Realty Income: Separating The Wheat From The Chaff

seekingalpha04-24

Being a value investor requires challenging conventional wisdom and standing apart from the crowd.Realty Income Corporation is a leading net lease REIT with a strong balance sheet and a history of ...

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Igor Alecsander/E+ via Getty Images It’s not always easy being a value investor, especially when the markets get excited about growth stocks. There are plenty of people who will mock or pity us for not getting onboard the supposed gravy train. It’s enough to make many would-be value investors give in and buy their own ticket – often at hefty costs. And as for those who do manage to stay strong, they might very well avoid telling anyone about what they’re doing and not doing. Personally, I get it. It can get exhausting fending off FOMO (the fear of missing out) to everyone (including yourself) all the time. Even I feel that way from time to time. But when I start sinking into doubt, I remind myself that market downturns are always inevitable. And that when they do hit, it’s best to be backed by investments built on more than mere hype. I know hype can do short-term wonders to a portfolio, putting value investing to shame. But eventually, it’s the latter that really pulls through. To quote Joe Carlen’s The Einstein of Money:  “At least ninety years after [the father of value investing, Benjamin] Graham first applied it to his own investments, this business-owner’s paradigm has continued to define the value-investing approach. As Pat Dorsey… told me, “‘To me, the core insight of Benjamin Graham is that you view a stock as a piece of a business and, by doing so you remain focused on the cash the business will generate and on its balance sheet as opposed to the opinion of other investors in the market. The importance of that hasn’t changed since Graham’s time.”  It’s certainly worked for me. While I haven’t participated in many a trend-based rally, I also haven’t participated in their inevitable falls. Call me silly if you will, but I’m happy sticking with the “boring” companies that last. Great News: Size Matters Realty Income Corporation (NYSE:O) is the largest figure in the net lease REIT sector.   iREIT® Now, if you look at the dividend yield + AFFO/share growth in 2024 across the Net Lease REIT spectrum, what does that tell you?   iREIT® If size and quality were headwinds, how is it that Realty Income is well ahead of Agree Realty (ADC)? At the midpoint of its 2024 AFFO/share guidance, Realty Income is +4.3%; factor in a 5.9% dividend yield, and you have 10.2% total operational return, which is among the tops in the industry (together with VICI Properties (VICI)). Importantly, it’s the power of diversification that provides Realty Income with an enhanced ability to absorb or win deals of size (e.g., Bellagio, Wynn Encore Boston Harbor, EG group deal, etc.). And the power of the platform – only one year with negative AFFO/share growth, and not a single year when total operational return was negative. Investors like to point to Investment Grade ratings as a metric that indicates “quality,” which is a very lazy way to look at things. Some of Realty Income’s top tenants (e.g., Sainsbury’s) don’t have public debt, and thus they do not need a rating. Some are unquestioned leaders in a space that doesn’t have any IG ratings at all (e.g., Wynn) or carry real estate dynamics that are second to none (e.g., Bellagio). Realty Income has never flagged IG as being the end all, and in fact has talked down its importance over the years. Some folks like to reference perceived risk with “new verticals.” Let’s look at the facts, and where is the risk?  Bellagio Wynn Encore Boston Harbor New country entry in Spain (Carrefour) New country entry in Italy (Metro, which is a leading wholesale club) New country entry in UK (Sainsbury’s) New country entry in Germany, France, etc. (Decathlon, a widely respected sporting goods chain) Vertical farming (first, only $40 million investment and with Plenty, the leader in the space – they partner with the likes of Whole Foods, and Walmart has invested in the concept) Data centers (partner with strong operator in DLR, pre-leased to S&P 100 IG client in NoVa, which is the strongest data center market in the U.S.).  Realty Income focuses on partnering with leaders in their respective industries and with that backdrop, one could look at the actual examples of new verticals and make an argument these are quality accretive. Great News: Balance Sheet Matters Realty Income is the only A-rated net lease REIT and one of only eight S&P 500 REITs with 2 A3/A- ratings or better. The company finished 2023 with net debt to annualized pro form EBITDA of 5.5x, in line with its targeted leverage ratio. Fixed charge coverage finished the year at 4.7x, which was the high watermark in 2023, benefiting from higher investment yields in Q4-23 and less and lower cost short-term borrowings outstanding. From a liquidity perspective, Realty Income is in excellent shape, with approximately $4 billion of liquidity at year-end 2023, variable rate debt representing less than 5% of total debt and no capital market execution risk to fund growth in 2024.   Realty Income IR The balance sheet is a major competitive advantage for Realty Income, and it’s the primary reason that the company has been able to grow earnings and dividends across many economic cycles.   Realty Income IR Great News: Shares are Cheap  You're looking for a mispriced gamble. That's what investing is. And you have to know enough to know whether the gamble is mispriced. That's value investing.  Charlie Munger.    FAST Graphs As you can see (above), it’s rare that Realty Income gets this cheap. In 2009 shares traded at 8.9x. In 2020 shares traded at 13.1x. Currently, shares trade at 13.2x. The normal valuation for Realty Income is 17.5x.   FAST Graphs What’s normal, you may ask? After all, interest rates are elevated and maybe Realty Income’s pricing power has deteriorated and deserves repricing? Remember that companies create value by investing capital at rates of return that exceed their cost of capital. In addition to the $9.3 billion Spirit merger, Realty Income provided 2024 acquisitions guidance of approximately $2 billion, which is expected to be fully funded via a combination of internally generated cash flow. While acquisition activity has moderated, Realty Income is sitting in an enviable position right now… Because the opportunity to consolidate the fragmented net lease real estate market is massive. Realty Income estimates “$14 trillion total addressable market in the U.S. and Europe across traditional net lease and emerging verticals like data centers and gaming.” The dominant net lease REIT has demonstrated capabilities for deploying capital - having invested $9 billion including public M&A in each of the last 3 years since exiting the pandemic year of 2020. Over that time frame, Realty Income has generated annualized AFFO per share growth of approximately 6% and provided a total operational return to stockholders of approximately 10% per year. Yet, Mr. Market has ignored it, for the most part. Eventually, rates will come down and according to Realty Income’s CEO, Sumit Roy, “If the cap rates were to adjust, we will be first in line to take advantage of that. If the interest rate environments were to start to go down, which would then have an impact on our cost of capital, i.e., lower cost of capital, we would be first in line to react.” Currently, Realty Income’s dividend yield is around 6%... So, you (and me) can get paid to wait…   FAST Graphs The above forecast has Realty Income returning to a 16.8x multiple, which would deliver annual returns of 24%... The more optimistic model (returning to normal valuation) forecasts Realty Income to return over 30% annually.   FAST Graphs In Closing I’ve been a net lease investor for over three decades (including 22 years as a developer and 14 years as an income analyst), and I consider Realty Income one of the most attractive REITs to buy right now.  I consider the management team one of the best in the business, and this stock represents over 10% of my REIT portfolio. \"The big money is not in the buying and selling, but in the waiting.\" Charlie Munger.","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/2429439593"}