O - 3 Monthly Dividend Payers: One For Safety One For Growth And One For A Bit Of Both

2023-09-29 08:54:54 ET

Summary

• Main Street Capital, Realty Income Corporation, and Agree Realty Corporation are stock market stalwarts with a history of providing robust dividends.
• All three companies have an average yield of 6.14% and sustainable dividends.
• MAIN and O have a strong track record of performing well during economic downturns and have well-diversified portfolios. ADC offers potential for market-beating growth.

Main Street Capital (MAIN) and Realty Income Corporation (O) are stock market stalwarts. The pair have a long history of providing robust, safe dividends through good times and bad. Agree Realty Corporation (ADC), is a relative newcomer, with a business model that in many respects mirrors that of Realty Income. I think of ADC as Realty Income's little brother: the two look alike, but one still has lots of room to grow.

The three have an average yield of 6.14%. and an average 5-year dividend growth rate of roughly 5.3%. Main Street Capital, has a history of providing fairly frequent special dividends, and Realty Income Corporation is a Dividend Aristocrat.

Big yields and monthly payouts aren't all these three have in common. MAIN and O have a history of faring well during economic downturns, each company boasts strong balance sheets, and all three have sustainable dividends.

I will also contend that at least two of these three tickers are at near bargain-basement valuations. And the fall in share prices has nothing to do with fundamentals. I contend that investors turning to bonds and the like has led to the downturn, and I believe that presents a buying opportunity for long-term shareholders.

A Brief Review Of BDCs

Before I review MAIN, let me provide a brief insight into Business Development Companies ((BDC)).

A major attraction of BDCs is that they are required to distribute at least 90% of taxable income to shareholders in the form of dividends. Oftentimes, this results in double-digit yields.

Congress created Business Development Companies in 1980 as a means for public investors to invest in private U.S. businesses. BDCs were also meant to provide smaller companies with access to capital.

By law, BDCs must invest at least 70% of assets in the debt and/or equity of non-public U.S. businesses valued at $250 million or less. BDCs must also maintain an asset coverage ratio, a financial metric that measures a company's ability to repay its debts by selling or liquidating its assets, of at least 150%.

Many of the best BDCs have the bulk of their investments in floating rate loans; however, the majority of their funding is at a fixed rate. Therefore, it is common for many BDCs to have a 500-900 point yield spread between borrowing costs and the income they receive on their investments. Consequently, BDCs often report increased net investment income and cash flow per share during rising rate environments.

Top-notch BDCs also have a high level of industry and borrower diversification, a high percentage of first-lien debt investments, a very low percentage of non-accruals, and well laddered debt maturities.

Additionally, BDCs are required to diversify their portfolios to limit the concentration of an investment in any single company.

All of this means well managed BDCs have reasonably safe business models.

Main Street Capital

Most analysts that focus on BDCs would agree that MAIN ranks at or near the top of the Business Development Company universe.

MAIN IPO'd in 2007, shortly before the dawn of the Great Recession. Investors might recall that the 2008-2009 market crash resulted in the largest dividend cuts since WWII, with about a third of dividend paying companies cutting their payouts during the Great Recession.

However, MAIN did not cut the dividend then, nor did the company cut the dividend during the COVID crisis, a testimony to the strength of the company and its management team.

In fact, MAIN's regular dividend has more than doubled since 2007, and the company also frequently pays a special dividend.

The BDC has grown its net asset value ((NAV)) to $14.84 per share, or by 115%, since 2007, and an investor that purchased the stock on the IPO would have pocketed roughly two-and-a-half times the original share price.

The following chart gives a picture of MAIN's outperformance of the S&P 500 over the years.

MAIN has a high degree of diversification across industries, geography and by transaction type.

The bulk of MAIN's funding is at a fixed rate while most of its investments are floating rate loans. This generally causes a surge in cash flow per share and net investment income during rising rate environments.

Most of the firm's debt investments are first lien loans.

The company currently has nine investments on non-accrual status, representing just 0.3% of the total investment portfolio.

Analysts forecast MAIN's EPS to increase by 25%, from $3.29 in 2022, to $4.11 in 2023.

MAIN has well laddered debt maturities and investment grade credit ratings of BBB-/stable from Fitch and S&P. Taking special dividends into account, Main current yields approximately 8.3%.

Realty Income Corporation

Like MAIN, Realty Income flexed its muscles while others faltered. During the pandemic, Realty Income was the only REIT listed in the S&P 500 and the only retail net lease REIT that raised the dividend.

Throughout the Great Recession, O recorded the lowest operational and financial volatility of any A-rated S&P 500 REIT.

Furthermore, the company has a history of relatively robust dividend growth. While the average REIT listed in the S&P 500 has a dividend CAGR of 3.1%, Realty's dividend has grown a CAGR of 4.4%.

During the last earnings call, management reported that the REIT notched the third consecutive quarter with occupancy at 99%.

With a portfolio that includes properties in all fifty states, Puerto Rico, Spain, Italy and the UK, plus 1,303 clients in 85 industries, Realty Income is well diversified on all levels. Furthermore, management estimates that 91% of total rent is resilient to economic downturns and/or isolated from ecommerce competition. Plus, investment grade clients constitute 40% of rent.

There are many that question Realty Income's growth prospects due to the sheer size of the REIT; however, management points to the fact that public net lease REITs comprise 3% of the total addressable market in the US and less than 1% of the market in Europe.

Realty is one of only seven S&P 500 REITs with two A3/A- ratings or better. The company has well laddered debt with a weighted average term to maturity of 6.7 years and zero debt payable in 2023.

In an environment in which many companies are forced to finance floating rate debt in a rising rate environment, 93% of Realty Income's debt is at a fixed rate. Additionally, the firm can borrow in Europe at rates that are significantly lower than in the US.

Realty Income yields 5.56%, has an AFFO payout ratio of approximately 76%, and a 5-year dividend growth rate of 3.71%.

When one considers that Realty Income is trading at a current P/AFFO ratio of 13.93x versus the REIT's 10-year average AFFO multiple of 18.86x, and that the company is also trading roughly 7% below net asset value, the current share price marks a bargain basement level.

The REIT briefly traded at or slightly below this share price at the peak of the COVID crisis, and for about three months in 2018. Otherwise, you must go back to 2015 to find a time when the stock traded below this share price.

Agree Realty

Like Realty Income, ADC is a triple-net lease REIT. For those unfamiliar with the term, tenants renting triple-net leases properties pay all expenses related to property management, including property taxes, insurance, and maintenance.

ADC has over 1,900 properties in 48 states. The REIT's weighted average lease term is roughly 8.8 years, and 68% of tenants are investment grade.

Management focuses on recession resistant, omnichannel, and e-commerce-resistant clients. As the following chart shows, ADC's tenant mix provides a board degree of diversification with an array of very solid renters.

Something that sets ADC apart from most competitors is the REIT's ground lease platform. These are properties on which ADC owns the land while the tenant owns the building. The firm's 208 ground leases generate 12.1% of ABR and have an average weighted lease term of 11.1 years.

Furthermore, 87% of the ground lease tenants are investment grade. Home Depot (HD), Walmart (WMT), Lowe's (LOW), Wegmans, and Costco (C O ST) are the top tenants in the ground lease portfolio.

ADC has investment grade credit ratings of Baa1/BBB stable, and well laddered debt maturities.

The current yield is 5.28%, the AFFO payout ratio tends to hover around 74%, and the 5-year dividend growth rate is 6.80%.

Summation

Take a look at the total returns for the Vanguard S&P 500 ETF (VOO), the Vanguard Real Estate Index Fund ETF ( VNQ ) and the three featured stocks.

Total Returns 5-year 10-year

VOO 59.7% 204%

VNQ 12.9% 67%

O 14.1% 101%

MAIN 51.4% 190%

ADC 28.7% 185%

Size matters, but in the case of ADC, a markedly smaller property portfolio is a plus. Simply put, significant growth in a company the size of Realty Income is a much more difficult task versus growing ADC.

One should consider that prior to the recent run up of the S&P 500, and the fall in valuations of many dividend-bearing stocks, ADC and MAIN had total returns greater than VOO. For example, shares of both O and ADC have fallen by about 22% year-to-date while the S&P is up nearly 17% in 2023.

An investment in O comes with little risk but may result in stifled growth. IN contrast, ADC offers potential for market-beating growth, while MAIN sits in a sweet spot that provides a bit of both.

I rate MAIN, O, and ADC as BUYS.

However, I view Main as a buy by a narrow margin.

I rate O as a solid buy, and I view ADC as the best of the three at this juncture.

I will add that in the current market environment, it would not surprise me if the shares of O and ADC remain at low valuations for quite some time. I suspect their valuations are unlikely to recover significantly until interest rates drop.

I own shares of MAIN and O and I am adding to each position in small increments albeit routinely.

I do not own ADC stock. However, I intend to initiate a position in the company and build it into a middling sized investment over the next month.

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