STORE Capital: Maintaining My Buy Rating
Summary
- Last month, STORE Capital delivered a 2.9% increase in its quarterly dividend from $0.35/share to $0.36/share.
- Given the challenges that STORE Capital endured through the first half of this year, I find it impressive that the company's diluted AFFO/share only declined 5.1% YoY.
- STORE Capital's steadily improving rent collection and proportion of properties that are currently open bode well for the company's operating results in the second half of this year.
- Adding to the case for an investment in STORE Capital is the fact that shares of the stock are trading at an 11% discount to fair value.
- Between its 5.1% yield, 5.0-6.0% annual AFFO/share growth potential, and 1.1% annual valuation multiple expansion, shares of STORE Capital are positioned to exceed my 10.0% annual total return requirement over the next decade.
As I have noted time after time in my articles, the COVID-19 pandemic and its interruptions to the global economy have reiterated the importance of investing in the highest quality stocks at or below their fair value.
One such stock that I believe fits this profile is STORE Capital (NYSE:STOR).
I'll be revisiting STORE Capital's dividend safety and growth potential for the first time since I last covered the stock in June, discussing operating results for the first half of this year and STORE Capital's risk profile, as well as STORE Capital's stock price relative to my fair value estimate of its shares, which I believe overall justifies my continued buy rating on shares of the stock.
STORE Capital's Dividend Remains Safe, While Its Long-Term Growth Potential Remains Strong
While I believe it is always wise for investors to examine the safety of a stock's dividend, I believe it is especially important to do so when a stock's yield is significantly higher than the S&P 500's 1.69% yield, as is the case with STORE Capital's 5.15% yield, which is why I will be measuring STORE Capital's AFFO/share against its dividends/share payout through the first half of this year.
Through the first half of this year, STORE Capital generated $0.93/share in AFFO against $0.70 in dividends/share paid out during that time, for a relatively sustainable AFFO payout ratio of 75.3%.
While this is materially higher than the 67.3% AFFO payout ratio through the first half of 2019 (according to data sourced from STORE Capital's Q2 2020 earnings press release), I believe that STORE Capital's dividend remains rather safe for the foreseeable future, given the significant COVID-19 related headwinds endured by STORE Capital and its tenants year to date and STORE Capital's resiliency despite these challenges.
When I take into consideration that STORE Capital's AFFO payout ratio is only slightly on the high end of its typical 65-70% payout ratio in the midst of a global pandemic, I believe that STORE Capital's dividend growth is positioned to roughly track whatever AFFO/share growth the company is able to deliver over the long term.
Since I believe that STORE Capital is poised to deliver 5.0-6.0% annual AFFO/share growth over the next decade, I am only lowering my long-term DGR from 6.0% in my previous article to 5.5% to adjust for COVID-19's impact on STORE Capital's near-term results.
Fair Operating Results, Given COVID-19 Headwinds
Image Source: STORE Capital 2020 Second Quarter Investor Presentation
When taking the bigger picture into account that the COVID-19 pandemic and its accompanying restrictions have hit even well run businesses particularly hard this year, I believe that STORE Capital's Q2 2020 and H1 2020 results were satisfactory.
Starting with revenue, STORE Capital reported a 2.7% YoY increase in its total revenue from $163.8 million in Q2 2019 to $168.3 million in Q2 2020 (according to data sourced from STORE Capital's Q2 2020 earnings press release).
Moving to AFFO, STORE Capital reported a 2.1% YoY decline from $107.9 million in Q2 2019 to $105.6 million in Q2 2020 (as illustrated above in slide 61 of STORE Capital's 2020 Second Quarter Investor Presentation).
Adjusting for the uptick in average weighted shares outstanding from 228.2 million in Q2 2019 to 248.3 million in Q2 2020 (as per data sourced from STORE Capital's Q2 2020 earnings press release), STORE Capital reported a 12.0% YoY decline in AFFO/diluted share from $0.50/share in Q2 2019 to $0.44/share in Q2 2020.
Transitioning to STORE Capital's results through H1 2020, the company's revenue increased 8.0% from $320.4 million in H1 2019 to $346.2 million in H1 2020 (according to data sourced from STORE Capital's Q2 2020 earnings press release).
STORE Capital reported $228.8 million in AFFO through H1 2020, which is a 3.0% YoY increase compared to the $222.0 million through H1 2019 (as indicated by the above slide).
Adjusting for the increase in average weighted shares outstanding from 225.5 million through H1 2019 to 245.8 million through H1 2020, STORE Capital reported a 5.1% YoY decline in AFFO/diluted share from $0.98 in H1 2019 to $0.93 in H1 2020.
Image Source: STORE Capital 2020 Second Quarter Investor Presentation
Despite the challenges of COVID-19, STORE Capital's occupancy rate remained strong through the first half of this year at 99.5%, according to CEO Chris Volk's opening remarks during STORE Capital's Q2 2020 earnings call, which is a testament to the durability of STORE Capital's business model in both good times and bad.
The weighted average annual lease escalation through the first half of this year improved 10 basis points from the last couple years to 1.9% (as illustrated in the above slide), which is an encouraging trend for the company's overall strategy in generating at least 5% annual AFFO/share internal growth that relies on annual lease escalations and reinvested cash flows (as indicated on slide 14 of STORE Capital's 2020 Second Quarter Investor Presentation).
Another encouraging trend for STORE Capital is that its rent collection rate improved once again in September to 88%, which is a marked improvement compared to the 73% rent collection rate reported in Q2 2020.
STORE Capital's proportion of properties open across the portfolio also improved from 93% in August to 98% in September.
Image Source: STORE Capital 2020 Second Quarter Investor Presentation
Further adding to STORE Capital's encouraging results is the fact that the company's investment pipeline to generate future growth increased $400 million from $12.3 billion heading into the second quarter to $12.7 billion going into the third quarter (as illustrated in the slide above).
STORE Capital has proven itself to be conservative in its acquisitions year to date, executing $399 million in acquisitions compared to $757 million last year through the first half as a cautionary measure related to the uncertain operating environment in light of near-term COVID-19 headwinds (as illustrated by the slide above).
The weighted average cap rate of these acquisitions of 7.9% is significantly higher than STORE Capital's 4.3% borrowing cost year to date, which leaves STORE Capital with a significant investment spread between the cap rate and borrowing cost, which will result in a continuation of meaningful wealth creation on behalf of its shareholders.
Image Source: STORE Capital 2020 Second Quarter Investor Presentation
STORE Capital's balance sheet remains stable and strong since the last time that I covered the company, boasting investment grade Baa2/BBB/BBB credit ratings from Moody's, S&P, and Fitch, respectively.
Not only does STORE Capital possess investment grade credit ratings from the major ratings agencies, but the company's key financial ratios also remain comparatively stronger than that of its peers with similar credit ratings.
STORE Capital's debt to EBITDA ratio as of Q2 2020 was 4.8, which was slightly better than the BBB+ net lease average debt to EBITDA ratio of ~5.
Secondly, STORE Capital's unencumbered assets/unsecured debt ratio of 3.4 is stronger than the BBB+ net lease average of ~3.
Finally, STORE Capital's debt service coverage ratio of 6.2 is considerably stronger than the BBB+ net lease average of ~5.
When I take into consideration STORE Capital's fair operating results through the first half of this year, STORE Capital's internal growth strategy that has historically allowed for strong annual AFFO/share growth, and STORE Capital's investment grade balance sheet, I believe that the stock is capable of being a great long-term investment if shares are acquired at or below fair value.
Risks To Consider
While STORE Capital is a resilient triple net lease REIT, it's important for prospective shareholders and current shareholders to occasionally monitor the company's risk profile to ensure that STORE Capital's investment thesis remains intact, which is why I will be reiterating key risks from STORE Capital's most recent 10-Q.
The first risk facing STORE Capital that is important to consider is that, while STORE Capital's operating results were satisfactory through the first half of this year, STORE Capital's results included $38.2 million of revenue that is subject to short-term deferral agreements that were entered into as a response to the COVID-19 pandemic (slide 72 of STORE Capital's 2020 Second Quarter Investor Presentation).
While it's likely that most of this revenue will ultimately be collected prior to the end of 2021, there is always the risk that a significant portion of this deferred revenue will not be realized, especially if key industries such as restaurants, health clubs, and furniture stores are harmed by another wave of lockdowns (pages 31 and 48-49 of STORE Capital's most recent 10-Q).
If this scenario manifests itself, STORE Capital's financial results would be adversely impacted in the near term.
Another risk that could result from COVID-19-related interruptions to the operations of STORE Capital's tenants and/or their supply chains is that STORE Capital's tenants' revenues could be adversely impacted, potentially resulting in tenant vacancies, which could increase renovation expenses in the short term to attract new tenants and lower revenue in the meantime.
Yet another risk to STORE Capital relates to the fact that the company was able to transition to a remote work environment as a response to COVID-19 (as outlined on page 31 of STORE Capital's most recent 10-Q).
While this has had minimal impact on operations to date, the uncertainty associated with the ultimate duration and severity of the COVID-19 pandemic means that operations could become unfavorably impacted at some point if the pandemic drags on for longer than expected.
Although I have discussed several risks facing an investment in STORE Capital, the above shouldn't be interpreted as a complete discussion of STORE Capital's risk profile. For a more thorough discussion of STORE Capital's risks, I would refer interested readers to pages 13-31 of STORE Capital's most recent 10-K, pages 48-49 of STORE Capital's Q2 2020 10-Q, and my previous articles on the stock.
STORE Capital's Valuation Remains Appealing
Even though STORE Capital is a well run triple net lease REIT, it remains important that investors avoid overpaying for shares of the stock in order to minimize the risks of a lower starting yield, valuation multiple contraction, and lower annual total return potential.
It is for this reason that I'll be using a couple valuation metrics and a valuation model to determine the fair value of STORE Capital's shares as a gauge on the stock's attractiveness as an investment from a valuation standpoint.
The first valuation metric that I will utilize to approximate the fair value for shares of STORE Capital is the TTM dividend yield to median TTM dividend yield.
According to Gurufocus, STORE Capital's TTM dividend yield of 5.04% is well above its median TTM yield of 4.29%.
Factoring in a reversion to a yield of 4.50% and a fair value of $31.33 a share (which I believe appropriately factors in the risks facing STORE Capital), STORE Capital's shares are trading at a 10.7% discount to fair value and offer 12.0% upside from the current price of $27.98 a share (as of October 11, 2020).
The second valuation metric that I'll be using to arrive at a fair value for shares of STORE Capital is the TTM EV to EBITDA ratio compared to the median TTM EV to EBITDA ratio.
As indicated by data sourced from Gurufocus, STORE Capital's TTM EV to EBITDA ratio of 15.93 is significantly lower than its median TTM EV to EBITDA ratio of 18.90.
Assuming a reversion to a TTM EV to EBITDA ratio of 17.50 and a fair value of $30.74 a share, STORE Capital's shares are priced at a 9.0% discount to fair value and offer 9.9% capital appreciation from the current share price.
Image Source: Investopedia
The valuation model that I'll utilize to assign a fair value to STORE Capital's shares is the dividend discount model or DDM.
The first input into the DDM is the expected dividend/share, which is simply the annualized dividend/share. Following STORE Capital's 2.9% dividend increase last month, STORE Capital's annualized dividend/share is currently $1.44.
The next input into the DDM is the cost of capital equity, which is the annual total return rate that an investor requires from their investments. While this generally varies from one investor to the next, I require 10% annual total returns because I hold the opinion that such returns offer adequate reward for the time and effort that I dedicate to researching investment opportunities and periodically monitoring my investments.
The third and final input into the DDM is the long-term dividend growth rate or DGR.
While the first two inputs into the DDM only require data retrieval to find the annualized dividend/share and subjectivity to set the required annual total return rate, accurately forecasting the long-term DGR requires an investor to consider multiple variables, including a stock's payout ratios (and whether those payout ratios are positioned to remain the same, expand, or contract over the long-term), annual AFFO/share growth potential, industry fundamentals, and the strength of a stock's balance sheet.
Upon factoring in that STORE Capital's AFFO payout ratio is likely to slightly contract over the long term and that I'm expecting 5.0-6.0% annual AFFO/share growth over the next decade, I believe that a long-term dividend growth rate of 5.5% annually is a reasonable assumption for shares of STORE Capital.
When I plug the above inputs into the DDM, I arrive at a fair value of $32.00 a share, which indicates that shares of STORE Capital are trading at a 12.6% discount to fair value and offer 14.4% upside from the current share price.
Upon averaging the three fair values above, I compute a fair value of $31.36 a share, which implies that STORE Capital's shares are priced at a 10.8% discount to fair value and offer 12.1% capital appreciation from the current share price.
Summary: STORE Capital Offers A Safe Dividend With Moderate Growth Potential
While STORE Capital's dividend track record isn't as established as the upper echelon of its triple net lease peers, that doesn't take away from the fact that the stock has delivered consistent dividend increases each year since its IPO in 2014.
It's especially impressive that STORE Capital announced a 2.9% dividend increase for its shareholders last month in light of the current operating environment, but it isn't surprising, considering that the company is well run and had plenty of room with regard to its AFFO payout ratio.
Even through a challenging first half of the year, which will likely be the low point of STORE Capital's ability to generate AFFO through the COVID-19 pandemic, STORE Capital's AFFO/share declined by merely mid-single digits compared to the first half of 2019.
STORE Capital's balance sheet remains investment grade from the major ratings agencies, which bodes well for the company going forward.
Adding to the case for an investment in STORE Capital is the fact that I estimate the stock is trading at an 11% discount to fair value based on my interpretation of a couple valuation metrics sourced from Gurufocus, as well as the dividend discount model or DDM.
Between its 5.1% yield, 5.0-6.0% annual AFFO/share growth potential, and 1.1% annual valuation multiple expansion, shares of STORE Capital are positioned to exceed my 10.0% annual total return requirement over the next decade.
It is with the foregoing points in mind that I have made the decision to reiterate my buy rating on shares of STORE Capital at this time.
This article was written by
Analyst’s Disclosure: I am/we are long STOR. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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