Following my recent posting on inflation, I thought it would be interesting to take a look at one of the more popular Real Estate Investment Trusts (REIT), Realty Income Corp. (O).
Company:
Realty Income Corp. (hereinafter RIC) advertises itself as “The Monthly Dividend Company” and , according to the description on its Web site:
Realty Income is a 44-year old, publicly traded real estate company dedicated to paying monthly dividends to its shareholders. The revenue to pay these dividends is generated from over 3,500 commercial properties in 49 states and Puerto Rico that we own under long-term leases, primarily with large commercial enterprises that operate multiple locations. Our shares are listed under the ticker symbol “O” on the New York Stock Exchange.
Source: Company Web Site
The company caters to businesses and corporations that provide goods and service to consumers, and its top fifteen tenants are:
Again, borrowing from the company’s Web site, the main characteristics of RIC’s business are:
Real Estate
- 15 to 20-year leases have tended to be reliable generators of cash to pay dividends
- Owning real estate primarily for cash provides a more unencumbered cash flow
- Properties leased under triple-net leases tend to eliminate the costly upkeep and tax costs usually associated with owning real estate as these costs are generally paid for by our tenants.
Financial
- Funds to acquire new properties generally come from cash on hand or from our $1.0 billion acquisition credit facility led by Wells Fargo. We permanently fund property purchases with the proceeds from common stock, bonds, or preferred stock offerings.
- Access to capital to fund growth is important – REIT tax status limits the amount of retained earnings that can be used to grow our business
- Our balance sheet has historically been considered to be one of the healthiest in our industry.
Growth
- Rent increases built into leases have historically provided same store rental increases of 0.2% to 2% every year
- Additional growth has traditionally come by acquiring new properties thereby increasing our lease revenue base
Now, jumping to the company’s most recent 10-K filing (filed on 2/14/13), we see the following:
Realty Income, The Monthly Dividend Company®, is a publicly traded real estate company with the primary business objective of generating dependable monthly cash dividends from a consistent and predictable level of cash flow from operations. Our monthly distributions or dividends are supported by the cash flow from our portfolio of properties leased to commercial enterprises. We have in-house acquisition, leasing, legal, credit research, real estate research, portfolio management and capital markets expertise. Over the past 44 years, Realty Income and its predecessors have been acquiring and owning freestanding commercial properties that generate rental revenue under long-term lease agreements.
In 1994, Realty Income was listed upon the New York Stock Exchange and we elected to be taxed as a real estate investment trust, or REIT, requiring us to distribute dividends to our stockholders aggregating at least 90% of our taxable income (excluding net capital gains).
We seek to increase distributions to stockholders and FFO per share through both active portfolio management and the acquisition of additional properties.
At December 31, 2012, we owned a diversified portfolio:
- Of 3,013 properties;
- With an occupancy rate of 97.2%, or 2,929 properties leased and only 84 properties available for lease;
- Leased to 150 different commercial enterprises doing business in 44 separate industries;
- Located in 49 states;
- With over 37.6 million square feet of leasable space; and
- With an average leasable space per property of approximately 12,500 square feet.
Of the 3,013 properties in the portfolio, 2,996, or 99.4%, are single-tenant properties, and the remaining 17 are multi-tenant properties. At December 31, 2012, of the 2,996 single-tenant properties, 2,913 were leased with a weighted average remaining lease term (excluding rights to extend a lease at the option of the tenant) of approximately 11.0 years.
Source: RIC 10-K For FY 2012
Fundamentals:
RIC, with its conservative strategy, is a company that has delivered reliable growth and a source of steady income to its investors for the past forty-four years. Through its measured approach to acquisitions and a strong capital structure, RIC has managed to position itself as one of the best publicly traded REITs in the marketplace. As a registered REIT, the company is required to pay at least 90 percent of its taxable income to shareholders and, since 1970, the company has consistently paid monthly dividends, which also include 62 consecutive dividend increases.
The company’s mission is to provide its shareholders with dependable, monthly dividends which increase over time. The company has been able to achieve this goal through a very conservative and well managed sale-leaseback structure which focuses on retail properties. Essentially, the company seeks to purchase properties from retailers, known to be in profitable locations, and then leases the property back to the retailer, often under a triple-net lease structure which makes the tenant responsible for taxes, insurance and maintenance costs; and the sale-leaseback contracts the company signs with its tenants normally results in long-term commitments of fifteen years or longer. This arrangement serves to minimize RIC’s expenses and helps to secure a steady stream of income.
The company diligently evaluates each property’s ability generate enough cash to cover lease payments and then adds a margin of error to protect against losses should the store’s performance deteriorate. If this become the case, RIC will seek to sell the property. Under this structure, RIC has, since 1970, successfully achieved an occupancy rate of ninety-eight percent.
With roughly $700 million in cash-flow-accretive acquisitions in 2010, $1 billion in 2011, $1.16 billion in 2012, and the $3.2 billion ARCT acquisition in early 2013, RIC’s cash flow is poised to continue to improve, meaningfully, in coming quarters. However, the firm’s recent 19 percent dividend hike in February, 2013, puts near-term dividend growth into question for reasons mentioned below.
Also, of concern is management’s desire to move into nonretail rent arrangements. The company’s management team is currently seeking to position RIC’s portfolio for a future that will place much more downward pressure on the consumer and discretionary spending. As a result, RIC is adding more investment-grade tenant properties and nonretail assets to its portfolio which are, generally, costlier to acquire than noninvestment grade retail properties. One of the major snags to RIC’s new strategy is that nonretail assets are generally more difficult to evaluate in terms of potential profitability than retail spaces, and that nonretail tenants, such as office spaces, distribution centers and industrial properties, usually have weaker ties to a particular property, which could have a profound effect on occupancy rates going forward.
When we look at the company’s financial figures, and key ratios, most appear to be in good shape. However, when we look at EPS figures and the company’s dividend payout ratio, there is cause for concern. For FY 2012, the EPS figure showed an 18.1 percent decline from the previous year, and the Payout Ratio climbed from 172.1 percent to a whopping 233.9 percent. Essentially, that number tells us that RIC’s dividend payments for 2012 were over two hundred percent higher than net income, which is not sustainable! Also of concern is the fact that Return on Invested Capital (ROIC) declined 126 percent to negative 0.18 percent; and, in looking at a recent chart pattern for RIC, it would appear that investors are beginning to take notice.
Technicals:
From its high of $55.48 on 5/22/2013, RIC’s stock price has declined 21.68 percent to $43.45 (as of the closing price on 6/19/2013). Though the upward price pattern is still intact, caution may be warranted here.
In looking at a close-up view of the chart we see that On Balance Volume (OBV) has taken a nosedive, the 8-Day Moving Average has crossed over the 50-Day Moving Average, and that the 50-Day Moving Average appears to be heading rather quickly toward crossing over the 200-Day Moving Average. All of which may portend bad things to come.
Conclusion:
RIC is a great company that appears to be going trough a bit of a painful aging process. It is a company that has, over a fairly significant period of time, delivered positive results to shareholders; BUT, right now would not appear to be a good time to take any new positions in the company’s stock. For those who already own shares of RIC, the use of tight stop losses and/or hedging strategies at this point in time would be prudent.
Note: Information for this article was collected from RIC’s Web site, its most recent 10-K filing and Morningstar.com. Charting data provided courtesy of optionsXpress.com.
Disclosure: I own shares of RIC, indirectly, through Vanguard’s (VTI) ETF.
