2023-09-12 05:22:06 ET
Summary
- NNN is a net lease REIT very similar to Realty Income.
- The REIT pays a high 5.9% dividend which it has increased for 34 consecutive years.
- I present my outlook for the company, compare it to peers and guide you through my calculation of expected 15% annual return.
Dear readers/followers,
NNN REIT ( NNN ), formerly known as National Retail Properties, is a net lease REIT very similar to Realty Income ( O ). I've covered the REIT before in my article called National Retail Properties: A Dividend You Can Count On .
In particular, I rated the stock a BUY in February, because of its highly reliable dividend which has increased for 34 consecutive years and because the stock was priced to deliver 10% annual returns. Since then, the stock has underperformed, dropping by about 18% to $38 per share. I was indeed too early to invest in this net lease REIT.
Today, following Q2 earnings , I want to publish an update to my thesis and compare the company's valuation and growth prospects to other notable net lease REITs, namely O and Essential Properties Realty Trust ( EPRT ) to determine whether it's worth buying today.
While comparing any net lease to Realty Income is logical, my choice of EPRT may be surprising to some. First, let me note that both make very good peers, because they focus on very similar properties in the $2-5 Million range and rent to similar groups of tenants. A comparison to EPRT is valuable, because the REIT is expected to grow at the fastest rate of all major net lease REITs of 6.3% (vs 1.8% for O and 1.2% for NNN).
EPRT Presentation
NNN REIT
NNN holds about 3,500 net lease properties all across the country. These properties are leased to a variety of tenants for 10-20 years, resulting in a long weighted average unexpired lease term (WAULT) of over 10 years. NNN's properties are primarily occupied by fast-food and casual dining restaurants (18%), convenience stores (16.5%), and automotive services (13.7%) and are essential for tenants to run their business.
NNN Presentation
NNN's business model is very stable. Long lease terms, tenants with high rent coverage of over 3x and small properties that are highly fungible and easy to re-lease have resulted in one of the most resilient portfolios in the sector. This is well illustrated by occupancy, which has never fallen below 96.4% and currently stands at 99.4%, which is above their own target of 98%. To give you an idea of how well the portfolio is doing, consider this - of their nearly 3,500 properties, only 22 are currently vacant!
NNN Presentation
And since only 3.3% leases expire until the end of next year, the leasing team really won't be under any kind of pressure to maintain near perfect occupancy going forward.
The market has, however, gotten a bit worried about rent collections. It is true that some of NNN's tenants are closing stores and/or struggling a bit. This includes AMC Theatre which accounts for 2.8% of ABR and especially Walgreens ( WBA ) which accounts for 1.9% of ABR. I'm not too worried about this and neither is management. Recently on their earnings call they said the following:
I'm not worried at all about their ability to pay rent. I guess that's the most important thing. They did announce store closures, none of ours are in that list. And so we don't have any concerns at all on that front. And just a reminder, even to folks, investors, even if a tenant closes a store, ... ,it doesn't change their obligation to pay us rent for those properties (for the duration of the lease).
In addition, it wouldn't be too difficult to re-lease Walgreens' stores to another tenant, because their stores are quite fungible and in good locations.
Overall, I like NNN's portfolio because it makes for highly visible cash flows, which in turn result in very safe dividends. The flip side of this, is that the REIT will not be able to grow much internally.
Sure, most lease agreements have build-in rent escalators of about 1.5% per year, but with a low number of leases expiring over the next few quarters and years, the company (unlike some of its peers) will not benefit from significant rent spreads on new leases.
Externally, the company is able to grow its portfolio and even make additional profit by recycling capital. During the first half of the year, they have acquired 79 properties for $338 Million at an average initial cap rate of 7.1%. Notably, all of these transactions have come from existing relationships, rather than from the open market. On the sell side, they have disposed of 13 properties for $40 Million at an average cap rate of 5.6%. For the rest of the year, management guides towards additional acquisition of $200-300 Million.
The reason why management is guiding to sub-2% FFO growth this year, is mainly connected to increased interest expense on their $300 Million outstanding on their line of credit, which they've been using to fund acquisitions. The problem is that it's very expensive at a 6% interest rate (floating). Apart from this, the BBB+ rated balance sheet with a net debt / EBITDA of 5.5x is quite strong with no maturities this year and reasonably low maturities from June 2024 onwards.
Valuation vs peers
We've discussed the reasons why NNN's dividend is safe and why FFO is likely to grow relatively slow going forward. Now let's compare it to peers.
Those interested in NNN will likely buy it, at least in part, because of its dividend. And for a good reason. NNN has the highest yield, the longest track-record of dividend increases and a very reasonable sub-70% forward payout ratio. Hence, from an income perspective, it's certainly worth a look.
REIT | Dividend Yield | years of increases | payout ratio |
NNN | 5.9% | 34 years | 69% |
O | 5.5% | 29 years | 74% |
EPRT | 4.7% | 4 years | 64% |
It also trades at the lowest P/FFO multiple of the peer group at 12x FFO. Some might say that this is somewhat expected, given the lowest level of expected growth and perhaps a slightly worse public perception compared to O, but in reality, the company isn't inferior to O in any meaningful way, especially when we consider that it pays a higher dividend at a lower payout ratio.
REIT | FFO growth | P/FFO |
NNN | 1.2% | 11.9x |
O | 1.9% | 13.5x |
EPRT | 6.3% | 14.1x |
NNN's return to a higher multiple likely won't happen overnight and will require the same catalysts as most REITs, i.e. a decline in interest rates. At the same time, sub-2% FFO growth clearly will not generate significant upside. But the reality is that we get to collect a very safe 5.9% dividend while waiting for multiple expansion, which I believe is only a question of time.
While I will not go as far as forecasting a return to the historical average of 17x FFO, I see no reason why the company couldn't return to 15x FFO (FFO yield of 6.7%).
Note that it has only traded below the current 11.9x multiple very briefly following the 2008 crisis and the pandemic. Apart from those two times, 15x FFO has been a trough valuation for NNN. A return to 15x FFO would result in 26% upside, which could easily be realized over the next 24-36 months.
FAST Graphs
All things considered, I see NNN returning the following from current levels:
- 5.9% dividend yield, growing very slowly at 1-2% annually
- 2% FFO growth
- upside of 26% realized over three years
- total expected annual return of 15%+
That, in my opinion, deserves a BUY rating here at $38 per share.
For further details see:
NNN REIT: A Worthy Alternative To Realty Income