American Realty Capital Properties's Valuation Is Lower Than Its Peers - While Justified, It Still Is A Buy

May.26.14 | About: VEREIT Inc. (VER)

Summary

ARCP has lower valuation multiples than its peers O and NNN.

ARCP's asset quality is lower, but should improve over time.

7% yield and massive insider buying are reasons to buy.

American Realty Capital Partners (ARCP) looks like a strong buy… Is it really?

Bret Jensen and Brad Thomas recently wrote good articles on American Realty Capital Partners, mentioning its low valuation. Here are links to both articles: American Realty: 7%-Yielder Continues To Deliver and Is American Realty Capital A Monster Or A Machine? In addition to these articles, the fact that many insiders are massively buying the stock really caught my attention. The following article is an attempt to answer some additional questions that a potential investor could review before allocating capital to ARCP.

ARCP has a somewhat lower valuation compared to Realty Income (NYSE:O) and National Retail Properties (NYSE:NNN)

The array below displays the main financial ratios for ARCP, NNN and O:

ARCP

NNN

O

Asset Value ($M)

16,896.19

4,454.00

9,899.48

Debt Value ($M)

10,950.41

1,676.24

4,503.00

Total Book Value Equity ($)

5,945.77

2,777.76

5,396.48

Market Cap ($M)

9,390.00

4,260.00

9,600.00

Enterprise Value

20,340.41

5,936.24

14,103.00

EV-to-Assets ratio

1.20

1.33

1.42

Price-to-Book Value

1.58

1.53

1.78

Price-to-Asset Value Ratio

0.56

0.96

0.97

Debt-to-Assets Ratio

64.81%

37.63%

45.49%

Click to enlarge

These numbers show that ARCP's Enterprise Value-to-Assets ratio is lower than that of its comparables by a margin of 10% to 20%. The lower EV-to-Assets value comes at a cost of a significantly higher leverage of ARCP compared to NNN and O.

ARCP's asset quality is slightly lower than that of its peers

ARCP

(as of Q1 2014)

NNN

O

Nb. Sq. Ft. (in M)

101.80

20.40

62.64

$ Value per Sq. Ft.

165.97

218.31

158.03

Rental Revenues ($ M)

977.78

397.01

759.80

Yearly Rev. Per Sq. Ft. ($)

9.60

19.46

12.13

Yearly Re. Per Asset Dollar

5.79%

8.91%

7.68%

Click to enlarge

Here is a look at ARCP's FFO and AFFO comparative metrics:

ARCP

(annualised Q1 2014 data)

NNN

O

Rental Income

977.78

371.95

473.74

Total FFO

748.00

229.52

462.03

Total AFFO

588.00

239.13

463.14

FFO-to-Assets ratio

4.43%

5.15%

4.67%

AFFO-to-Assets ratio

3.48%

5.37%

4.68%

Click to enlarge

ARCP's asset quality can be measured by the book value per square foot or, more significantly, by the revenue-to-asset-value yield. The conclusion of this benchmark is that ARCP's assets are less valuable in terms of revenue per sq. foot and per asset dollar than those of its peers. Reading ARCP's annual report informs us that ARCP's stated strategy is to acquire underpriced assets and to increase their value over time (increase the lease payment). Hence, the lower efficiency metrics for ARCP should not be cause for strong concern if we believe that management can deliver on their promise.

Insiders are buying massively

A quick look at the insider transaction history shows that insiders (the CEO, COO, and directors) are massively buying shares of ARCP. Nicholas Schorch is an industry veteran with a good track record in the business. While buying with insiders is not a guarantee for success, it's a good sign to be on the same side of the table as insiders.

Dividend yield is higher than that of its peers

Based on prices as on May 22nd, 2014, the comparative dividend yields are shown below:

ARCP

NNN

O

Dividend Yield

8.09%

4.69%

5.05%

Click to enlarge

REITs are obliged to pay all their AFFOs as dividends. Given the fact that ARCP's AFFO-to-Assets ratio is lower than that of its peers, one can assume that if ARCP's Asset-to-AFFO ratio becomes comparable to that of O and NNN (because of higher leases), ARCP's dividends could increase over time, unless a strong dilution is pending.

Risk profile mainly linked to long-term interest rates

ARCP's risk profile is typical of an ARCP.

The operational risk related to the leases is low. Lease terms are long enough (above 7 years), tenants are reasonably diversified, and the risk of tenant default is limited.

ARCP

NNN

O

Average Cost of Borrowing

3.70%

5.09%

4.02%

Average Cost of Borrowing as a proportion of Assets

2.40%

1.91%

1.83%

Click to enlarge

While ARCP's average cost of borrowing is lower than that of its peers because of leverage, the average cost of borrowing as a proportion of its assets is higher than that of its peers. This makes ARCP more exposed to increases in long-term interest rates than its peers.

Conclusion

ARCP presents an interesting risk/reward profile. While the apparent undervaluation is justified by the lower asset quality and the higher leverage than its peers, ARCP serves a good dividend yield today and has the potential for capital appreciation as its operational metrics become more in line with those of its peers. The strong dividend served enables investors to remain patient. Given the management's insider buying and strong track record, I recommend ARCP as a buy at the current price of $12.30 per share. The stock has 20% to 30% capital appreciation potential within the next 12 months.

Disclosure: I am long ARCP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.