The market generally does not like American Realty Capital Properties (ARCP). The stock trades at a large discount to its triple-net REIT peers both in yield and FFO multiple. There are several reasons for this discount such as concerns over the Red Lobster sale-leaseback, an undervalued equity offering, and concerns over the future of the CEO. However, as I noted in a previous article, ARCP has resolved many of these issues and is ready for a bounce back.
Q2 2014 Overview
On July 24, ARCP reported its Q2 2014 results. Below are some of the highlights of the quarter:
Revenues: $382.0 million, up 595.2%
Adjusted FFO: $205.3 million, up 429.0%
Adjusted FFO per share: $0.24, up 26%
Dividends paid per common share: $0.25, up 10.6%
Portfolio occupancy: 99.8%
ARCP had a pretty good quarter considering that it still has not closed some major acquisitions. Adjusted funds from operations "AFFO", a key metric for profitability in REITs, increased 26% on a per share level to about $0.24 per share.
Though no dividend increases were announced during the quarter, ARCP current dividend of $1.00 per share ($0.833 per month) is around 10% higher than where it was last year. Based on the adjusted FFO of $0.24 per share, the dividend payout ratio for the quarter was 104%. However, I would not worry about the elevated payout ratio as this is mere short-term noise.
In its guidance, ARCP noted that the pro forma AFFO run rate for 2014 was $1.18 to $1.20 per share. This factors in all of the completed or announced transactions (Cole Capital, Red Lobster) for 2014. As a result, ARCP's 2014 AFFO guidance is actually $1.13 to $1.19. Using the midpoint of this metric ($1.16), ARCP's payout ratio is around 86%.
Operationally, ARCP is well on its way to fully integrating its various REIT acquisitions, achieving $77 million in cost synergies in the first year. Given the company's breakneck growth, I expect many more such savings in future quarters.
As of the end of the June quarter, ARCP had 4,429 properties with 541 commercial tenants in 94 different industries with about a weighted average 12.2 years lease-term remaining.
Red Lobster sale-leaseback update
On July 28, Darden Restaurants (NYSE:DRI) completed the $2.1 billion sale of Red Lobster to Golden Gate Capital. ARCP is helping Gold Gate fund this transaction via a $1.50 billion sale-leaseback transaction for 500 of the properties.
93.5% of these leases will have a 25-year term, with the rest having an average 18.7-year term. The GAAP cap rate of 9.9% (7.9% cash rate) is quite high, which should result in some very solid accretion in coming quarters.
ARCP is taking on elevated risk with the addition of so many Red Lobster locations, with the restaurant now represent about 12% of ARCP's rental income. Red Lobster is seeing nearly double-digit same store sales decline, a very poor trend for any chain.
However, I think the risk is well worth the reward with Red Lobster. ARCP is buying the portfolio at well under the replacement cost, around 82%. In addition, Darden has spent significant sums on remodeling older locations, with about $1.4 billion in overall CapEx over the past ten years. In addition, as noted above, the cap rate of 9.9% is way above average in the triple-net REIT industry, beating the average by 200 to 300 basis points.
As of this writing, ARCP shares are up 2% to around $13.20. It seems as if the market approves of the Q2 results. While the quarter was mostly inline with estimates, I believe some negative news may have been priced into the stock. ARCP is still down around 15% from its YTD high.
With its 7.60% yield and 11.40x AFFO multiple, ARCP is a solid choice for income. The stock is way cheaper than say Realty Income (NYSE:O), though it does carry slightly more risk. I think ARCP should trade at the very least a 12.50x AFFO multiple, which is around $14 per share.
Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.
Disclosure: The author is long ARCP, O. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.