Agree Realty: Opportunistic Growth During Turbulent Times

Summary

• Agree Realty has a strong track record of market-beating returns.
• It had one of the highest rent collection rates among peers in May, due to its high quality portfolio of many essential tenants.
• The company has a strong growth runway as it is able to take advantage of depressed prices, backed by its strong balance sheet.

We are certainly living in turbulent times with COVID wreaking havoc on the economy, resulting in millions of jobs lost. With the Fed Chairman Jerome Powell announcing the intention to keep rates near zero through 2022 and an expectation that GDP will contract by 6.5% in 2020, it seems we should be prepared for more volatility ahead.

Currently, the market is seemingly bouncing between exuberance of the re-opening of the economy with a desire for a return to normal, and the reality of a recession and the possibility of a second wave of infections. While the volatility undoubtedly spooks many investors, I believe there are companies that provide a safe haven for investment dollars and can opportunistically emerge from the recession stronger than before.

A Choice For Turbulent Times

Agree Realty (NYSE:ADC) is a $4 billion net lease REIT with 868 retail properties covering 16.3 million square feet in 46 states. It collects steady rent checks from established tenants, 61% of whom are investment-grade rated, with an average remaining lease term of 9.8 years.

As seen below, Agree Realty has underperformed the S&P 500 over the past six months by an 8% margin. While ADC has recovered from the ‘sell-everything’ phase of the downturn, the market is still seemingly pricing in a fair amount of risk into its share price. To be sure, there has been plenty of headline risk for the retail sector, which has inevitably affected their landlords. However, as I will show later, things are not all doom and gloom for this REIT as the positives far outweigh the negatives.

(Source: Yahoo Finance)

While the short-term performance gives pause for concern, a look into the long-term picture below provides a much clearer perspective.

(Source: Dividend Channel)

As seen above, Agree Realty has vastly outperformed the S&P 500 over a 25-year period. 10,000 invested in ADC back in 1995 with dividends reinvestment would be worth over $250K today, equating a CAGR of 13.9%. By comparison, the same investment in the S&P 500 would be worth a much less $87K today, with a CAGR of 9.1%. As a reflection of the power of compounding, the nearly extra 5% per year in CAGR that ADC yielded has helped this investment outperform the S&P 500 by a wide margin.

A Durable Business Model

Perhaps the most telling aspect of Agree Realty’s high-quality portfolio is that, given the current pandemic, it recently announced that it had collected a high 87% of rents for the month of May. That compares favorably against its closest Net Lease peer, Realty Income (O), which reported that it had collected 82% of rents in May.

Looking outside of its direct peer group and into the Shopping Center REITs, the high-quality landlord, Federal Realty Investment Trust (FRT), collected just 54% of rents in May. This is a good indicator that the majority of ADC’s tenants are deemed essential and have healthy cash flows without needing support from the government’s Paycheck Protection Program (PPP). As its CFO Clay Thelen indicated on the latest conference call, its tenants are mostly ineligible for the government’s PPP program as most of them have over 500 employees.

As the graphic below illustrates, most of the tenants are investment grade, with just 39% of tenants as a percentage of average base rent (ABR) being not-rated or sub-investment grade. Having sub-investment grade tenants for a net lease REIT is not as concerning as it sounds, as rents are considered an operating expense that cannot be forgone in bankruptcy court. Also, management has made it a priority to curate a portfolio of recession and e-commerce-resistant tenants.

(Source: June Investor Presentation)

Agree Realty’s occupancy rate compares favorably against peers, as seen below:

(Source: June Investor Presentation)

Not only does the occupancy remain high, management has also strategically de-risked the tenant portfolio by shifting away from higher-risk tenants, who, by no surprise, have been more vulnerable to the effects of the pandemic.

(Source: June Investor Presentation)

Management also noted that it will not grant abatements to tenants, and that any assistance will be in the form of deferrals that will need to be paid back, as CEO Joey Agree noted on the conference call:

We’ve given zero abatements. We will not give any abatements – they will all be – any deferral that we gave will be amortized into a – every deferral we have given or will give will be amortized into the rental rate and paid back over a quick period, especially subject to any credit concerns that we have, it will be paid back faster. The higher credit quality, we would potentially look out a little bit longer, but again we’re talking months here, not years.

Plus, he mentioned that restaurants tenants who are open for drive-through but did not pay rent are expected to pay, lest they be put in default.

With the support of a strong BBB rated balance sheet that has a Net Debt to EBITDA of just 4.8x and a total debt to Enterprise Value of just 26.5%, management plans to take advantage of the low interest rate environment to acquire an estimated $700 to $800 million worth of properties in 2020.

(Source: June Investor Presentation)

While some may note the presence of publicly-traded net lease peers as competition for these deals, it really shouldn’t be a concern as the net lease arena is and continues to be highly fragmented. In addition, recent lockups in the CMBS market and shortage of bank financing play to Agree Realty’s advantage as it takes competition for deals offline and raises cap rates. This is what the CEO noted on the conference call:

We very, very, very rarely ever run into our peers. They most of them have differentiated business models. And so we very rarely run into our peers. Our traditional competition in the net lease space and the highly fragmented net lease space, which I tell you our average price point of just over $4 million is generally financed purchasers, either from the 1031 market that would be a larger 1031 transaction or a private party purchaser.

And so I would tell you with the lockup in the CMBS market and frankly the unavailability of bank debt. That is very – that’s taking a significant amount of competition offline. You didn’t ask this directly, but I think we will hopefully see cap rates rise accordingly.

In this current environment, I expect companies with strong balance sheets such as Agree Realty to be the primary benefactors as it scoops up properties on the cheap, thereby enabling it to emerge out of the recession even stronger than before.

Management seems confident enough with its business model by being one of the few REITs to increase its dividend by 2.6%. At the new rate of 0.60 per share and a payout ratio of 73%, I view the dividend as being safe given the strength of the tenant portfolio and the strong balance sheet.

Key Risks

As with any net lease REIT, rapid increases in interest rates can hurt profitability in that it increases financing costs. In addition, inflation may eat away at investor gains if the company is unable to raise rents fast enough. I currently see this as a low probability event as the Fed has pledged to keep interest rates near zero through 2022.

Another risk, which may be obvious, is a second wave of infections as the economy opens up. I believe this is worth paying attention to. This risk, however, is mitigated by the fact that many of Agree Realty’s tenants are deemed essential, as evidenced by the high rent collection rates, which are much higher than those of the Shopping Center REITs.

Investor Takeaway

Agree Realty provides both a safe haven and growth opportunity for investment dollars during the pandemic-induced recession. Its portfolio of high quality tenants that provide essential services shields it from negative effects of the recession. In addition, I believe Agree Realty will actually emerge from this recession stronger than before as it flexes its financial strength to acquire properties on the cheap at higher cap rates due to less competition for deals.

At the current price of $63.27 and a P/FFO of 20.9, I rate the shares as a Buy based on the company’s growth plans in what I consider to be a target-rich environment, backed by a class leading balance sheet and a low interest rate environment. At my price target of $72, share price appreciation and dividends combined give a potential investment return of 18% over the next year.

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.