- ADC continues to not only grow at a rapid clip but also to innovate, building out systems and processes by which it can efficiently manage a much larger portfolio.
- The REIT recently revealed its proprietary acquisitions and portfolio management system, called "ARC."
- Ultra-conservative ground leases continue to make up a larger and larger portion of the portfolio.
- Over two-thirds of the portfolio is leased to investment grade retailers.
- ADC is a wonderful company trading at a fair (or maybe better than fair) price.
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This article was amended on 5/6/2021 to include new information on a recently announced public bond offering.
Thesis: Wonderful Company At A Fair Price
Most of us are probably familiar with the Warren Buffett quip that it is better to buy wonderful companies at fair prices than fair companies at wonderful prices.
Net lease REIT Agree Realty (NYSE:ADC) is a wonderful company trading at a more than fair price, and it's worth buying right now. The end.
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Alright, alright. There's more to be said than that. But the above pretty much sums up how I feel about ADC at the moment.
- ADC is a wonderful company that owns highly defensive properties with long-lived revenue streams from financially strong tenants.
- The REIT continues to provide impressive results, find unique investment opportunities, innovate, and look forward to the future of their industry.
- Though not cheap on an absolute basis, ADC's current price to FFO of 20.15x is on the low end of fair market value — or perhaps slightly undervalued.
Thus, the stock makes a good buy even after its recent rally.
A Brief Note (To Self) On Labeling
Readers might be confused by my haphazard, seemingly random labeling of ADC as "bullish" or "neutral" in my previous articles when I'm clearly bullish on the company. What I've been trying to do is reflect when the stock has reached what I perceive as "fair value" at the time, but it ends up looking confused and wishy washy. Pardon me while I write a note to myself.
Note to self:
Dear Cashflow Capitalist,
Stop trying to be cute with your ratings of ADC. One minute you're bullish, the next you're neutral, then you're back to bullish. Get a hold of yourself, man! You know this a phenomenal company with a long growth runway. You know this REIT is run by some of the finest minds in the retail real estate business. Just buy the stock.
So here's what I'll do. After a quick update on ADC's first quarter performance, I'll draw a line in the sand and name a price at which I would no longer be bullish on (read: a buyer of) ADC's stock.
Checking In On The Growth Machine
ADC owns single-tenant, net lease properties across the United States. Leases are structured such that the tenant is responsible for building maintenance, real estate taxes, and insurance.
As of the end of March, the REIT owns 1,213 properties across 46 states. Its portfolio is 99.4% leased, bears a weighted average remaining lease term of 9.8 years, and generates 67.2% of rental income from investment grade tenants. The tenant roster is weighted heavily toward the best of the best retailers in the nation, such as Walmart (WMT), Dollar General (DG), Tractor Supply Co. (TSCO), Sherwin-Williams (SHW), and TJX (TJX).
Here is the updated top tenant list as of Q1:
Source: Q1 2021 Press Release
And here is the REIT's top ten retail sectors by annual base rent:
These are the most defensive trade lines in the realm of brick and mortar real estate, and they are filled with retailers that are actively honing their e-commerce businesses to remain competitive with online e-tailers.
And after a record 32% of Q1 acquisitions being ground leases (31 GL assets), 11.4% of the total portfolio is now made up of these ultra-conservative assets. I highlighted both the ground leases' defensiveness and upside potential in "Agree Realty's Secret Weapon."
But it appears that ADC has yet another secret weapon that was revealed in this most recent quarterly update. It's a machine so powerful ADC has to keep it in a vault to prevent it from falling into the wrong hands. Who knows what a more villainous landlord would do with it.
It's called "ARC." I don't know what it stands for yet, but it is a propriety technology platform that
provides the Company with real-time access to portfolio and pipeline data from multiple sources, seamlessly integrating the data into a comprehensive decision-making tool. ARC allows the Company to quickly underwrite and value real estate while understanding the proforma impact on portfolio concentrations and other key metrics.
This strikes me as a tool for maximizing the efficiency of the acquisitions team, allowing the pipeline to expand without compromising on due diligence or underwriting standards.
In addition, ARC includes critical lease information and a proprietary work order management system that has improved efficiency and visibility for the Company's Asset Management team.
And this bit strikes me as means of making the property management team more efficient at managing a larger number of properties.
So, in short, ARC is ADC's internal platform used for acquisitions and property management. It's a tool to prepare the company to handle a rapidly expanding portfolio. It will make the company's personnel more efficient at their jobs and allow general & administrative expenses to fall from the ~8% of revenue it was last year to ~7% by the end of 2021.
The ARC system seems to be working so far.
In Q1, operating income rose 34.5% year-over-year, and adjusted funds from operations increased 41.1%. While AFFO per share increased only 2.3%, that is largely because of a hefty equity offering completed in the first quarter. Once those funds are deployed into accretive investments, per share AFFO growth should spring up to the mid to upper single-digits.
Given strong Q1 acquisitions of $386.8 million and a robust pipeline for the quarters ahead, management raised 2021 acquisitions guidance from a range of $800 million to $1 billion to a new range of $1.1 billion to $1.3 billion. This is incredibly impressive given than 72.2% of Q1 acquisitions were of properties leased to investment grade retailers Dispositions of $25 million to $75 million for the year should include franchise restaurants (mostly QSRs) and some entertainment/experience-based properties.
This acquisition guidance bump gives me some déjà vu, as last year ADC raised its acquisition guidance three times over the course of the year. It wouldn't be surprising to see management raise it yet again in Q2 or Q3.
Debt refinancing is another opportunity for future growth. ADC has quite a bit of debt outstanding taken out in previous years before they earned an investment grade credit rating in March 2020. Perusing the Q1 10-Q, we find:
- $33.2 million of mortgage debt at an average 4.2% interest rate maturing 2023 and 2026
- $100 million term loan at 4.26% due 2026
- $50 million of 4.16% senior unsecured notes due 2025
- $50 million of 4.26% senior unsecured notes due 2027
- $60 million of 4.42% senior unsecured notes due 2028
- $100 million of 4.19% senior unsecured notes due 2029
- $125 million of 4.32% senior unsecured notes due 2030
- $100 million of 4.41% senior unsecured notes due 2031
- $125 million of 4.42% senior unsecured notes due 2031
That's just a smattering of the higher interest rate debt ADC has outstanding. But on the Q1 2021 conference call, CFO Simon Leopold mentioned how the bond market is becoming increasingly hungry for ADC's debt, which translates into lower interest rates. How low of rates could ADC obtain?
Well, as this article was going to press on Wednesday, May 6th, ADC announced a dual-tranche senior unsecured notes offering:
- $350 million of 2% notes due 2028 (effective yield 2.112%)
- $300 million of 2.6% notes due 2033 (effective yield 2.684%)
This is one step toward significantly lowering ADC's cost of debt, which in turn lowers the REIT's weighted cost of capital. Simon Leopold commented on this offering by saying:
This offering, in combination with the anticipated prepayment of all our unsecured term loans, extends our weighted-average debt maturity to approximately 9 years while reducing our effective weighted-average interest rate to approximately 3.2%, excluding the unsecured revolving credit facility.
ADC's cost of capital is falling faster than its acquisition cap rates, which means that its crucial profitability spread is widening, not compressing.
Given ADC's hyperactive external growth, analysts expect 8% AFFO per share growth this year and 6.9% next year.
Enough talk! Time for action.
I hereby draw a line in the sand: At $73.30 per share, ADC would trade at 21x estimated 2021 FFO. At that price, I would no longer be a buyer of ADC for the remainder of 2021. (I think that's a conservative "buy under" price, since the analyst consensus 1-year target price is $77.08.) Below $73.30, I am a buyer, with my enthusiasm rising the lower the price goes.
Another way I like to measure valuation is by performing a projected 10-year yield-on-cost based on the dividend growth rate I believe the company is able to achieve. I like to target at least a 7% 10-year yield-on-cost.
In April, ADC declared a monthly dividend of $0.217 per share, which represents an 8.5% year-over-year increase. That payout accounts for a mere 75% of expected AFFO this year, leaving plenty of retained cash for growth.
That said, I don't believe 8.5% dividend increases can be sustained for ten years straight. Up to the most recent hike, dividend increases averaged closer to 5.5% per year. In order to get to a 7% yield-on-cost in ten years, given the current 3.74% starting yield, average annual dividend increases would need to reach 6.5%. Is that achievable? Based on the REIT's current level of growth, I think it might be.
Though ADC exhibited strong growth before COVID-19, the REIT really kicked growth into overdrive during the pandemic.
Source: April 2021 Presentation
I could easily see ADC surpassing its acquisition volume from last year, especially with the new ARC platform up and running.
With ADC continuing to innovate, improve its processes, and achieve astounding levels of external growth, I think the bigger risk right now is underestimating the REIT rather than overestimating it. ADC is in fine form, and I'm excited to participate in its growth as a shareholder.
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This article was written by
I write about high-quality dividend growth stocks with the goal of generating the safest, largest, and fastest growing passive income stream possible. My style might be called "Quality at a Reasonable Price" (QARP) in service to the larger strategy of low-risk, low-maintenance, low-turnover dividend growth investing. Since my ideal holding period is "lifelong," my focus is on portfolio income growth rather than total returns.
My background and previous work experience is in commercial real estate, which is why I tend to heavily focus on real estate investment trusts ("REITs"). Currently, I write for the investing group, High Yield Landlord.
Analyst’s Disclosure: I am/we are long ADC. 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.