O - NNN REIT: Lock In Dividends Before Rates Fall

2023-12-18 08:10:00 ET

Summary

• NNN REIT is a triple-net lease REIT with a highly diversified portfolio and a 34-year streak of consecutive dividend raises.
• The company has a strong track record of high occupancy and respectable shareholder returns.
• NNN is conservatively leveraged, has a well-laddered debt maturity schedule, and offers a 5.4% yield with a below-average valuation.
• Recent momentum around NNN stock could build as the Federal Reserve has signaled rate cuts next year.

If you listen to the market pundits on TV, you would think that the economy is always on the verge of a recession. Whether if one will actually happen in 2024 is anyone’s guess. As for myself, I don’t discount the fact that the market experts can be right on occasion, and that’s why I hedge my market bets with durable names that can not only survive but thrive in a lower interest rate recessionary environment.

Such is the case with triple-net lease REITs, which are in one of the most economically resilient sectors of the economy in the event of a recession. That’s because they come with high operating margins since the tenant pays for the property maintenance, insurance, and taxes, and long-term leases.

While there are a number of newcomers in this space, conservative income investors may want to stick with the industry stalwarts with lengthy track records of success. This brings me to NNN REIT ( NNN ), which is one of the oldest names in the space. Despite the recent rally in share price, NNN still trades 9% below where it was 12 months ago, as shown below.

I last covered NNN here with a ‘Buy’ rating back in May, highlighting its experienced management team and strong fundamentals. The stock has seen its share of ups and downs since then on interest rate fears, and is currently down 4.6% in price since my last piece (down 1.8% including dividends). In this article, I provide an update and discuss why now remains a great time to pick up NNN for uncertain times, so let’s get started!

Why NNN?

NNN REIT is a triple-net lease REIT as its name suggests, with a highly diversified portfolio of 3,511 properties that are spread across 49 U.S. states, 395 tenants and over 30 lines of trade. It’s worth noting that NNN has an even longer dividend growth streak than Realty Income Corp. ( O ) with 34 years of consecutive dividend raises under its belt.

This has enabled NNN to produce respectable shareholder returns. As shown below, NNN has given investors a 121% total return over the past 10 years, sitting below that of peer Realty Income and the S&P 500 ( SPY ), but ahead of office and industrial property focused W. P. Carey’s ( WPC ) 90% total return.

While peer Realty Income has produced a greater total return, investing doesn’t have to be a popularity contest, as owning NNN can be a great hedge for future returns. That’s because NNN is smaller compared to its bigger peer, and therefore it wouldn’t take as many deals to move the needle. At the same time, investors still get the benefits of a diversified property base. As shown below, NNN has a presence in every region of the U.S. with most of its properties being in the west of the Rocky Mountains.

True to its form NNN maintains high occupancy of 99.2% with a weighted average remaining lease term of 10 years, putting it more or less on par with Realty Income Corp. As shown below, NNN has had 10+ years of over 98% occupancy and occupancy has never dipped below 96.4% over the past 20 years.

Meanwhile, NNN still managed to grow FFO/share by 2.5% YoY to $0.81 during the third quarter despite economic uncertainties stemming from inflation and higher interest rates. It also doesn’t show signs of slowing down, as NNN made $213 million in property investments covering 46 properties at an attractive initial cash cap rate of 7.4%.

Importantly, these investments are accretive to the bottom line, as NNN was able to issue $500 million worth of senior unsecured notes in part to fund the aforementioned and future investments at a 5.6% interest rate over 10 years (due 2033), sitting lower than the aforementioned 7.4% initial cap rate. The respectable third quarter results are part of healthy growth for the first nine months of the year, with FFO/share growing by 4.3% YoY over this time period.

Looking ahead, NNN should be able to maintain quality fundamentals, with leases expirations that are well-staggered. This is reflected by just 2.0% of leases expiring through 2024. This provides portfolio stability for uncertain times while also giving NNN the ability to raise rents on expired leases to account for inflation.

Moreover, NNN’s aforementioned $500 million 10-year unsecured note offering at a 5.6% interest rate puts it in great position to pursue accretive growth. This is considering the fact that many over-leveraged private market buyers have been pushed out of the acquisition market, pushing cap rates above well above 6% , and NNN was able to achieve above 7% cap rates, as noted earlier.

Notably, NNN is also conservatively leveraged, with a debt-to-gross assets ratio of 41%, sitting well under the 50% level generally considered to be safe for REITs. It also carries strong interest and fixed charge coverage ratios of 4.6x. As shown below, NNN’s debt maturities are well laddered with no remaining maturities this year and just 3-4% of its debt maturing each year between 2024 and 2027.

At present, investors are paid a well-covered 5.4% yield, and the dividend is well-covered by a 69% payout ratio. Understandably, NNN isn’t a get rich quick stock, as it has a 5-year dividend CAGR of just 2.7%. The forward growth rate could be closer to 3% as that’s what analysts expect for the annual FFO/share growth rate to be over the next 2 years. I believe this could be achieved as interest rates stabilize or even decline, and as NNN gradually reprices its expired leases to account for inflation.

As shown below, NNN’s dividend yield remains towards the high end of its 10-year range despite the recent bounce in share price.

(Note: The following chart shows TTM yield. Forward yield is 5.4%)

Risks for NNN come from higher than expected inflation, which could outpace the rates at which it’s able to raise rents on annual escalators. This could also raise interest rates (although the market is now pricing interest rate cuts next year) and thereby increase NNN’s cost of debt. Also, increased competition for investments should rates go lower could result in cap rate compression.

Lastly, NNN remains solid value at the current price of $42.12 with a forward P/FFO of 13.1, sitting well under its normal P/FFO of 16.0, and under the 13.9 P/FFO of close peer, Realty Income Corp. At the current yield and modest expectations of around 3% annual FFO/share growth, NNN could produce close to the long-term total return of the S&P 500, all with a far higher yield and the stability of long-term net leased assets. In the near term, NNN's share price could go higher as the market now anticipate interest rate cuts next year, thereby making NNN's 5.4% yield more attractive to investors.

Investor Takeaway

Investing in NNN can be a great hedge against potential for a recession, as the company has a strong track record of high occupancy, 34 years of consecutive dividend raises and respectable shareholder returns. Additionally, NNN maintains high occupancy rates and has a well-laddered debt maturity schedule, positioning it well for continued growth and stability in uncertain economic times. At present, investors can get into NNN at a +5% Yield with a below average valuation. Considering all the above, and the potential for share price appreciation should interest rates go lower, I maintain a 'Buy' rating on the stock.

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