For the second time in three years, I was able to attend the 2016 Realty Income (NYSE:O) Annual Meeting of Stockholders. Held at the Marriott Del Mar Hotel, which is across the street from Realty Income's headquarters, the meeting is generally a positive, upbeat affair from my limited experience.
Mr. Mike McKee chaired the meeting and quickly and professionally covered the formal business of the meeting. For the first time in the company's history, the Blacks were not in attendance, but they had a good excuse. Their grandson graduated from Washington State University - congratulations! All formal matters were approved, with the final vote to be tallied and amended to the meeting report.
Mr. McKee concluded the formal portion of the meeting and introduced Mr. Case to give an overview, report the performance of Realty Income in 2015, and give an outlook for 2016. Much of this information has been covered in the many solid articles on Realty Income on this site and others, and no bombshells were dropped. Realty Income continues to execute their single tenant, freestanding, non-discretionary, net-lease strategy as the company has grown from 630 to 4,615 properties since going public.
The steady reduction in retail vs. other property types continues but retail still makes up 80% of the portfolio, followed by industrial and then agriculture (about 2%, primarily Napa area). The capital structure is 3/4 common and preferred stock, 1/4 debt, which is a bit higher than the 2/3-1/3 target, but Mr. Case mentioned the stock price is trading near an all-time high.
This along with the company's strong credit rating reduces cost of capital and made using overnight stock issuance a good source of acquisition capital in 2015. While this could potentially be seen as dilutive, stock issuance of $1.2B in 2015 was surpassed by $1.3B in acquisitions - a positive sign. Another sign of the prudent management team, nearly $32B in acquisitions were reviewed by Realty Income in 2015, so the $1.3B mentioned above is only 4% of the possible deals. While Realty Income continues to grow, growth is not occurring for growth's sake only.
A question and answer session followed. Mr. Case answered most the questions single-handedly, clearly and succinctly addressing the question. He also had Mr. Summit Roy help answer one question, and Mr. McKee one as well.
First, a question was asked on how the company determined when to raise the dividend. While not giving an exact rule of thumb, Mr. Case mentioned the payout ratio has historically been in the mid-80s of AFFO, so as AFFO increases, management normally recommends to the Board a dividend increase. With the payout ratio at 83%, the dividend is comfortably covered.
Another question regarding macroeconomic concerns also relates to the dividend, a key attraction of Realty Income. Mr. Case stated that Realty Income was one of only ten retail REITs not to cut their dividend in 2008/2009. Mr. Roy added that with a cost of capital among the lowest in the sector, any adverse macroeconomic events such as higher rates or recession would affect all of Realty Income's competitors as well and the management team would still capitalize on the relative advantage the company possesses.
Another couple of questions focused on the threat of e-commerce and other disruptive technologies. Mr. Case mentioned that tenants are specifically chosen to be at limited risk from e-commerce and also mentioned theater chains as an example of disruptive technology. The company is encouraged by theaters making improvements and upgrades away from stadium seating and even consults with chain management on some of these programs. This protects the income stream and likely helps keep the occupancy rate high.
Another two questions touched on portfolio concentration and disposition. Two large holdings are Walgreens (NASDAQ:WBA) and CVS (NYSE:CVS), which together make up 9% of revenue. On top of that, Rite Aid (NYSE:RAD) is another 2% of revenue and is being acquired by Walgreens. This is of concern but not alarming to management, and will be reviewed to ensure this doesn't overweight the portfolio or put it at risk. He mentioned there is a strong asset management team that reviews all properties for return, value and potential, and $500M in dispositions occurred in 2015 to keep the quality of the portfolio high. While not giving a specific disposition figure for 2016, he said pruning would occur - size wasn't the main barometer for the company.
An interesting final question was asked about employee turnover, which potentially has been near 50% in the past 5 years. Mr. Case said he would address the question also, but asked Mr. McKee to answer first, as this has been brought to the attention of the Board. Mr. McKee stated that three factors likely contributed to what appears to be high turnover. First, Mr. Lewis was CEO for 17 years and developed his team during that lengthy tenure. Many of these employees had been with Realty Income for many years.
On top of that, many were reaching retirement age (reason two) at the same time, the company decided to move across San Diego County from Escondido to its current location. Many employees who had done great work for the company left, but have been replaced by a new generation who seem to have maintained the same high espirit de corps and continue the high performance of the company. He summed up by saying the past four years have been some of the best in company history, which Mr. Case echoed.
One interesting tidbit for holders of the E class preferred stock was a question regarding the potential to call the class beginning in February 2017. While Mr. Case did not say a decision had been made to call the preferred, he did compare the stated 6.625% yield to the ability to issue new preferred at 6%. He stated management and the board would be watching this between now and February, and implied the company would call the preferred if it's able to replace it at the lower yield. This could set up a nicely yielding position with a likely workout, especially if it drops below par. Today, it traded above $26, so I would be cautious buying now.
Bottom line, I continue to hold Realty Income as a foundational holding of my market account and reinvest dividends month after month. While the stock price has risen rapidly this year, I am not looking to sell at this point, as the solid yield and conservative portfolio management make this a fairly safe holding. One metric I have used on adding to my position is the stock's yield, which is trending lower of late as the stock price rises.
At below 4%, this dividend is on the far low end of O's range, but the stock has now fallen nearly 5% in two days. While the stock price of O normally has a premium to its peers, it may still be little bit ahead of itself. That said, trying to time any purchase, but especially Realty Income, could cost months of dividends. I would think a prudent strategy would be to dollar-cost average into Realty Income if building a large stake. My opinion is the stock likely won't appreciate greatly above the $63-$64 range it has been in lately, but also won't drop down to the high $40s or low $50s like some mention as their entry point.
Of course, there are many different opinions and strong articles on O on Seeking Alpha, and I recommend you review them, think it through and make your own decision.
Best wishes for investing success!
Disclosure: I am/we are long O.
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: This is not an offer to sell securities in any jurisdiction and is published for academic reasons to track my own investment ideas over time. It is also to share my observations at a stockholders' meeting for those who were unable to attend.