Fitch Affirms National Retail Properties, Inc.'s IDR at 'BBB+'; Outlook Stable

Fitch Ratings has affirmed the credit ratings for National Retail Properties, Inc. (NYSE: NNN) as follows:

--Issuer Default Rating (IDR) at 'BBB+';

--$650 million unsecured revolving credit facility at 'BBB+';

--$1.7 billion senior unsecured notes at 'BBB+';

--$575 million preferred stock at 'BBB-'.

The Rating Outlook is Stable.

KEY RATING DRIVERS

The affirmation of NNN's IDR at 'BBB+' reflects the company's disciplined investment focus on single-tenant retail real estate and predictable cash flow in excess of fixed charges generated from a granular net leased property portfolio. Credit strengths also include strong financial flexibility as measured by good liquidity coverage and unencumbered asset coverage of unsecured debt, and minimal secured debt. Balancing these strengths is some tenant concentration and exposure to predominantly below investment-grade rated tenants. However, tenant credit continues to improve via recent mergers and acquisitions activity affecting top tenants, notably Susser Holdings Corporation and The Pantry, Inc.

Fitch anticipates that leverage will rise moderately from currently low levels and remain appropriate for the 'BBB+' rating. NNN has prudently funded its recent acquisitions primarily with common and preferred equity but also from proceeds from asset sales and long-term debt; a more aggressive approach toward funding acquisitions more heavily with debt would be a credit concern.

Disciplined Investment Focus

NNN invests in a fragmented industry with increasing institutional investor competition. The company's portfolio generates predictable cash flow as evidenced by annual rent bumps of 1.5% to 2% over a 15-to-20-year lease term and consistent occupancy. From 2003 to 2013, occupancy did not fall below 96.4% and stood at 98.8% as of Sept. 30, 2014. Lease renewal rates have been strong at 88% from 2007-2013.

NNN's weighted average remaining lease term is long at 12 years, signaling durability in cash flows, absent tenant bankruptcies. Approximately 25% of the company's annualized rental revenue is derived from properties leased to investment-grade rated tenants. This level is low when compared to Realty Income Corporation (Fitch IDR of 'BBB+' with a Stable Outlook) at 46%, American Realty Capital Properties, Inc. (not rated by Fitch) also at 46%, and Lexington Realty Trust (IDR of 'BBB' with a Stable Outlook) at 39%.

Tenant Consolidation

NNN is benefiting from consolidation within select tenants industries, which should further strengthen cash flow predictability. For example, in August 2014, Energy Transfer Partners, L.P. (NYSE: ETP, IDR of 'BBB-' with a Stable Outlook) and Susser Holdings Corporation completed a $1.8 billion merger. An operating subsidiary of ETP remains NNN's top tenant at 6.6% of annualized base rent (ABR) in third quarter 2014 (3Q'14).

In December 2014, Alimentation Couche-Tard Inc. (TSX: ATD), and The Pantry, Inc. (NASDAQ: PTRY), announced a definitive merger agreement under which Couche-Tard will acquire The Pantry in a $1.7 billion all-cash transaction. After Mister Car Wash (4.6% of ABR), Pantry was NNN's third largest tenant at 4.1% of ABR in 3Q'14. ATD's debt-to-adjusted EBITDAR ratio was 2x in 4Q'14.

Tenant consolidation in recent years has also included 7-Eleven's purchase of Speedy Stop and Tigermarket retail locations from C. L. Thomas, the acquisition of Orchard Supply Hardware by Lowe's, and the acquisition of General Parts International by Advance Auto Parts. Overall, average tenant rent coverage was solid at 2.9x as of Sept. 30, 2014, with only 0.3% of leases set to expire in 4Q'14 followed by 1.3% in 2015 and 1.5% in 2016.

Granular Portfolio

As of Sept. 30, 2014, the company owned 2,038 properties leased to over 350 tenants across 47 states. Top states included Texas (20.7% of ABR), Florida (9.8%), North Carolina (5.3%), Illinois (5.0%), and Georgia (4.8%). NNN is overweight in Texas and Florida; however, the portfolio is spread across numerous metropolitan statistical areas in these states, such as Dallas, Houston, Brownsville, Austin and San Antonio in Texas, and Tampa, Orlando, Miami and Jacksonville in Florida.

The company's top lines of trade as of Sept. 30, 2014 were convenience stores (c-stores, 18.8% of ABR), full service restaurants (9.1%), automotive service (7.2%), limited service restaurants (6.6%) and family entertainment centers (5.2%).

C-Store Exposure

The non-discretionary nature of NNN's retail locations offset Fitch's concerns about the company's exposure to c-stores. According to the National Association of Convenience Stores, c-stores sell 80% of the fuels purchased in the U.S. On average, 71% of a store's total sales are motor fuels, but motor fuels only account for 36% of profit dollars. The discrepancy between sales and profits is due to the fact that fuel margins are low; retailer gross fuel margins averaged 17.1 cents per gallon from 2009-2013 according to Oil Price Information Service. Therefore, the recent decline in crude oil prices has had a negligible impact on c-store operators.

Strong Fixed Charge Coverage for 'BBB+'

The company's fixed charge coverage (FCC) ratio was strong for the 'BBB+' rating at 3.2x in 3Q'14 pro forma for the company's November 2014 common stock offering and recent acquisitions (3.1x for the trailing 12 months [TTM] ended Sept. 30, 2014), compared with 3.1x in 2013 and 3x in 2012. Contractual rent escalators on existing properties and recently acquired assets are the primary drivers behind the slight improvement in FCC. Fitch defines FCC as recurring operating EBITDA less straight-line rent adjustments divided by total cash interest incurred and preferred stock dividends.

NNN's tenants are responsible for funding all recurring maintenance capital expenditures, leasing commissions, or tenant improvements associated with its properties. Fitch's base case anticipates that 1.5% same-store net operating income (SSNOI) growth along with additional acquisition-related NOI at capitalization rates in the low 7% range will result in coverage sustaining in between 3x and 3.5x through 2016. In a stress case not anticipated by Fitch in which the company experiences tenant bankruptcies resulting in a 5% decline in SSNOI, FCC would remain just above 3x. In both cases, this ratio would be appropriate for the 'BBB+' rating.

Good Liquidity Position and Access to Capital

Liquidity coverage, calculated as liquidity sources divided by uses, is 4x for the period Oct. 1, 2014 to Dec. 31, 2016. Sources of liquidity include unrestricted cash, availability under the company's unsecured credit facility (upsized to $650 million from $500 million in October 2014) pro forma for the November equity offering, and projected retained cash flows from operating activities after dividends. Uses of liquidity include debt maturities and projected development costs. Liquidity coverage benefits from full availability under the unsecured line, the aforementioned lack of recurring capital expenditures and laddered near-term debt maturities. As of Sept. 30, 2014, the company had 8.1% of debt maturing in 2015 and 7.6% maturing in 2016; however, pro forma for the November equity offering, the company had 8.1% of debt maturing in 2015 and 0.4% maturing in 2016.

Only 0.2% of total market capitalization as of Sept. 30, 2014 was secured debt, illustrating excellent financial flexibility. In addition, contingent liquidity is strong, as unencumbered assets (3Q'14 unencumbered NOI divided by a stressed capitalization rate of 9%) covered net unsecured debt by 2.7x as of Sept. 30, 2014, which is strong for the 'BBB+' rating. This ratio has been between 2.5x and 3x since 2012. Secured lenders in the insurance company and CMBS markets have an appetite for small net lease retail properties, as evidenced by borrowing by certain public peers such as Spirit Realty Capital, Inc. (not rated by Fitch) and non-traded REITs.

The company has strong access to capital and since 2006 has issued $1.2 billion in common equity at a weighted average premium to consensus mean net asset value of 9.8%, $667 million of preferred equity, and $2 billion of unsecured bonds.

Leverage Expected to Rise Moderately

NNN's Sept. 30, 2014 net debt-to-recurring operating EBITDA was strong for the 'BBB+' rating at 4.3x pro forma for the November equity offering (4.7x for annualized 3Q'14 and 4.9x for the TTM ended Sept. 30, 2014), compared with 4.4x in 2013 and 5.3x in 2012. The company funded recent acquisitions more heavily with equity than debt and in July 2013 converted its 5.125% convertible senior notes to equity, resulting in de-leveraging. Fitch anticipates that NNN will fund its growth more heavily with debt than equity on a go-forward basis, which would result in leverage trending back towards the high 4x range, still in line with the 'BBB+' level.

The company improved its leverage profile despite its track record of acquisitions. From 2010-2013, the company acquired $2.3 billion of properties (69.2% from relationship tenants) at a weighted average capitalization rate of 8.3%, but for the year-to-date period ended Sept. 30, 2014 acquired $532 million of properties (43.4% from relationship tenants) at a weighted average capitalization rate of 7.4%, including a portfolio of Chuck E. Cheese's restaurants.

Dividend Trend Highlights Growth Focus

The company raised its dividend annually for the past 25 years as a result of increases in adjusted funds from operations (AFFO) and taxable net income, stemming from both internal and external growth. NNN's AFFO payout ratio was 78.5% in 3Q'14, down from 79.2% in 2013 and 83.4% in 2012. The current payout ratio is not a credit concern as it remains comfortably below 100% and results in the company retaining nearly $60 million annually in organic liquidity.

Preferred Stock Notching

The two-notch differential between NNN's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB+'. Based on Fitch research titled 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', these preferred securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default.

RATING SENSITIVITIES

The following factors may have a positive impact on NNN's ratings and/or Outlook:

--Fitch's expectation of leverage sustaining below 4x (net debt as of Sept. 30, 2014 to TTM recurring operating EBITDA was 4.9x and 4.3x pro forma);

--Fitch's expectation of FCC sustaining above 3.5x (coverage was 3.1x for the TTM ended Sept. 30, 2014 and 3.2x pro forma);

--Fitch's expectation of the ratio of unencumbered assets-to-unsecured debt based on a 9% capitalization rate, sustaining above 3x (this ratio was 2.5x as of Sept. 30, 2014 and 2.7x pro forma).

The following factors may have a negative impact on NNN's ratings and/or 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 5.5x;

--Fitch's expectation of FCC sustaining below 2.7x;

--Fitch's expectation of the ratio of unencumbered assets-to-unsecured debt based on a 9% capitalization rate sustaining below 2.5x.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis' (Nov. 25, 2014);

--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 18, 2014);

--'Corporate Rating Methodology' (May 28, 2014);

--'Rating U.S. Equity REITs and REOCs: Sector Credit Factors' (Feb. 26, 2014).

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=974715

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