ADC - Agree Realty Corporation: Worthy Portfolio Addition

2023-05-20 04:37:22 ET

Summary

• Agree Realty leases big box store some of the largest retailers in the country.
• This makes it incredibly safe, especially when combined with a conservative balance sheet unlike any other in the net lease space.
• I rate the company as a BUY despite total expected return of only 8-9%.

Having covered a number of net lease REITs in my recent articles, today I'd like to present one of my favorite ones - Agree Realty Corporation ( ADC ). Why is it my favorite? It's simple. I believe ADC is one of the safest ways to invest into real estate. This is because the company leases to some of the most established and crisis resistant companies on the planet including the likes of Walmart ( WMT ), Dollar General Corporation ( DG ) or Best Buy ( BBY ). It is the investment grade tenants which account for 68% of total rental revenue, which makes income very predictable. Afterall, these are strong businesses with a high rent coverage so management can count on near perfect 100% collections.

Not only is the company collecting all rent due, but it operates a nearly fully occupied portfolio as occupancy stands at 99.7%! So frankly it couldn't get much better. This, combined with the fact that less than 10% of leases expire over the next three years, means that the leasing team won't have too hard a job and won't have to lease too much space. This is good because the next few quarters are going to be difficult as companies try to cut costs in anticipation of an economic slowdown.

Another thing that I like about ADC is the fact that they are involved in ground leases. This is quite unique in the net lease space as I don't know any other REIT that does this. It is, however, a great addition to a portfolio, because it can be considered safer than a traditional lease. This is because the tenant who leases the land builds his own building. That means that if he doesn't pay his rent, ADC will get to keep the building on their land. This gives tenants an extra incentive and makes ADC's position as a landlord much safer. In total, about 13% of total rental income comes from ground leases so it's in no way insignificant. Personally, I'd like to see this number grow over time.

Indeed, during the first quarter , the portfolio did grow somewhat. Although only two ground leases were acquired, the company acquired 66 properties at an average cap rate of 6.7%. That's a relatively high cap rate given the quality of the properties, especially considering the quality lease terms such as a 13 year average duration and a high percentage of investment grade tenants of 76%. Going forward management seems to be committed to growing their portfolio to achieve growth of 2-5% per year over the next three years. This level of growth also seems to be the analysts' consensus.

I also like the fact that the company pays a solid 4.4% dividend which currently stands below the low end of the targeted payout ratio. This means that even if FFO stagnates, there is still some room to increase the dividend here so I wouldn't be surprised if the yield on costs reaches 5% in the not too distant future. This would be consistent with a historical average dividend growth of about 6%.

Finally, what makes this really safe beyond their quality tenants is a very conservative balance sheet. We're talking BBB rating with extremely low debt maturities for the next five years and a large liquidity of $1.2 Billion which the company can use to go shopping for new properties now that prices have dropped. This could result in some great long-term buys for ADC.

So to sum up, there's a lot to like. A premium portfolio of big box properties leased primarily to investment grade tenants who will most definitely pay their rent on time. The portfolio is fully occupied and backed up by a very conservative balance sheet which essentially means no interest rate sensitivity of FFO. With these characteristics, the company is obviously not going to be cheap. Trading at 17x FFO, the stock is relatively pricey, but frankly, ADC barely ever trades lower than that. Given a historical average multiple of 20x, I think there's some upside here, but even if the multiple doesn't rerate higher, we can still earn a 4.4% growing dividend and about 2-5% annually from growth which is likely to result in a total return of around 8-9%. While that's not a market-beating return, given the safety, I think ADC is a worthy addition to conservative portfolios which is why I rate the stock as a BUY.

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