NNN's Financial Strength and Diversified Tenant Base Provide Some Flexibility in this Environment

National Retail Properties (NNN) is one of America's oldest triple net lease REITs and has grown its dividend each of the last thirty years. Triple net lease contracts shift most operating expenses (insurance, maintenance, utilities, and property taxes) to the tenant.  NNN simply collects rent and typically enjoys highly stable cash flow.

However, the coronavirus outbreak has prompted a growing number of retailers to temporarily close their stores to help slow the spread of the virus, calling into question whether NNN's tenants will be able to meet their rent obligations in the near future.

Moreover, it's unclear when stores will be able to reopen. Two weeks is when many governments and businesses plan to reevaluate the situation, and it would be unsurprising to see store closures extended at that point.

The degree of uncertainty facing retailers and the sudden drop to virtually zero cash flow for many is unprecedented. The financial implications of the shutdown that's currently taking place across the country are unknown. Much depends on how long the shutdown will last, how quickly traffic will return to stores, and what assistance the government will be able to provide to soften the blow to businesses and consumers.

Due to uncertainty presented by these sudden developments and the potential for material impacts on NNN's cash flow, we are downgrading NNN's Dividend Safety to Safe. We still plan to hold our shares of NNN in our Conservative Retirees Portfolio.

For now, NNN's dividend still looks safe, but the situation is evolving rapidly. A significant percentage of NNN's rent is generated from convenience stores (18.2%), automotive stores (9.6%), and fast food restaurants (8.8%), all of which appear to remain open to some degree, though this could change quickly.

NNN's tenants also appear to have been in somewhat better shape financially than many other retailers coming into the shutdown. The weighted average rent coverage (the ratio of cash flow to rent expense) of NNN's top tenants is 3.5x, suggesting tenants have some capability to suffer a temporary financial hit and still pay rent.

Of course, the next several months will be an extraordinary test of the resilience of tenants. NNN targets primarily tenants with non-investment grade credit ratings or no credit rating at all, which increases the risk profile of NNN's portfolio.

That said, NNN has one of the strongest balance sheets amongst REITs, has earned an investment grade BBB+ credit rating from Standard & Poors, and has access to a $900 million credit facility. In an unusual environment like this, borrowing capacity will be paramount for management teams that choose to maintain their dividend should cash flow suffer.

Also, thanks to a relatively low payout ratio of 73% as of NNN's last earnings report in February, NNN could, in theory, take about a 22% hit to cash flow and still cover its dividend. However, this would imply diverting investments into new property acquisitions (i.e. future growth) towards the dividend, which management may not find prudent.

Perhaps most important during this period of intense uncertainty is how committed management is to the dividend. NNN's business model is built in part on an impressive dividend track record, which attracts investors and helps the firm raise capital at lower costs than other REITs. Management won't be rash with the dividend given its streak of paying growing dividends each of the last thirty years.

All said, this is a highly unusual environment for NNN to operate in. NNN looks to have the ability to maintain its dividend, but that could change quickly as governments weigh the economic and public health costs of their strategies to contain the outbreak of the novel coronavirus outbreak