This article was coproduced with Nicholas Ward.
When it comes to REITs that generate reliably increasing dividend income streams… it doesn’t get much better than Realty Income (NYSE:O). This company calls itself, “The Monthly Dividend Company” for good reason.
Realty recently declared its 596th consecutive monthly dividend, which means it’s been paying a monthly dividend for nearly 50 years. And that’s despite it only being a public company now for 25.
As a result of that “official” quarter-century of not only doling out dividends but also raising it, the stock was added to the S&P 500 Dividend Aristocrats Index last quarter.
That’s just the start of why we like Realty Income, both today and tomorrow.
Source: Q4 CC presentation, page 45
Since joining the New York Stock Exchange in 1994, Realty Income dividend growth CAGR has been roughly 4.4%. Needless to say, if you’re looking to generate wealth via regular compounding of your dividend income stream…
Realty Income is one of the very best options for long-term investors to partner with.
Source: Q4 CC presentation, page 4
During its Q4 conference call presentation, management highlighted the company’s strength. Specifically, its low beta and high returns hold up very well compared to its peers.
For that matter, as shown below, O’s long-term results compare very favorably to just about every other blue-chip out there.
Source: Q4 CC presentation, page 10
Realty Income’s 2019 Results
Realty Income recently published its Q4/full-year results, which exceeded our expectations. For starters, its quarterly revenue came in at $397.53 million, well above Wall Street’s consensus estimate of $375.2 million.
That represented 16% year-over-year growth is the highest it’s seen in years.
Oftentimes, Realty Income is considered to be a slow, stodgy, low-beta, defensive name. Yet results like what we just saw show that its conservative management team still has what it takes to be aggressive and generate strong returns for shareholders.
Also for the quarter, Realty Income’s net income per share was $0.39 – 34.5% up from the $0.29 in Q4-18. Its funds from operations (FFO), meanwhile, were $0.85/share, up 16.4% year over year.
As for its adjusted funds from operations (AFFO), they totaled $0.86, which was up 8.8%.
For the full-year, the company’s revenue totaled $1491.6 million, up 12.3% from 2018’s $1327.8 million. And here are some other strong numbers to take into consideration:
- Net income per share came in at $1.38, up 9.5% from 2018’s $1.26.
- FFO was $3.29, up 5.45%.
- AFFO was $3.32, up 4.1%.
Of course, that was last year. How about what we’re looking at now?
Realty Income’s 2020 Guidance
Here’s what Realty Income had to say about its yearly guidance:
“We estimate AFFO per share for 2020 of $3.50 to $3.56. AFFO adjusts FFO for unique revenue and expense items, which are not as pertinent to the measurement of Realty Income’s ongoing operating performance.
“We estimate FFO per share for 2020 of $3.45 to $3.51, inclusive of a $0.03 per share loss due to the early redemption of the 5.750% notes due 2021. FFO per share for 2020 is based on a net income per share range of $1.42 to $1.48, plus estimated real estate depreciation and impairments of $2.09 per share, and reduced by potential estimated gains on sales of investment properties of $0.06 per share (in accordance with Nareit’s definition of FFO).”
At the mid-points of these estimated ranges, O is calling for:
- 5.77% FFO growth
- 6.33% AFFO growth
- 5.1% net income growth.
In other words, guidance is calling for an even brighter 2020 and therefore, no doubt, yet another year of dividend increases.
Looking at Its Real Estate Portfolio
At the end of Q4, Realty Income’s property portfolio consisted of 6,483 properties. Geographically, the lion’s share of that exists in the U.S. Though it also has assets in Puerto Rico and an expanding presence in the U.K.
Its average remaining lease term is 9.2 years. And, at the end of Q4, its occupancy ratio was 98.6%, with just 94 of its 6483 properties available for lease.
Realty Income’s portfolio is highly exposed to physical real estate. However, we’re not talking about malls and shopping centers here. Instead, its focuses primarily on single-tenant properties in industries that are fairly well-isolated away from disruptive eCommerce trends.
Consider the examples below.
Source:
To really hammer this point home, Realty Income provided the following image to shareholders and analysts. This clearly shows that its exposure to the most volatile and potentially troublesome areas of retail is slim.
Slim to none at all.
Source: Q4 CC presentation, page 28
Last quarter, Realty saw rent increases across its portfolio of 2% year over year. For the full year, it rose 1.6%.
Back in April, it made the very big announcement that it would be pursuing international expansion via a sale-leaseback agreement with the U.K’s Sainsbury’s.
Then, during the investor presentation, O acknowledged the large, untapped commercial real estate opportunity in Europe. It’s an $11 trillion market, with $30 billion to $35 billion in annual single-tenant transaction volume that aligns with O’s core verticals.
Furthermore, it intends “to establish an office in London and to judiciously grow in Europe over time as we have in the U.S.”
As you can see in the chart below, Realty continues to be aggressive, growing its asset base. Though it does appear that the cash-lease yields it can lock in the U.K. are significantly lower than those in the U.S.
It will be interesting to see whether or not this trend holds true over the long-term or not. Yet, either way, we’re bullish on O’s long-term international growth prospects.
Capital Raises
Now, to fund all these transactions, O did have to raise funds during 2019. Such is the nature of REIT management.
It has an unsecured revolving credit facility of $3 billion, with a $1 billion expansion feature. As of 12/31/19, the outstanding balance on this revolving credit facility was $704.3 million.
Management then raised $582.2 million in cash via common stock sales in Q4 at a weighted average price of $75.52 per share. For the full year, it used equity sales to raise $2.2 billion, with a weighted average sale price of $72.40.
The company could have tapped debt to continue expanding its portfolio. But instead, management decided to raise funds by selling equity.
Due to the strength of its equity throughout 2019, we see this as a prudent decision.
More about that in a moment…
Source: Q4 CC presentation, page 41
Valuation
Regarding the strength of Realty Income’s equity in 2019, let’s start off with the FAST Graph below. But, since a picture is worth 1,000 words, we’ll let this graph show how overvalued the stock is right now.
Source: F.A.S.T. Graphs
By following the black line of its current share price/valuation and the pink line – its 24x FFO threshold – we see that O is trading in fairly rarified form today.
The stock has only touched an FFO multiple this high three times during the last 20 years. The current 24.1x trailing 12-month FFO multiple is well above its long-term historical average in the 15.9x area.
O’s performance in recent years has been solid. And, looking forward, we expect to see similar, mid to high single-digit growth.
However, that doesn’t justify such an elevated premium compared to its historical average. Even when using forward-looking guidance, we arrive at fundamental multiples that exceed historical averages by a wide margin.
In the $80 area, O’s forward-looking price to FFO multiple – using the mid-point of its 2020 guidance – is 23x. And its forward-looking P/AFFO multiple is 22.7x.
These figures result in 40%+ premiums to Realty’s 20-year average in the 16x range. And they result in a 20%+ premium to the 10-year average P/FFO ratio in the 18.9x range.
Essentially, our fair value estimate of $65 implies that Realty Income is overvalued by roughly 23% right now.
As you can see in the chart below, Realty’s long-term track record, high-quality property and tenant portfolio, and reliable dividend results in the highest R.H.I.N.O. rating out of all the companies we track in the triple net REIT space.
Without a doubt, Realty is a sleep well at night, or SWAN, stock for income-oriented investors who already own it.
For those who don’t yet though, beware its current valuation.
Conclusion
We believe that the best way to generate long-term wealth is to buy and hold the highest-quality companies. But we also believe those purchases should be made at intelligent valuations.
While we see no compelling reason to sell out of a blue-chip name like Realty Income… we also don’t believe now is the best time to buy. Therefore, we’re rating it as a Hold.
It’s clear to us that this stock is not trading primarily on underlying fundamentals. Instead, bullish sentiment is being driven by the market’s thirst for yield in a low-rate environment.
This creates a potentially dangerous environment for income-oriented investors looking for blue-chip names. It’s easy to be swayed by Realty’s wide-margin long-term outperformance of its peers and the major market averages.
Source: Q4 CC Presentation, page 8
However, that outperformance becomes less and less likely moving forward as investors potentially overpay for shares. We believe that patience is paramount when putting new capital to work in an environment like this.
Luckily, current shareholders can be appeased by the company’s incredible monthly dividend. And we’re sure there will be another day to buy in for everyone else.
Trim Idea: We consider O a trim candidate, depending on the investor risk profile (concentration-level) and costs basis. Personally, I find it difficult to sell shares in a blue-chip like O, but shares are now trading at all-time highs. We have plenty of new ideas at the iREIT on Alpha marketplace service.
Author's note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: written and distributed only to assist in research while providing a forum for second-level thinking.
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