Realty Income Corp.: A Good Long-Term Value Investment?

Nov. 9.11 | About: Realty Income (O)

Realty Income Corp. (NYSE:O) buys commercial real estate assets for cash and leases them to tenants that have a good business and operating track record. The leases are typically for 15 to 20 years, providing O with dependable lease payments that support monthly dividend payments for its shareholders. Most of the assets are leased to tenants in various retail industries and are located in prime locations with an average remaining lease time of 11.1 years as of September 30, 2011.

Most of O's assets are triple net leases, meaning that each tenant pays all operating costs, taxes, insurance and maintenance costs in addition to the rent.

If you seek portfolio diversification, that's not a problem with O: They own 2600 properties in 49 states for tenants in 38 different industries.

The occupancy rate at the end of September was an impressive 97.7% and has been over 96% for many years. That indicated excellent work performed by the experienced management team in renewing the expiring contracts.

O uses two ways to grow its revenues:

1. Through purchasing more assets – Financed either by using its credit facility or by regular public offerings of common or preferred stocks or bonds (three offerings in 2011 so far). Despite the credit crunch, the market pays that, showing confidence in the company's portfolio and management. However, based on its SEC filing, I would like to see assets purchased at higher cap rates.

2. By rent increases that are built into the rent contracts - These increases have historically contributed 0.2% - 2% in same store rentals annually (1.5% in the first nine months of 2011 vs. the same period in 2010). These increases will provide limited defense against inflation once it arrives.

O constantly purchases assets for its portfolio, but it also evaluates existing profitability for purchases and sells them on a regular basis according to these evaluations. During the first nine months of 2011 O purchased 125 new assets and sold 21 assets of its portfolio.

O is well known for its monthly dividend payments as well for its impressive dividend track record. They have increased dividend payments during the last 56 consecutive quarters, and have increased annual dividend payments by an average of 4% annually. The management is committed to continue increasing the monthly dividend payments.

Some more facts and figures about O:

O has a current market cap of about $4.5 billion as it trades just 7.3% below its all-time high price. As of September 30, 2011, net debt was $1.9 billion and real estate book value before depreciation was $4.8 billion. That is a fairly conservative balance sheet although some REITs show a less leveraged balance sheet.

Cash flow from operations during first the nine months of 2011 indicates a $265 million annual pace.

New assets purchased during 2011 were bought at an average cap rate of 7.9%, a little low compared to other REITs, definitely when you consider the real estate market's situation.

FFO per share for the first nine months of 2011 was $1.46, up from $1.36 for the same period of 2010. FFO per share for the third quarter of 2011 was $0.50, up from $0.46 for the same period in 2010. Based on the third quarter, current stock price implies FFO multiple of 17. That is considerably high compared to other REITs like Government Properties Income Trust (NYSE:GOV) or Senior Housing Properties Trust (NYSE:SNH) (see my other articles about these 2 REITs), but lower for example than Equity Residential's (NYSE:EQR) 23. Management's forecast for 2012 is FFO of $2.07 to $2.11.

O currently pays a $1.74 per share dividend, or 5.2% on current stock price. The average dividend yield between 1995 and 2010 was 7.7%, implying current price is historically high.

During 2010-2011 there were several insider sales of the stock, at price levels that were close to the current stock price. That data too implies that current stock price is too high.

Summary

Realty Income Corp. is a very stable company with an extremely diversified portfolio, a solid balance sheet and reliable cash flow.

Add to that a 5.2% dividend which you get to meet on a monthly basis (instead of the regular quarterly of its competitors) and you get the classical income/retirement stock that still beats U.S. treasuries.

However before investing you still have to ask yourself if the stock will be a value investment, leaving enough room for capital appreciation as well.

I believe the answer to this question is no. Based on the reasons mentioned above I think its $33.7 current price is simply too high, especially in today's real-estate's market condition.

I will keep monitoring the stock and will be a buyer at dividend levels of 7%, meaning a stock price of about $25 which implies FFO multiplier of approximately 12 on 2012 FFO.

Disclosure: I am long GOV.

Additional disclosure: I may initiate a long position in SNH during the next 72 hours.