RTL - Necessity Retail's 13% Yielding Dividend Is Enticing But Are Shares A Buy?

Summary

• Necessity Retail owns a diversified portfolio of both single and multi-tenanted properties leased to tenants operating in a wide range of industries.
• The portfolio was significantly expanded over the past year through a large acquisition, which resulted in a strategic shift away from a primary focus on single-tenant retail properties.
• The company is posting strong operating performance and has an encouraging outlook.
• While the 13% yielding dividend is enticing, an elevated debt load does necessitate an increase in risk premiums.

The Necessity Retail REIT ( RTL ) is an externally managed real estate investment trust (“REIT”) that has an interest in both single and multi-tenanted properties.

These properties are leased to a diversified group of tenants with no single tenant representing more than 4% of annualized straight-line rents. In addition, the properties are geographically diversified and serve 40 different industries, with no single state or industry representing more than 10% of their portfolio.

At the end of 2021, RTL signed a purchase and sale agreement to acquire 79 multi-tenant retail centers and two single-tenant properties for +$1.3B from CIM Real Estate Finance Trust (“CIM”). This represented a strategic shift away from their primary focus on single-tenant retail properties. In connection with the purchase, the company subsequently changed their name from “American Finance Trust, Inc” to its current name.

Through the year, the acquisition, which was completed in tranches and most recently completed in full in Q3, has yielded several portfolio enhancements. For one, it increased emphasis on necessity-based retail tenants and reduced overall concentration, while also de-risking from office assets.

In Q4FY21, for example, their top-ten concentration represented 38% of total rents. This has dropped to 28%. Similarly, office exposure has dropped from 7% previously to just 1% at present.

Though the acquisition has produced numerous accretive benefits, it has also significantly increased their debt load, which was already high. The company has now committed their focus to deleveraging through asset dispositions. While this is positive, the still high leverage position presents risks, especially in a rising rate environment. For income investors, the current 13% yield on the dividend is just as enticing as the upside in the shares. The continuity of the payout, however, is more at risk of a cut due to their leveraged position. And the upside may fail to materialize in the near-medium term. Despite elevated risks, shares present enough risk/reward prospects for at least further consideration.

Recent Performance

In the most recent quarter ended September 30, 2022, RTL leased over 1M square feet (“SF”) of space. This includes 500K SF of new signings and 550K SF of renewals. On the renewals, the company achieved spreads of 7.7% during the quarter.

Together, the total leasing volume amounted to +$11.9M of annualized straight-line rent. As measured by square feet, the quarterly activity was the most in any quarter since 2018. This in-turn contributed to a sizeable boost in occupancy levels in their multi-tenant segment from 89.4% in the second quarter to 90.6% at the end of the third. Including their pending commencements, occupancy would be up another 220 basis points (“bps”) to 92.8%.

Through nine months of the year, the company has now leased over 1.9M SF of space, 1.1M of which are related to renewals with positive YTD spreads of 7.1%.

YOY, annualized straight-line rents have also increased nearly 38% on square footage growth of over 43%, due primarily to the accretive effects of their recent acquisition of CIM’s portfolio, which was completed in full in the current quarter following their close on the one remaining property in the portfolio. In addition, though adjusted funds from operations ("FFO") was down YOY, it was up 18% when compared to Q4FY21.

Looking ahead, the company has a disposition pipeline of over +$250M. This will add to the over +$300M completed YTD and will ultimately be used for deleveraging purposes.

Liquidity And Debt Profile

In connection with their CIM portfolio acquisition, RTL took on significant debt to finance the transaction. This has significantly levered their balance sheet. Net debt as a multiple of adjusted EBITDA, for example, presently stands at 9.7x.

In addition, interest coverage is down to 2.5x from 3.5x last year. Part of this is due to the overall higher debt balance. But the other aspect is the lower fixed-rate composition. Last year, fixed-rate debt represented 89.7% of their load. That has since dropped to 83.1%.

Recent dispositions along with their existing pipeline is encouraging. But this is unlikely to significantly reduce their overall stack, which was high even prior to the acquisition. At the end of Q4FY21 , the last full quarter prior to the CIM acquisition, for example, the net debt multiple stood at 8.2x. This does create risks, especially in an environment where rates are higher for longer.

Partially offsetting this risk is their favorable debt ladder that is weighted more heavily towards later years; 63% of their total load is due after 2026. RTL does, however, have about +$300M coming due in 2023. Though existing liquidity of +$81M is short, they do have the disposition pipeline, which should be able to cover the maturity in full.

Still, despite the favorable debt ladder and a viable path to address their near-term obligations, a higher risk premium is necessary due to the size of their liabilities.

Dividend Safety

RTL’s yield is highly attractive to income investors. Presently, the quarterly payout is $0.2125/share. Annualized, this represents a yield of over 13%. And for the most part, the payment has remained stable for the past few years, after having been cut early in 2020.

Whether it is safe from a cut is a different matter. In its current form, the payout is just over 80% of their adjusted FFO. While this represents adequate coverage, it is higher than the sector average . In addition, the company is currently in deleveraging mode following the completion of their CIM acquisition. With the added focus here, the Board could be more inclined to preserve cash by means of a dividend cut. Given the current yield, that decision is easier since any cut would likely still result in an above-average yield.

Main Takeaways

RTL’s current operating performance reflects accretive gains captured in their CIM acquisition. This is seen in double-digit growth in straight-line rents, as well as in AFFO from Q4FY21. Leasing volumes also remain in record territory. And this is accompanied by a healthy pipeline of pending commencements.

Full rent collections and high exposure to investment-grade tenancy provide assurance of the stability of their reoccurring cash flows. Offsetting their current portfolio metrics, however, is their elevated debt load. A greater mix of floating rate debt also exposes the company to the risks relating to rising rates.

In addition, the company's external management structure is another credit risk due to the conflicts of interest often associated with such arrangements. In fact, RTL is currently going through a proxy fight relating to this.

While the 13% yielding dividend is enticing, investors should apply it with a higher risk premium. Though covered by AFFO, rising rates can pressure earnings in future periods. And with management now focused on their de-levering efforts, a cut should not be treated with surprise.

Down over 30% over the past year, shares do have room to run higher. At 6.6x forward FFO, the stock does trade below their peer set, though the higher debt load partially justifies the lower multiple.

Still, an 8x multiple would not be unreasonable, considering the strategic shift in their operating portfolio. At this multiple, shares would have upside of about 20%. In addition to the current dividend yield, that could produce sizeable returns for long-term shareholders. For those with higher risk tolerance, the stock offers a good risk/reward proposition. For others, it’s at least worth an addition to the watchlist.

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