB-/Stable). O's historical earnings growth, as measured by AFFO and portfolio diversification, positions it as more profitable and more stable relative to all four. KEY ASSUMPTIONS Fitch's key assumptions within the agency's rating case for the issuer include: --Internal operating cash flows grow by 1.5% driven principally by contractual base rent increases; --Net acquisitions totalling $900 million in 2017, $1.1 billion in 2018 and $1.3 billion in 2019 at a 6.25% cap rate; --Recurring operating EBITDA margins remain around 90%; --Sufficient equity and debt issuances throughout the rating horizon to repay debt, fund acquisitions and maintain leverage at or below 5.25x. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action --Fitch's expectation of leverage sustaining below 4.5x (leverage for the quarter ended September 30, 2017 was in the low 5.0x range); --Fitch's expectation of FCC sustaining above 3x (FCC was in the mid-4.0x range for the TTM ended Sept. 30, 2017); --Fitch's expectation of unencumbered assets to unsecured debt sustaining above 3x Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --A more aggressive approach toward funding acquisitions heavily with debt financing, which is not Fitch's expectation; --Fitch's expectation of leverage sustaining above 6x; --Fitch's expectation of FCC sustaining below 2.5x; --Tenant bankruptcies resulting in a weakening of the company's credit metrics. LIQUIDITY Realty Income's liquidity coverage is strong for the rating. The company has ample liquidity due largely to its undrawn $1.3 billion of availability under its line of credit due 2019 and relatively modest near-term debt maturities. Fitch defines liquidity coverage as sources of liquidity (readily available unrestricted cash, availability under the unsecured revolving credit facility, and projected retained cash flows from operating activities after dividends and distributions) divided by uses of liquidity (debt maturities and projected recurring capital expenditures). Near-term debt maturities are manageable with negligible maturities for the remainder of 2017 and maturities of 7.6% of outstanding debt in 2018; O has $1.2 billion of maturities (including its credit facility) in 2019 representing 21% of outstanding debt. FULL LIST OF RATING ACTIONS Fitch currently rates O as follows: Realty Income Corporation --Long-Term Issuer Default Rating 'BBB+'; --Unsecured revolving credit facility 'BBB+'; --Senior unsecured term loans 'BBB+'; --Senior unsecured notes 'BBB+'; --Preferred stock 'BBB-'. The Rating Outlook is Stable. Contact: Primary Analyst Christopher G. Pappas Director +1-646-582-4784 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Steven Marks Managing Director +1-212-908-9161 Committee Chairperson John Culver Senior Director +1-312-368-3216 Date of Relevant Rating Committee: June 28, 2017 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected recurring operating EBITDA is adjusted to add back non-cash stock-based compensation. --Fitch had adjusted the historical and projected net debt by assuming the issuer requires $10 million of cash for working capital purposes, which is otherwise unavailable to repay debt. 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