Spirit Realty: I'd Rather Chase This High Yield

Summary

• Spirit Realty Capital, Inc. offers a high yield of 6.8% and attractive total return potential, making it a good investment option.
• The company has transformed its portfolio to become more resilient to e-commerce disruption and has solid operating fundamentals.
• With a strong balance sheet and low leverage, Spirit Realty is well-positioned to continue pursuing accretive deals.
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Chasing asset bubbles is not a good idea, and today's AI-powered rally is reminiscent of exuberance around the tech bubble from the late 1990s. Sure, it may feel good to see some paper gains and the rally may last longer in the near-term, but nothing goes up at such a rapid pace forever, since the economy is only so big, and doesn't grow at an exponential pace.

That's why building a durable income stream of high income may be a better idea, especially when the rest of the market is seemingly ignoring yield while falling in love with bubble stocks at nosebleed valuations.

This brings me to Spirit Realty Capital, Inc. (NYSE:SRC), which I last covered here back in March, in which I noted robust deal activity. SRC has since fallen back below the $40 level and now sports a near 7% yield. In this article, I discuss why this presents a great buying opportunity on this high-income stock.

Why SRC?

Spirit Realty is a growing net lease real estate investment trust, or REIT, with properties in 49 U.S. states. Its current portfolio consists of 2,083 primarily retail and industrial properties leased to 347 tenants in 37 different industries.

SRC has gone through a series of transformations over the years. This includes moving from being a Shopko-heavy REIT that was e-commerce vulnerable, to becoming an e-commerce beneficiary with high industrial property exposure. As shown below, SRC's top tenant industries are now in the distribution / manufacturing and convenience / service-related industries.

Investor Presentation

Meanwhile, SRC enjoys very high occupancy of 99.8% and saw its AFFO per share grow slightly by $0.01 YoY to $0.89 in the first quarter despite economic uncertainty and the higher interest rate environment. This was drive in part by external growth, including $289 million worth of new investments during the first quarter alone at an attractive cash cap rate of 7.9%.

The acquisitions brought onboard 7 properties with a long weighted average lease term of 19 years and a healthy weighted average annual rent escalator of 2.4%. Notably, the rent escalator is 80 basis points higher than that of properties that SRC acquired in the same period of last year. At the same time, SRC is seeing healthy demand as it disposes of less desirable movie theaters, Red Lobsters, and other properties, with management noting interest coming from 1031-exchange buyers, family offices, and other institutional bidders.

Importantly, SRC's higher cap rates on acquisition don't imply higher risk, as management noted that it is a function of the current market. This was addressed during the Q&A section of the recent conference call:

Q: And just to follow-up, the cash cap rate picked up 30 basis points sequentially, so you’re now acquiring in the 7.6% range. Is that a function of moving higher up the risk curve or cap rate for the product that you’re looking for?

A: I’d say absolutely we have not taken risk up. Like I said, two of the deals that we’ve bid on the last quarter, we were probably 50 basis points inside. So in other words, we’ve bid 50 basis points tighter in the third quarter of last year, and we were able to secure these deals this in the first quarter 50 wider, same transaction, same credit. So I think it’s just a step function of where cap rates are moving right now as opposed to us incrementally chasing more risk.

Turning to the balance sheet, SRC has the capacity to continue to pursue accretive deals, as it carries a solid BBB credit rating with a sizeable $1.6 billion in total liquidity. It also carries reasonably low leverage with a net debt to EBITDA ratio of 5.3x, sitting comfortably below the 6.0x level generally regarded as being safe by ratings agencies.

Notably, SRC currently throws off one of the highest yields in the net lease sector. Moreover, its 6.8% dividend yield is well covered by a 74% AFFO payout ratio, based on the midpoint of management's full year AFFO per share guidance of $3.57.

Lastly, SRC is attractively priced at $38.97 with a forward P/FFO of just 10.7, making it far less pricey than that of peers such as Realty Income Corporation (O), NNN REIT, Inc (NNN), and Agree Realty Corporation (ADC), which carry forward P/FFO ranging from 13 to 16. Sell side analysts who follow the company have a consensus Buy rating with an average price target of $44, which represents a potential 20% total return over the next 12 months.

Investor Takeaway

All in all, Spirit Realty offers one of the highest yields in the net lease space and attractive total return potential at the current price. It has made dramatic improvements in transforming its portfolio, becoming more resilient to e-commerce disruption, while continuing to deliver solid operating fundamentals and a well-covered dividend.

With a solid balance sheet and low leverage, SRC is well positioned to continue to pursue accretive deals. Considering the number of high-flying growth stocks in the market today, I find high-yielding Spirit Realty Capital, Inc. stock to be far more attractive with a better risk/reward profile than many of the bubble stocks out there.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of SRC 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.

I am not an investment advisor. This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.

Comments

[Keep it Country]

SRC-A is good spot for now. The common will get cheaper.

[alexalekhine]

High dividend yield makes it more difficult to do acquisitions since cost of capital is almost as high as cap rates.

[AlexandreD]

@alexalekhine does it matter? I’m perfectly happy getting 7% return without any new acquisitions

[alexalekhine]

@AlexandreD Yes, it matters. If the company's capital costs are low enough to enable profitable growth it will get a higher valuation than otherwise. It's a virtuous cycle thing.

[RayRay1000]

@alexalekhine SRC is still treated as a turnaround and it's time for the market to dish it some respect which I think will happen once the current REIT storm blows over. As long as 10 yr Treasury yields continue to rise, the whole REIT sector is subdued which is why it's prime time to load up on some fantastic income. Once rates stabilize let's see if SRC starts to move up.

[alschroed]

I sold my STOR and bought SRC, a large position.

[Total Returns]

@alschroed I did the same.

[RayRay1000]

@alschroed if SRC goes private or is consumed by a larger public player there will be nowhere to run for good yields. The few who think SRC will command a 25% premium in the event of an acquisition are not only dreaming but that premium will be sucked up in a lower yielding REIT like O. WPC has issues with debt and large tenant lease terminations coming up so I wouldn't look to it as a safe harbor or as an acquirer. The likely exit for SRC, like STOR, will be through the private door and the resulting reduction in the number of retail and diversified NNN's will not serve the long term investor well.

[alschroed]

@RayRay1000 I think you are right about O buying SRC, they usually pay a small premium of 10-15%.

[spokane rich]

My only REIT - if you had to build a retirement portfolio using 10 or fewer positions w/o ETFs what would that look like ? You have $3M to invest

[Yellowreef44]

@spokane rich Buy income!!! BDC, MLP, preffered cumulative stock, baby bonds and CEF and REITS and Blue chip high yield !! I just loaded on APTS reits!!

[Yellowreef44]

@spokane rich a must!! ARCC, EPD, ET, AM, OKE,TSLX, O, ARE, CSWC, RNP, THQ….

[beersnbeaches]

@spokane rich @Yellowreef44 tax free bonds with a 5% coupon gives you 150K a year to do absofruitely nothing. skip the capital risk and get the income...

[Robert Rio]

Been holding it quite a while love the dividend

[RayRay1000]

This leadership team has done a fantastic job of turning the ship around but given its high cost of capital and lack of Wall Street love my biggest fear is that it will go private or get sucked up by a larger player. In the meantime, full steam ahead.

[AlexandreD]

@RayRay1000 Agreed

[Stewo234]

@RayRay1000 what’s wrong wit getting acquired for 20-30% premium and then move that cash into another REIT like WPC or BDCs

[Jambr403]

@RayRay1000 That's a great worry to have. "Oh no, my REIT just got acquired for a 25% premium over current share price!"