GOODN - Gladstone Commercial: A Fat 10% Yield Paid Monthly

2023-04-22 00:41:04 ET

Summary

• Gladstone Commercial's annual dividend yield has widened to nearly 10% following a 35% year-to-date decline.
• Its price to trailing FFO multiple is 37% below its peer group median.
• The preferreds have also seen their discount to par value widen since the start of the year.

Is Gladstone Commercial ( GOOD ) now a buy after a 35% year-to-date decline? It depends. Bulls would be right to highlight that its yield has been pushed up to a record high only recently eclipsed by the early pandemic panic. The REIT last declared a monthly cash dividend of $0.10 per share , in line with its prior payout for a 9.9% forward yield. Most REIT investors are still feeling the heat from the March mini-banking panic and a Fed that continues to hike rates to quell inflation that remains elevated even against falling energy prices. The broader macroeconomic environment is now characterized by historically anaemic economic growth, inflation, and the fastest period of monetary tightening in well over a decade.

However, Gladstone trailing 12-month yield has moved up to a record only eclipsed by the 2008 financial crisis and the early pandemic stock market crash since it went public in 2003. To be clear here, Gladstone's yield has only over been higher on two other occasions in its history. Whilst this yield is retrospective, it underscores the abnormal extent that the current selloff has gone. Hence, the medium-to-long-term play here is that the current price to trailing FFO multiple of 7.79x moves higher as broader economic concerns wane and the so-called banking crisis moves into the rearview mirror.

The P/FFO Discount To Peers

Gladstone's price to trailing FFO multiple is 37% below its peer group median of 12.35x. Whilst the REIT being externally managed likely plays into this discount to its peer group, its tenure under manager Gladstone Management Corporation has been broadly shareholder accretive. The REIT up until the new year had paid out a consistent monthly dividend and up until the start of 2022 had delivered strong total returns to shareholders.

Earnings for its fiscal 2022 fourth quarter were mixed. Revenue of $37.22 million was a miss by $1.28 million on consensus estimates but growth of 5.4% over its year-ago comp. This was driven by 137 properties spread across 17.2 million square feet of mainly industrial and office properties in 27 states. This was leased to 112 different tenants across 19 industries to underlie Gladstone's broad portfolio diversification. The REIT had 96.8% of its portfolio leased as of the end of the fourth quarter, down by around 10 basis points sequentially but with an average remaining lease term of 7 years.

Fourth quarter funds from operations per share came in at $0.34, a miss by $0.05 on consensus estimates and a 15% decline from $0.40 in its year-ago quarter. The new FFO payout ratio at 88.24% fully covers the current monthly payouts but is still somewhat high even after the 20.3% dividend decrease earlier this year. Hence, there is a lingering specter of another cut in 2023 if FFO remains under pressure. The company's 6.625% Series E Cumulative Redeemable Preferred Stock ( GOODN ) remain a good income good play here. They've declined further since the start of the year to offer an 8.9% yield on cost against their $1.66 annual coupon also paid monthly. Their difference to par has also widened to $6.43, around a 25.7% discount, following a 17.5% year-to-date decline.

A Potential Recovery In 2023

The core risk to FFO comes from rising Fed funds rates. However, this is somewhat mitigated with 47.9% of Gladstone's debt being fixed, another 49% being a floating rate but fully hedged and the remaining floating 3.1% being the amount drawn on their revolving credit facility. Its management recently launched a $50 million share buyback program to convey their confidence in the REIT as well as buff up investor sentiment. Critically, it also signals that they're comfortable with their ability to maintain the lowered dividend through 2023 in spite of the broader macroeconomic headwinds that are forecast to remain persistent.

Management stated during their earnings call that corporate layoffs and the stickiness of working from home will form fundamental barriers to office space leasing and overall occupancy in the quarters ahead. Bears share this sentiment and the valuation gap between Gladstone and its peers will be hard to close if office properties remain unattractive to income investors. The current fat yield could remain a quasi-permanent feature as the REIT continues its capital recycling efforts away from office properties into industrial buildings. Indeed, whilst Gladstone acquired two industrial buildings during the fourth quarter with a combined 134,000 square feet , the company disposed of 146,200 square feet of office space also spread across two buildings. This has set the backdrop for 2023 with occupancy likely to remain high through 2023 and as sentiment likely recovers to pre-banking crisis levels. Gladstone continues to walk the market through its capital recycling effort and its progress here will be key for a valuation reset if office properties remain out of favour. I remain neutral on the commons but might take a position in the preferreds if the discount expands further than current levels.

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