VICI Properties: Price Disconnected From Strong Fundamentals

seekingalpha07-21

VICI Properties stock is a strong buy due to efficient capital management, growth potential, and consistent performance in a challenging environment.The REIT's portfolio is strategically crafted with ...

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Hispanolistic/E+ via Getty ImagesVICI Properties Overview VICI Properties (NYSE:VICI) remains one of my strongest conviction buys within the real estate sector due to its efficient capital management, strong growth potential, and consistent performance in an environment that is generally unfavorable. VICI operates as a REIT that maintains exposure to experiential properties within the gaming and activities sector. Just to give you an idea of some tenants, VICI provides properties for MGM Resorts (MGM), Bowlero (BOWL), and Caesars Entertainment (CZR). I previously covered VICI Properties and rated it as a strong buy due to its strong fundamentals, but this time around, I wanted to discuss the future outlook and potential catalysts. While REITs aren't typically known for their growth, I believe that we have the opportunity to capture large double-digit upside growth. We can see that the real estate sector continues to be one of the worst performing sectors over the last three years. This can be attributed to the Fed aggressively hiking interest rates to their decade high. REITs typically thrive in lower interest rate environments since they are very capital intensive businesses that can fuel research, acquisitions, new developments, and improve operational efficiencies by using cheap debt. However, I believe that the higher interest rates have heavily suppressed VICI's potential to shine through as one of the highest REITs in the sector. I noticed economic indicators that signal a potential change in interest rates may happen soon. Data by YChartsAdditionally, the current dividend yield of VICI sits at 5.3% which sits slightly above its four-year average yield of 4.9%. Despite being a REIT that already has a yield above the sector median of 4.36%, the dividend growth delivered here has been excellent. Therefore, I also wanted to touch on why I continue to accumulate shares here as a way to grow my dividend income stream. I view this as an opportunity to essentially get paid handsomely while awaiting these growth catalysts to play out over the next year. I believe that VICI's portfolio was strategically crafted as a way to enable growth while also remaining well protected from a risk perspective. For some context, VICI has a current market cap of $32.2B and has a public inception dating back to 2017. The REIT collects over $3.1B in annualized cash rent and has maintained a 100% rent collection since formation, which is an incredible achievement through the covid and post pandemic markets. This excellence in fundamentals continues to be suppressed by macroeconomic conditions, and I strongly believe that investors have a good opportunity to capitalize on this disconnect. Additionally, VICI is one of my strongest conviction buys due to the huge growth potential over the next decade. Let's start by digging into this REIT's portfolio potential. Portfolio Potential One of my favorite aspects of VICI's portfolio is that they maintain a 100% exposure to triple net leases. This is great for REITs because it means that the tenant is typically responsible for maintenance related costs, taxes, insurance and general operating expenses. As a result, this limits the risk that VICI absorbs while simultaneously increasing the operating profit margins for the REIT since they have less costs to handle. This structure takes away a lot of the guess work since the tenant is responsible for the costs that are typically variable in nature. As a result, VICI has more steady and predictable levels of cash flow. Remember how I mentioned strong fundamentals? Well, VICI has 91% of their annualized rent coming in from tenants that have rent roll with parent guarantees. This means that the parent companies of the tenants have essentially promised to back the lease obligations in cases where the tenant may fail to pay. The also applies through tenants undergoing a default. This drastically lowers the risk of VICI as it helps ensure that rent will always be collected from somewhere. This risk mitigation is built upon even more when you consider that 81% of their portfolio has a master lease protection in place. This means that there is a master lessee that assumes the responsibility of paying VICI rent, no matter if there are vacancies or not. This helps VICI have a greater sense of stability against vacancies and reduce the vulnerability. While the structure and strategies in place are top tier, I will admit that the portfolio is a bit small in terms of the number of tenants. VICI's portfolio consists of only 13 tenants, with two of these tenants accounting for 74% of the annualized cash rent received. I do believe that this may present some level of risk during trouble markets, so I would ultimately love to see some more growth happen throughout the portfolio.   VICI Q1 PresentationThe largest tenant remains Caesars Entertainment, which accounts for 39% of the annualized cash rent. Their rent amounts to about $1.2B across its 18 different properties. This is followed by MGM Resorts, which accounts for 35% of the annualized cash rent, totaling about $1.07B. This exposure spans across 13 different properties and the weighted average lease term is long at 51 years. Despite the small size of the portfolio at the moment, I think that presents an opportunity to invest into the future growth of this REIT. VICI maintains exposure to properties that are experiential in nature, and this means that the opportunity for growth can be massive into the future. While they are predominantly in the gaming, leisure, and hotel space, there are lots of opportunities to expand horizons into other experiential sectors. Approximately 60% of Gen Z and Millennials would rather spend money on life experiences than save for retirement. So how would VICI capitalize on this? There is a wide range of experiential properties that I can think of on the top of my head, such as:  Waterparks Live Entertainment Venues Theme Parks Sports Arena  It seems like VICI is already testing the water in these areas by implementing loan and embedded growth pipelines in these areas before fully committing. For instance, VICI has initiated a mezzanine loan with Kalahari Resort in Virginia amounted to $212M. Funding isn't expected to begin until 2025, but this would potentially enable VICI to take an equity interest in the property and business in the future. For now, it only enables them to capture some interest income from the loan, but perhaps this is a way to test the waters to see how profitable the business is and how reliable the income streams are. Similarly, VICI has a portfolio of 9 separate Great Wolf Lodge indoor water parks that they also maintain mezzanine loans in totaling $250M. Some other examples of this branching exposure are:  Canyon Ranch: sale leaseback and preferred equity exposure. Cabot: construction and development loan exposure that VICI collects interest on. Margaritaville Resort: construction loan for expansion developments  In my opinion, this is a very wise approach to gaining exposure to these sectors while also testing the waters to see how dependable their cash flows are. For example, if one of these endeavors struggles to pay back their debts at a steady rate, VICI can make an informed decision to steer clear going forward. Conversely, if the investment works out, then they may increase exposure to fuel more portfolio growth and diversity in revenue stream. Financials - Earnings Outlook VICI reported their Q1 earnings back at the beginning of May. As a brief overview, the company reported revenue growth of 8.4% year over year. AFFO per share landed at $0.57 for the quarter, amounting to a total of $590M. AFFO also grew by a large 9.4% year over year, which helps solidify the company's strong earning power in unfavorable conditions. We can see that the annual revenue totals have continually increased through their portfolio of solid tenants. Even through the pandemic, they maintained full rent collections, which is a testament to the quality tenants VICI has chosen to operate with.   Seeking AlphaThe company is set to announce their Q2 earnings on the last day of July. FFO estimates currently sit at $0.66 per share, and there have been six positive FFO revisions in the last 90 days. I personally expect VICI's earnings to land between an FFO range of $0.65 per share to $0.70 per share due to the consistent growth that they've displayed. A lot of the earnings potential here is tied to the balance between VICI's tenant awareness around customer experiences, as well as the fact that VICI continues to find opportunities to grow. The efficient capital management will also contribute to the company's strong future. We can see that revenue increased year over year while expenses remained the same. Taking a look at their latest 10-Q form, total operating expenses actually very slightly decreased, but this is always a recipe for success and I believe that as long as VICI can maintain this trend, shareholders will be rewarded handsomely. With the continued investments into new endeavors, I expect the near quarter earnings to show year over year revenue increases.   VICI Form 10-QFirst, the experiential properties that VICI remains exposed to has a strong understanding of their consumers, and this creates a sense of durability. The operators in the gaming sector and entertainment sector are experts are triggering the stimuli in their consumer's brain. There are several studies that confirm everything from the decor of these properties, colors used, sounds of gambling machines, and even the lack of light are all strategic tactics they use to create extreme senses of reward and addiction in consumers. Over long stretches of time, this has proven to provide a low cyclicality experience compared to other sectors, which is reinforced by the fact that VICI maintained a 100% rent collection rate during 2020. This also creates an environment with low secular threat that cannot be replicated anywhere else. I believe these things will always keep VICI and their tenants in business. Secondly, growth can be driven from the recently announced investment agreement between VICI and The Venetian Resort Las Vegas. VICI has agreed to provide The Venetian with capital for different reinvestment projects, total up to $700M depending on the capital needs. The agreement lays out that The Venetian can draw up to $400M for the year of 2024 and may be able to withdraw an additional $300M that they cannot draw until November 2026. This capital is being lent with an annual yield of 7.25%, which could produce a minimum $30M of extra income for VICI. In addition, there is a 2% incremental rent escalation that will commence in March 2029 that will also contribute to earnings growth. Lastly, a lot of the future growth of earnings will be tied to general improvements within the sector. This revolves around improving conditions surrounding interest rates, inflation, consumer spending habits, and an environment that fosters more aggressive growth. Sector Catalyst One of the major catalysts continue to be the future of interest rates. Although VICI's history is relatively short, we can see the relationship that the price has shared with the federal funds rate. As rates were cut to near zero levels in 2020, VICI's price rapidly increased to the upside. Conversely, when rates started to rapidly get hiked throughout 2022 and 2023, we saw the price level off and stabilize a bit. Being a very capital intensive business, VICI's growth may be very dependent on access to cheap access and maintenance to debt. As interest rates reached their decade peak, this slows growth and incentivizes the REIT to take a more defensive and conservative stance rather than focusing on growth. This isn't unique to VICI as we've seen this exact momentum play out with most of the real estate sector as a whole (XLRE). Taking a look at the chart below, we can also see how XLRE and VICI mimic similar price moves alongside the federal funds rate. Real estate has remained the worst performing asset class over the last two years and this has only given us an opportunity to continue accumulating. Data by YChartsHowever, I believe that a shift with interest rates may finally start to happen soon. The Fed has continued to leave rates unchanged throughout 2024, but recent economic indicators are signaling a change in the market. For instance, higher than anticipated levels of inflation has been one of the main concerns but recent data shows that the inflation rate has trended downward for three consecutive months and now sits at 3%. In addition, the unemployment rate has slowly crept up to 4.1% over the last twelve months which could grow to levels that require some economic stimulus. When you take these factors into consideration alongside the upcoming US Presidential elections, the Fed may have more of an incentive to begin cutting rates. Elections typically cause elevated levels of volume, volatility, and uncertainty in the markets as the nation awaits the polling results and impact of potential changes. If inflation continues to cool while unemployment begins to rise, we may have conditions primed for rate cuts. JPMorgan compiled data that actually shows the Fed more frequently made changes to the federal funds rate during election years, versus leaving them unchanged. In fact, over the last 40-year period, the federal funds rate was only left unchanged one single time in 2012.   JPMorganWhile history shouldn't be used as a reference point to future movements, I also wanted to point out that when democrats were elected, rates were typically cut. Versus the reality that when republicans were elected, rates were more frequently increased. Either way, the data indicates that we're more likely to see rate cuts than not. Lastly, this anticipation of interest rate cuts have caused investor capital to flow out of the high growth sectors like tech. As the growth of the tech sector begins to slow its pace, this has made other sectors that have previously lagged the market more appealing. This includes real estate because there are a lot of opportunities to buy into solid companies at a discounted valuation. VICI Stock - Valuation & Comparison In terms of valuation, I previously ran a dividend discount calculation and determined an estimated fair value of about $37 per share. This was based on an estimated growth rate of 4.5% going forward and an average annual dividend raise of 4.35% for the year of 2024. While it's too soon to say whether or not this growth has been successful, we can confirm that the dividend has not been increased yet. Instead of providing another dividend discount model with different inputs, I wanted to provide another source of reference. At the time, Wall St. has an average price target of $35.08 per share. This would represent a potential upside of 14.5% from the current level. It's worth mentioning that the current price of VICI still trades below the lowest price target of $31 per share, while the highest price target sits as high as $43 per share. For additional reassurance, Seeking Alpha's Quant gives VICI a buy rating with a score of 4.27 out of 5. This likely comes as a result of the strong A+ growth grade that VICI earns through its strong AFFO growth. We can see that the three-year AFFO growth CAGR (compound annual growth rate) sits at 9.45%, which is more than double the sector median growth rate of 4.07%.   Seeking AlphaWhen referencing some other peer REITs, VICI also remains undervalued. The most popular REIT in the market is Realty Income (O) which currently trades at a price of $57 per share and an expected annual AFFO of $4.22 for the year. This would indicate a price to AFFO ratio of about 13.5x. For reference, the sector median price to AFFO ratio sits at 15.7x. Another pee for VICI would be Gaming and Leisure Properties (GLPI) which currently trades at $47.8 per share and has an estimated annual AFFO of $3.76 per share. This means that GLPI trades at a price to AFFO ratio of 12.7x. VICI currently trades at about $30 per share and has an estimated annual AFFO of $2.53 per share. This means that VICI trades at a price to AFFO ratio of 11.85x, which significantly undercuts peers and the sector median. I believe that once rates start to get cut, the market will begin to realize VICI's true value. Just for the sake of comparison, here are some growth metrics of peer REITs so that we have a better sense of how attractive valued VICI is.  Realty Income - 3-year AFFO CAGR of 5.6% with 4 separate revenue misses on earnings reports. Gaming and Leisure Properties - 3-year AFFO CAGR of 2.2% with a 5-year EBITDA CAGR of 9.3% VICI Properties - a 3-year AFFO CAGR of 9.4% while never missing revenue expectations. Additionally, the REIT has a 5-year EBITDA CAGR of 34.12% while maintaining a higher Wall St. price target than both mentioned peers.  Additionally, free cash flow per share sits at $2.15 as of the latest earnings. If we input this into a discounted cash flow projection, assuming a 5% growth rate, the upside potential is huge. For reference, the sector median AFFO growth has sat around the 2.2% mark over the last five-year period. VICI's AFFO growth over the same period has averaged about 8.5%. Therefore, taking a ballpark average between the sector median and VICI's performance, a 5% growth rate is pretty realistic and takes any unexpected headwinds into account.   Money ChimpWith these inputs in mind, we determine an estimated fair value of about $56 per share. This would indicate that there is a potential massive upside of 86% from the current levels throughout the next five-year period. Of course, this is assuming that VICI maintains the current growth and earnings trajectory and continues to outperform the sector median. This is why I maintain my strong buy rating on VICI going forward and continue to accumulate shares before interest rates are cut. VICI Dividend As of the most recently declared quarterly dividend of $0.415 per share, the current dividend yield is 5.3%. As previously mentioned, AFFO per share landed at $0.57 over the last quarter, which means that the dividend is covered by a comfortable margin. This indicates that the distribution is covered by AFFO at a rate of 137.3%, and therefore I have no concerns about the current sustainability of the distribution. It speaks volumes that the distribution maintains such a wide coverage margin throughout conditions that weren't the most ideal for the REIT. In addition to this, the dividend has continued to grow at a consistent rate. Since the REIT's inception, the dividend has increased by a total of 159.4%. Despite having a higher starting yield, VICI also managed to maintain a high rate of annual growth. For instance, the dividend has increased at a CAGR (compound annual growth rate) of 7.62% over the last five-year period. This sort of growth packs enough punch to compound your income and create a sizeable income stream with continued investment. Data by YChartsTo better visualize this, I ran a backtest of an original $10,000 investment at the start of 2018. This graph assumes that you also contributed a fixed amount of $500 on a monthly basis throughout the entire hold period. Lastly, it assumes that all distributions received were reinvested back into VICI to help accumulate more shares. In 2018, your dividend income would have amounted to $678 for the year. However, because of all the consistent distribution raises from VICI in combination with added capital, this would have grown to a total of $3,745 for the year of 2023.   Portfolio VisualizerSomething that investors should be aware of is that the distributions received from a REIT like VICI are classified as ordinary dividends. Ordinary dividends are typically taxed at unfavorable rates compared to the qualified dividends that you would receive from a more traditional dividend growth company. As a result, a position in VICI may be best utilized in a tax advantaged account if you want to mute the tax consequences of a position. Risk Profile While the REIT is diversified across many different regions of the country, there is a heavy reliance on the Las Vegas region. The revenue brought in from gaming is spread throughout 15 different states and one Canadian Province. However, the Las Vegas concentration accounts for 47% of their annualized rent from this segment. Additionally, I also mentioned previously that two of their tenants account for the large majority of their annualized reoccurring rent. As a result, this does present a bit of a concentration vulnerability that could certainly impact VICI through some unforeseen headwind. We have to consider things like slowdowns in tourism for the area and how that might affect the rent received. Although the excellent navigation of the pandemic in 2020 has proven that VICI is well-structured, we have to consider all possibilities. It seems like VICI is aligning themselves to continue growing their portfolio, so we may see these top tenant exposure weights decrease over time.   VICI Q1 PresentationHowever, management continues to maintain a positive outlook here by spinning the Las Vegas exposure as potential growth opportunities. For instance, they highlighted that VICI owns 33 acres of undeveloped land throughout the region that are all subject to part of a master lease with Caesars. Liquidity remains solid, with cash and equivalents sitting at $485M. However, long-term debt totals have considerably grown, now totaling $15.9B. The current debt levels are the highest that VICI has ever held on their balance sheet since the REIT's inception. This elevated debt level can be attributed to the growth avenues that VICI is pursuing. On a positive note, this debt consists of 99% fixed rate debt, which helps add some stability in the expense levels. The weighted average years to maturity also sits at 6.8 which provides plenty of runway to accumulate cash if needed. For reference, the last time I covered VICI they only had a weighted average of 5.9 years to maturity.   VICI PresentationLastly, we've already seen how VICI remains sensitive to interest rate changes. As a result, we have to consider the possibility that if interest rates are increased, we may see VICI's price continue to stay suppressed. A lot of the economic forecasts anticipate rate cuts, but the truth is that we really don't know what can actually play out. Even if rates remain unchanged, we may experience continued suppression in VICI's stock price as growth initiatives are delayed until conditions improve. Takeaway In conclusion, VICI remains a strong buy at these levels and the price is severely disconnected from the fundamentals of the business. The real estate sector has been crushed over the last three years, and I believe that market sentiment is beginning to shift with the anticipation of interest rate cuts. VICI's portfolio remains well-maintained following a triple net lease structure and maintaining a portfolio that is covered in parent guarantees. Valuation continues to indicate severe undervaluation and assuming conservative growth estimates, VICI has a huge double-digit upside potential. While we await the growth of the sector to improve, VICI continues to pay a growing and well-supported dividend to shareholders.  Editor's Note: This article was submitted as part of Seeking Alpha's Best Growth Idea investment competition, which runs through August 9. With cash prizes, this competition -- open to all analysts -- is one you don't want to miss. If you are interested in becoming an analyst and taking part in the competition, click here to find out more and submit your article today!","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"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":"4.26.3","shortVersion":"4.26.3","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/2453271102"}