The Realty Income share is very popular among dividend fans. The reasons for the extraordinary popularity of the REIT are a handsome dividend of currently almost 5 percent and a reliable dividend history with a 25 year dividend increase in a row.
The dividend is also paid in monthly installments. That is why Realty Income is also known as “The Monthly Dividend Company”. 25 years of dividend growth suggest an excellent business model that works in both economically good and bad times. Accordingly, the company has passed the previous tests, including the competition from online retail from Amazon & Co, mastered relatively well.
|Realty Income share|
|Market capitalization||€ 17.1 billion|
|Stability dividend||0.99 of max. 1.0|
|Stability gain||0.96 of max. 1.0|
In this stock analysis, you can find out whether realty income will also master the corona crisis, whether it is currently valued favorably and whether it is a purchase for me.
The business model: How Realty Income earns money
Realty Income is a real estate investment trust or REIT that mainly invests in commercial real estate and leases it primarily to large retail chains in the long term. Realty income is similar to the STORE Personal-Financial.com Corporation, which I presented in the previous article, a triple-net lease REIT. This means that the tenant pays for the rent as well as all operating and maintenance costs, which means that realty income generates high margins and at the same time only has to make minimal investments in order to rent and maintain the property. Advantages for the tenant are lower rents as well as a high degree of predictability due to very long-term rental contracts, usually over 10 years. Realty Income boasts a huge real estate portfolio that consists of over 6,500 assets. I like to look at such a huge portfolio from three perspectives: by tenants, industries and location.
The anchor tenants of Realty Income are the drugstore chain Walgreens with a rental share of 6%, followed by other larger chains such as 7-Eleven (4.7%), Dollar General (4.4%) and FedEx (4.0%). With the exception of walgreens these tenants are minimally or not at all affected by the corona crisis, while other significant realty income tenants such as LA Fitness (3.4%) and AMC Theaters (2.9%) are in serious trouble – but more on that later.
Overall, the 20 largest tenants contribute 53.1% of the annual rental income, of these 20 tenants enjoy an investment grade credit rating, which speaks for a high credit rating. Overall, Realty Income has an economically strong tenant base. Maintaining a diversified portfolio of quality properties leased to strong tenants helps ensure income stability, which in turn ensures payment of monthly dividends.
The industry mix
When looking at the sector, it is striking that realty income is primarily a so-called retail REIT, i.e. the tenants are mainly in the retail trade. The retail segment accounts for 84.1% of annual rental income, while the remaining 15.9% is divided between the industrial (10.7%), office (3.5%) and agriculture (1.7%) segments.
Within retail, the dominant stores are small grocery stores (11.9%) such as 7-Eleven, which are often located at gas stations. In addition there are drugstores (9%), dollar stores (8%) as the equivalent to the “1-EURO Shops” in Germany as well as supermarkets (7.7%), fitness studios (7.2%) and cinemas (6.3%). A total of 51 retail sectors are in Realty Income’s portfolio, so that the company is highly diversified within the retail sector.
The location of the shopping centers
Realty Income is present in all U.S. states except Hawaii and also has select properties in Puerto Rico and the United Kingdom, with the latter two contributing less than 4% of total rental income.
Within the United States, the portfolio is concentrated in the 6 key states of Texas, California, Illinois, Florida, Ohio and New York. Together, these markets are responsible for around 40% of total rental income. Realty income is very broad in these metropolitan regions, while huge areas in the interior, mainly in the north, that are not directly on the coast or the Great Lakes, make up only a very small proportion of the annual rental income.
The Effects of the Corona Crisis on Realty Income
The last quarterly figures as of March 31, 2020 did not yet reflect a burden from the pandemic. In order to measure the financial health and earning power of a REIT, the following two key figures are essential: “Funds from Operations” (FFO) and “Adjusted Funds from Operations” (AFFO). Both indicators look at the REIT’s profit adjusted for depreciation and amortization, with AFFO also taking into account the influence of recurring capital expenditures, for example for the maintenance costs of real estate. Both indicators are relevant for the fundamental analysis of realty income, whereby I personally prefer AFFO, since this indicator still adjusts the FFO for special factors on the revenue and cost side. Since these are relatively rare, the two indicators are mostly very close to one another for realty income. Compared to the previous year, AFFO achieved a very solid increase of 7.3%.
Realty Income is financially strong and has increased AFFO in 23 of the last 24 years – the only exception was in 2009, when the financial crisis raged. However, the dividend was increased even during the financial crisis and has grown an average of 4.75% annually over the past 10 years. Realty Income can boast of a permanently high occupancy rate, largely isolated from economic crises. This figure has never dropped below 96% since 1996. At the end of the first quarter of 2020, the occupancy rate was 98.5%.
Similar to the STORE Personal-Financial.com Corporation, the importance of this key figure only plays a secondary role for realty income in the midst of the corona crisis. In the midst of the crisis, it is more important to consider the amount of monthly rental income and the burden of COVID-19 on individual tenants and entire industries in Realty Income’s portfolio. Realty Income recently released its second quarter results known (at normal times 100% of the rent is usually earned). Overall, 85.7% of the contractually agreed rent was received (86.9% in April, 83.5% in May and 85.7% in June). This excellent rate is primarily due to the fact that only a few industries in Realty Income’s rental base have experienced payment difficulties. The problem children are the usual suspects from the areas of health & fitness, cinema chains, restaurants and preschool education.
In the event of missing rental payments for the months of April to June 2020, Realty Income either holds deferral talks with the defaulting tenants or has already concluded deferral agreements with them. Overall, Realty Income’s management is optimistic about the future and believes that the majority of defaulting tenants will recover.
I myself am also convinced of Realty Income’s tenant portfolio, but it is currently still completely uncertain whether and how the problem sectors will recover, especially as it is unclear how consumer behavior will change in the long term as a result of Corona. Those who used to go to the gym may enjoy the home workout during the lockdown, with or without equipment from competitors, such as Peloton found. Anyone who used to go to the cinema may have now enjoyed spending a cozy video evening with friends at home or preferred streaming to going to the cinema. The rental income from cinemas and fitness studios is not essential for realty income, but nevertheless represents around 13.5% of the total rent, which I consider to be at great risk.
How Safe is the Realty Income Dividend?
Realty Income probably has the most emblematic dividend in the REIT universe. An impressive dividend history with monthly distributions and continuous dividend growth for over 23 years in a row puts Realty Income close to a dividend aristocrat.
As of Q1 / 2020, the AFFO-based payout ratio is approx. 80%, which should come close to 100% due to the rent losses already realized in Q2 and the expected third quarter. There is hardly a company that is more associated with its dividend than realty income. It is not for nothing that the name “The Monthly Dividend Company” is a registered trademark of Realty Income. Management is aware of this and emphasized the importance of the dividend in the last earnings call:
Yes, it is our brand. We are the monthly dividend company. It is very much part and parcel of how we operate our business. It is our mission. And so, this is one of those tools that we certainly have available to us, we manage liquidity.
But one that we feel, at least given the lay of the land today and despite all of the things that you have laid out, we do not need to pull on and part of that goes back to the liquidity strength that we have to be able to withstand disruptions, even medium term disruptions and still be able to maintain a profile of the business that continues to be very strong and continues to support the dividends
In other words, I deduce the following:
Yes, that’s our brand. We are “the monthly dividend company”. The dividend is an integral part of our business. We are very well positioned on the liquidity side and currently, and also in the medium term, see no reason to use debt to support the dividend.
At the end of the first quarter of 2020, Realty Income had $ 2.7 billion in liquid reserves, the majority ($ 2.4 billion) of which was from an existing credit facility consists. This liquidity reserve covers the total annual operating expenses of approximately USD 830 million and the annual dividend of approximately USD 960 million and still leaves enough scope for unforeseen costs or lucrative investment opportunities.
Is Realty Income stock valued favorably?
Before the corona outbreak, Realty Income shares hit a record high of $ 84.82. Then the crash followed up to $ 38. Since then, the stock price has recovered noticeably, but is still around USD 61, well below the all-time high.
Despite the pandemic, analysts estimate Realty Income’s FFO for 2020 to be $ 3.29 per share, roughly the same as last year’s FFO at $ 3.27. For the years 2021 and 2022, moderate growth of around 5% is expected. expected. However, due to the ongoing corona pandemic, estimates should be used with caution. Nevertheless, I currently consider the Realty Income share to be fair to even slightly undervalued.
The dynamic stock valuation of the stock finder enables the parallel calculation of 4 fair values for a share based on different assessment bases. It is striking that they are all relatively close together (between USD 60 and USD 62.30) and close to the current price (approx. USD 59), which makes the stock appear fairly valued. Overall, the historical multiples for the valuation of the Realty Income share seem meaningful, also because historically the share price has always approached the calculated fair values after phases of overvaluation and undervaluation.
Realty income is currently valued at a P / E ratio (rate divided by the FFO) of approximately 18.35, which is slightly below the historical multiple of 18.8. AFFO and historical dividend yield yields similar results. They all point to a slight undervaluation of the share.
Overall, I agree with the result, but that presupposes that Realty Income will be able to find its way back to the old path of success by 2021 at the latest. Otherwise there is considerable potential for devaluation, since historically realty income was valued with significantly higher multiples than the broad sector (P / E ratio of 18.8 for realty income vs. P / E ratio of 12.8 for the sector). Realty Income has earned this valuation bonus thanks to its excellent performance and flawless dividend history. However, should the pandemic lead to permanent and significant rent losses or lower rents, the market will have to revaluate it sooner or later.
Conclusion: No clear purchase recommendation for the Realty Income share
The Realty Income share has survived numerous crises and I am confident that this test will also be mastered. If consumer behavior changes fundamentally and permanently, management will react accordingly and, thanks to a solid balance sheet and a broadly diversified portfolio with long-term lease terms, have good chances of success. 550 consecutive monthly dividends speak a clear language.
Despite a slight undervaluation based on historical “pre-corona” multipliers, the share is not cheap in my opinion, because the rampant uncertainty has not been sufficiently priced in for me so far. And if you consider the effects that COVID-19 is likely to have on the company’s results, the share price no longer appears quite as attractive today, especially since the virus is getting out of control in the USA, especially in states like Florida and Texas – i.e. exactly in the States where Realty Income is strong. That is why, in my view, the Realty Income share at the current price level is more to be recommended as part of a savings plan and less as an individual purchase. The former is also my personal strategy for taking on and expanding a long-term position. At the same time, I have the stock on my notepad, so as not to miss a cheap purchase opportunity.
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