In my recent article The Retiree's Dividend Portfolio - John's May Update: When It Becomes Hard To Find A Good Deal, I asked for some feedback on potential deals in what feels like a fully-valued marketplace. The goal for John's portfolio is to own stocks that provide predictable and consistent income that will help fund his retirement.
One of the suggestions that piqued my interest was Vereit (VER) which I actually owned years ago before disposing of my entire position prior to a scandal where the former management team was "cooking the books" and it has taken years for the company to regain the trust of the investment community. For those unfamiliar with the company's history, it was known as American Realty Capital (ARCP) but changed its name to Vereit on July 31, 2015.
Since then, the stock price has remained stagnant for years and the dividend of $.1375/quarter or $.55/annually has remained unchanged. As someone who looks for companies that have a record of consistently increasing its dividend payments, I have had to reconcile this with the fact that VER's management has made significant improvements to the company's situation.
The last four years have been characterized by VER's post-scandal management team righting the ship and reconstituting the company's portfolio of properties. Given the changes made, VER looks undervalued and is poised to perform well in a market where many REITs can be considered overvalued or fully-valued at best.
The goal of this article is to figure out just how far VER has come since its scandal and name change in order to better understand how undervalued might be. If the stock is undervalued enough, I am potentially willing to overlook the lack of dividend growth because I believe that management was taking the steps necessary to reincarnate the company which will likely lead to dividend increases in the future. At a current yield of 6.15%, the current payout is enough to make me believe that it has the potential to be worth the wait.
VER - The Company Then And Where It Is Now
A stagnant stock price represents a portfolio that has undergone some major changes (dispositions and newly acquired properties). The primary characteristics that have changed over the last several years can be seen in the image below which was taken from the Q4-2014 earnings call presentation (left image) while the information on the right was taken from the Q1-2019 investor presentation.
Source: Q4-2014 and Q1-2019 Investor Presentations.
- At the end of 2014, Red Lobster accounted for 11.6% of straight-line rent (SLR) which is a significant amount of exposure to have. Management has made it a point to reduce exposure to Red Lobster and was able to cut the percentage of total rental income that comes from Red Lobster to 5.4% by the end of Q1-2019. Red Lobster is still the single largest contributor to rental income for VER.
- Interestingly enough, the drop in the Top 10 Tenant Concentration appears to have been largely achieved through the reduction of Red Lobster properties (thus decreasing the amount of rent they contribute).
- Even though the number of tenants has decreased (by around 151), VER has been able to continue reducing its exposure to any single tenant. It should be noted that the amount of rental income contributed by each of the 652 tenants is not proportional with 48 tenants comprising of 57.2% of total rental income while the remaining 604 tenants contribute 42.8% of total rental income.
- Lastly, the glaring negative is that the weighted average lease term (WALT) has decreased by more than three years which indicates that the properties sold and removed from VER's portfolio had lengthy lease terms. With this in mind, 8.7 years is still a healthy WALT for a REIT that has the size and scope of VER.
Given the changes shown above, one would think that the composition of VER's portfolio (by property type) would have changed each property type is still contributing about the same amount of rent compared with 2014. The main reason why it looks so different is that the graphic from 2014 combines retail and restaurants into one category.
Source: Q4-2014 and Q1-2019 Investor Presentations.
At this point, I can't help but think to myself that the reason why the stock price has remained flat is that VER is really the same company that it was 4+ years ago. In other words, these similarities between ARCP and now VER's portfolio is actually somewhat disheartening because it implies that management slapped lipstick on the corporate pig and have been repairing the company's image without truly solving the underlying fundamentals. I began to seriously question this until I compared the Key Financials from the Investor Presentations.
The good news is that a review of the Capital Structure and Balance Sheet demonstrates everything that I needed to see to prove that the post-ARCP management team is for real. The way I see it, the new management team came in and kept what was good while tweaking the portfolio to make slight adjustments (specifically when it comes to risk and tenant exposure).
By making these changes, I believe that it's possible for management to begin tackling its finances and de-leveraging while taking advantage of buying back undervalued shares. Here are some of the key improvements and moves made by VER in 2019.
- Principal Outstanding was reduced from $10.47 billion at the end of Q4-2014 to $6.1 billion at the end of Q1-2019. With total rent generated down during this time frame from $1.38 billion in 2014 to $1.2 billion annualized in 2019.
- VER repurchased 50 million shares at an average price of $6.84/share.
- Weighted Average Debt Term of 4.5 years and a Weighted Average Interest Rate of 4.44%.
- Currently, no year accounts for more than 20% of total debt maturities.
Weighted Average Lease Term
Additionally, VER still maintains a healthy weighted average lease term (WALT) across its various property types.
- Retail - 9.1 Years WALT
- Restaurant - 11.7 Years WALT
- Office - 5.1 Years WALT
- Industrial 8.1 Years WALT
Office properties have the shortest WALT but are only responsible for just under 20% of annualized rental income (ARI). VER's office properties have some particularly interesting strengths with more than 1/3 of properties serving as corporate headquarters and roughly 2/3 focused on corporate operations. I see these properties as a much safer bet than other REITs because VER's office properties are typically mission-critical locations and therefore less likely to change locations, etc.
FastGraphs - Historical And Performance Comparison
As I mentioned before, VER's share price is essentially flat when compared with the share price at the end of 2014. To give an additional perspective on what this means I've decided to incorporate the performance metric offered by FastGraphs to show how VER performed relative to the S&P 500.
The point in showing this is to demonstrate that VER's annualized rate of return (ROR) has underperformed the annualized ROR offered by the S&P 500 by approximately 50% over the course of the last five years. Notice that the ROR for VER has been almost entirely dividend-based while the return for the S&P 500 has been almost entirely based in capital growth.
As a potential investor, the key question to ask is whether or not VER deserves the same historical discount that the market has assigned to it for the last five years or if the improvements made over this time period are worthy of a higher P/AFFO. It is my belief that each day that passes represents a brighter future for VER.
Simply put, VER has improved its portfolio in nearly every capacity possible since Glenn Rufrano took the helm as CEO but the market has remained skeptical because of the scandal that reduced adjusted funds from operations (AFFO) by $12 million in Q1-2014 and $10.9 million in Q2-2014.
Through the efforts of a highly-seasoned management team, VER has seen roughly four years of quarterly funds from operations stability resulting in a stable dividend of $.55/share annually.
Investors should also consider that VER has very little exposure to companies that have announced store closures in 2019. As of the Q1-2019 earnings call, there were a total of 6,000 store closings announced compared with 2,800 store openings during the same time frame. VER's largest exposure is to Family Dollar stores (owned by Dollar Tree (NASDAQ:DLTR)) as the company indicated the plan to close 18 of the 388 stores which represent .1% of annualized rental income. On the earnings call, Glenn Rufrano points out that "14 of the stores related to close are in master leases and have a range of 8.1 to 13.5 years of remaining term. Four stores have four years or less with the earliest being two years."
I personally believe that VER represents a compelling value at its current price of $9.15/share and have even added it as a holding to my client John's retirement portfolio. I plan to add more shares of VER if the price drops below $8.50/share. I believe that the market has failed to appreciate the improvements made to VER's operations and their portfolio of properties. At the same time, I believe that VER will still see a relatively flat share price over the course of the next year which means that anyone who adds VER should not expect the capital appreciation just yet. Income investors who are looking for a stable income source that has future growth potential should consider adding VER to their portfolio.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in VER 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.
Additional disclosure: This article reflects my own personal views and is not meant to be taken as investment advice. It is recommended that you do your own research. This article was written on my own and does not reflect the views or opinions of my employer.