Vereit: Is A Breakout Just Around The Corner?

Summary

• Since the accounting scandal, VEREIT has largely traded in line with Fed policy.
• The stock has not received any credit for the progress the current management team has made.
• VEREIT is attractively priced for those willing to accept the legal risks.

Background

Last year, I started the year by calling VEREIT, Inc. (VER) my mid-cap stock of the year in an article published on Seeking Alpha here. I asserted that at $8.48, the stock was due for some multiple expansion, as it was not receiving credit for the progress that the new management team was making in improving its financial situation. Management had laid out a clear plan to improve itself by paying down debt (by shrinking the real estate portfolio), reducing the Red Lobster concentration, rebuilding Cole Capital, and achieving investment grade metrics.

I followed that first article up in April with an update here where I noted that even with a nice run in the stock to over $9.00, there was still room to go.

Then, in May, when the REIT rally continued, I grew concerned with the pace and wrote here that I viewed REIT valuations as getting a bit frothy and that I had taken some profits. I ended up selling most of my VER shares at $9.43 (held outside of my MnM Portfolio, for those who follow me regularly; I did not sell any of my REITs at that time in the MnM Portfolio). Looking back, I didn't get the top of the REIT rally 100% correct, as it continued into July and topped $10, but for those like me who took profits, it turned out to be a good move. VER ended up closing the year out at $8.46, largely in line with where it had started the year, giving all of the rally back. My mid-cap stock of the year ended up being the stock of the first half of the year, but you can't say I didn't warn you.

Fed Policy has Driven REIT Pricing

It shouldn't be any surprise to any seasoned REIT investor, but REITs, with their high yields, are particularly sensitive to interest rates. So, for the first half of 2016, when the Federal Reserve was releasing dovish reports and reducing its planned pace of rate hikes for the year, many REITs rallied. As we moved into the second half of the year, the dovish sentiment at the Fed began to grow more hawkish and we found out that 2017 would feature a much more accelerated pace of rate hikes. We have since seen many REITs sell off.

To illustrate this, let's take a look at a chart of the best-of-breed Realty Income (NYSE:O), VER as well as the Vanguard REIT Index ETF (VNQ). It quickly becomes clear that the Fed policy has indeed been the largest factor driving pricing trends in all three.

Source: Yahoo Finance, July 13, 2017

I find it very interesting that when we look at just the past year, largely when Federal Reserve sentiment changed, the pricing of O and VER has largely been identical. The market is essentially giving neither stock credit for their fundamentals, and likely punishing them more than even VNQ due to their retail exposure.

Source: Yahoo Finance, July 13, 2017

So, as a result of this steep sell-off, VER stock, which was trading at over $10 per share, now trades in the low $8s. On occasion it has even dipped into the high $7s.

Reviewing Management's Progress

While the stock hasn't shown any pricing improvement, I wanted to highlight what the new management team has accomplished since taking over the reins of VER in 2015. I compared the Q1 2017 Investor Review to the 2015 Investor Roadmap that was issued when the new management team first outlined its strategy for turning the company around. To date, it has executed on the key objectives as follows:

• Reduced Red Lobster concentration from 11.9% of the portfolio to 7.4%
• Achieved investment grade status
• Reduced debt significantly from over $9 billion to just over $6 billion

• Reduced the debt-to-EBITDA ratio from 7.5x to 5.48x
• Extended the terms of debt considerably. Back in 2015, nearly $6 billion of VER's debt matured by 2019, and now that figure is just over $2 billion.

With regard to Cole Capital, the progress hasn't been as quick. Management has highlighted that every quarter brings more and more broker dealers back online, which will ultimately lead to more capital raised. Despite this, to date the contribution to FFO from Cole has been fairly muted. There's room to go here, and I will be looking for more progress with Cole in the coming quarters.

Lastly, with regard to the portfolio culling and dispositions, on the Q1 2017 earnings call Glenn Rufrano commented that:

Our guidance, which we reaffirmed on this call Sheila has us selling about 450 to 600 in assets and buying about 450 to 600 in assets. We believe those bids for now. We also mentioned when we gave guidance that we would have more dispositions in the beginning of the year and acquisitions at the end of the year and we're conforming to it. And I would also mention that as you would expect, we are very cautious on acquiring anything at any point in time in the economy.

- Source: Seeking Alpha transcripts

Essentially, if management's estimates play out, we will see one more quarter of dispositions exceeding acquisitions. After that, in the second half of the year, management estimates that acquisitions will begin outpacing dispositions.

Summary

Over the past two years, VER stock has traded largely in line with Fed policy, receiving no credit for the improving condition of the company. This presents an opportunity to still get shares while they are depressed. The stock currently trades at a 12.1x FFO multiple and yields nearly 7%.

As compared to some of its peers, VER trades on the lower end of the multiple range.

For what it's worth, the insiders seem to echo the opinion that the stock is trading on the cheap. According to Nasdaq, there has been a decent number of insider buys in the last couple of months.

Source: Nasdaq.com, July 13, 2017

Lastly, the company recently announced $200 million share repurchase plan. Announcing a plan isn't any sort of guarantee that shares will ultimately be repurchased, but if this management team has shown me anything, it's that the team knows how to execute on its plans.

I will play devil's advocate, however, and try to explain the discounted valuation a little bit. First, we are still waiting for growth, which, if company management executes on its guidance, will be just around the corner in Q3. Second, I won't view VER as being entirely "out of the woods" until its legal issues surrounding the accounting scandal are resolved. Unfortunately, there isn't much visibility as to what's going on with the cases. Further, estimating any degree of exposure would be very difficult and highly subjective.

Adding to the uncertainty, recently Brian Block, the former CFO, was found guilty of misleading investors. I do not know what spillover effect, if any, this will have on VER and its lawsuits. The press releases indicated that he plans to appeal. It is important that investors keep the ongoing legal risk in mind.

Overall, I find there is value in VER and recently repurchased the stock at $8.40 with plans to hold and acquire more on dips like the current one. I will be collecting a nice yield while management continues to execute on its strategy. I anticipate that at some point, maybe in the latter half of this year, if management is able to begin delivering growth, continues showing improvement in Cole Capital and makes any headway with the lawsuits, we may finally see a breakout in the stock's valuation.

Analyst’s Disclosure: I am/we are long VER, 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.