Realty Income Corp. (NYSE:O) delivered another exceptional quarter of performance. It is a trend that has become common for shareholders. Despite some price volatility over the last year, the underlying business has performed exceptionally well and shares are now trading at fairly high levels. Prior to earnings, shares were trading at about $57, but since earnings they moved as high as $60 and are currently trading at $59.28.
If you haven't seen the earnings release, you may want to check it out. This piece is analyzing the earnings and price movements, not restating the values. Fourth quarter FFO beat analyst expectations by $.02, though revenue underperformed slightly.
The company was growing metrics both at the income statement level and the per share level. For shareholders, the "per share" metrics are substantially more important. However, it is worth noting that when Realty Income Corporation is significantly increased the volume of shares outstanding they also tend to have substantially better performance on growing their operating metrics. The diluted weighted average shares outstanding grew by 14.05% for fiscal 2015 compared to fiscal 2014, but growth in full year FFO and AFFO figures was substantially less impressive. FFO per diluted share for the year was up 1.63% and AFFO per diluted share for the year was up 1.01%. If metrics are simply compared on a fourth quarter to fourth quarter basis, the performance looks significantly more impressive.
Getting More Expensive with Good Reason
While it feels like Realty Income Corporation can only move higher lately, it is important to recognize that a substantial portion of this growth has been fueled by the decline in Treasury rates which is sending more income investors into shares of Realty Income Corp. Perhaps it is simply because I'm constantly checking through interest rates, but I decided to start tracking the AFFO and FFO yields on Realty Income Corporation compared to Treasuries. Since my thesis is based on income investors buying into Realty Income Corporation and maintaining a spread between Treasuries and shares of O, it may seem ironic that I'm not simply using the dividend yield.
If O were a lower quality REIT, it would make sense to stick to a more definite measure such as the cash dividends. As a very high quality REIT, I have no concerns about the accounting policies and trust management to represent their results in a very honest and transparent manner. Therefore, I am willing to believe any FFO or AFFO that is not paid out in dividends is being intelligently reinvested in growing the portfolio to improve those metrics (and the dividends they can pay) in future years.
The trailing FFO yield is 4.66% and the trailing AFFO yield is 4.61%.
The following chart demonstrates the Treasury yields from last night compared to the current trailing FFO and AFFO yields using the latest market price (around 2:20PM Eastern):
For comparison sake I've incorporated the comparable metrics for December 31st. The largest potential issue here is that the yields calculated for December 31st are incorporating the data we just learned for the full year performance of Realty Income Corporation. As a result, the values on December 31st would have required some estimation if they were provided in real time.
The yellow highlighting is emphasizing all the areas where the spread has increased. The FFO yield available on shares has decreased substantially as a result of rising share prices, but it has not decreased as rapidly as the yield on Treasury securities at most durations. In general, this would could be seen favorably if it were not for Treasury rates already being at such low levels.
There are two significant concerns here. One is that the decline in yield has been almost as quick for O as it has for Treasuries. Keep in mind that domestic equity markets are pulling back which suggests that investors are becoming more risk averse rather than less risk averse. The second issue is that Treasury yields are reaching exceptionally low levels. While I'm in the "lower for longer" camp on interest rates, I am concerned that we may see some yields spike higher. A few comments by the Federal Reserve about selling some long term assets and the panic could send bond prices lower and yields higher. Such a situation could hammer away at share values.
What I'd Love to See
I'd love to see Realty Income Corporation talking about making more acquisitions. The rest of the market is weak, but O has access to equity financing at relatively low rates. The result is a low WACC (weighted average cost of capital) that would make deals look more attractive.
O had an excellent quarter, but share prices are reaching fairly high levels that would be unlikely to be sustained if the interest rates move higher. Over the next few years I expect Treasury yields to remain suppressed, but I expect some volatility in those interests rates over time. When the rates go up, I would expect shares of O to come back down. If those events come to pass, I'd love to be buying up shares at lower prices. With hindsight, I missed out on some great prices below $50 and just over $50. I'll accept missing out on some good opportunities to avoid buying in when shares are too high.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.
Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.