2023-09-21 10:00:00 ET
Summary
- Spirit Realty offers investors a safe, and secure 7% yield currently.
- I have a price target of $45.50 offering investors more than 25% upside from current price.
- SRC's portfolio is geographically diversified with most of its properties in two of the fastest growing states in the U.S.
- REIT dividends have outperformed 10-year treasury yields on a monthly basis for the last 3 decades.
Introduction
As many know, the stock market has not been kind to the REIT sector over the last year. But as I've said before, I don't see things as problems, only opportunities. I consider myself an experienced investor with some time under my belt. And one of the best things I've learned from the stock market over the years is to not panic. Another thing it has taught me is patience which is something I've struggled with most of my life.
But as we all know, that doesn't always work in your favor when investing. The great Warren Buffett once said, "Price is what you pay, value is what you get." Buying a great stock when it's overvalued can lead investors to get burned. Some of this depends on your time horizon but still, no one wants to overpay, especially during these times. So while some are hesitant to invest in REITs because of recent downturns, I see opportunities as some high-quality stocks are trading at a discount. And one of those happens to be Spirit Realty Capital ( SRC ). And in this article I'll discuss what makes SRC stock a buy in my opinion.
#1 The Dividend
As my name states I collect dividends. I enjoy it, in fact I love it. Some find it boring but I get quite the satisfaction from dividends hitting my brokerage account every month. And one way to ensure this is to constantly search the stock market for high-quality bargain stocks like SRC. I think it's safe to say real estate has been out of favor for a while due to rising rates. As you can see the sector is down slightly over the last 90 days in comparison to the market's 0.9% positive return, and down 9.3% compared to the market's positive return of 12.5% over the same period.
Although the sector is up over the last 3 & 5 years, you can see the overall market's return is far superior at almost 26% and 45% respectively. So a reader might say "Why would I invest in REITs when I can put my money in T-bills and CDs for a higher return?" And that may be true for some, but SRC currently offers a yield above the average at 7.28% at the time of writing. Furthermore, when you include dividends, REITs' 3 & 5 year returns increase dramatically to 17.5% and 21.5% respectively, while the market's increases to 31.9% & 60.7% over the same period.
The REIT recently raised its dividend 1% to $0.6696 from $0.6630 last month. And this is backed by a low payout ratio of 73%. They also trade at less than $37 right now so investors would be getting in at a great price. But just because something is cheap doesn't always mean it's a bargain. Buying into low quality stocks that are cheap and offer large dividends is yield-chasing . As a soon to be military retiree, I will also collect a nice pension and free healthcare as well for the rest of my life. I also managed to keep my debt low during my extensive career which has allowed the financial freedom to not get caught chasing high-yielding stocks that are low quality.
I'd rather buy something that has a lower dividend-yield that offers less risk. The dividends hitting your brokerage account every month or quarter is nice and all, but what happens when those dividends stop because of a cut? Anybody remember Medical Properties Trust ( MPW )? Just because you decided to invest in a company that was $10 a share and paid a $0.50 dividend and now that dividend has been cut because it couldn't sustain it. I'm just hypothetically speaking but you get my point.
I always tell people "Why not have a mix?" A mixture of high-yielders and low-growth dividend stocks. Dividend showers & growers. But even though I don't expect growth from all of mine or them to have high yields, I also don't expect any of my holdings to cut their dividend in the near term. How do I know they won't? Well I guess you can never truly know but I try to do my due diligence on all of my holdings.
And yes the average bond is yielding over 5% right now because of treasury rates, but that will not be the case once the FED begins to pivot. As you can see here, investing in REITs have been on par with regular stocks both returning 10.6% while far outpacing bonds over the same period. But who says you can't have both.
One thing I've noticed is people will downplay something they're not familiar with. Some are more familiar with bonds, money market securities, CDs, or shiny tech stocks. And I believe many prefer investing in traditional real estate instead of investing in it through the stock market. But because you lack familiarity doesn't mean it's a bad investment. Below is the average annualized REIT dividend yield and U.S. 10-year treasury yield on a monthly basis over the last 3 decades. As you can see the two have been positively correlated. But historically REITs have outshined treasuries on average.
#2 Impressive Portfolio Diversification
I know from looking at their top tenants one could say "They have controversial tenants like Walgreens ( WBA ), CVS Health ( CVS ), and AMC Entertainment ( AMC ) in their top 10 holdings". But all three account for less than 2% of annualized base rent. Another thing to consider is SRC's geographic location of their properties. Currently 48% of their ABR comes from properties located in the Southeast & Southwest regions. Their top two states, Texas & Florida, also happen to be two of the fastest growing states in the U.S. with both experiencing 1.5% to 1.9% growth from 2021 to 2022.
The industrial portfolio is also impressive leasing to big companies like L3Harris Technologies ( LHX ), Whirlpool ( WHR ), and FedEx ( FDX ). Not only are these mission-critical properties, most of them generate over $100 million in revenue and they typically have longer leases. At the end of Q2 the portfolio was 99.8% occupied with a weighted-average lease term of 10.3 years. Their CEO stated he expects leases to get longer as they look for sale-leaseback opportunities. They're now expected to be 15 years minimum and up to 20 years.
#3 Strong Balance Sheet
The third thing I like about Spirit Realty is their impressive balance sheet. The REIT sports an investment grade rating of BBB from all three major agencies. 100% of their debt is also fixed-rate with no debt maturities until 2025. And with the promised higher for longer environment, I still expect to see rates lower by 2H 2024, so I don't see this as a problem for the company.
Additionally, at the end of Q2 SRC had an impressive $1.6 billion in liquidity and a Net debt to adjusted EBITDA of 5.3x. They also revised AFFO guidance per share range from $3.54-$3.60 to $3.56-$3.62. This is impressive, especially in an environment where there's so much uncertainty and REITs have been punished over the last year. Even if AFFO came in on the low end of guidance, that would still put the payout ratio at 75%, well below the REIT average.
#4 Their Valuation
I don't know many stocks trading this low with a dividend this high. And if there are, I would say it's probably a red flag. But SRC has not displayed anything but green flags in my research. Strong balance sheet, well-laddered debt maturities, diversified portfolio, low payout ratio, etc. And their dividend yield is trading above its 5-year average making it undervalued. I say, what's not to like?
SRC's dividend growth over the last few years has been slow. The last 3 raises have averaged 2%, so using the Dividend Discount Model ((DDM)) I went with a 2% dividend raise for next year. Using a conservative 8% expected rate of return and 2% growth, this brings me to a price target of $45.50, slightly above analysts' target of $43.50. I rate SRC a buy and think it has some good growth in the coming years. Who knows maybe Realty Income will acquire them soon as stated recently by Brad Thomas. I wouldn't complain as I recently add O to my portfolio.
Risks
I don't think you can write about any company without it having any risks. Even some of the largest companies in the world have risks. With retail REITs, their largest risk is usually their tenants. In a recession, which some are expecting in 2024, tenant defaults could become a bigger issue. Although SRC has a diversified tenant base with most generating over $100 million in revenue, they do have some tenants considered risky such as WBA.
Another risk is increased interest rates but the company has well-staggered debt maturities with none maturing in 2025. One good thing is 100% of their debt is fixed-rate and 99.9% is unsecured. One thing to note is SRC does have a term loan due in '25 for $600 million. This has an average interest rate of 3.86%, so if rates do remain higher for longer, they may have to refinance at a higher rate. But as previously mentioned, I expect rates to be lower by then.
Conclusion
Although REITs are down over the last year, SRC offers investors a high and secure 7% yield. They have a low payout ratio and recently raised AFFO guidance in an environment where there so much uncertainty. I think this speaks volumes to the strength of the company, and I think the market is being too pessimistic when it comes to REITs. With treasury rates elevated, this has caused investors to rotate into safer, fixed investments for the time being. I suspect rates to come down by 2H 2024 and market sentiment to shift in favor of REITs. Right now SRC stock is a great buy that offers investors upside to its price target. And I expect this growth to continue once rates begin to fall.
For further details see:
4 Reasons To Cry Now Laugh Later With Spirit Realty