Doubling Down On Dividends With Diageo And Realty Income

Includes: DEO, O
by: Brad Thomas

As a REIT journalist, I focus my writing on a broad spectrum of real estate sectors and I enjoy exploiting the differentiating fundamentals of various REITs. Of course, REITs are driven by rent checks and; consequently, I also write on many of the tenants who occupy the facilities leased by REITs. In this research, I have found that there is a close correlation between the quality of a tenant-based rent check and the quality of a REIT's FFO (and dividend). Historically, many of the REITs with sound dividend performance also lease facilities to high-quality and well-established tenants.

So as I was researching one of these extraordinary dividend REITs, I came across a durably powerful "beer and wine" brand. But as explained by Steve Jones, author of Brand Like A Rock Star, this durable rock star brand extends beyond its "multinational " boundaries and is "more of a corporate entity that has strategically built individual brands generating millions and millions of dollars." At first glance, I was not familiar with Diageo plc DEO, a UK-based alcohol conglomerate.

However, after researching the business model, I discovered that the alcoholic beverage industry giant ($54.46 billion market cap) operates a diverse platform engaged in producing, distilling, brewing, packaging, distributing, developing, and marketing a wide variety of spirits, beer and wine products worldwide. This 116 year-old (founded in 1886) global conglomerate ships a vast number of products including brands such as Johnnie Walker, Smirnoff, Baileys Original Irish Cream Liquors, Crown Royal Canadian Whisky, Captain Morgan Rum, Jose Cuervo Tequila, Ciroc vodka, and countless other brands. With a global reach, Diageo has nearly 20% of the world's top 100 brands of spirits making the European-based company a uniquely diversified investment choice (with only 25% of its global sales from Europe).

As explained in a recent Morningstar report,

Despite the challenges created by the apparent slowdown in the global economic environment, we've been saying that Diageo is positioned well due to its unrivaled distribution scale, strong brand portfolio, and exclusive distribution agreements in the U.S., which played out in fiscal 2011. As explained by Chief Executive Paul Walsh, 'The firm's full-year results came in about where we expected, and we are not making any changes to our fair value estimate for the firm, but we will update our outlook when we've had a chance to dig into the full-year results.' Diageo announced a 5% growth in annual profits (fiscal year ended June 30, 2011), an increase that Chief Executive Paul Walsh largely attributes to its activities in emerging markets. While sales fell in Greece, Spanish and Ireland (all economies that have struggled in the last few years), Diageo's acquisition of the leading Turkish spirits company Mey Icki, and its performance in North America and Asia-Pacific have offset the downturn in European trade. Diageo's international growth model is based on acquisition of brands with a strong presence in the target market, which gives them a more rapid path to market in a new economy. Branching out where other companies in the same field do not already have a market share can be a good route to rapid growth.

One example of Diageo's projected growth is Africa. According to an article in The Economist, Diageo is making a tremendous marketing push with its Johnnie Walker brand. The most recent data indicates that the South African middle-class has purchased around $147 million worth of the products (up 34% over last year) during the first six months in 2011. Another example is the speculative disposition rumors associated with the owners of Jose Cuervo. Currently the $2 billion crown jewel is owned by the Beckmann family; however, rumors have surfaced that Diageo would be a well-aligned suitor that could broaden the conglomerates reach into the lucrative tequila market.

With considerable growth prospects looming, I thought I would research the capitalization metrics of the world class alcoholic beverage giant. As of the latest annual report (6-30-11), Diageo had around $31.751 billion in assets and $23.331 billion in debt (73.48%). Long term debt consists of around $10.9 billion (rated A- by S&P); however, the company has reduced its long-term debt by around 12% from the previous year (2010 long term debt was $12.347 billion). In addition, cash is increasing (paving the way for future acquisitions) as the company reported cash equivalents of $2.543 billion (6-30-11) compared with $2.174 billion in 2010 and $1.505 billion in 2009.

The latest income data also suggests a growing trend in shareholder value as the conglomerate rang up year-ending sales of $15.952 billion - a 9% year-over-year increase (sales were $14.632 billion in 2010). The bottom line income was also exceptional as Diageo grew its net income by around 24% from $2.608 billion to $3.238 billion. Finally, the world-class beverage giant pays an intoxicatingly robust 3.7% dividend. And with a P/E of 13.9%, the tempting beverage giant should quench the thirst for value-driven investors.

Double Down on Diageo?

As I alluded to earlier, I research and write on a number of equity REITs and, in doing so, I dig deep into the revenue drivers. And although alcohol consumption has never been a vice for me personally, I admit that I enjoy watching cards flopping on the table. And while I'm not addicted to the game of blackjack, I certainly enjoy the strategy of blackjack and the sum of multiple cards that total twenty one. As most people know, when you are playing blackjack one of the most favorable situations arises when you have the opportunity to "double down". When you "double down" you are allowed to double your bet after receiving two cards. You then receive one card on your hand - making for an extremely profitable outcome of events.

As mentioned, Diageo is a world-class alcoholic beverage conglomerate paying a robust dividend of 3.7%. Conversely, there is another opportunity to "double down" and invest in real estate (my area of expertise) leased to Diageo. Realty Income O is a triple net REIT that owns around 2,600 individual assets in 49 states (all but Hawaii). In 2010, the Escondido, CA-based REIT acquired around 1,690 acres in Napa Valley, CA. This sale-leaseback transaction was valued at around $ 269 million and leased under a long term lease (20 years) to Diageo. The Diageo Chateau & Estate Wines properties are located throughout the Napa Valley area (the premier wine producing region in the U.S.) and the Realty Income owned vineyards have producing premium grapes (for 25 to 100 years) that are used for several of Diageo's highly regarded wine brands.

With assets of around $ 4.275 billion (as of 9/30/11) and latest quarterly revenues of around $ 107.28 million (up 23.6%), Realty Income provides for a strategically balanced risk-averse REIT model. The "monthly dividend company's ® " Diageo-based concentration level is around 5% of the overall revenue base (as of 9/30/11) - making Diageo the 2nd largest tenant (based on revenue) of the 43 year-old "safe margin" REIT. With around 26.8 million square feet and leasing from around 134 different regional and national enterprises, Realty Income is perhaps one of the most diversely managed REITs in the U.S. And because of the high level of risk-control and strategically deployed acquisition fundamentals, Realty Income maintains an exceptionally safe 97.7% occupancy rate (based on 9/30/11).

Evidenced by historically attractive dividend results of 63 increases (since the 1994 NYSE listing), 56 consecutive quarterly increases, and 496 consecutive monthly dividends declared (since 9/30/11), the balance sheet is exceptionally sound with just around $68.1 million in mortgage debt and $1.75 billion in unsecured debt (26.7% of unsecured to capitalization). In addition, Realty Income is one of around a dozen REITs (out of 123) that has a BBB+ (or higher) S&P rating. The sustainable risk-aligned equity REIT is paying a dividend of around 5.2%, making Realty Income an exceptional dividend machine.

Two Ideal Cards for Doubling Down on Dividends

In closing, Diageo (trading at $86.96 a share) and Realty Income (trading at $34.79 a share) are two excellent dividend stocks. Both provide exceptionally attractive balance sheet fundamentals along with low-risk dividend growth. In addition, both equities are distinguished by their unique ability to control risk while also generating sound returns. Both highly sustainable revenue models are distinguished by extraordinary risk-control characteristics driven by diversified brand management fundamentals.

This winning combination appears to be an intelligent bet as the duo provides for the sum of a risk-averse "double down" strategy and an exceptional "margin of safety" investment choice. And as the dealer stares at me asking me whether to hit or stay, I recall that voice in my head giving me that "trace of wisdom" and telling me to take another card and double down.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.