HR - Billionaire Investor Says: Don't Miss The New Bull Market

2023-06-09 07:35:00 ET

Summary

• Billionaire investors are quietly loading up on quality stocks.
• A bull market is often confirmed only after it is well underway, don’t miss the best days.
• Two +6% yields to buy when they are still cheap.

Co-authored with "Hidden Opportunities."

While some analysts continue propagating fear about impending doom, billionaire investors are busy scooping up bargains in the bear market. Warren Buffett's Berkshire Hathaway Inc. ( BRK.A , BRK.B ) has recently initiated new positions in discounted opportunities - Capital One Financial (COF), Diageo (DEO) - and boosted its stake in Occidental Petroleum (OXY). Billionaires Seth Klarman and Ken Fisher have also been busy growing their holdings. Prominent investors are quietly buying bargains while Main Street is fearful.

Ken Fisher, the founder, and CEO of Fisher Investments, recently told investors to take advantage of the discounts and not to miss the next bull market.

While There might be many bears prowling Wall Street right now, the pendulum has already swung the other way, and we are in the early innings of a bull market. The key, now, is to stay in the game. While many will suffer breakevenitis, you can avoid it - by keeping long-term goals top of mind" - Ken Fisher.

If you still fear the minuscule rate hikes the Fed may or may not pursue, I encourage you to examine the history. Looking at past Fed rate hikes since the 50s, it is clearly seen that the markets ended substantially higher just a couple of years after the first rate increase.

You could follow the fear pundits and stay away from the markets. Or you could shop the sale to grow your passive income. If you choose the latter, we have two +6% yielding picks for you. Let's dive in!

Pick #1: HR - Yield 6.2%

The average American visits their doctor four times per year. Individuals under 45, visit the doctor ~3 times annually and spend $4,800 on average towards healthcare. An older American visits a doctor seven times yearly, generating $12,000 in annual spending. These essential requirements don't sway based on the economic outlook. Notably, in recent years, fewer patients prefer visiting a hospital for their routine appointments, giving rise to Medical Office Buildings ("MOB").

MOBs are facilities specifically designed for healthcare practices with elements intended to improve patient outcomes and enhance the patient experience. The system works well for patients and practitioners, and MOBs have added more than 60 million sq. ft. of space over the last four years across the top 50 U.S. metros.

Founded in 1992 in Nashville, Healthcare Realty Trust Inc. ( HR ) is a REIT (real estate investment trust) specializing in outpatient medical facilities. HR owns a diversified portfolio of 715 medical office properties in 35 states. In 2022, HR shareholders approved the merger with HTA, creating the largest pure-play MOB REIT in the United States. Source .

92% of HR's portfolio is medical office and outpatient facilities, a segment that increasingly benefits from a remote workforce seeking significant flexibility in day-to-day living.

HR maintains relationships with 58 of the top 100 health systems in America and is the landlord for a very high-quality tenant base. 89% of its rent comes from tenants with a credit rating of A or higher. Less than 2.5% of its rent comes from non-investment-grade tenants. The REIT's average lease term is 48 months, but medical practitioners are typically long-term tenants since they spend years building their reputation in a specific locality. At the end of Q1 2023, HR reported an 89.4% occupancy rate.

At the end of Q1, HT maintained a 6.6x leverage ratio with a weighted average interest rate of 4.8% on its debt. This is a healthy cost of debt compared with its cash flow yields of 6.5% to 12% on its development and redevelopment projects.

Due to the headwinds from higher rates, HR trades at a historically low P/FFO ratio of 11x. The REIT currently sports a 6.9% dividend yield with a 97% TTM payout ratio. While HR maintains 4.2x interest coverage from operations, these temporary higher rates are a significant expense. According to management, a 1% reduction in variable interest rates results in almost 200 basis points improvement in the dividend payout ratio.

Despite above-average rates, HR targets a 5-7% FFO growth in 2024 and a significant improvement in the dividend payout ratio due to these projects going online. The REIT maintains over $1 billion in liquidity to support the pipeline. Now is an excellent opportunity to buy this quality MOB operator, collect the 6.2% yield, and wait for the tailwind of declining rates.

Pick #2: GNL & RTL Preferred - Yields Up to 9%

On May 24th, Global Net Lease, Inc. ( GNL ) announced its intent to buy The Necessity Retail REIT, Inc. ( RTL ) for $950 million in an all-stock merger. If this transaction is successful, it will make the new GNL the third-largest Net Lease REIT. RTL shareholders will receive 0.67 GNL shares for every RTL share (a 35% premium to RTL's 30-day volume-weighted average price).

We hold positions in the preferreds of both net lease REITs. And this deal (currently expected to close in Q3 2023) isn't set in stone yet. Shareholder approvals are pending, and most importantly, RTL has 30 days to solicit alternative third-party proposals and accept a superior one.

Today, we will unemotionally examine the proposal and how it applies to us as preferred shareholders.

We like the property portfolio of GNL and RTL separately and like it even better as a unified entity. The company projects operational synergies to result in $75 million in annual cost savings. As part of the merger, GNL looks to internalize the management of its properties by hiring the employees of its external management team, AR Global. Elimination of management fees is expected to provide $54 million in annual cost savings for the combined REIT.

The post-merger GNL will have a higher quality portfolio of 1,356 properties globally with 96% occupancy, with a 7-year weighted average remaining lease term. 80% of the leases will have contractual rent escalators, and the REIT's top ten tenants will represent 19% of the Straight Line Rent. 55% of the resultant company's portfolio will be leased to investment-grade tenants. RTL's higher exposure to necessity-oriented retail will reduce the resultant company's exposure to office properties down to a modest 20%.

Looking into the numbers, post-merger GNL will have a net debt to Adj. EBITDA of 7.6x, below the levels of GNL and RTL today. The company projects the transaction to be highly accretive, bringing the $1.42/share dividend to be adequately covered by the $1.68/share AFFO at a modest 85% payout ratio. RTL common shareholders will immediately realize a 12% dividend increase due to GNL's higher dividend yield. A meaningful takeaway from this is that the surviving entity continues to prioritize dividend payments, which provide an extra layer of protection for the investors of the cumulative preferreds of GNL and RTL. If this merger goes through, then from the projections, we see increased dividend safety for common shareholders, which implies higher security for preferred investors.

GNL and RTL have two public preferreds each, trading at deep discounts to par value. All four classes of preferred stock are cumulative, offering additional protection to shareholders of a potential transaction that highlights the improvement of the common dividend coverage.

• Global Net Lease 7.25% Series A Cumulative Redeemable Perpetual Preferred Stock ( GNL.PA )

• Global Net Lease 6.875% Series B Cumulative Redeemable Perpetual Preferred Stock ( GNL.PB ).

GNL-A notably presents 9.1% yields and offers ~25% upside to par.

• Necessity Retail REIT 7.375% Series C Cumulative Redeemable Perpetual Preferred Stock ( RTLPO )

• Necessity Retail REIT 7.5% Series A Cumulative Redeemable Perpetual Preferred Stock ( RTLPP ).

GNL ended Q1 2023 with $119 million in cash and cash equivalents. Looking at TTM numbers, GNL's $20 million preferred dividends and $100 million interest expenses were adequately covered by the REIT's $183 million Net Cash From Operating Activities. The $168.3 million AFFO for this period provided coverage for the $166.3 million common dividend payment. In Summary, GNL preferreds enjoy substantial coverage and safety even if the merger fails.

Among GNL and RTL preferreds, GNL-A presents the best income opportunity. Merger or no merger, we will win this one with big dividends by investing in GNL/RTL preferred securities.

Conclusion

The media has been sounding the recession horn for almost a year, scaring the average investor into selling their precious equities. They will not come and beat the drums announcing the birth of the new bull market, at least not until it is too late.

Looking at the history of the markets, 78% of the stock market's best days occur during a bear market or the first two months of a bull market. Over the past 30 years, if you missed the market's ten best days, your returns would have been cut in half. As an income investor, I have no inclination toward paying more for lower yields (and that will be the case when these temporarily high-interest rates disappear).

Why endure the stress and anxiety of missing out or timing the bottom when you can get paid to wait patiently? This is the greatest time to be (or start being) an income investor - two cheap +6% yields to build a second paycheck.

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