Written by Nick Ackerman. This article was originally published to members of Cash Builder Opportunities on May 11th, 2022.
We recently added to our Agree Realty Corporation (NYSE:ADC) position in the Satellite Income Builder Portfolio. I think it felt like an appropriate time to take a look at how this REIT's earnings have been looking and what we might expect through these volatile times. Looking at this from the perspective of a long-term dividend growth position, we might not be so concerned about what might happen over the next six months or a year. We can see how analysts are looking at the growth over the next several years, though.
This latest add was the third time we added to this position. The previous buy was executed in January. An initial position was picked up in September 2021. This was shortly after I had initially covered this name. I'm looking to continue to add slowly over time to build up this position—basically, dollar-cost averaging in. With 2022 being so volatile, we can continue to get opportunities to add to this strong REIT name.
The latest earnings were posted rather recently; the Q1 results came on May 3rd, 2022. They provided a beat on both the FFO and the revenue expectations. This isn't overly surprising, given that they have beat FFO estimates 14 times out of the last 16 quarters. The same case with revenue, it has also beaten 14 out of the last 16 quarters.
ADC highlighted that the $0.97 FFO was a 15.5% increase from Q1 2021. The AFFO came in at the same figure and resulted in a 16.4% increase.
They also had 99.6% of their portfolio leased, with an average remaining lease term of approximately 9.1 years. That's all good news, as they won't have to be dealing with a large number of their tenants potentially leaving any time soon.
They also have updated us on the ground lease portfolio. This is one of the areas it is going in a bit of a different direction than the larger Realty Income Corporation (O). As a reminder, here's a bit about the ground lease from our prior coverage.
A ground lease is a bit unique in that they just own the ground that a tenant builds on, simple enough. However, they can potentially end up with the building under certain conditions. They note this is very rare, as obviously, companies aren't going to be so willing to give up the buildings they are using for their own operations. I believe that can make it quite compelling and a way to keep tenants where they are.
"The majority of the portfolio includes rent escalators that result in average annual growth of close to 1% while the average per square foot rent is only $9.65. This growing portfolio continues to be a source of tremendous risk adjusted returns when reviewing the lease term, credit, underlying real estate attributes and of course the free building and improvements of a tenant wherever to vacate."
For a triple-net lease, the REIT owns the land and the building. However, the tenant pays for all the improvements, repairs and maintenance. One of the benefits here is that a triple-net lease operation can depreciate the building. Since the REIT doesn't own the building with a ground lease, they cannot use that benefit.
ADC announced that they acquired five ground leases in the latest quarter, which represented 3.1% of annualized base rents acquired. In total, they listed 186 ground leases throughout 32 states. Ground leases represented around 13.5% of annualized base rents. That is up from the 13% of exposure previously. This is consistent with their intent to continue to increase their exposure to ground leases.
In addition to the ground leases they've been working on, they have quite a resilient tenant base. An area where they have also been putting a focus on is investment-grade tenants. This can be important to consider if or when we enter into the next recession. Being that they have a lot of retail exposure, they can be impacted more directly during an economic slowdown. With ADC, a majority of their tenants are investment grade. This should help keep ADC potentially more sheltered during tough economic conditions by having more financially secure tenants.
During the first quarter, we invested approximately $430 million and 124 high quality retail net lease properties across our three external growth platforms. 106 of these properties were originated through our acquisition platform, representing acquisition volume of just over $407 million. While investment volume was impressive, we maintained our discipline focused on best-in-class opportunities with our leading retail partners as demonstrated by more than 74% of first quarter acquisitions being comprised of investment grade retailers.
In fact, they even have exposure to businesses such as Walmart (WMT), Dollar General (DG) and Dollar Tree (DLTR). These are businesses that consumers can turn to when times get tough, and they need to make their dollars stretch further.
In total, when we last looked at this REIT, they had listed 1262 properties. This has now increased to 1510. They have ramped up their acquisitions in the last several years. Even increasing their guidance for expected acquisitions through fiscal 2022.
This had been in the $1.1 billion to $1.3 billion range previously. More acquisitions can fuel growth in FFO and AFFO for investors if it is done wisely, of course. So far, they've shown that these acquisitions have been to the benefit of investors. FFO had increased 31% from Q1 2019 when they began the more aggressive growth.
The market has been struggling through 2022; even real estate hasn't escaped the volatility - despite being somewhat of a natural hedge against inflation due to rising asset prices. Real Estate is in the bottom half of performance relative to the other 11 sectors.
To me, that signals that the valuations of these REITs should be coming down and becoming more attractive for long-term investors.
One way we can measure this is to take a look at the price to FFO or P/FFO. The last four quarters gave us an FFO of $3.70. Given the share price at the time of writing of $65.53 gives us a P/FFO of 17.8.
Going forward, analysts are expecting FFO to grow to $3.87. That would give us a forward P/FFO of 17.01. Analysts are continuing to expect ADC to grow over the next several years. So the forward P/FFO would just keep going lower in subsequent years.
This can be helpful if compared with Realty Income for some idea of where we stand; the forward P/FFO there is 16. While that is lower compared to ADC, ADC has been growing a bit faster. That can be helped by being just a smaller operation to start. Both of these REITs have been tumbling with the latest market downturn, so valuations have come down considerably for both.
Less than a month ago, ADC was trading at around $72. That would have put the P/FFO closer to 19.5.
Although O's merger with VEREIT has given it a big boost, it also makes it that much bigger and even harder to potentially grow going forward. Over the next year, O is expected to grow faster than ADC in terms of FFO due to that merger. However, in the next couple of years, analysts expect ADC to grow FFO faster.
To help provide some context on sizing difference, O invested $1.56 billion for the latest quarter. That's towards the upper end of what ADC is anticipated to do all year. ADC has a market cap of $5.09 billion, and O is at $39.81 billion.
Another way to look at a REIT's valuation is simply looking at how the latest dividend yield compares to the average. This is for the last five years. As we can see, the latest dividend yield comes in a bit above the average currently.
To get closer to the average yield here, we would have to see the price of ADC rise to $75.
There is a caveat here, though. It doesn't tell us the whole story because interest rates have been low through this period. Therefore, it could be assumed that income investors would be willing to pay up and accept lower yields. Investors might be more cautious with rates rising and the 10 year above 3%. Rather than investing in relatively riskier equity REITs, an income investor could be content with collected 10-year Treasury yields at this time.
Looking at it as a dividend growth play and potential price appreciation, I still believe that investing in ADC can result in the best outcome.
According to Seeking Alpha, they have been growing their dividend for the last 10 years. Even before this, it was a fairly steady payout for investors. Albeit lacking in any meaningful growth for the most part.
They then switched to a more appealing monthly dividend schedule in 2021. That already generally affords them a bit of a premium trading valuation compared to a quarterly payer.
The latest monthly payout comes to $0.2340, which was an increase from the previous month of 3.1%. This also is an increase of 7.83% from the previous year for the month of May. They noted that the payout ratio is sitting at approximately 70% of core FFO. Meaning they have plenty of capacity for further growth.
ADC has come down in price, along with the rest of the market. I have taken this opportunity to once again add to my position. I'm taking small bites where I'm hoping to have a significant position over time as opportunities arise. They have a commitment to increasing the dividend to investors. They've been increasing more than annually, which is encouraging to see. That makes it even more attractive for income investors if the trend of raising every six months stays in place. They aren't just raising to raise. They have been providing growth through acquisitions to increase FFO, making it a sustainable trend.
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Cash Builder Opportunities provides high-quality and reliable dividend growth ideas to build growing income for investors. A special focus on investments that are leaders within their industry to provide stability and long-term wealth creation. Along with this, the service provides ideas for writing options to build investor's income even further.
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Nick Ackerman is the lead author for Cash Builder Opportunities. Nick is an avid student of the markets and has been investing in his own accounts for over 10 years. He is a former Financial Advisor and has previously qualified for holding Series 7 and Series 66 licenses. These licenses also specifically qualified him for the role of Registered Investment Adviser (RIA), i.e., he was registered as a fiduciary and could manage assets for a fee and give advice. His specific focus is on closed-end funds, dividend growth stocks and option writing as an attractive way to achieve income as well as general financial planning strategies towards achieving one’s long-term financial goals.
Stanford Chemist is a scientific researcher by training who has taken up a strong and passionate interest in investing. His members appreciate the analytical and agenda-free insight and analysis that he brings to investments. He has developed his own metrics and tools for understanding closed-end funds and exchange-traded funds and how to profit from them and will seek to apply the same logical principles to Cash Builder Opportunities.
Disclosure: I/we have a beneficial long position in the shares of ADC, O, SHORT O PUTS 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.