Realty Income: Waiting For A Pullback

| About: Realty Income (O)


Realty Income is out again with another strong quarter.

FFO grew inline with guidance.

Acquisitions were brisk, which may signal a future equity raise.

While a solid performer, Realty Income remains overvalued.

Known as "the Monthly Dividend Company," Realty Income (NYSE:O) has had a wonderful run so far in 2016, up 15% YTD and up 30% from over the past 6 months or so. This performance has been driven by solid operational results as was the case with the recently reported Q1 2016 numbers.

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Inline FFO growth

For Q1, Realty Income's funds from operations ("FFO"), the key metric for a triple-net REIT, increased to $170.6 million, up 11% from last year. Though, on a per share basis, FFO was flat at $0.68 stemming from a $5.8 million, or $0.02 per share, charge related to a fair value adjustments interest rate swaps.

When adjusted for these various one-time items, Realty Income's adjusted FFO ("AFFO"), was $175.9 million, up 15.6% from last year. On a per share basis, AFFO was up 4.5% to $0.70 compared to $0.67 last year.

That Realty Income grew AFFO by just 4.5% in Q1 is minor disappointment as the company was posting high single digit growth (~7%) for much of last year. Nevertheless, 4.5% growth is still within the 2016 guidance range of 4.0% to 5.8% growth.

As for how Realty Income is growing, much of this growth came from new investments as same store rents grew by only 1.3% to $224.7 million. Acquisitions and investments totaled $352.6 million in 103 new properties and properties under development or expansion during Q1. These are 100% under lease with a weighted average lease term of ~15.8 years, with an average lease yield of 6.6%.

As of quarter end, the real estate portfolio now stands at 4,615 properties with a weighted average remaining lease term of 10.0 years. While the portfolio occupancy rate was 97.8% with 101 properties available for lease, up slightly from 98.0% and 86 properties last year.

Expect an equity offering in the near-term

Keep in mind that Realty Income blew through 47% of its initial $750 million 2016 acquisitions guidance just in Q1. The company has bumped this guidance to $900 million. Though, this may be raised again as the annual acquisition run rate is closer to $1.47 billion. Generally, it is a good thing long-term for Realty Income that it is able to investment so much capital so quickly.

On the capital raise front, Realty Income did not sell equity directly via any secondary offerings. Though, it did have an active At-the-Market (ATM) program which saw 500,000 common shares sold for $30.1 million. Realty Income also retained $3.5 million via its DRIP program, issuing 61,458 common shares. In total, Realty Income raised $34 million in capital in Q1 2016 at an average price of ~$60 per share with a low yield of just 4%.

Realty Income ended of quarter with ~$1.35 billion of capacity on its revolver, enough dry powder to fund its projected acquisition growth spending.

Though, I would not be surprised with another secondary equity offering in the short-to-medium term as the share price is very elevated. Realty Income last did an offering in October 2015 at ~$46.88 per share, 28% above the current price at ~$60 per share.

Dividend coverage remains strong -- look for more dividend growth going forward

For Q1 2016, Realty Income generated FFO per share of $0.68 per share and AFFO per share of $0.70. With dividends paid at $0.588 per share during the quarter, up 4.8% from last year, this resulted in a dividend payout ratio of 87% of FFO and 84% of AFFO, towards the low end of the long-term average payout ratio of 85%-90%.

Realty Income's 2016 guidance has FFO at $2.82 to $2.89 (1.8% to 4.3% growth) and AFFO at $2.85 to $2.90 (4.0% to 5.8% growth). This results in a forward dividend payout ratio of 83% of FFO and 83% of AFFO (using the midpoint of guidance range).

Given the brisk pace of acquisitions for Realty Income, I believe the company will beat its FFO/AFFO guidance for 2016. 2015 growth came in at ~7% for both metrics and I think more of the same is slate for this year. If Realty Income were to grow its FFO/AFFO by 7% in 2016 (~$2.95 per share), the dividend has the potential to reach as much as $2.50 per share using a 85% payout ratio, 4.7% above current levels.

Conclusion: Valuation is a concern

Lastly, a few words of caution about Realty Income's valuation. Simply put, I think it is time to sell. While Realty Income has performed well operationally, as was the case in Q1, the valuation is no longer attractive. The dividend yield is low at just 4% -- I typically look for 4.5 to 5% yields in the triple net REIT space.

In addition, the stock is trading for over 21x its projected 2016 AFFO per share. Even when using my bull case AFFO estimate of $2.95 per share, Realty Income's valuation is still 20x. The current rally really seems over done.

For a stock growing single digits, mid or high, I do not think it is wise to pay an over 20x multiple. Looking at the charts, Realty Income has typically traded at around 16-17x AFFO multiples. Just last October the was trading at ~$48 per share, good for a 16.5x AFFO multiple. I would wait for the low $50s ($51-53, ~4.5% yield) before going long again.

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: I/we have no positions in any stocks mentioned, but may initiate a long position in O over 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.