ADC - Agree Realty: From Ugly REIT Duckling To Super SWAN

2023-06-14 07:00:00 ET

Summary

• I bought shares in 2011, and I’ve never sold (one share), and they've returned 12.1% annually during that period.
• I've witnessed the transformation of what was once an "ugly duckling" into a beautiful super SWAN.
• I believe Agree Realty is set to soar to new heights, and I'm betting on both the jockey (Joey Agree) and the horse.

This article was published at iREIT on Alpha on Sunday June 11, 2023.

Agree Realty ( ADC ) is a net lease REIT that owns more than 1,900 properties (including ground leases) in 48 states. The portfolio contains 68% investment grade tenants with a weighted average lease term of approximately 8.8 years.

I began covering Agree back in 2011, my first article can be viewed below:

At the time Agree had a market capitalization of just over $200 million and I concluded that article as follows:

“Agree Realty is one well recommended REIT that should benefit from the ongoing recovery and provide investors with an extraordinary dividend. The current stock price is $23.01 (as of July 8, 2011) and the 12-month target pricing level is around $27.50. The expected stock appreciation (20%) and current dividend (7.6%) should generate some exceptional alternative investment options. So in the words of Paul Johnson, Take Charge!”

That’s exactly what I did. I bought shares in 2011 and I’ve never sold (one share), while they have returned 12.1% annually during that period.

Agree Realty is a textbook buy-and-hold stock and today I want to explain the reasons that I continue to not only own shares but increase my exposure.

Let’s start with the beginning…

The Basic Business Model

In 1971, Richard Agree, the executive chairman of the board of directors, founded Agree Development Company, the predecessor to Agree Realty Corporation.

Over its 23-year history, Agree developed more than 40 community shopping centers primarily throughout the Midwestern and Southeastern United States. With an IPO of 2.5 million shares in 1994, Agree commenced operations as a publicly traded REIT listed on the New York Stock Exchange.

As you can see (above), Agree shares have seen impressive growth over the years, especially as the company was digging out of the Great Recession and navigating its challenging exposure with Borders and Kmart that represented 43% of ABR:

None of these tenants (Borders, Walgreens, and Kmart) appear in Agree’s current portfolio for a reason. Over the last decade or so Agree has been capitalizing on its distinct market positioning in the retail net lease space. As Joey Agree, CEO, told me in an exclusive iREIT on Alpha interview :

“…our focus and our sandbox is really the 30 to 35 best retailers in the country today. We think, and this is before any of the economic concerns or headwinds that we're facing, that retail really has binary outcomes, that true omnichannel retailers, which retailers all have to become today take significant capital investment price.

Obviously there's price transparency at any time on your iPhone and a unique value proposition to be able to fulfill all customers different types of desires, whether it's same hour, same day, next day, pick up in store.

And so when you combine all the investments that those retailers have to make and a lot of it's experimentation still, we think those retailers that have the pricing power and the balance sheets frankly are going to be the winners here.”

Clearly Joey and his team are on a mission to become a best-in-class net lease REIT differentiated by a simple investment strategy rooted in repeatable rent checks and “fungible” boxes. He uses O’Reilly Automotive ( ORLY ) as an example,

“Net lease is a function of credit, term, and real estate. Well obviously, with O'Reilly you've got great credit as you mentioned, you've got great term. But then as we mentioned in our white paper, our average O'Reilly pays approximately $12 per square foot.

You've got a concrete floor, maybe an exposed ceiling or acoustic ceiling tiles, and then ADA compliant restrooms in a very fungible 7 to 8,000 square foot rectangle.”

He added,

“…we want those rectangles that have limited improvements, that have limited tenant specific improvements that aren't advertised into the rental rates, that aren't paying artificially high rental rates. And if and when we were to get that box back, we think it's easily re-tenable and potentially even with an upside.”

As a net lease developer for decades I can attest to the large and fragmented opportunity set for Agree. The company has reviewed $60 billion of opportunities since 2018 and has acquired $5.59 billion.

I don’t know of any other property sector that has such opportunity. According to Agree Realty there are more than 162,000 properties that could be acquired:

In addition to acquisitions, Agree develops or provides capital solutions (‘PCS’) for the REIT. As of Q1-23 the company had 29 development or PCS projects completed or under construction for more than $115 million.

Once again, speaking from experience (as a net lease developer and investor), Agree is wise having direct relationships with its customers. As the company increases in size, it will position itself to become sale-leaseback partners with these firms.

One unique differentiator for Agree is its ground lease platform that consists of 208 leases (12.1% of ABR) with a weighted average lease term of 11.1 years. The G-Lease portfolio has 87% investment grade rated tenants (9% not rated) and just 4% sub investment grade. Joey told me ,

“We have zero investment in those buildings. We get those buildings for free. There's nothing better than getting something for free. And so we own the underlying fee simple interest in the dirt.

Almost 90% of that portfolio is investment grade. We use it a lot of times as a risk mitigation strategy for larger boxes: Home Depot, Walmart, Lowe's, Wegmans, Costco are amongst our top tenants in our ground lease portfolio.

At the end of the day, the risk adjusted returns - we see significant upside and we have a couple near term ground leases actually rolling with no options here very shortly, which we'll be able to hopefully put in front of investors and they can see the potential upside there.”

Here’s an example the company provided in a recent investor deck that highlights embedded value with a 159% recapture rate. This is the before snapshot:

Here's the after snapshot:

The Fortress Balance Sheet

In 2010 Agree had just $285 million in total assets and around $118 million of liabilities. Since that time, the company has witnessed significant growth by investing in over $7.6 Billion in properties.

The management team has practiced strict discipline by maintaining a flexible balance sheet with a combination of debt, equity and preferred equity.

As of Q1-23 the company had net debt to recurring EBITDA of 3.7x (pro forma for the settlement forward equity) and excluding the impact (of unsettled forward equity) net debt to recurring EBITDA was approximately 4.5x.

Total debt to enterprise value at quarter end was approximately 24%, while the fixed charge coverage ratio was 5.1x. Agree ended the quarter with total liquidity of $1.2 billion, including approximately $804 million of availability on the revolver, $362 million of outstanding forward equity and $13 million of cash-on-hand. The company is rated Baa1 and BBB.

Management Matters

As many know, Agree Realty’s CEO, Joey Agree, occasionally drops into Seeking Alpha to chat with readers. That’s important because it demonstrates his willingness to interact with investors and provide transparency. I also thought it’s interesting that Joey and his senior management team list email address and phone numbers on the website.

Kudos Joey!

Also, I like to see management with “skin in the game,” and once again, Agree Realty delivers on that front as well.

Joey recently purchased another 5,000 shares in May 2024 at $64.91:

Of course, another sign that management and the board are aligned is when I see dividend increases. During Q1-23 the board declared a monthly cash dividend of $0.24 per common share for each of January, February and March.

On an annualized basis, the monthly dividend represents a 5.7% increase over the annualized dividend from the first quarter of 2022.

At 73%, the payout ratio for Q1-23 was below the low end of the targeted range of 75% to 85% of AFFO per share. Subsequent to quarter end, the company announced a monthly dividend of $0.243 per share for April that equates to an annualized dividend of nearly $2.92 per share, which represents a 3.8% year-over-year increase and a 2-year stack increase of 11.7%.

As shown below, the dividend has grown by 6% CAGR over the last 10 years:

Why Am I Buying?

During Q1-12 Agree Realty invested more than $314 million in 95 retail net lease properties across the three (above-referenced) external growth platforms. This includes the acquisition of 66 assets for approximately $302 million in the tire and auto service, home improvement, grocery, auto parts, Dollar Store and farm and rural supply sectors, among others.

The weighted average cap rate of the acquisitions was 6.7%, a 30-basis point expansion relative to Q4-22 and 50 bps higher than the full-year 2022. Agree also commenced five new projects with total anticipated cost of over $19 million. The company also increased full-year 2023 acquisition guidance to at least $1.2 billion.

As seen below, Agree Realty now trades at $65.39 with a P/AFFO of 16.9x and dividend yield of 4.5%. The normal P/AFFO ratio is 17.8x.

As you can see below, Agree Realty was growing by an average of 7% from 2018 to 2022, and analysts are forecasting modest growth of 4% in 2024 and 5% in 2025.

The company has 10 analysts providing these consensus numbers, which is a good sample size:

I want to highlight once again that around 12% of Agree Realty’s rental income is derived from ground leases, which are much safer and provide icing on the cake (due to the unrealized capital gains).

That’s hard to quantify, and Safehold ( SAFE ) believes that the icing on the cake is worth a lot more (i.e. their CARAT program ).

Even though Agree Realty is not growing the needle as much as previous years (7% AFFO per share growth) the company’s ability to scale has enhanced dramatically, as the Michigan-based platform can now be competitive in the larger sale-leaseback arena and also pursue a few smaller fish in the sea, like Alpine Income Property Trust ( PINE ) – see my latest article on the topic .

Also, in another recent article I explained the concept of betting on the jockey and the horse ( see article here ), and for that reason, I plan to increase exposure to Agree. I admire Joey (and his team) for turning what was once an ugly duckling into a beautiful SWAN (sleep well at night).

As most know, I went through a similar transformation back in 2008 and 2009, and this is why I keep this quote front and center in my office:

“Adversity is bitter, but its uses may be sweet. Our loss was great, but in the end, we could count great compensations.”

-Ben Graham

Let’s go Joey!

We’re in it to win it…

Note: Agree Realty is a constituent in the iREIT-MarketVector ^™ Quality REIT Index that provides exposure to high-quality, US-listed common and preferred equity securities of REITs while ensuring sector diversification.

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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