2024-01-10 06:59:20 ET
Summary
- Getty Realty's shares have underperformed due to its equity issuance and the impact of electric vehicle penetration on gasoline-related businesses.
- GTY owns 1,480 properties across 40 states, focused on convenience stores, gas stations, and car washes, providing stable and growing cash flow.
- Getty's properties have a high occupancy rate of 99.7% and a long average lease life, ensuring a high certainty of cash flow in the coming years.
Shares of Getty Realty ( GTY ) have been a poor performer over the past year, losing about 16% of their value. Like many real estate stocks, its valuation was negatively impacted by higher interest rates; however while much of the sector has recovered sharply, Getty has lagged in the recovery. While its equity issuance is higher than I prefer, Getty's underperformance has left it offering attractive relative value.
With a ~$2.3 billion enterprise value, Getty is a relatively small real estate company, though it has a large presence within its fairly unique niche. The company owns 1,480 properties across 40 states, focused on convenience stores, gas stations, and car washes.16% of its rent comes from the New York City metropolitan statistical area ((MSA)) with Washington DC at 7% and Boston at 5%. While the company's legacy sits within convenience stores, it has diversified into areas like car washes, maintaining its focus on cars and convenience.
As the company has diversified and moved into higher-earning properties in major MSAs, it has seen operational improvement. As you can see below, its average property is about 70% larger, leading to 40% more rent. Thanks to its improving property mix, its AFFO margin has expanded from 46% in 2015 to over 60% today.
Now, one barrier to the stock's performance has likely been the fear that gasoline-related businesses could face headwinds from increased electric vehicle penetration. Recently, EV plans have been scaled back given slower-than-hoped-for consumer demand, but the trend over time is highly likely to include more EVs on the road. While gasoline is not a growth business, it is very slowly declining, and given the number of years it will take to fully transition new sales, let alone the existing stock of cars on the road to EVs, this demand is likely to be a slowly melting ice cube, not a sudden drop. Indeed, gasoline demand is down just 3% from 2019, less than 1% per year
Moreover, much of the profits from Getty's operators come from convenience stores. No matter what car you drive, pit stops on the road for bathroom breaks, or to grab a soda, are highly likely to continue. This is also a segment of the retail industry largely insulated from e-commerce pressures. Indeed, we have seen ongoing strong growth in convenience store sales, even against a backdrop of declining gasoline sales. This demand has also proven to be noncyclical, continuing to rise through four of the past five recessions. Similarly, an electric vehicle needs to be washed just as often as a car with a combustion engine, a reason GTY has made car washes a meaningful share of its growth cap-ex spending.
This provides stable and growing cash flow for the tenants in Getty's properties, ensuring that they will continue to be able to make rent payments. Importantly, its customers have solid financial health, given the strength of the c-store business. The average tenant has 2.7x rent coverage. Furthermore, only 7% of tenants have less than 2x rent coverage with none below 1x which will keep bad debt limited.
Getty's properties are also highly sought after with a 99.7% occupancy as of the third quarter . Getty also has a long average lease life, as it acquired many of its properties in sale-leaseback transactions. Overall, it has a 9-year average remaining life with less than 1% of leases expiring in 2024. The majority of its leases expire in 2032 or later, providing a high certainty of cash flow in the coming years.
These strengths were apparent in the company's third quarter results. Adjusted funds from operation (FFO) rose by 14% to $29.4 million. Revenue rose by 18% to $49 million. Getty's 60% AFFO margin declined from 62% last year due to higher interest expense and straight-line revenue recognition impacts, but it remains quite high. Additionally, Getty's leases include 1.7% annual rent escalations on average, which helps to grow cash flow over time but has lagged inflation rates over the past year. Over 60% of these escalators occur annually with others occurring every 3-5 years. Given these strengths, the company increased its dividend by 4.7% alongside Q3 results to $0.45 and raised AFFO guidance by $0.01 to $2.24-2.25
On the negative side, while AFFO rose double digits, AFFO per share was up a more modest 6% to $0.57. This is because Getty's share count rose about 8% from last year. Getty has been aggressively expanding its property ownership. Through nine months, it has invested $269 million in cap-ex this year, spending $169 million on 34 properties, including 20 car washes and 10 convenience stores. It has spent a further $46 million on 16 car washes still under construction. Getty runs a fairly tight dividend coverage ratio of 1.27x based on Q3 results and the dividend increase.
Now, given the long-term nature of its leases, its cash flow is highly predictable, allowing a lower coverage ratio. This means though that Getty only retains about $25 million of cash after its dividend, just a fraction of its investment program. While it uses some debt funding for growth projects, GTY needs to issue equity to help fund investments in order to maintain a solid balance sheet. That is why it has a $350 million at-the-market equity issuance program.
This increased share count dilutes some of the underlying growth from the investments. It also means that if shares fall significantly, its cost of equity can be quite high, meaning new property acquisitions may not be accretive to existing shareholders. This is why, all else, equal, I would rather see the company pay a somewhat smaller dividend and need less equity issuance, though I recognize the trade-off of lower income for investors would be viewed negatively by others. Regardless, this strategy is unlikely to change. I view it as an ongoing risk, but for now, the program is working relatively well.
Third-quarter investments have an initial cash yield of 7.2% with a 17.2-year average lease. Getty also has another $95 million in investment activity under contract. These are expected to provide a 7.4% day-one cash yield. As a reminder, these leases also have annual escalators, which should increase their yield over time. When we consider Getty's day-one funding costs, its shares have a 6.2% dividend yield today, and Getty has $48 million of unsettled equity issuance proceeds, which will go towards this and other growth spending. Subsequent to quarter end, it entered into a term loan at 6.13%, including the impact of associated interest rate swaps. Its all-in cash cost of funding on day one is below 6.2%, and it is earning 7.2-7.4% on investments it just made and is just about to make.
This still provides a ~120bp spread over its cost of funding. On the upcoming $95 million of projects, that is about $1.14 million, providing about $0.02 of accretion to existing shareholders, or about 1% of accretion to annual FFO. $95 million of investments equates to just about 4% of the company's enterprise value, so about 75% of the growth from these projects is consumed by higher interest expense and share count. Now, management did guide to higher investment yields in coming quarters, given the pressures facing the real estate industry, which should make deals more accretive. However, this share count headwind is why I would expect Getty's per share growth results to be significantly smaller than might be expected given the scale of its investment program. Still, with 1.7% annual rent growth, 1-2% accretion from growth projects, and a 6.2% dividend yield, Getty can provide a long-term total return of about 10%. Importantly, with the company pushing its revolver into a term loan, it has a well-laddered debt schedule, which limits refinancing risk in an era of higher rates.
Amidst the recent decline in long-term yields over the past three months, we have seen many real estate stocks surge, which is why I have recommended taking profits in names like Extra Space Storage (EXR). As you can see below, GTY shares moved alongside long-dated treasuries ( TLT ) as yields rose in Q3, but they have materially underperformed over the past two months, which I believe makes shares relatively attractive.
One reason for this underperformance may be a concern that yields on its new investments will be lower given declining bond yields, narrowing the spread GTY earns. However, Getty locks in yields several months before it closes on acquisitions, meaning its $95 million in pending investments will be accretive as should new deals announced alongside its next earnings report. Moreover, if yields on new acquisitions no longer are accretive relative to Getty's funding costs, it can always slow the pace of deals, and just based on its retained cash from its FFO coverage and base rent increases, it can grow its dividend over 2% per year. Moreover, lower bond yields should increase the value of its portfolio, allowing for potential dispositions and portfolio optimization.
Getty operates in a unique niche, but even with electrification, its convenience-oriented portfolio should prove resilient and provide durable income growth to investors. Its funding structures do make it susceptible to capital market volatility, but its investment program is accretive nonetheless. I view its 6% dividend as secure with mid-single-digit growth likely. Holding interest rates flat, I would expect shares to migrate to $31 over the next year, providing about a 12% total return opportunity, and making Getty a buy for income-oriented investors.
For further details see:
Getty Realty: Recent Underperformance Creates An Opportunity