2023-06-30 07:00:00 ET
Summary
- Spirit Realty Capital, Inc. is a net-lease REIT with a well-diversified portfolio and a 6.5% yield, making it an attractive investment option for those seeking retail REIT exposure.
- Spirit Realty has a 99.8% occupancy rate and has significantly improved its tenant mix and industry exposure, with a focus on service retail and industrial sectors.
- The company has a strong track record of positive results, and its current valuation decline may present a good investment opportunity.
This article was published at iREIT® on Alpha on Wednesday, June 28, 2023. This article was written by Wolf Report.
So let's say that you're already fully invested in some of the more common and higher-yielding retail real estate investment trusts, or REITs - but you want more retail REIT exposure.
Or perhaps you want some diversification overall but don't want to skimp on yield or on valuation. It's a tall order, even in today's market, but there are solutions to such a conundrum.
The solution that I want to talk to you about today is called Spirit Realty Capital, Inc. ( SRC ). It's a REIT we cover here on iREIT®, and it's a very solid business with a good upside.
More importantly, though, for the past few months, we've seen the company decline to valuation levels that I would consider to be well below its overall average, with the average on a 5-year basis being a 13-14x P/FFO.
Let me show you why this company should elicit some interest from you.
Spirit Realty Capital - Plenty to like about net lease with this exposure
SRC is a net-lease REIT. That means that the tenants have responsibility for what are otherwise considered some of the larger risks of being a landlord.
Like other net lease REITs and REITs overall, SRC has seen some pressure over the past few months, and is now trading at a significant relative discount to its typical trends. Some would consider this justified in the light of current interest rate and real estate risks - I would respectfully disagree with such an assertion.
SRC is an investment-grade retail REIT in net lease, that yields over 6.5% that is well-covered with a funds from operations ("FFO") payout ratio of 73% on a 2023E basis, and that's despite an estimated 1% FFO drop. So the dividend is well-covered at this time.
There's significant fundamental quality to be had here when looking at SRC. It has good diversification, with good tenants in its annualized base rent ("ABR"). It has very little overexposure to any one area. The company has an average lease length of over 10 years, which is very good in the context of net lease. The average size of an SRC asset is just above 100k sq ft.
Diversification has improved 3%, meaning that the top 10 tenants are now less than 22% of its annual ABR. The company's industrial exposure is up to 20%, from close to 8% back in 2017, and public exposure is up to 53.4% from 36.7% in 2017. Obviously, if you know my work, you know that I'm a fan of industrial exposure as well as increased amounts of public company/player exposure.
The rent collection issues during COVID-19 are now completely gone. Rent payments are in full - and there are plenty of good tenants to like here. The company's diversification is up significantly.
Some basic data here - 10.4 years of WALT in its portfolio, almost double-digits in terms of billions of real estate investments, and an ABR of nearly $700M in total. That ABR is now coming from the following industries, with a focus on service retail and industrial.
SRC IR
The company doesn't have perfect occupancy. No. "Only" 99.8% occupancy, making it one of the best in the REIT sector.
88.1% of the company's tenants have more than $100M in annual revenues, and the company now leases to a total of 347 tenants across 37 industries in 49 U.S. states.
SRC IR
Spirit Realty is not the same company it was a few years back. It has substantially improved its exposures, essentially building a fortress for a time like this.
The company "wins" on both offense and defense, due to its conservative tenant metrics and exposure, together with its relatively low leverage and high liquidity, which enables it to act on opportunities when they arise.
The company has top-tier underwriting, backed by modern tools and approaches...
SRC IR
...and couples this with some excellent portfolio stats - both current, as well as developed since its IPO. Looking at its tenant details, we can clearly see trends where the company makes sure to underexpose things like discount retail, pet supplies, and discretionary retail next to things like distribution and manufacturing, Health & Fitness service retail, and convenience stores.
Its industrial portfolio has ballooned to $2.4B, which is now close to 25% of the overall portfolio, and the focus is on mission-critical real estate. This is easy to see from the 12.2-year average WALT, and many attractive properties - and customers - in the mix.
SRC IR
Initially, in this article, I said that you may want to look at SRC if you want diversification in standard retail net lease - and that is true. But I also think that SRC, regardless of what you own or how exposed you are, has merit as an investment. No other REIT really has this mix - and this mix is attractive overall.
Like Realty Income Corporation ( O ), Spirit had exposure to the theater segment. This exposure was more or less removed when the company recently disposed of the entire portfolio at a disposal cap rate of 6.13%. This transaction closed in February of this year.
SRC IR
While I believe there to be room for high-quality theaters, the fact is I do not want to invest in REITs that predominantly own them. They are assets that have essentially no other use and are incredibly complex to redevelop due to their very specific layout and use case. I find this change a positive one and it strengthens my conviction when it comes to investing in Spirit Realty.
The retail portfolio as it currently stands is, as I see it, a non-stop positive. 9.5 year WALT from some of the best tenants you can find.
SRC IR
Almost 50% of the company's assets are reporting on a unit-specific level, with 95.4% unit and/or corporate-level reporting, giving good visibility. Not as good as, say, STORE Capital - but decent overall. The company manages a 2.8x weighted average unit level coverage, and 45.1% of the leases are under a master lease agreement. 66% of tenants have more than $1B in revenues.
Expirations are attractive. There is very little expiring in the next 2-3 years. The first year with 100 expirations is 2026 - until then, less than 8% of the total ABR goes up for releasing, which is very small. 49.8% of the company's ABR expires after 2032, which is really as good as it gets outside of some specialized REITs.
The company's occupancy rates have stayed consistent for very long. At worst, it dipped to 99.2% in mid-2020, which implies just how high quality and in demand some of these locations are.
What's more, almost 78% of the leases are exposed to contractual fixed increases in rent, rather than flat or CPI-related, and the company has a good exposure geographically, with almost nothing in the Pacific Northwest, and a good focus on Southwest, Midwest, and Southeast.
Overall, results have been very positive here - and I do not see much reason for the valuation decline, perhaps beyond the relatively flat expectations in terms of FFO growth expectations until 2025E.
Let's look at this.
Spirit Realty - A lot to like at this valuation - Upside both to conservative and premium forecasts
The main "issue" with Spirit Realty is the fact that the growth estimates are essentially zero. The company is unlikely to go anything above a single-percent FFO growth for the next few years, between increased financing costs and inflation and other things weighing the company down.
Is this a problem?
Generally, yes. But at a 10.6x P/FFO, I would argue it's not that much of a problem. Even if you use a GDF-based 11-12x P/FFO estimate, that puts the upside close to 12% annually for this company. If I got a 12% annual RoR from my portfolio in 2023, that would make me pleased, given where I believe the market is headed.
In fact, SRC tends to trade at around 12.5x P/FFO, and the upside here is around 15% annually, or 43% in the case of reversal until that time, which I consider quite likely. That's why I consider this an exciting investment. It's essentially a "safe" company with a lot of upsides and very little overall downside, based on its both defensive and offensive appeal. In fact, I consider this company so well-priced that I would call it "cheap." I did call it cheap in my last article, and I still believe it to be cheap here.
The current share price represents a Price/NAV of 0.93x, which is well below where I believe it should be - it should be at least 1x-1.1x, reflecting the quality of the REIT asset quality and the quality of its tenants.
What's more, this company is very forecastable. On a 2-year forward perspective with a 20% margin of error, the analysts have a perfect forecast accuracy, either hitting the target or having the company outperform the targets.
Historically, triple net-lease stocks tend to do well enough during periods of increased instability, by which I mean their ability to retain their payouts. In terms of their overall performance, there is an inverse tendency for net lease during periods of higher rates - but due to the company's excellent balance sheet, I view this as an acceptable risk. And while SRC hasn't exactly been a superb outperformer historically - because a 6.26% annualized RoR since 2012 is sub-par - this is due to the massive shifts in its portfolio that the company has gone through.
I now view the company's portfolio to be in a position where I expect it to either perform well or perform very well - and this is what lays the foundation for a continued "BUY" rating here.
The main concern with this company is the higher WACC relative to many of its sector peers. Also, and again compared to many of its peers, the company's liquidity doesn't look as impressive when put next to some other net-leasers.
To be clear - there are higher upsides, and some I would consider "better" qualitatively. But this is also a diversification play - and while I could accept an argument that there are better alternatives out there - I can't accept an argument that says that Spirit Realty isn't undervalued here, because I believe that it is.
I believe that the analysts who are calling this a "HOLD" are underestimating the appeal of the company's new asset portfolio, the fact that the company lacks material exposure to things like theaters, and the value of a 10+ year WALT.
S&P Global targets are at $43/share, from a range of $39 to $52, meaning the company is currently cheaper than the lowest analyst target from any of the 15 analysts covering the company. 6 of those analysts are at "BUY" here, and most seemingly are willing to "HOLD" and wait to see if the company drops lower.
That is one way to go - but the only rating I can give Spirit Realty at $38.5/share, which is where we are as I write this article, is a "BUY."
Here is my thesis on the company.
Thesis
- Spirit Realty is an above-average REIT in the net-lease segment. It's a market outperformer that also has a higher yield than other companies in the subsector.
- It's not the best growth prospect that you'll end up seeing - but it's nonetheless a solid sort of "BUY" at a cheap or good valuation. I see this good valuation, and this "BUY" being possible at anything below $45/share.
- That means that at the current pricing of below $40/share, this company is worth adding to your portfolio - so that is exactly what I am doing.
Remember, I'm all about:
- Buying undervalued - even if that undervaluation is slight and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
- If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
- If the company doesn't go into overvaluation but hovers around fair value, or goes back down to undervaluation, I buy more as time allows.
- I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them (italicized).
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside that is high enough, based on earnings growth or multiple expansion/reversion.
I went back and forth on calling this cheap or not, but in the end, I do believe SRC is priced well enough to be called "cheap" here, even if I admit that the case here is somewhat thin.
For further details see:
Nothing Spooky About Spirit