Realty Income Corporation (NYSE:O) is a real estate investment trust that invests in free-standing, single-tenant commercial properties in the United States, Puerto Rico, and the United Kingdom that are subject to NNN Leases. The company is organized in Maryland with its headquarters in San Diego, California.
With the stock price falling an incredible 48% in the last month, is it time to buy this stock at a discount?
I will use the 5 screen-criteria from my previous post to determine whether this stock is trading at a discount or if the price drop reflects a fundamental problem with the company’s business model:
- Strong franchise
- Consistency and predictability
- Financial situation
- Dividend payout
- Dividend growth
Realty Income Corporation’s Investor Presentation states that the company boasts more than 6400 commercial real estate properties, 301 commercial tenants spread across 50 industries and 49 states in the USA, Puerto Rico and the U.K., and a 98% occupancy rate.
Their tenants include such corporate behemoths as Walgreens, FedEx, LA Fitness, Walmart and Home Depot. This is reassuring to investors who can reasonably expect these companies to remain in the buildings for a long time. Indeed, if business is good, tenants have no reason to leave.
Further, the industry diversification of O’s tenants is very spread out, with no single industry accounting for more than 8.6% of rental revenue. This is also reassuring because it means that a crisis in one or more sectors will not disproportionately affect O’s income.
In addition to industry diversification, O’s geographical diversification is also quite spread out, with even a 2.3% revenue income stream in the U.K. However, one potential cause for concern is the fact that Texas, California and New York alone account for nearly 25% of revenues.
Nevertheless, O’s portfolio is fairly well diversified, both from an industry and geography standpoint.
Lastly, two additional metrics to consider are occupancy and property growth. These are important in determining whether the company’s income is sustainable and capable of growth year over year.
Again, O’s data is solid with portfolio occupancy never dipping below 96.6%.
Total property count has more than doubled in the past 7 years, going from 3,013 properties in 2012 to 6,483 properties in 2019. This indicates that the company is seriously investing its earnings to generate growth and income. Lastly, we notice that vacant properties are below 100 units, which is impressive given the company owns thousands of properties.
The aforementioned elements indicate that O is indeed a solid franchise.
CONSISTENCY AND PREDICTABILITY
O’s average net margin over the past 6 years is 26%, which is considered exceptional.
How can O have such high net margins?
This is based on their business model, which operates as a net lease REIT. O owns the properties but the tenants are responsible for the majority of operating expenses of the assets they occupy: property taxes, insurance, and maintenance.
This is how the company can maximize income while keeping costs low.
Looking at the financial ratios, there is one indicator which slightly worries me: O’s negative free cash flow (FCF). This can indicates that the business is either not generating enough cash to sustain the business or that it is investing heavily to grow.
The “Company Highlights” section of their “Fourth Quarter and 2019 Operating Results” reveals that in 2019, O “invested $3.7 billion in 789 properties and properties under development or expansion, including $797.8 million in 18 properties in the United Kingdom (U.K.)“.
O invests considerable sums to grow and generate future profits and this may partly explain why FCF per share is negative.
Often, a stock price plunges during a downturn because investors fear that the company’s debt burden could jeopardize its future. Is this the case with O?
Judging from its Debt/Equity ratio, no.
In 2019, the D/E is 0.80, meaning that the companies’ assets exceed its liabilities.
The Long-term debt / Capital ratio is even lower, sitting at 0.44, so the companies long term debt burden is low.
Unless there is a huge liability buried deep in their accounting, O’s finances appear healthy and investors have no reason to worry about a potential bankruptcy in the near future.
O’s dividend payout ratio is 79.64%, which is a healthy ratio for a REIT. (For a normal company, this would be considered very high).
True to their slogan, O pays a monthly dividend. On March 17th, 2020, investors enjoyed yet another dividend increase.
Speaking of payouts, what is O’s track record when it comes to increasing its dividend?
Looking at the charts and figures, the data reveals that the company’s track record is, once again, exceptional. 26 consecutive years of dividend increases is truly impressive and a 10-year growth rate of 4.75% is quite respectable.
Increasing the dividend is great, but a company needs to generate cash flow to sustain it year in year out. Fortunately, O’s income statement reveals that Total Revenue and Net Income are increasing every year.
Further, the company’s Cash Flow statement reveals that the company’s Free Cash Flow is also increasing every year. These are all positive signs indicating that the company is generating sufficient cash flow to sustain and increase the dividend.
Although a stock can pass all the basic screens, there two last metrics investors should consider before buying it: the price and the dividend yield. Is the asset currently overvalued or undervalued?
O’s chart shows that the current price decrease is bringing the stock price back to 2014 levels. Given the fact that the company’s fundamentals are solid, there is no valid reason why the price should have decreased so much.
The only reason I can think of is that investors are worried about the economic perspectives of O’s tenants: the current coronavirus crisis may lead to a recession that will hurt American businesses. If business is bad, companies will have less income and some may close shop. If they close, O loses tenants and its income decreases. Thus, investors are fleeing the stock to see how the situation pans out.
The risk of a recession is real. However, I remain skeptical as to the possibility of major chains such as Walmart, Kroger’s and Walgreens going bankrupt anytime soon.
Thus, in my opinion, a sub-$50 price and a dividend yield of 5% presents an attractive entry.
Nevertheless, prudent investors may want to wait a few weeks or even months to see how the coronavirus affects the global economic outlook and, consequently, O’s stock price.
However, keep in mind that time in the market beats timing the market and the time-tested strategy of dollar-cost averaging is a long-term investor’s best friend.
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Disclaimer: This is not financial advice. Always conduct your own research before investing in any asset.