O - Realty Income Stock: Should You Buy Ahead Of Earnings?

2023-11-03 09:00:00 ET

Summary

• Realty Income Corporation will report its third-quarter results post-market on November 6th.
• The recent selloff in Realty Income's stock price has made it an attractive investment opportunity.
• The strong results from other net lease REITs suggest that Realty Income is likely to have positive earnings results.

Realty Income Corporation (O) will report its third quarter results post-market on the 6th of November.

Is now a good time to buy Realty Income shares ahead of its quarterly earnings?

We believe so, but before I explain why, let's back up a bit.

We recently posted an article that explained why we are finally buying Realty Income. In short, until recently, Realty Income was priced at a premium valuation relative to its peers and that's despite growing at a slower pace.

But this changed following its recent crash.

Its valuation multiple is now slightly lower than that of its peers and its dividend yield is also about 100 basis points higher:

So if you are a conservative income-oriented investor who isn't seeking to maximize total returns, then Realty Income is a great pick at these prices.

And we think that especially today could be a good time to buy shares ahead of its earnings.

That's because Realty Income just announced that it would acquire its close peer and fellow real estate investment trust ("REIT") Spirit Realty Capital, Inc. ( SRC ) in a massive $9.3 billion all-stock transaction that will be immediately accretive. I don't think that SRC would have accepted such an all-stock transaction if Realty Income was about to disappoint investors with poor results.

Moreover, most of Realty Income's peers have already reported their results and they have all been surprisingly strong.

To give you a few examples:

• VICI Properties ((VICI)) boosted its 2023 guidance on the back of strong acquisition volumes and it is now guiding to grow its AFFO per share by 11% this year alone.

• Essential Properties Realty Trust ((EPRT)) also hiked its 2023 guidance and guided for consistent mid-single-digit growth in 2024 and 2025, despite the surge in rates.

• EPR Properties ( EPR ) also lifted its guidance and noted that its theater's rent coverage is now near pre-pandemic levels, which is very good news for those who follow EPR.

• Agree Realty ((ADC)) also beat its earnings expectations for the quarter and guided for steady growth in the years ahead. It noted that it should be able to grow by 3% annually even without accessing capital markets because it has no debt maturities until 2028, enjoys steady rent growth, and retains a big chunk of its cash flow for new acquisitions.

• Netstreit ( NTST ) also beat its earnings expectations and increased its guidance for the year, now expecting to grow its AFFO per share by 5% in 2023.

So across the board, net lease REITs did better than was expected, and all these strong results are very positive for Realty Income.

It means that the net lease property sector is doing well, and in fact, even better than what most analysts were expecting.

But despite that, Realty Income is still today priced at near its lows. None of these positive news items have been priced into the stock:

And while I don't have a crystal ball, I believe that all these strong results also increase the likelihood that Realty Income will also positively surprise us on November 6th.

It seems that net lease REITs are outperforming this quarter across the board because they have been able to buy new assets with attractive cap rates.

Net lease REITs use relatively little debt when compared to private investors and this is today a major advantage. The average LTV of net lease REITs is just around 35% compared to closer to 60% for private investors, and this lower debt today puts them in an enviable position to acquire properties at low prices from overleveraged landlords.

I think that the commentary from Agree Realty's CEO is especially interesting for Realty Income because it is a very similar REIT that focuses on higher-quality net lease properties.

Here's what he said (emphasis added):

"We continued to push cap rates higher during the quarter without sacrificing quality and maintaining our stringent underwriting criteria. Within our targeted sandbox, there continues to be a lack of capitalized competition and our track record of execution makes us the buyer of choice in today's market. We anticipate this dynamic will persist and consequently, cap rates will continue to move higher , albeit slowly and steadily given the large and fragmented nature of the net lease space." Joe Agree, CEO of Agree Realty, Q3 2023 earnings call .

Then he later also added that (emphasis added):

"We acquired properties at a weighted average cap rate of 6.9%, a 10-basis point expansion relative to the second quarter and 70 basis points higher than full year 2022. The weighted average lease term was 11.5 years and approximately 73% of annualized base rents are derived from investment-grade retailers. We acquired 7 ground leases during the quarter, representing approximately $35 million or 8.2% of total acquisition volume for the quarter."

So in other words, they are buying higher quality assets than in the past at now higher cap rates, resulting in faster growth.

Netstreit's CEO also made an interesting remark on cap rates. He said that:

"We are seeing significantly more opportunity for acquisitions in the fourth quarter at higher cap rates than what we have seen in 2023." Mark Manheimer, Netstreit's CEO, Q3 2023 earnings call .

I believe that Realty Income is ideally positioned to benefit from that.

It is the only A-rated net lease REIT with access to debt even in Europe, and this gives it access to significant liquidity at a relatively low cost.

Realty Income has recently also begun to take advantage of higher-yielding opportunities that nicely compensate for its now higher cost of capital.

So based on all these remarks, I am quite optimistic about the coming quarters for Realty Income, and if I didn't own a position, I wouldn't wait for earnings to come out to start accumulating.

But with all that said, I want to remind you that I don't have a crystal and can't predict what the market will do over the short run.

Maybe, Realty Income will report strong results and its share price will drop anyway. Or maybe unlike its peers, Realty Income could disappoint in the near term.

But none of that really matters.

What should matter to long-term-oriented investors is that valuations are historically low even as the net lease sector is doing well. Rents keep on growing, cap rates on new acquisitions are attractive, and conservatively financed REITs like Realty Income should be able to take advantage of that.

Trading at just 11.4x FFO and offering a 6.7% dividend yield, we give Realty Income a Strong Buy rating ahead of its earnings.

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