Realty Income: One Of My Favorite Holdings Is Now A Bargain Buy

seekingalpha04-19

Realty Income's weighting in my portfolio is the biggest for a REIT and the 12th-biggest overall.The equity REIT set a record for total property investment volume in 2023 and has ample room to keep ...

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Portra As a dividend growth investor, it's my goal to build a portfolio centered around reliably growing passive income. The idea is that one day, my portfolio will generate enough dividend income to cover my living expenses. My rationale for doing so is that such an approach would allow me to avoid having to sell off my portfolio to fund my lifestyle in potential retirement. That would save me the trouble of being at the mercy of the market for the valuations that I could fetch for my investment holdings. Thus, this rising passive income stream could prevent me from being a forced seller at inopportune times. One of the more noteworthy holdings within my portfolio is the triple net lease REIT, Realty Income (NYSE:O). Comprising 1.7% of my portfolio, Realty Income earns the distinction of being my largest REIT holding and my 12th-biggest overall holding. When I last covered the REIT with a buy rating in July 2020, I appreciated Realty Income's consistent growth and safe dividend. In that time, shares have shed 7% of their value - - against the 54% gains of the S&P 500 (SP500). In hindsight, the massive spike in interest rates that began in Spring 2022 resulted in substantial downward pressure on the valuation multiple. For context, the P/FFO multiple was around 17 at that time per FAST Graphs. Now, that multiple is below 13. As rates have climbed, alternatives to REITs arose and equity REIT share prices had to come down to compensate. So, the timing of my buy rating was off. However, as I'll explain, Realty Income's current fundamentals and valuation remain appealing enough for me to keep my buy rating with conviction. Dividend Kings Zen Research Terminal Realty Income's 6% forward dividend yield is comfortably above the real estate sector median forward yield of 4.9%. This is why Seeking Alpha's Quant System awards a B grade to Realty Income for forward dividend yield. This above-average starting income also doesn't appear to come with a sacrifice of safety, either. Realty Income's 75% FFO payout ratio leaves a margin of safety versus the 90% FFO payout ratio that rating agencies desire from net lease REITs. The company's 40% debt-to-capital ratio is also well below the 60% that rating agencies have set as the industry-safe guideline. As a result, Realty Income possesses an A- credit rating from S&P on a stable outlook. This implies the risk of the REIT going to zero in the next 30 years is 2.5%. Taking these elements (and the dividend growth track record) into consideration, the forecasted likelihood of a dividend cut from Realty Income in the next average recession is 0.5%. If the next recession was severe, this probability would increase to 2%. Put into perspective, these are each the lowest values allowed within the Zen Research Terminal. Dividend Kings Zen Research Terminal Realty Income's stock performance has been underwhelming in recent years, but this could be an advantage moving forward. By that, I mean the current valuation arguably appears to be a coiled spring waiting to snap higher. This is because Realty Income's five-year average dividend yield is 4.4%, which could mean shares are worth $70 each. I believe a return to this yield could be reasonable. That's because this five-year period accounts for a variety of interest rate policies from the Federal Reserve. That includes the more normalized interest rate policy pre-COVID, the zero interest rate policy in 2020 and 2021, and the current high-rate cycle over the last two years. As rates work their way back down, I wouldn't be surprised to see Realty Income's yield move back into the 4% range. The REIT's 10-year normal P/FFO ratio of 19.3 could suggest shares are fairly valued at $82 apiece. For the same reasons that I noted above, I could see an eventual reversion to a high-teens P/FFO multiple as interest rates return to the mean. Averaging these fair values out gives a 2024 fair value of $75 a share. Accounting for the 19.3 normal P/FFO ratio and the $4.36 FFO per share consensus for 2025, I get an $85 a share fair value. Blended with the $70 five-year average dividend yield fair value, this is a $77 average, 2025 fair value. Weighing on the 69% that's left of 2024 and 31% of next year, this works out to an average fair value of $76 a share. Compared to the $52 share price (as of April 18, 2024), this would represent a 32% discount to fair value. If Realty Income returns to the aforementioned fair value and can match the current growth consensus, these are the total returns that could lie ahead in the next 10 years: 6% yield + 3.7% FactSet Research annual growth consensus + a 3.9% annual valuation multiple expansion = 13.6% annual total return potential or a 258% 10-year cumulative total return versus the 9.8% annual total return potential of the S&P or a 155% 10-year cumulative total return Executing In An Uncertain Environment With A Massive Potential Market Realty Income Q4 2023 Earnings Press Release At a glance, Realty Income's financial results for the full year 2023 were boring. The company's AFFO per share edged higher by 2% year-over-year to $4 during the year. This doesn't seem impressive until one considers the environment that Realty Income had to navigate throughout the entirety of the year. This is because in a stable rate environment, obtaining financing and pricing deals is tough enough. In a year when 10-year U.S. Treasury notes regularly swung by as much as 50 basis points in a matter of weeks, it's a testament to the business model that the company grew at all. This marked the 27th year out of the past 28 that the REIT's AFFO per share climbed higher. Amid the chaos in debt markets, Realty Income thrived on the dealmaking side. The company executed a record $9.5 billion of deals (excluding the VEREIT merger in 2021) at a weighted average cash yield of 7.1%. For more color, that topped Realty Income's prior record of $9 billion in deals done at a 5.9% weighted average cash yield in 2022. Realty Income Q4 2023 Investor Presentation Realty Income also wasn't under pressure to do deals for the sake of just doing them, either. Against the $59 billion in sourced volume, this was a still reasonable 16% selectivity rate. This qualitative acquisition approach is what led Realty Income's occupancy to conclude 2023 at 98.6% across its 13,458 properties as of Dec. 31. Compared to the company median of 98.2%, this suggests the fundamentals of the REIT and its tenants are holding up quite well. Moving forward, the ability for Realty Income to remain selective with deals should remain in place. That's because, when also accounting for emerging investment opportunities like data centers and gaming, the company estimates that the U.S. net lease market is worth $5.4 trillion. Across the Atlantic in Europe, an even bigger addressable market remains largely untapped for Realty Income. Comprising 35% of Realty Income's total investment activity in 2023 per CEO Sumit Roy's opening remarks during the Q4 2023 Earnings Call, this market is becoming an increasingly important growth driver for the company. There is also plenty of room to run, with Realty Income's $10.1 billion European portfolio representing just a fraction of the estimated $8.5 trillion European net lease market. Along with the company's annual rent escalators, this is why I believe mid-single-digit annual AFFO per share growth is likely to continue in the years ahead. Realty Income Q4 2023 Investor Presentation The company's balance sheet is also flexible enough that it can easily support the $2 billion in acquisitions that it forecasts will be completed in 2024. This is because as of Dec. 31, Realty Income had nearly $4.1 billion in liquidity at its disposal. Against the $3.7 billion in maturities that are coming due through 2025 (including revolver and commercial paper maturities), this is a respectable liquidity profile. Realty Income's financing options are also on favorable terms. In January, the company issued $450 million of 4.75% notes due in 2029 and $800 million in 5.125% notes due in 2024. Given that 10-year notes were just above 4% at that time, this is an enticing investment spread for the company (unless otherwise noted or hyperlinked, all details in this subhead were sourced from Realty Income's Q4 2023 Earnings Press Release, Realty Income's Q4 2022 Earnings Press Release, and Realty Income's Q4 2023 Investor Presentation). Expect Status Quo Dividend Growth To Continue Since 1994, Realty Income's monthly dividend per share has compounded by 4.4% annually (slide 18 of 59 of Realty Income's Q4 2023 Investor Presentation). Looking ahead, I forecast that similar dividend growth should happen in the years to come. This is because Realty Income paid $3.051 in dividends per share in 2023. Stacked up to the $4 in AFFO per share posted during this time, that equates to a 76.3% payout ratio. That's right within the range in which a net lease REIT should be in my view. Paired with Realty Income's low cost of capital, this leaves the company with enough capital to keep funding future property investments. Risks To Consider Realty Income is a world-class REIT, but it's still not foolproof. Some risks are worth weighing before thinking about buying here. Realty Income's continued expansion into international markets comes with foreign currency translation and regulatory risk. If the U.S. Dollar remains strong against European currencies, that could weigh on the company's future results. Operating internationally also comes with the added risk of having to navigate regulations that could vary significantly from those in the United States. This could open Realty Income up to the potential of not complying with European regulations, which could result in sizable monetary penalties. CME Group FedWatch Tool Even now, there is still a 5% probability that the Federal Funds rate could remain unchanged over the next 12 months. If the U.S. economy keeps delivering hot economic data, these probabilities could increase. That could lead to rates coming down slower than expected, which would hold back sentiment and Realty Income's higher valuation re-rating. Summary: Realty Income Is A True SWAN On Sale FAST Graphs, FactSet From my perspective, Realty Income is the ultimate measure of consistency as a REIT. Thanks to the company's reliable growth track record, huge addressable market, and A-rated balance sheet, I am very comfortable with my current weighting.  The current valuation is so compelling that if Realty Income merely re-rates to a multiple of 15 and grows as expected, 45% cumulative total returns could be in store through 2026. This is why, after all of these years, I'm standing by my buy rating.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2428320916"}