2023-09-11 16:13:44 ET
Summary
- NNN REIT faces challenges due to inflation, but it offers a 6% yield, a strong balance sheet, and dividend growth potential.
- Despite inflation concerns, the retail real estate industry shows resilience with increasing store openings, benefiting NNN's stability and tenant retention.
- NNN stands out as a consistent player in the REIT space, boasting a robust portfolio, prudent management, and attractive valuation, making it an appealing income-focused investment option.
Introduction
This is not a great environment for a lot of REITs, consumer staples, utility companies, and a wide range of other companies that are expected to struggle with pricing power in an environment of sticky inflation.
Year-to-date, all of these investments are underperforming the S&P 500 - by a wide margin!
One of the stocks that cannot catch a break is NNN REIT ( NNN ) . This net lease giant is down 14% year-to-date, including dividends.
Since my prior article on July 17, the stock price has fallen 11%, showing that downside momentum has accelerated.
The company, which used to be named National Retail Properties, is one of the casualties, as investors aren't keen on holding companies that could struggle with future retail bankruptcies, as the consumer is not in a great place right now.
On top of that, sticky inflation could put tremendous pressure on cash from operations, as most REITs are prone to capped rent escalators.
The good news is that NNN REIT is now offering a 6% yield. The company is a dividend aristocrat, it has a stellar top-tier balance sheet, and it just upgraded its full-year guidance.
Although I have to agree that some REITs aren't the best plays for high inflation, picking up top-tier income plays for long-term portfolios is highly attractive at these prices.
Furthermore, since my prior article, we've seen new data showing that the retail real estate industry is in better shape than one might have thought. When adding the company's guidance hike and other qualities, we get an even better bull cash for income-focused investors.
In general, I have to say I'm extremely pleased with NNN's progress, which is one of the many reasons I'm taking another look at this gem.
So, let's get to it, as we have a lot to discuss!
Retail Isn't That Bad
I've been on the sticky inflation and higher-for-longer (regarding Fed rates) train for a while. Hence, I get it when people aren't keen on investing in certain REITs.
However, it's not all bad.
For example, in this environment, a lot of high-quality companies are being sold, which comes with attractive long-term opportunities.
It also helps that the fundamental data isn't too bad.
On August 21, the Wall Street Journal published an article discussing the health of the retail segment of commercial real estate.
Wall Street Journal
According to the article, retailers in the U.S. are defying expectations by planning to open a net total of 1,000 new stores this year despite record-low retail availability and challenges in the commercial real estate sector.
Demand for retail space remains strong, even in the face of inflation, elevated interest rates, and liquidations of major retailers.
This is what that would look like:
Wall Street Journal
Note that we're seeing two consecutive years of net store additions. This is better than some years with subdued inflation and high consumer sentiment!
This resilience in the retail sector can be attributed to several factors.
- Firstly, there has been a significant reduction in retail construction since the 2008-09 financial crisis, allowing the market to stabilize.
- Additionally, retailers have harnessed online sales data and analytics technology to strategically choose store locations.
- Contrary to predictions, internet sales haven't eliminated physical retail; instead, online-native companies are venturing into brick-and-mortar spaces.
- As pandemic restrictions eased, consumers returned to stores and restaurants.
As of mid-August, retailers had announced plans for around 4,500 new store openings while closing approximately 3,500, according to Coresight Research. Nationwide, the availability of retail space dropped to 4.8% in the second quarter, marking an 18-year low.
This brings me to NNN, which may very well be one of the two best retail REITs money can buy - the other is Realty Income ( O ), also known as The Monthly Dividend Company .
Consistently Rising Income & Stability
NNN is a giant. The company owns close to 3,500 properties. Its largest tenants are convenience stores, automotive service companies, restaurants (full service and limited service), family entertainment centers, and health and fitness companies.
NNN REIT
Its largest tenant is 7-Eleven, which accounts for 138 properties and 4.6% of the company's annual base rent ("ABR"). Number two on its list of largest tenants is Mister Car Wash, followed by Camping World - both account for 4% of ABR.
AMC Theatre ( AMC ), which is doing very poorly (to put it mildly), accounts for 2.8% of ABR, as NNN owns 20 of its theatres. So, if the company were to lose a struggling tenant, that would be manageable.
I'm not worried about that, and the market is currently pricing in the probability that some major tenants in the retail industry may go bust - giving us a better risk/reward.
NNN REIT
Ignoring economic risks, the company benefits from the fact that it has renewed more than 80% of its leases since 2007. The weighted average remaining lease term of its portfolio is 10.2 years. Only 3.3% of its leases expire through 2024.
It also needs to be said that only 4.7% of its properties are in the West. I know that a lot of readers want to avoid cities like Los Angeles (Southern California, in general) and San Francisco. NNN has major exposure in the Southeast, the South, and Midwest.
NNN REIT
Its resilient portfolio has provided tremendous stability in the past. Not only is the company's occupancy rate above 99%, it has consistently outperformed its peers. Even during the Great Financial Crisis, the occupancy rate did not drop below 96%.
NNN REIT
Whenever NNN buys properties, it tries to buy small properties with a value between $2 and $4 million and a high land value.
While this environment is unfavorable for margins, it does benefit from the fact that most companies have a hard time getting access to capital. NNN is a major beneficiary of sale-leaseback acquisitions, where the company buys the property of a company that needs cash. In return, it receives rent.
It's a way for some companies to become asset-light and get access to funding. It also means losing one's building, but that's a major win for NNN - if it buys the right properties.
NNN prides itself on maintaining relationship business model and targeting sale-leaseback transactions . There is a lot that goes into deploying capital at the right risk-adjusted returns, and the value of NNN lease form is a tool to mitigate risk within the portfolio, which is easier to obtain if you have the sale-leaseback model. It can sometimes be overlooked.
[...] Based on bump in guidance on acquisition volume, our pipelines are a little stronger today than it was 3 to 6 months ago. The sale-leaseback market is still fairly robust. We're not seeing the distressed sale leasebacks just because -- we don't want to do business with the company as being distressed and has to do it .
- NNN 2Q23 Earnings Call
Not only does all of this sound like NNN is a fairly consistent player, but it also has the data to back it up.
NNN has raised its dividend for 34 consecutive years. This is the third-longest streak of all public REITs and 97% of all NYSE-listed companies.
Needless to say, this includes the Great Financial Crisis and the pandemic.
NNN REIT
Over the past five years, the average annual dividend growth rate was 2.9%. On July 14, the company hiked by 2.7%.
While NNN currently yields 6%, the slow dividend growth rate is a bit of a headwind - especially if inflation remains elevated.
The company has a 70% payout ratio, using its 2023 adjusted funds from operations guidance. That's a healthy number, and it protects investors against turmoil. A lot needs to go wrong for NNN to cut its dividend. We need a recession much worse than the Great Financial Crisis for that to happen.
The dividend (and company, in general) is also protected by a healthy balance sheet. The company has a BBB+ credit rating, which is one step below the A- range.
It has no secured debt, meaning that its assets are not used as collateral!
The weighted average debt maturity of its debt is 12.3%. It has a 5.5x net leverage ratio and zero debt maturities in 2023.
So, again, while this environment is unfavorable for REITs, NNN remains in a terrific spot to withstand turmoil.
Having said all of this, let's take a look at its recent results and guidance. After all, this tells us a lot more about how this company is doing.
NNN Remains In Great Shape
In the second quarter, the company continued what it does best - even in this environment. It made acquisitions totaling slightly more than $180 million. These deals had a 7.2% initial cash yield, which is impressive.
For the first half of the year, NNN invested more than $337 million in 79 new properties with an initial cash cap rate of 7.1% and an average lease duration of 19.4%.
Looking ahead, NNN anticipates initial cap rates for the second half of the year to be slightly higher than the second quarter, ranging from 10 to 20 basis points.
The company's portfolio maintained a high occupancy rate of 99.4% and had robust lease renewals, surpassing historical levels!
At the end of the quarter, NNN had only 22 vacant assets, a result of strategic efforts by its leasing department. Impressively, nearly 90% of leases up for renewal during the quarter were extended at 105% of the prior rent, demonstrating strong tenant retention.
Furthermore, in the second quarter, the company reported a quarterly core FFO (funds from operations) result of $0.80 per share, which marks a 1.3% increase from the prior year's $0.79 per share.
As a result of its success so far (and despite headwinds!), the company raised its 2023 core FFO guidance, increasing the lower end by $0.03 and the upper end by $0.02, resulting in a range of $3.17 to $3.22 per share.
NNN REIT
AFFO guidance was also adjusted, with a range of $3.20 to $3.25 per share.
This year's more modest growth was attributed to the high bar set by 2022's 9.8% growth and the reduced impact of tailwinds, coupled with the tapering of scheduled deferred rent repayments in 2023.
Valuation
NNN is trading at $38 per share. This is 11.8x AFFO (midpoint of its 2023 guidance). It's 11.9x FFO.
Looking at the chart below, this is the cheapest valuation since the Great Financial Crisis.
The current consensus price target is $45. This is 18% above the current price.
New data reinforces my belief that NNN is one of the best income plays in the REIT space. The company has a top-tier portfolio, prudent management capable of making the right deals, and a balance sheet that can withstand a vicious macro environment.
However, I do not disagree with a weaker stock price. Investors are selling REITs as they are focusing on stocks with better inflation protection.
The good news is that this comes with opportunities. NNN Is very attractively valued and yields 6%.
If I were an income-focused investor, I would be a buyer at current levels.
However, do not be an aggressive buyer if you decide that NNN is right for you. We could see more selling if inflation remains sticky and the Fed keeps interest rates elevated.
I would start small and add gradually over time. If NNN sells off further, investors can average down. If the stock takes off, investors have a foot in the door.
As some readers may have noticed, this is how I currently approach all of my investments. L3Harris ( LHX ) is a good example of a great stock that keeps dropping.
All things considered, this environment may not be fun, but I have little doubt that NNN will remain a terrific source of steadily rising income for many more decades to come.
Takeaway
NNN REIT is a gem worth considering. It offers a 6% yield, boasts a top-tier balance sheet, and recently upgraded its full-year guidance.
NNN is a dividend aristocrat with a remarkable 34-year history of raising dividends, even weathering crises like the Great Financial Crisis and the pandemic.
With a resilient portfolio, NNN maintains an occupancy rate above 99% and has renewed over 80% of its leases since 2007. Furthermore, its strategic approach to sale-leaseback acquisitions has proven successful, thanks to its relationship-based model and the value it brings.
While the current environment may pose challenges, NNN remains well-positioned to weather the storm.
For income-focused investors, NNN's attractively valued stock and 6% yield present an attractive opportunity.
However, caution is advised, given the uncertain macroeconomic climate.
For further details see:
6% Yielding NNN Hasn't Been This Cheap Since The Great Financial Crisis