NNN - 2 Income Plays For Long-Term Investors

2023-07-04 08:22:45 ET

Summary

• NNN and GAIN are two income investments that have rewarded long-term investors.
• Going forward, both of these names can continue to reward investors with income and potential appreciation over time.
• Both are trading at valuations that make them worthwhile considerations.

Written by Nick Ackerman. A version of this article was originally published to members of Cash Builder Opportunities on June 19th, 2023.

Being a long-term dividend investor means sometimes buying into areas that appear discounted. That generally means when the outlook for an area of the market is often dim, and that makes investors flee from certain areas. This can boost our income while waiting for a rebound to occur.

Real estate investment trusts, or REITs, have been taking substantial hits in the last year or so as interest rates have been ramped up aggressively by the Fed. The latest July meeting had the Fed pausing for now, but they expect two more hikes in 2023 before potentially being cut in 2024 and 2025 based on current projections. These were increases from the outlook previously, even while they've maintained that the expectation was for rates to stay higher, for now, to continue to combat sticky inflation.

However, that still means rates are expected to stay high for now, and that can continue to pressure REITs as they go into refinancing. Still, the outlook for a potential recession in the coming year means that anything can happen. For a longer-term investor, this is also representing a fairly attractive time to consider investing in REITs - while they are beaten down. I believe that NNN REIT ( NNN ) represents one attractive area to invest in. Shares of NNN are off around 12% from their 52-week high.

However, I believe that another area that is worthwhile to invest in that can benefit from rising rates is the business development space or BDCs. A name that looks attractively valued while being able to see some increased income generation in that space has been Gladstone Investment Corp ( GAIN ). Morningstar assigned a fair value of $15.64, and shares are off 17.50% from their 52-week high.

However, it should be noted that this isn't your typical BDC; at the same time, they have exposure and have benefited from rising interest rates. Their buyout strategy makes them a bit more aggressive with heavier exposure to equity investments.

These two investments can boost one's income substantially as these are higher-yielding plays. In particular, GAIN is sporting a strong regular dividend yield and has been able even to throw off some supplemental despite the uncertain environment.

NNN REIT

NNN recently announced a snazzy new name from National Retail Properties, now being called NNN REIT. The new name is minimalistic and modern and tells us what they are all about. It hasn't changed anything with this powerhouse of a triple-net REIT that isn't as popular as Realty Income ( O ) but still remains just as attractive for investors.

FFO growth is expected to be fairly minimal going forward, given the new environment of higher interest rates. It was never really about NNN being a growth monster, but the more slow and steady. However, Thirty-three years of dividend increases with a 67% AFFO payout ratio with a 99.4% current occupancy means that the dividend currently is not only incredibly safe, but the growth potential going forward remains intact.

Even during Covid, occupancy only dropped to 98.5%. 2009 was the lowest in the last several decades at an occupancy of 96.4%. In comparison, these occupancy levels have dominated their REIT peers , making them a standout.

They have strong and resilient tenants despite being a retail-oriented platform that actually targets "selective non-investment grade tenants." They target this area of the market due to better pricing power, including better potential rent growth. They also note that the "durability of tenant credit can be fleeting." Meaning that what is potentially investment grade today could be below-investment grade next week. Or even vice versa, as they note the opportunity for credit improvement. However, that can leave them less recession resistant than something like O.

Helping to balance out the higher-risk portfolio of tenants would be the vast diversification of NNN's portfolio of properties. They have 3411 properties across 48 states with more than 400 retail tenants. So they have the different geographies and different tenant exposure boxes checked.

In turning to the balance sheet, they have locked in debt costs with added debt maturities. They have a weighted average effective interest rate on their debt of 3.7% at a weighted average maturity of 13.7 years.

That puts them in a position where they won't be eating substantially higher interest rates even over the next couple of years with laddered maturities. With the Fed and market anticipating cuts in the next year when their debt starts to mature, that bodes well for refinancing compared to if they had substantial debts to refinance this year.

Shares of NNN are trading well below their longer-term fair value range based on P/AFFO.

Gladstone Investment Corp

GAIN's main focus is on its buyout investment strategy. They are generally the primary equity and secured debt issuer for an investment. They also carry a rather concentrated portfolio of companies, with only 25 in their last report. They focus on companies with positive cash flows and don't participate in "early-stage" companies.

Incorporating more equity positioning makes them a relatively more aggressive BDC play. They target a mix of generally having 25% equity and 75% in debt. Simply put, being lower in a company's capital stack should things go sideways means less recovery potential.

Still, they carry a meaningful allocation to floating-rate loans, which can still help provide meaningful growth in net investment income to shareholders. Adjusted NII per weighted average share in the last fiscal year came to $1.10. That was an increase from $1 or 10% from the prior fiscal year.

They can grow NII because the floating rate loans saw increased yields as interest rates increased. 100% of their debt portfolio is based on floating rates. At the same time, the majority of their debt is fixed-rate in nature. They are mostly leveraged through fixed-rate notes. However, they also have a credit facility based on floating rates.

Additionally, in order to grow their leverage and, consequently, their investment portfolio, they've had to pay up in the current environment . The latest public offering of notes that will be trading under GAINL was recently offered at 8%. That's a substantial increase from the 2026 ( GAINN ) notes that carry a 5% rate and the 2028 ( GAINZ ) notes at a 4.875% yield.

This more aggressive strategy has worked incredibly well for this BDC. It has allowed them to deliver regular dividend growth and provide annual supplemental distributions to investors as well in more recent years. They cut only during the great financial crisis, but they have raised ever since.

Of course, the more aggressive strategy has worked out well not only in the growth of the distribution but in terms of GAIN being able to outperform other BDCs with a less aggressive strategy. This is exactly what we'd want; we'd want to see that a higher-risk investment is delivering higher returns. That said, the opposite can happen during bad times because things don't always work out so rosy.

The strong performance wasn't just against the BDC peers, but they've been able to smoke the S&P 500. It's been a volatile ride at times, but that's to be expected for a leveraged BDC.

In terms of the environment, they noted that the buyout focus strategy remains attractive to them but that there is still quite a bit of competition in the space. However, they also noted that they've seen multiples decline in valuing buyouts, which would hit the current value of their portfolio companies.

So looking forward and even though there seems to be some decline in the multiples being used to determine the values of buyouts, the market is still very competitive. Deal flow appears though to be picking up as sellers who have been holding back over the past six months are testing the market and we hear it from the M&A and the sell side bankers that we deal with that the backlog of new opportunities in fact has been building somewhat.

However, there continue to be significant liquidity in buyout funds, which is our competition, so we remain selective while we aggressively seek new acquisitions and we are patient in our diligence and review process. We are in the due-diligence phase on a couple of new buyout opportunities right now. So we'll see how that plays out over the next few quarters and hopefully we'll be adding to our portfolio in the new buyout phase.

Seeing valuations decline is not that unexpected, given last year's broader market performance in the public space. GAIN saw its NAV decline from $13.43 to $13.09 year-over-year.

We did experience though a small aggregate net decline in valuations across the portfolio, mainly due to declining industry valuation multiples and even though we experienced an increased EBITDA at many of our portfolio companies

The more aggressive portfolio of GAIN isn't going to be for everybody. However, for those that can handle a bit of risk for a long-term type of holding, the valuation currently is quite attractive.

GAIN has regularly flirted with a premium on several occasions over the years; they are actually trading right at parity with the NAV based on the latest close. A recession could see this name return back to a discount as relatively smaller companies can struggle and are generally more economically sensitive.

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