In part 1 of this series, I discussed, at a high level, why I like the REIT space in today’s market environment. In part 2, I highlighted the first company on the list of five that I have been buying: Federal Realty Investment Trust (FRT). In this piece, I will shift gears into the safe, triple-net REIT space, and highlight another beaten-down name that I’ve been accumulating lately: Realty Income (O).
Realty Income (O)
In part 3, we’ll move from what I believe to be the most dangerous REIT on this list, FRT, to the safest.
Realty Income is known as “The Monthly Dividend Company.”
This is for good reason. Realty Income has now paid a dividend in 602 consecutive months. This means that O has been paying a monthly dividend for more than 50 years. However, O has only been publicly traded since 1994, which is why the company’s official annual dividend increase streak is only 27 years.
Granted, 27 years is nothing to scoff at. It means that Realty Income is a dividend aristocrat (it’s just not technically a Dividend King like Federal Realty is). And, not only has O generated strong passive income growth over the long term for its shareholders (since its IPO in 1994, O has generated a 4.5% dividend growth CAGR for shareholders) but its total returns have been amazingly impressive as well. Since its IPO, O has generated a total return CAGR of 15.3% for its investors. This implies that over the long term, an investment in O has doubled every 4.7 years or so. This is amazing compounding power, which is exactly why I continue to accumulate shares and increase the size of my position.
Realty Income has collected a much higher percentage of its rent recently than Federal Realty. This too factors into my stance that O shares are safer.
In August, O collected 93.5% of contractual rent. The company continues to collect nearly all of its rent from investment grade tenants as well, showing that the company’s focus on higher quality tenants over the last decade or so is paying off during times of distress.
O’s single tenants triple-net business plan not only offers incredibly high margins (and therefore, profits) but also a higher degree of flexibility with regard to location (remember that we discussed the importance of location for FRT’s business model as well) and industry. Realty Income has well-balanced exposure to a myriad of different industries, which helps to provide safety. There are some problematic areas of the company’s portfolio, such as the 6.3% of O’s portfolio that is dedicated towards theater assets (both AMC (NYSE:AMC) and Regal (OTCPK:CNNWF) are amongst its top-20 tenants) and the 7.1% which is dedicated towards health and fitness (we see that both LA fitness and Lifetime Fitness as also amongst O’s top-20 tenants). However, overall, the high degree of rent collection speaks for itself. While O has exposure to areas of retail that are still struggling to open due to the COVID-19 pandemic, it’s clear that the selective nature of O’s real estate investment plan has allowed it to exceed industry-wide averages and therefore, generate more than enough cash flows to safely cover its dividend (which is of the utmost importance to me as a dividend growth investor).
Although O has done relatively well with regard to rent collection, the company’s stock still trades well below its pre-COVID highs.
O’s current 52-week high is $84.92. As I write this, shares trade for $59.63, meaning they are down ~30%. O shares bottomed out at $38.00 during the worst of the March sell-off this year, meaning that they have recovered by nearly 57% in recent months. One might assume that after such a massive recovery the stock would be overvalued.
As you can see on the F.A.S.T. Graph below, while O was certainly overvalued in late 2019/early 2020, the stock’s momentum to the downside during the March sell-off was equally irrational, if not more so, and today, after the strong recovery, shares are trading back in line with their long-term average.
And, when it comes to such a high-quality company like Realty Income, I have no qualms with paying fair value for shares. This is why I’ve been accumulating O in recent months.
I’ve bought shares a handful of times in the $50-60 area. I regret missing out on the March lows (certainly); however, I don’t expect to see those types of prices again and I don’t think it makes a lot of sense to get caught up over missed opportunities of the past when one has a change to buy O shares trading for ~17.5x forward AFFO and offering a 4.7% yield.
Did I prefer O with a 5% and even a 6% yield earlier in the year? Sure, I did. But today, investors have the chance to buy O shares at a valuation that is cheaper than its 5-year and 10-year average P/AFFO ratios (19.52x and 18.51x, respectively).
Once again, we’re talking about an A-rated company (low cost of capital) with a long-term history of generous dividend growth and a best-in-class management team that has begun to use its expertise to expand internationally where there are even better potential deals in the commercial real estate space.
Now that O is mature, I don’t expect to see the ~15% annual total returns that the company has provided in the past moving forward into the future. But with a nearly 5% dividend yield, mid-single-digit AFFO growth prospects, and the benefit of compounding when it comes to dividend re-investment, I think that low double-digit, long-term CAGRs are possible here and that’s exactly what I’m looking for as a dividend growth investor.
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Disclosure: I am/we are long FRT, O. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Originally published on Seeking Alpha