There are valid reasons to view Realty Income Corporation (NYSE:O) as a top notch investment.
The REIT has a history of performing well in both bear and bull markets. The company has a firm financial foundation, a long history of paying solid dividends, and a business model that requires that only 0.6% of the company’s net operating income is spent on recurring capex.
Additionally, management notes that most of the Realty Income’s (hereafter to be referred to as Realty) clients are in ecommerce resistant businesses. However, there is a dark side to that claim: a significant portion of the REIT’s portfolio of properties are leased to businesses that have been blindsided by COVID-19. Furthermore, Realty is a no moat business that has little protection from inflationary pressures.
The Manifest Strengths Of Realty Income
With around 11,000 properties under lease in all 50 states, Puerto Rico, the UK and Spain, and roughly 650 clients representing 60 industries, Realty is the definition of a well diversified REIT.
O can also boast of a 15.1% annual total return since the ticker first appeared on the NYSE in 1994.
The following chart records the impressive growth in the REIT’s adjusted funds from operations (AFFO) over the last half decade.
With a credit rating of A3 by Moody’s and A- from S&P, Realty stands out among REITs for its firm financial foundation.
As of the last quarterly report, O has a portfolio occupancy of 98.8%. This exceeds the highest annual occupancy rate for any year in this century. The top 20 clients represent 51% of the firm’s annual rental revenue, and the largest client, 7-Eleven, generates just 5.7% of Realty’s income.
Management touts that most of the company’s clients are resistant to ecommerce disruption. The following chart illustrates how the tenant mix insulates investors from ecommerce pressures, and economic downturns.
Because Realty operates with a triple-net lease structure, tenants pay the property's operating expenses, real estate taxes, insurance, and maintenance costs. This relieves O of the burden of all operational risk. The fact that these costs are placed on tenants is the reason Realty has an average annual capex of less than 1%
Furthermore, the leases are often 15 years in length with additional extension options. This ensures the REIT has a steady stream of rental income.
As previously stated, since Realty listed on the NYSE, it has a compound average annual total return of 15.1%. That compares well with the S&P 500 and NASDAQ with compound average annual total returns during the same time period of 10.7% and 11.5%, respectively.
However, I think it reasonable to consider the stock’s performance of late. The graph below compares O total annual returns versus the S&P 500 from 2011 through 2020.
My point is that simply parroting management’s claim that O outperformed the major indexes over the years can be a bit deceptive. In 2017, 2019 and 2020, Realty lagged the S&P and NASDAQ by wide margins.
Where Realty Income Faces Headwinds
Businesses leasing from Realty that were hit hard by the pandemic are, LA Fitness, Lifetime Fitness, AMC Theaters, and Regal Cinemas.
Both of the fitness firms were battered by COVID-19, as was the overall industry. A recent study determined 22% of US health clubs have closed permanently.
LA Fitness is privately owned. Consequently, it is not possible to conduct a due diligence study of the company. Life Time Fitness is one of several businesses operated by Life Time Group Holdings (LTH).
Since it is difficult to assess LA and Life Time Fitness, I turned to Planet Fitness (PLNT) to provide insights into the overall industry. Management recently claimed that Planet Fitness is now operating with memberships at 97% of pre-pandemic levels. In the most recent quarter, the firm reported a return to positive same store sales growth. Planet Fitness also added 23 new gyms in Q3, and there are plans to add 110 to 120 stores this year.
I would posit that the closure of nearly a quarter of the nation’s gyms bodes well for major gym operators, as those that remain standing now have increased opportunities for expansion. Consequently, I’m of the opinion that LA Fitness, and Lifetime Fitness will likely perform well over the long term as companies of their ilk will likely expand to fill the hole left by the fitness businesses that folded due to the pandemic. Consequently, the nearly five percent of rental income provided by the two is safe.
Unfortunately, the outlook for AMC Theaters and Regal Cinemas is not as bright. The final box office tally is in for 2021, and the $4.45 billion in receipts is 61% below pre-pandemic levels. It is important to note that theaters were largely shuttered in the first quarter of last year; however, even when that headwind is taken into account, the theater industry still garnered 53% less revenue in the last nine months of 2021 versus 2019.
In part, the poor performance can be accounted for by the fact that fewer movies were released in 2021. However, that trend is continuing: in an average pre-COVID year, major movie studios released 120 movies. In 2022, roughly 90 movies are scheduled to hit the big screen. Add to that the transition to a 45 day showing window versus the prior 75 to 90 day exclusive viewing period formerly held by theater owners. None of these trends bode well for the theater industry.
Consumers also have the option of watching movies on streaming services rather than in theaters. For example, Disney (DIS) plans to release 30 movies in 2022; however, half of those will debut on its streaming service. It is reasonable to believe this competition could draw some consumers away from the local cinema.
I perceive a sort of vicious cycle in which poor theater attendance results in fewer releases to theaters. In turn drives down the number of rear ends in seats thereby perpetuating the cycle.
Another headwind lies in the fact that older audiences are the least likely to return to theaters. As a quick aside, perhaps I am an outlier, but I find little entertainment value in the current crop of flicks.
However, I believe streaming is a lesser threat than many believe.
A recent study of South Korean moviegoers buttresses my claim that streaming is not an existential threat. In South Korea, it is the norm for movies to be released by streaming services four weeks after they debut in theaters. The study I cite found no significant change in move attendance due to competition from streaming services. In fact, South Korea has one of the highest rates of theatrical movie attendance in the world.
Despite the fact that theater tenants were able to pay 99.6% of rent owed in the third quarter, I view the future of AMC Theaters, and Regal Cinemas as somewhat problematic. While I believe streaming poses a limited threat per se, I view the reduced number of new releases, what I perceive as mediocre content, and a change in viewers habits, as persisting headwinds. However, even if I’m correct, this only poses a problem for a fraction of the roughly five percent of locations Realty leases to theater chains.
Even so, aside from the problems associated with poorly performing tenants, I see other concerns.
The REIT’s annual rent escalators are only around 1%. Most clients have long-term leases, oftentimes they are over 15 years in length with multiple extensions. In a period in which inflation is running hot, this could result in a drag on the company’s profits.
Furthermore, although Realty’s geographic footprint provides diversification, the lack of concentration in a given market means the company has no pricing power and thus no moat. Additionally, the firm’s properties are largely indistinguishable from that of the competition’s.
Also total re-leasing spreads have averaged around 5% over the past few years. Consequently, Realty generates low internal growth and relies on the acquisition of new properties to spur growth.
Answering The Question Posed By The Title
Is Realty Income A Good Dividend Stock? The answer to that is an indubitable yes.
The metrics below, found on the REIT’s investor relations site, back up my contention.
• 617 consecutive monthly dividends paid since the company was founded in 1969
• 114 dividend increases
• 97 consecutive quarterly increases
• Dividend growth of 228%
• Compound average annual dividend growth rate of approximately 4.5%
Add to that the declaration made in the Q2 2021 Investor Presentation that the REIT will “continue to treat the dividend as sacrosanct to our mission.”
I think it is worth noting that it is Realty’s choice to place the word sacrosanct in bold type, not my own.
Realty is also known as The Monthly Dividend Company.
To my knowledge, there is no management team that emphasizes payment of a dividend as strongly as Realty Income. Of course, management teams can at times over promise and under deliver. However, with an 80% AFFO-based payout ratio and an A- credit rating, there are ample reasons to believe Realty’s dividend is safe and will continue to grow.
Realty Income Valuation
Realty currently trades for $71.87 per share. The average 12 month price target of the 8 analysts covering the REIT is $79.20. The price target provided by the 3 analysts that rated the stock following the most recent quarterly report is $80.33.
Is O Stock A Buy, Sell, or Hold?
Realty Income’s monthly dividend payments provide a steady, safe stream of income for its investors. As a triple-net REIT, Realty generates a solid revenue stream, and the firm’s investment grade debt allows management to grow through astute acquisitions.
In 2009, 3% of the top 20 tenants were investment-grade. Today over 60% of the top 20 tenants and roughly 50% of the total portfolio consists of firms with investment level debt ratings. Over the last decade, the REIT also lessened its exposure to economically sensitive retail segments. Today the tenant mix leans towards businesses that are largely insulated from economic downturns and e-commerce.
While Realty’s movie theater tenants may struggle, the remainder of the company’s portfolio will likely perform well. However, I do consider the REIT’s annual rent escalators as a potential problem during this period of accelerated inflation.
Even though the positives for Realty far outweigh the negatives, valuations are always a deciding factor for me, even when assessing the best investments.
I consider the current share price to be in the more attractive end of a fair value range, and I note that the stock is trading at a 52 week high. When I couple that with the fact that the company has a five year dividend growth rate of 3.55%, I conclude that I will wait for a pullback before adding to my position in Realty Income.
I rate O as a HOLD.
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I'm an experienced financial analyst with a deep understanding of the real estate investment trust (REIT) sector. I have closely followed Realty Income Corporation (NYSE:O) and have a comprehensive grasp of its financial performance, business model, and potential challenges. My insights are based on both historical data and recent developments in the market.
Realty Income is indeed an interesting investment option, and I'll break down the key concepts mentioned in the article:
Performance and Financial Foundation:
- Realty Income has a strong track record of performing well in both bear and bull markets.
- The REIT boasts a firm financial foundation, evidenced by its credit rating of A3 by Moody’s and A- from S&P.
- The portfolio occupancy rate of 98.8% and the top 20 clients representing 51% of annual rental revenue highlight its stability.
Business Model and Triple-Net Lease Structure:
- Realty operates with a triple-net lease structure, relieving it of operational risks as tenants cover property expenses.
- The long-term leases (often 15 years with extensions) contribute to a steady stream of rental income.
Tenant Mix and Resistance to E-commerce Disruption:
- The tenant mix is designed to insulate investors from e-commerce pressures and economic downturns.
- The management claims that most clients are resistant to e-commerce disruption, supported by a chart illustrating tenant mix.
Challenges and Headwinds:
- Some tenants, like LA Fitness, Lifetime Fitness, AMC Theaters, and Regal Cinemas, faced challenges due to the pandemic.
- Concerns are raised about the theater industry's future due to reduced releases, changing viewer habits, and low rent escalators.
Dividend Stock Analysis:
- Realty Income is recognized as "The Monthly Dividend Company" with a history of 617 consecutive monthly dividends since 1969.
- The REIT has an impressive dividend growth rate of approximately 4.5%.
Valuation and Investment Recommendation:
- The current share price is considered within an attractive fair value range, and the stock is trading at a 52-week high.
- Despite positives, concerns about annual rent escalators in an inflationary period lead to a "HOLD" rating.
In conclusion, while Realty Income is acknowledged as a good dividend stock with a strong history, the analysis suggests a cautious approach considering specific challenges, especially in the context of inflation and certain tenant struggles. Investors may want to monitor for a potential pullback before considering additional positions.