W. P. Carey: Protection Against Inflation (NYSE:WPC)

Summary

Quarterly AFFO beats again.
60% of the rent base tied to CPI.
Room to grow the dividend without harming the balance sheet.

Stock Market Capital Gains Increasing From A Bull Market — Darren415/iStock via Getty Images

The Quarter

W. P. Carey (NYSE:WPC) reported one of its clockwork quarters: a beat on the AFFO line ($1.35/share vs $1.31/share estimated) and small raise of the dividend (to $1.057/share quarterly) and a reaffirmation of the annual guidance for the year $5.18-5.30 (6.47% midpoint yield at $81/share).

Management spent a lot of time on the company's positioning for an inflationary world during the conference call. The first highlight was how active the company was in refinancing their debt last year, when interest rates were very low. They raised over $1.5 billion in debt with all of it maturing past 2030 at interest rates from 0.95% to 2.45%. The company has less than $300 million of mortgage debt maturing before year end 2023, no unsecured debt maturing before April of 2024 and that bond is one with the higher interest rates in the company's capital stack at 4.6%. This maturity profile and interest rate picture is strategic asset.

bar chart of WPC debt — WPC Debt Maturity Schedule (Bloomberg)

More importantly, management reminded the market that 99% of the company's leases include some sort of rent increase with over 60% having some sort of tie to CPI. Remember, real estate is a cash flow versus cost of capital business. Assuming occupancy and rent collections remain strong (around 99% in both instances), it's a matter of rent rates versus interest payments. If the company has 99% of its ABR (average base rents) with escalators, ~60% of which are tied to CPI and has largely funded itself through the rest of the decade at interest rates far below CPI, cash flow from rents will exceed interest expense at progressively higher rates without any organic growth in the form of accretive acquisitions or organic expansions. In short, unlike many other companies, WPC actually benefits from inflation. I pointed out this dynamic for WPC in my October write up on the company.

Management spelled out the above virtue succinctly by saying on the call:

"In ABR basis 40% of our assets with rent increases tied to CPI went through scheduled rent increases during the first quarter with an average increase of 4.5%. It's important to keep in mind that the 4.5% is capturing the year-over-year impact of fourth quarter CPI.

And with inflation currently running at around 8% in both the US and Europe, we'd expect to see statistically higher rent growth in 2022, then even more significant impact in 2023. We view this as a specialty valuable in the current environment, perhaps under appreciated by REIT investors given that it has no cost of capital associated with it and has the potential to provide a prolong tailwind to earnings even after inflation begins to decline. And of course if inflation expectations continue to move higher and for longer, we would expect to capture additional upside."

I also said in that write up that thanks to WPC's inflation protection, I preferred WPC to other single-tenant REIT's such as Realty Income (O), National Retail Properties (NNN), and Necessity Retail (RTL). That has proven to be the right call as you can see below.

chart of WPC stock performance — Performance of WPC vs NNN, O, RTL since October 29, 2021 (Bloomberg)

I expect this outperformance to continue and not just because of WPC rent escalators. I am getting progressively more bearish on discretionary spending as food and energy costs start bearing down on the consumer. The company's retail exposure is only about 18% and many of its largest tenants are high credit quality operators like DIY stores in Europe.

Risks:

35% of the company's assets are in Europe. The war in the Ukraine is throwing a wrench in Europe's economy. To date, the company has not seen any disruptions but any company with assets in Europe faces some degree of uncertainty.

Conclusion

I have been pounding the table on WPC since this time last year. I'm happy to say that anyone who bought when that article was published enjoyed over a 13.5% total return. My view has not changed despite the stock's appreciation. I believe this company provides investors (particularly income investors) with a safe source of income that somewhat uniquely benefits from inflation.

This article was written by

CashFlow Hunter

9.77K Followers

Cashfow Hunter has over 25 years of experience in the markets, with nearly 20 of them as a hedge fund portfolio manager. His experience investing in debt and equity markets gives him unique insights into markets. He successfully predicted the implosion of Silicon Valley Bank. He has degrees from Wharton and MIT.

He leads the investing group Catalyst Hedge Investing, in which he shares his best long and short ideas. He looks for investment ideas with asymmetric risk/reward and a clear catalyst. Learn More.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of WPC either through stock ownership, options, or other derivatives. 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.

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