O - Realty Income: Great Buying Opportunity So Don't Over-Think It

2023-10-20 16:25:40 ET

Summary

• Realty Income offers a growing monthly dividend with a current yield of 6% and 29 years of consecutive growth.
• The recent surge in interest rates has impacted the stock and other REITs, resulting in a significant decline in their value. Nothing changed fundamentally for O.
• With an estimated FFO growth of 4% going forward, we are looking at double-digit returns when combining the 6% dividend.

Introduction

Over a decade ago, I was an inexperienced investor that added stocks to my portfolio on nothing but a hunch. I was a college student trying to get my feet wet in the world of investing and I was really passionate about making my money work for me. I was fortunate enough to have a full time job while being a student, so I managed to consistently tuck money into my brokerage account.

I remember really committing to my investing when the portfolio reached $10k and I was so excited. However, 6 months later my excitement would come to an end when my positions tanked 35% in a day. Buying low quality stocks without understanding the business or industry was a result of my ignorance and I paid a price for the lesson. I was a stupid kid that only put in half the effort required but I was stubborn so I never gave up on my financial education.

I bring this up because now over a decade later, I'm wiser, more experienced, and more emotionally hardened as an investor. Even though I'm in the red from a cost basis perspective, I can remain sensible and see the opportunity in front of me rather than panic. Realty Income ( O ) has fallen 22% YTD and I've never been more excited at the opportunity. The younger me would be freaking out right now and would've foolishly sold out of his position. However, when a sector sell-off like this happens I am now highly capable of analyzing the business itself and seeing if the fundamentals have been affected. In the case of Realty Income, I believe this to be a strong buying opportunity as the business is resilient to turndowns, the dividend sits at a historical high, and the upside price potential is attractive.

Overview

Realty Income Corporation ((O)) is a dividend community favorite. Realty income is a REIT that offers a growing monthly dividend, making it an appealing choice for income-focused investors. For years I've been closely monitoring this stock, looking for a strategic entry point to add a sizeable amount of cash to my current position. Now that the price has fallen substantially, that perfect entry point is now.

Currently, the stock boasts a high starting dividend yield, hovering around 6%. Realty Income has always attracted investors seeking consistent income due to its impressive history of dividend growth over the past two decades and its monthly payouts. Realty Income has consistently increased their dividend payouts for over 29 years and with a conservative payout ratio of 75%, there's ample room for continued growth.

It's essential to recognize that Realty Income is backed by a strong balance sheet. Even in the midst of the challenging real estate market conditions, it remains a standout performer. However, the recent surge in interest rates has impacted not only O stock but also numerous other REITs, resulting in a significant decline in the entire sector.

Recent Downward Movement

Realty Income's stock has fallen more than 22% YTD now. The question is, when is the right time to invest? My perspective is that the price will begin turning around at the slightest indication of interest rate cuts happening.

It's important to emphasize that Realty Income is in no financial danger and the price drop does not reflect some sort of internal conflict happening. What we are experiencing is an entire sector being hit. If you don't already own shares, I think now would be a great entry point. I believe that Realty Income's portfolio structure is as resilient as ever and I will attempt to outline some of the key points explaining why. The main contributors to Realty Income's future success are the following:

1. Their Structure - Triple Net Leases.
2. Consistent Income Generation - 6% Dividend.
3. Valuation - 30% Price Upside.

Resilient Structure

For those unfamiliar with Realty Income, the company owns and manages a diverse portfolio of commercial properties leased to single tenants on a long-term, triple-net basis. The company is organized as a REIT, with its monthly dividends covered by the cash flow generated from a portfolio of more than 12,200 real estate properties. These properties are predominantly held under long-term net lease agreements with commercial clients.

I like the triple net lease structure because it provides investors with a range of advantages which make them an attractive option. With these leases, tenants assume responsibility for property taxes, insurance, and maintenance costs, in addition to the base rent. So why would tenants willingly sign up for this sort of structure? Well, tenants usually have the benefit of a lower monthly rent, transparency in necessary maintenance, longer-term leases, and a sense of stability that offers predictability for the tenants. I believe this is why we've seen the historical median occupancy rate for Realty Income remain at a high 98.2% through economic downturns against the average S&P 500 REIT.

This structure helps maintain a steady and predictable income stream for investors. Triple net leases are notably hands-off, reducing management responsibilities for Realty Income as tenants are supposed to tend to the upkeep. Long-term stability is another perk, as trip net leases often involve well-established tenants signing long-term leases. These investments offer diversification opportunities and lower vacancy risks. This structure works especially well for Realty Income because of their tenant's creditworthiness.

Realty Income has an impressive enterprise value of approximately $62 billion. With an annualized base rent of around $3.8 billion. Its quality is further underscored by its A- credit rating from S&P.

Their diverse portfolio of real estate has exposure to 85 different industries and over 1,300 individual clients. An excellent 91% of their rent is resilient to any sort of economic downturn. Furthermore, 40% of their rent collection comes from investment-grade clients. In my opinion, this is top tier setup. In addition, a lot of their top tenants are very recognizable brands with great balance sheets.

The largest clients of their portfolio consist of popular businesses such as:

• Dollar General ( DG ) - 3.8%.
• Walgreens ( WBA ) - 3.8%.
• Dollar Tree ( DLTR ).
• 7-Eleven, owned by ( OTCPK:SVNDY ) - 3.2%.

The largest industry exposure is with convenience stores at 11.1% closely followed by grocery stores which account for 9.9% of their portfolio. All of their top 20 clients fall into categories that are more resilient to being affected by e-commerce competition. Realty Income has really tried to build a portfolio that limits exposure to changing consumer behavior in retail, has low price points, and is also service oriented.

Dividends

The current dividend yield sits above 6%. It's as if we've taken a time machine back to 2014. The only time the dividend yield has ever touched 6% was a decade ago and during the flash crash caused by COVID in 2020. If you were to buy during both of these periods, you would've collected some consistent dividend income this whole time. So if you missed out in 2014 or during the crash of 2020, here is your redemption: don't miss out now. Don't overthink this.

They've managed to increase the dividend payments for 29 consecutive years. Since 1994, the increases of the dividend comes out to an annualized growth rate of 4.4%. Starting a position captures an upfront yield of 6% and enables you to take part in this consistent dividend growth. The current payout sits at a relatively low 75% which means that management is able to use the remaining 25% to pay off debts and reinvest back into new acquisitions and expansion.

Now that the dividend sits at a high, I believe this presents an opportunity to collect a double-digit return annually. On average, Realty Income has grown at a slower AFFO (adjusted funds from operations) growth between 4% - 5%. This growth combined with the 6% yield brings your potential return into the double digits, not even including the inevitable future dividend raises that are likely to take place.

Valuation

As mentioned, AFFO growth comes in around 4% on average. Realty Income has only had 1 negative earnings year: 2009. They managed to not only survive, but remain profitable during previous economic downturns as well as through the crash in 2020. Albeit, their earnings may have been less during this time period, but still remained positive.

FFO is important because historically it has been much higher. As of now, we can take the current market price of $50/share and divide it by the FFO per share of approximately 4.

$50 per share / 4 = FFO of 12.5x.

Pre-pandemic shares traded at a price level that left the yield around 3.8% and the FFO was closer to 17.5x. In addition to this, the average price target remains at $64.47/share which represents an upside of 30%. As previously mentioned, I do think that once interest rates start to get lowered, we can expect a substantial price rise for shares of O. The key word is "if" interest rates go down.

Forward Looking - Interest Rates

Interest rates will have an effect on the price movement of O. It seems like the consensus is that analysts estimate rates remaining high. This is because despite a series of interest rate hikes, households and businesses have sustained high levels of spending. The persistent tightness in the labor market, along with consistent consumer and business spending, indicates that inflation remains a concern.

If interest rates remain elevated, we may see a prolonged period of sideways movement before the eventual recovery. Another believer that interest rates will remain elevated is billionaire, Howard Marks , who believes that the current environment that we are in should be considered normal.

It's worth noting that the Federal Reserve initially increased interest rates with the primary goal of reining in inflation. We've witnessed a notable decline in U.S. inflation, plummeting from its peak of 9.1% back in June 2022 to a more moderate 5.5%. In my personal view, I'd anticipate that if and when inflation dips below this benchmark of 2%, we might see a corresponding downward adjustment in interest rates and thus a rise in the price of Realty Income.

Takeaway

The recent 22% YTD decline in Realty Income's ((O)) stock price presents an enticing entry point for long-term investors. Realty Income's enduring strengths lie in its resilient structure, characterized by triple net leases and a diversified portfolio. The company's impressive history of consistently increasing dividends, coupled with the current yield surpassing 6%, further adds to its investment appeal as this consistency should continue into the future.

While external factors such as interest rates may influence short-term fluctuations, Realty Income remains well-positioned for the long haul. A potential decrease in interest rates, if it materializes, could potentially trigger a resurgence in the stock price. Realty Income continues to be an appealing option for those in search of not only reliable income but also substantial growth potential.

Lastly, it's worth noting that Realty Income's FFO (Funds From Operations) growth typically averages around 4%. This steady growth, when combined with the 6% yield, holds the potential for a double-digit annual return that I plan on capturing.

Editor's Note : This article was submitted as part of Seeking Alpha's Best Value Idea investment competition , which runs through October 25. With cash prizes, this competition -- open to all contributors -- is one you don't want to miss. If you are interested in becoming a contributor and taking part in the competition, click here to find out more and submit your article today!

For further details see: