I'm Buying This REIT For Safe Income

Summary

• This 5.3% yielding "Monthly Dividend Company" has a fortress balance sheet to ride out the current economic storm.
• Almost all (99%) of rent revenue from investment grade tenants was collected in April, with total rent revenue received at around 83%.
• Whilst the price has moved up significantly from the low of $38, the latest earnings call gives me confidence to invest in this REIT at a good (not great) price.

Investment Thesis

Realty Income (NYSE:O) is a very good dividend investment. It is offering a 5.3% yield at current prices, which is backed by cash flows from largely investment-grade tenants on a triple-net lease basis. It has dubbed itself "The Monthly Dividend Company" which shows the emphasis on the monthly dividend payouts that have been raised yearly for more than a quarter of a century now. After the latest earnings call, I've bought shares in this company.

Update during COVID-19

As tenants get hit due to the pandemic and the lockdown measures to combat it, ability to pay rent in time is compromised as well. As a landlord, Realty Income has not been unscathed by it, but is holding up well largely thanks to its investment-grade tenants. Realty Income was able to collect around 83% of contractual rent payments in April. Out of the investment grade tenants (which represent around 48% of total rent revenues), essentially all rent payments were received. Out of the rent not received, 86% is from tenants in the sectors hit hardest by the lockdowns and store closures due to the pandemic (theatres, health and fitness, restaurants and childcare). The company said it is dealing with rent deferrals on a case-by-case basis.

However, the approach we have taken is to independently review the individual financial and business positions of our tenants. And we have not and will not accept rent deferral requests that we believe are solely opportunistic in nature

- CEO Sumit Roy

The company provided a visual representation of rent collection from top 20 industries for the month of April in the latest presentation.

Source: Realty Income Investor Presentation

Balance sheet

Realty Income has a balance sheet to be able to weather the storm. It has $4 billion in liquidity which compares very favourably to the $400 million of debt that is maturing between now and end of 2021. Adjusted net debt-to-EBITDA is 5x and in the latest earnings call, the management stated that the company's fixed charge coverage ratio is the strongest it has ever been at 5.5 times. Total debt is around 30% of the total market capitalisation. Those strong figures result in a credit rating of A3 from Moody's and A- from S&P.

Dividend

Realty Income's dividend is paid monthly, with the latest 0.2% raise in March bringing it up to a $0.233 monthly payment per share. This translates to an yearly forward payout of $2.796 which is a 5.35% yield at the time of writing. Based on the Q1 annualised AFFO, dividend will be covered with a 79.4% payout ratio. Since 1994, the dividend has grown at a CAGR pace of 4.5%. I believe this to be one of the safest high-yielding dividends in the REIT space due to the tenant mix, solid payout ratio and the fortress balance sheet. The situation would have to change dramatically for the worse for O to consider cutting the dividend.

Source: Realty Income Investor Relations

Valuation

If you bought O in March, congratulations. But I believe it is still a good entry point at current valuation. Taking 2019's adjusted FFO of $3.39 as a guideline, at today's price of $52.25, shares are trading at around 15x FFO. It's still a good time to buy. Last 4-yr average yield of 4.39% also compares favourably to today's yield of 5.3%. You don't need to try and pick the exact bottom here to make it a successful investment.

Risks

22.7% of total rent payments come from movie theaters, health & fitness and restaurants. If the economy doesn't reopen within a reasonable time frame and the tenants' revenue dries up completely, that's almost a quarter of total rents that will have to be deferred. Although the dividend is a priority to the management and it has ample liquidity, this situation is not manageable for the long term. After all, we want our dividends to come from cash flows, not borrowed money. The stock price will surely be volatile, whenever there is news about re-opening or tightening of measures. Although I think it's a good entry point at current levels, this stock has traded between $38 and $85 in the last 52 weeks which is a really wide range.

Summary

For income-seeking investors, I believe that O is a great pick in the REIT sector. Whilst there was a more attractive entry point in March, the latest earnings call gives us more clarity on the situation and I believe O is still a Buy at current valuations for growth on top of an already high yield. I recently bought shares.

Analyst’s 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.

Comments

[Keep it Country]

I agree buying O at current levels will be rewarding in the longterm. I will add more if it dips again.

[craftbrewinfo]

Long O ( have been accumulating in tranches, anything 5% and above is good) and NNN

[check-mate]

I own o and wpc.
Like them both

[jgrever621]

Long O, Picked up some in he low 40's recently. WHEE.

Long term, O is not only safe with a sustainable dividend, but also grows in value. No reason to think this will change, and now with a lower cost basis for some of my shares, like it eve more.

[MAXonMONEY]

Love $O
I own only 50 share and have 10 put write contracts a month making me cash. ChaChing!

[tradingsystem]

yes writing options make cash, but also occasionally ruining everything like in my case

[Ethan Roberts]

Long and strong at $42.50. And who can argue with a 6.5% yield (at that price) that gets paid monthly?

[Dividend Athlete]

@Ethan Roberts
You got a great cost basis in this company!

[LeonFuchs]

What do you think about inflation risk for net lease REITS like O?

[Dividend Athlete]

In O's case, they would be negatively impacted.
The built-in rent escalators are only around 1% per year.
That's below inflation anyway, so O has limited growth internally. O has grown impressively through external growth though. That means they need access to low-cost capital to keep growing.
Also, the average lease length is around 15 year or so, so only a small % of rent's expire every year, where O could pass inflation on to the tenant through a new rental deal.
On a positive side eventually the debt gets inflated away as well so triple-net REITs would benefit from that.

Hope that was helpful

[LeonFuchs]

Thank you very much!

[Explorer86]

Stay away from REITS for at least a couple of years until the Coronavirus problem is under controls and 30 million workers go back to work.

[Dividend Athlete]

There are some great opportunities in the REIT sector, unless you think that life and business will never be the same after coronavirus .

[The guy from Europe]

@Explorer86 It is not under control in the USA, in other countries it is....

[MLian]

Buying O, holding O, collect O distributions - no brainer.

[Sfgiants6891]

Thoughts on SRC?

[Dividend Athlete]

In general I like SRC as well but just a comparison with O here:
Investment grade tenants make up 24% of rent ( 48% for O)
SRC collected 70% of rent in April (83% for O)
Net Debt/EBITDA 5.6-5.8 for SRC ( 5.0 for O)

Positive for SRC - Much lower valuation, higher yield, no debt maturing in 2020

You get a higher yield with SRC for slightly higher risk.

[Sfgiants6891]

I appreciate the reply! Very helpful information. Planning on starting a position with both on the next dip

[Dividend Athlete]

You are welcome:)
Wish you successful investing!

[wantitall]

Been very fortunate with O, bought and dripped over 5 years, sold 1/2 at $74, 1/2 at $56, and then bought them all back at $42! Not normally a swing trader, but too good an opportunity to resist with all this volatility.

[Bruce Bohannon]

Nice write up. On watchlist. Waiting /Learing..... Don't need income from Dividends.

[Jorel Boston]

O O it's magic......

[User 50867394]

I've got some questions for you - Question #1. Your 20 top industries chart do not count "apparel" as a separate item. But most Mall REITS constitute of clothing retailers. Question #2. Convenience stores - are you referring to drug store chains as opposed to mom/pop convenience stores?

[User 42280656]

I was worried about dividend cuts, but your analysis confirmed that I need to stay long with this REIT. Thank you!

[Caleb Leal]

STORE Capital is a better REIT fundamentally. They have a better debt structure, better target market, and stronger dividend.

[stevenweinberg33]

It’s absurd to say STOR Is a better REIT right now. I’m long both, but STOR’s non investment grade tenants (which is ALL of their tenants) as well as the non-essential businesses they’re operating are keeping me up at nights. More theaters, more restaurants, more childhood education, and more furniture stores (including the recent bankruptcy of Art Van furniture). The safety of STOR’s dividend is concerning given their tenant composition. They’ve collected 65% to O’s 83% rent in April. So why do I own both? Because Volk has convinced me that his company trading in the mid teens was ludicrous vs their net asset value. At <$18, it was trading below IPO, below Berkshire’s purchase, and according to Volk 20% below replacement cost. There’s more upside to STOR share price when the world finally gets back to normal, whenever that may be. Volk is a good salesman and a top notch CEO. I like a CEO who goes out there and defends his company on TV like he has. I just wished STOR had sought out a business model that included more investment grade tenants like O and ADC which result in both O and ADC having safer (albeit lower) dividends.

[Dividend Athlete]

What's your thinking behind this bold statement?:)

O is on a different level than STORE.

Also whilst I think STORE is a good REIT, dividend investors should be aware of the CEO's comments regarding the dividend:

"I think our board of directors is going to evaluate the dividend closely and they're going to do what they should do"

[Caleb Leal]

STOR is fundamentally a better REIT for some of the reasons I stated above:

1) Better Debt Structure - Out of the roughly $3.5 billion in debt, 65% of it represents their notes through their master funding program. The rest being fixed rate debt. This structure, touted by management and even some analysts, such as Morgan Stanly on the latest call in April, provides a level of safety and control that other REITs can't quite say.

2) Diversification of Portfolio - STOR's diversification is quite better than O by a long shot.
1) Top three tenants for STOR represent 7% of revenue, while the top three tenants for O represent 15% of revenue.
2) STOR's portfolio exposure is approximately 64% to service, 20% to retail, and 16% to manufacturing. Where as O has 83% in retail 12% in industrial, 3% in office, and 2% in agriculture. O is much more centered in retail, where STOR's exposure to one area of their business is quite less.

3) Dividend Growth - Compound average annual dividend growth for O is 4.5%, where STOR's is 7%, a whopping 55% higher.

4) Financials - Not comparing the two in this section. STOR always has enough FCF every year to pay of any debt maturities, something the management talks about a lot. 98% of leases or master leases. Excellent margins.

5) Management - They're management is by far the best of any REIT I've ever seen. The CEO writes 13 page letters with valuable information and his thoughts. Their extremely honest with great capital discipline.

6) The only REIT Warren Buffett owns - Anyone willing to argue with the Oracle on this one??

It's true that O is different than STOR in many ways which can make it hard to compare. And O is not a bad REIT by any standards, they have a lot of advantages. But in my opinion, STORE Capital is the best one of the two. There was a lot more things I could have mentioned, but it would take too long.