ADC - Agree Realty: A 5%-Yielding Monthly Dividend Payer On My Radar

2023-12-14 07:30:00 ET

Summary

• Agree Realty is a conservatively run REIT with a heavy emphasis on returning value to shareholders.
• The investment-grade portion of the REIT's portfolio reached an all-time high in Q3.
• Agree Realty enjoys an investment-grade credit rating from S&P on a stable outlook, with no significant debt maturities until 2028.
• Shares of the company appear to be 22% discounted relative to Dividend Kings’ fair value estimate.
• Agree Realty could slightly outperform the S&P 500 through 2025 and could be poised to also outperform over the next 10 years.

When done right, investing is a highly qualitative process from my perspective. If there's anything that I have learned over the six years that I've been investing, great businesses tend to make far more money for their shareholders than average businesses.

What do I mean by a "great" business? Well, I prefer to own proven businesses with room for future growth, excellent balance sheets, and savvy management teams.

The retail REIT, Agree Realty ( ADC ), appears to fit these characteristics to a tee. I will dig into the company's fundamentals and valuation to elaborate on why I am starting my coverage here on Seeking Alpha with a buy rating.

Agree Realty's 5% dividend yield is competitive versus the 4.1% yield of the 10-year U.S. treasury (as of December 13, 2023). Better yet, the company's dividend appears to be about as safe as they come in REITdom. This is because Agree Realty's 74% payout ratio is materially below the 90% that rating agencies prefer from REITs.

Moreover, the company's 31% debt-to-capital ratio clocks in at just roughly half of the 60% that credit rating agencies view as sustainable for a REIT per Dividend Kings. Thanks to this strong financial position, Agree Realty possesses a BBB credit rating from S&P on a stable outlook. That implies the probability of the REIT folding by 2053 is just 7.5%.

According to Dividend Kings, the company's risk of a dividend cut in the next average recession is merely 0.5%. Even in the next severe recession, this risk rises to a still very low 1.2%.

Besides fundamentals, the other factor that I especially like about Agree Realty is its current valuation. Factoring in historical valuation metrics like dividend yield and P/AFFO, Dividend Kings estimates that the REIT is worth $76 a share. Against the $60 share price (as of December 13, 2023), this suggests Agree Realty is undervalued by 22%.

Assuming that the REIT returns to fair value and matches the present growth consensus, these are the total returns it could generate over the coming 10 years:

• 5% yield + 4.9% FactSet Research annual growth consensus + 2.5% annual valuation multiple expansion = 12.4% annual total return potential or a 222% cumulative 10-year total return versus a 9% annual total return from the S&P 500 ( SP500 ) or a 137% cumulative 10-year total return

Agree Realty Is The Model Of Consistency

Since its founding in 1971 by Richard Agree, Agree Realty has grown into one of the largest retail REITs in the United States. As of September 30, the company owned almost 2,100 retail properties throughout the U.S. These properties are also well-balanced across resilient sectors of retail, such as grocery stores, home improvement, and convenience stores. The company's top retail sector of grocery stores contributed to just 9.7% of its annualized base rent as of September 30.

Agree Realty's diversification extends to its tenants as well. As of the end of the third quarter, the REIT's top 10 tenants comprised just 37.4% of its total ABR.

If this diverse tenant base wasn't enough, Agree Realty also has taken a prudent approach toward tenant quality. The company's allocation to investment-grade tenants reached an all-time high of 69% of total ABR in the third quarter, according to CEO Joey Agree's opening remarks in the Q3 earnings call . This suggests that the company's rent revenue has never been on more solid ground than it is today.

The structure of Agree Realty's ground leases also presents an interesting way for the company to add to shareholder value. These leases accounted for 11.6% of its annualized base rent as of September 30. These leases are attractive because tenants assume the risk of building a piece of property on top of the ground that is owned by the landlord. If these leases aren't renewed by the tenant, the property on the land reverts to the landlord.

Oftentimes, the tenant will renew their leases on terms that are favorable to the landlord because they don't want to walk away from their location or lose their investment. Fellow SA analyst Leo Nelissen provided a great example of this with Agree Realty and Chase Bank in Stockbridge, Georgia, that I'd recommend readers check out.

Due to these characteristics, it shouldn't be a surprise that Agree Realty has generated healthy and sustainable growth over the last decade. The company's adjusted funds from operations or AFFO per share has surged 82.5% higher from 2012 to $3.83 in 2022 - - a 6.2% compound annual growth rate (slide 30 of 31 of Agree Realty December 2023 Investor Presentation). More importantly, AFFO per share grew in each of those years. That even included the COVID-19 pandemic, which was a headwind for many REITs.

Agree Realty also doesn't appear to be anywhere near its peak potential, either. There are well over 100,000 net lease opportunities still available with best-of-breed retailers in the company's sandbox. This wealth of investment opportunities ensures that the company can maintain the conservative investment approach that has brought it immense success to this point.

Agree Realty is intent on remaining committed to qualitative growth over growth for the sake of growth. CEO Joey Agree noted that even without external growth or acquisitions, rent growth alone will deliver AFFO per share growth of around 3% in 2024. Including measured acquisitions, I believe that FactSet Research's long-term consensus growth estimate of 4.9% annually is reasonable for Agree Realty.

The company also has the financial position to make future growth happen. As of September 30, Agree Realty's net debt to recurring EBITDA ratio was 4.5. The REIT's 28.2% debt to enterprise value further demonstrates that it is well-capitalized. To top it all off, Agree Realty has merely $103 million of maturities that are due through 2027. For a company of its size, this is an unbelievably great position to be in while interest rates are elevated. This balance sheet could allow the company to seize upon any intriguing opportunities that arise in retail real estate in the months and years to come.

Finally, investing is just as much about the management team as it is about the business model and fundamentals. Agree Realty's team is led by a man who has real estate in his DNA: Since becoming CEO of the company in 2013, Joey Agree has steadily taken his father's company to new heights. I would suspect this will be the case moving forward as well.

A Monthly Dividend That Has Growth Ahead

Since transitioning away from a quarterly dividend to a monthly dividend in 2021, Agree Realty hasn't disappointed. The company has upped its monthly dividend per share by 19.3% over that time.

Through the first nine months of 2023, Agree Realty has declared $2.178 in dividends per share. That's a 4.5% increase over the year-ago period. Compared to the $2.96 in AFFO per share posted during that time, this is a 73.6% payout ratio. This is a well-covered payout ratio that should allow the dividend to keep growing in line with AFFO per share in the future.

Risks To Consider

Fundamentals show Agree Realty to be a high-quality REIT. However, the company isn't perfect.

One risk to the company is its geographic concentration. Approximately 30% of Agree Realty's ABR in 2022 came from Texas, Ohio, Florida, Michigan, and Illinois. If a natural disaster like a severe hurricane or ice storm were to occur, there could be damage to the company's real estate portfolio beyond the insured amount and disruptions to the operations of its tenants. That could weigh on Agree Realty's operating results.

Another risk is the potential for a breach of its IT networks and systems. If this happened, Agree Realty's proprietary information, sensitive employee information, and the like could be compromised. This could lead to litigation against the company and damage to its reputation.

Summary: An Ultra SWAN On Sale

Agree Realty's sound track record, high-quality real estate portfolio, and vigorous balance sheet earn it a 13/13 ultra SWAN quality rating from Dividend Kings.

The REIT's valuation makes it even more interesting as an investment. Agree Realty's P/AFFO ratio of 15 is just below its historical P/AFFO ratio of 15.3. Given that the company's operating fundamentals have arguably never been better, I believe it should be able to revert to the mean. Assuming Agree Realty also meets growth projections, the stock could deliver 19% cumulative total returns through 2025. By comparison, that beats out the 16% cumulative total return projection for the SPDR S&P 500 ETF Trust ( SPY ) through that time. Simply put, Agree Realty is a superb business with above-average total return potential looking out over both the next two years and 10 years.

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