Fitch Affirms Realty Income’s IDR at ‘BBB+’; Rates $250MM Term Loan

NEW YORK

Fitch Ratings has affirmed the ratings of Realty Income Corporation with the IDR at ‘BBB+’. Fitch has also assigned a ‘BBB+’ rating to the $250 million unsecured term loan due 2020.

KEY RATING DRIVERS

The affirmation of Realty Income’s IDR at ‘BBB+’ reflects the granularity of its predominantly retail net lease portfolio, its disciplined acquisition strategy and management track record. Credit strengths include strong fixed-charge coverage (FCC), ample liquidity, and access to multiple sources of capital.

The rating is balanced by leverage that has increased over the past several years (5.5x for the quarter ended March 31, 2015 pro forma for recent acquisitions compared to 4.4x at year-end 2009). The risks stemming from higher leverage has been tempered in part but not in full by the improving granularity and tenant credit quality. Fitch expects that leverage will decline slightly over the next 12 to 24 months but remain somewhat elevated for the ‘BBB+’ rating.

GRANULAR PORTFOLIO WITH IMPROVING TENANT CREDIT

Fitch expects Realty Income’s portfolio will exhibit durable and stable operating cashflows through the cycle as a result of the granularity (4,378 stores), lease structure and generally improving tenant credit profile of its portfolio. In addition, Fitch views the portfolio’s tenant industry diversification and focus on properties primarily leased to non-discretionary retailers favorably. Moreover, O’s underwriting focuses on non-discretionary retail segments that are believed to be more resilient through economic cycles and insulated from e-commerce pressures. Per the issuer, over 90% of the retail tenants offer a service, are non-discretionary and/or have a low price point component to the business. The portfolio’s top segments for 1Q’15 were convenience stores (9.6% of rental revenues), drug stores (9.6%), dollar stores (9.3%), casual dining and quick service restaurants (8.4%) and health and fitness (6.8%).

Realty Income has materially increased the percentage of annualized rental revenue derived from properties leased to investment-grade rated tenants to 48% as of March 31, 2015 from 2% in 2007 and 15% in 2011. Partially offsetting these factors is some tenant concentration, albeit with highly rated tenants. At March 31, 2015, the top tenants were Walgreens (Fitch IDR of ‘A-‘ with a Stable Outlook) at 5.5% of revenue, FedEx (IDR of ‘BBB’ with a Stable Outlook) at 5.2% of rent, and Dollar General at 4.8%.

CONSISTENT TRACK RECORD

Realty Income’s consistent and generally conservative track record underwriting investments and managing the balance sheet is a credit positive. Realty Income’s strategy centers on owning retail and non-retail real estate net leased to stronger credit tenants. However, its experience owning non-retail assets such as industrial and distribution (10.7% of 1Q’15 revenue), office (6.4%), manufacturing (2.4% and agriculture (2.3%) and manufacturing is somewhat limited. Moreover some of these asset classes have higher lease renewal risk (i.e. office) and may be less financeable than investment grade non-retail (e.g. agriculture), in Fitch’s view.

ELEVATED LEVERAGE BUT STRONG FIXED-CHARGE COVERAGE

Fitch expects Realty Income’s leverage will sustain in the 5.5x – 6x range through 2016 (5.5x at March 31, 2015 pro forma), which is towards the higher end of the range for the rating. Fitch views leverage sustaining between 4.5x – 6x as appropriate for the rating considering the portfolio quality and type. In a stress case (principally a material tenant bankruptcy) scenario not anticipated by Fitch, leverage could sustain above 6x, which would place pressure on the ‘BBB+’ rating and/or Outlook.

FCC is strong for the rating at 3.4x for the quarter ended March 31, 2015 pro forma up from 3.2x in 2014 and 2.6x in 2012. EBITDA growth from acquisitions as well as contractual rent increases and occupancy gains in the same-store portfolio, partially offset by increased fixed charges associated with debt incurred to fund a portion of those acquisitions, drove the improvement. Fitch defines leverage as debt less readily available cash to recurring operating EBITDA. Fitch defines FCC as recurring operating EBITDA less straight-line rent adjustments less recurring capital expenditures divided by total interest incurred and preferred dividends.

AMPLE LIQUIDITY AND STRONG ACCESS TO CAPITAL

Realty Income has ample liquidity pro forma for the expansion of its line of credit by $500 million to $2 billion, the $250 million term loan and the $276.7 million equity issuance in April 2015. As a result, liquidity coverage is strong for the rating at 2.7x for the period April 1, 2015 to Dec. 31, 2016. Fitch defines liquidity coverage as sources of liquidity (readily available unrestricted cash, availability under the unsecured revolving credit facility pro forma, and projected retained cash flows from operating activities after dividends and distributions) divided by uses of liquidity (debt maturities and projected recurring capital expenditures). Longer term, debt maturities are manageable with 4.9% maturing in 2015 and 13.3% in 2016.

Fitch anticipates that Realty Income will be able to generate approximately $80 million – $100 million of retained operating cashflow despite the track record of monthly dividend increases. Realty Income’s dividends comprised 83.3% of adjusted funds from operations in 1Q’15 as compared to the 83.1% – 92.5% range from 2006 – 2014.

Realty Income has adequate contingent liquidity in the form of unencumbered assets which covered unsecured debt by 2.4x at March 31, 2015. Fitch calculates unencumbered asset coverage as unencumbered NOI divided by a stressed capitalization rate of 9%.

KEY ASSUMPTIONS

Fitch’s key assumptions within the rating case for O include:

–Operating cash flows grow by 1.5% driven principally by contractual base rent increases;

–Net acquisitions totaling $650 million in 2015 and $500 million in 2016 at a 7% cap rate;

–Recurring operating EBITDA margins remain around 90%;

–Equity issuances sufficient to maintain leverage below 6x.

RATING SENSITIVITIES

The following factors may result in positive momentum in the ratings and/or Rating Outlook:

–Fitch’s expectation of leverage sustaining below 4.5x (March 31, 2015 pro forma leverage is 5.5x);

–Fitch’s expectation of FCC sustaining above 3x (1Q’15 pro forma FCC is 3.4x);

–Fitch’s expectation of unencumbered assets-to-unsecured debt sustaining above 3x (this ratio is 2.4x as of March 31, 2015).

The following factors may result in negative momentum in the ratings and/or Rating Outlook:

–A more aggressive approach towards funding acquisitions heavily with debt financing, which is not Fitch’s expectation;

–Fitch’s expectation of leverage sustaining above 6x (Fitch has not changed this sensitivity, as the improvement in tenant credit quality and portfolio granularity has been offset to some extent by the company’s shorter track record of owning non-retail assets);

–Fitch’s expectation of FCC sustaining below 2.5x;

–Tenant bankruptcies resulting in a weakening of the company’s credit metrics.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the ratings of Realty Income Corporation as follows:

Realty Income Corporation

–IDR at ‘BBB+’;

–Unsecured revolving credit facility at ‘BBB+’;

–Senior unsecured notes at ‘BBB+’;

–Preferred stock at ‘BBB-‘.

Fitch has assigned a ‘BBB+’ rating to the term loan entered into by Realty Income Corporation. The Rating Outlook is Stable.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 25 Nov 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=821568

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=987526

Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=987526

Endorsement Policy
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Fitch Ratings
Primary Analyst
Britton O. Costa, CFA, +1-212-908-024
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst:
Steven Marks, +1-212-908-9161
Managing Director
or
Committee Chairperson:
Monica Aggarwal, CFA, +1-212-908-0282
Managing Director
or
Sandro Scenga, +1-212-908-0278
Media Relations, New York
sandro.scenga@fitchratings.com