2023-10-16 11:19:24 ET
Summary
- Realty Income Corporation stock is currently undervalued, presenting a contrarian opportunity for investor.
- Successful investors like John Templeton and Juniper Capital Advisors have demonstrated the benefits of buying bargains and holding onto stocks for long-term gains.
- Many investors will instead panic when the stock goes down more even though the purchase was at bargain levels.
- Realty Income, with its high financial strength rating and consistent results, is likely to recover from its current decline and exceed old highs in the next cycle.
- Juniper Capital Advisors recently showed buying bargains still works.
No one wants Realty Income Corporation ( O ) now that the stock price has dropped. That makes this a contrarian opportunity for a quality real estate investment trust ("REIT") that rarely goes on sale.
"Buy straw hats in January" was a comment value investor Charles Allmon said many times when he was alive. He had another favorite saying, that the stock market was like a store where no one was interested in the merchandise until it was marked up 50% to 200%.
Warren Buffett would ask why a stock was a buy at $80 (for example) and a sell at $40. Yet when John Templeton went on "Wall Street Week with Louis Rukeyser," he went against a lot of shareholders by holding Ford ( F ) in the low teens after he bought it in the $30's. He later sold for a big gain (and more dividends). He did the same with Exxon Mobil ( XOM ).
Despite some of the leading investors of the day (and days past) commenting about buying bargains and selling at the right time in the business cycle when it is a sellers' market, many investors do the exact opposite. After all, if a stock is going down, it is bound to go down further. No analysis needed, and who cares about the future. Just because the stock went down, the bright future foreseen is "out the window," to be replaced by the market view that investors were wrong.
But this points out something that many investors often forget. The really good investors are thorough in doing their research and stick by that research. In the case of John Templeton, he bought bargains when he saw them and never, ever timed things to hit bottom. As his purchases demonstrated at the time, he missed the bottom by quite a bit and yet still made good money. While many of my friends sold both Ford and Exxon Mobil when they broke even or made a slight profit, John Templeton held on for far larger gains.
Sometimes when the story changed and Mr. Templeton had to sell, he had some big losses. But the diversification of his mutual fund allowed for a public record that few could match. The key was that his "wins" far outpaced his "losses." The key was not hitting the bottom and the top exactly. Mr. Templeton readily admitted that only about one-third of his ideas worked out. So those one-third had to win big.
Ranger Oil
This process was recently repeated by the major shareholder of Ranger Oil. Juniper Capital Advisors LLP was a firm with a lot of energy experience. The company made a major investment in Ranger at roughly $10 per share to become the major shareholder. This was just after the Pandemic when the deal closed in 2021. When Baytex ( BTE ) then made an offer for Ranger ( which was accepted), the company's investment was now 400% of the value of the original investment (approximately).
A whole lot of people thought it was too early to sell. Of course, on the other side, no one thought the deal would be good for Ranger when Juniper became a major shareholder. Yet a 400% value represented a roughly 300% profit in two years that many investors never see. There are a lot of successful people doing this all the time. "Taking your profits out of the middle" is a common successful investor theme. Yet the comments I repeatedly get is "will the stock keep going down?" instead of the focus "is it a bargain."
One of the things a lot of investors forget is that a stock that is down from $80 to $50 (for example) may show a decrease from that $50 of say 20%. But the change from $50 to $50 is a lower percentage of the original $80. In fact, it is much less from the $80 high before the investor purchased the stock. If due diligence shows the stock was worth $80 at the last market peak (and that is the risk that points out the importance of thorough due diligence) then most good managements will surpass the old high plus at least inflation (usually a lot more). This is why many great investors do not worry about the stock going down more after they purchase it.
The key is that a lot of famous investors rely heavily on the research they did before they invested. A lot of other investors can be talked out of their original plan easily because they have not been as thorough as many great investors.
A lot of investors lose faith in their own research. If they buy a stock at $10 and it goes to $5, they obviously "made a mistake" and buy high while selling low. The value determination process is weak enough that they are easily "talked out of" their original strategy by the market.
Realty Income
Realty Income has one of the highest financial strength ratings in the investment world. Not many surpass it. Not only that, but consistent results are well known. Despite this, the stock has been declining because "bonds yield more." But before bonds are compared to stocks, one has to remember that part of the return from bonds must be reinvested to keep up with inflation, whereas stocks already have that reinvestment as part of the consideration of a dividend. Therefore, a bond yield needs to be adjusted accordingly before comparing it to a stock.
Realty Income Common Stock Price History And Key Valuation Measures (Seeking Alpha Website October 14, 2023)
As interest rates go up, the stock price is falling. Mr. Market tends to head towards extremes in either direction. If interest rates are low, then clearly interest rates will be low "forever" which would lead to a relatively high valuation that seems to occur periodically.
On the other hand, if interest rates are high, then clearly, they will be high "forever" and the model that worked in the low interest rate environment will not work with higher rates. Never mind that most of these companies protect themselves with an escalator clause or they can literally add to the portfolio that takes into account current conditions.
The good management part that was so valuable in a low interest rate environment often fades in the mind of Mr. Market when interest rates rise. But finding solutions to challenges is what good management is all about. That includes high interest rates.
Realty Income Business Overview (Realty Income Second Quarter 2023, Earnings Conference Call Slides)
A company with that kind of credit rating is a company that is very likely to recover from the current stock market "doghouse." David Dreman wrote in his latest book " Contrarian Investment Strategies: The Psychological Edge" that stocks, even including inflation and other high interest rate times, do outperform bonds. The longer the period, the more likely the outperformance.
One of the things about a good credit rating is the ability to repay debt. It implies the ability to overcome things like high interest rates is superior to the competition for a superior credit score. It is a sign, and a significant one at that, of superior management. Obviously, since debt is superior in claims to common stock, there is more research to be done. But that credit rating is a darn good start that many competitors do not have.
Yet this industry leader's stock is declining along with "all the others" despite reporting consistent results for a long-time along with steadily increasing dividends. Part of the good credit rating is being able to handle past challenges just like the current set. Having lived through the 1970's and those interest rates. This current situation is a "piece of cake" compared to that.
This management is not going to "fold up and go home" in the current environment.
Realty Income AFFO Long-Term Growth Record (Realty Income Corporate Presentation For The Second Quarter 2023, Earnings Conference Call)
One of the ways for the company to keep up with inflation is to make a decent sized acquisition that results in a big cash flow jump as shown above. If one big acquisition is not available at the time, then a number of acquisitions that meet the criteria of management should do the job.
Unlike many investors, management views the current situation as the time to make more deals because the relatively high interest rates probably will not last.
Realty Income Interest Rate Spread (Realty Income Earnings Conference Call Slides Second Quarter 2023)
The conclusion is that Realty Income is making the same money in good times and bad times. The key is that as the leases end, the debt will refinance at the same time a new lease is signed. Therefore, the steady performance will persist.
More importantly, any potential recession, management views as a great time to acquire properties. Probably the same goes with higher interest rates because the property can be purchased in what is essentially a buyers' market and then later refinanced at lower interest rates.
W. P. Carey
W. P. Carey Inc. ( WPC ) is a REIT that has dropped more because it cut the dividend while spinning off the office services. Management showed the remaining business below:
W. P. Carey Corporate Spinoff Proposal (W. P. Carey Corporate Spinoff and Dividend Reset Presentation)
As these REIT's are seen as income vehicles, the market did not take too kindly to the dividend cut after years of consistency. However, now that it happened, as long as management resumes the consistent results, there is a good chance that the two entities will recover and likely exceed all-time highs.
Like Realty Income, this management sees the current situation as a good time to build the remaining business. Also, like Realty Income, that business building will likely result in a stronger company when the recovery begins.
Rebuilding investor trust after the dividend cut will take time. But there is also more value to recover as a result of that dividend cut. This is another company with a high credit rating. This kind of company will likely "be back" unless management has completely lost its touch.
Key Ideas
The whole REIT sector is seen as an unfavorable place to be during the current period of elevated interest rates. Yet, the comparison to bonds, for example, is flawed because some of the bond interest needs to be reinvested to keep up with inflation. That is usually not true with REITs, where management keeps enough money to maintain the assets combined with a business strategy to keep up with inflation.
Stocks tend to outperform bonds over the long term even if that long-term period includes some inflationary periods. REITs are unlikely to be an exception to the rule.
Therefore, much of the REIT sector, especially companies like Realty Income are probably strong buys because you should "buy straw hats in January." Diversification is also essential because some investors cannot resist a bargain like W. P. Carey which has a little more risk due to the dividend cut.
Realty Income is well diversified, with a size that few competitors can match. The strong credit rating provides access to relatively cheap money which is also a competitive advantage. Management can keep up with inflation by doing more deals in what is perceived to be a buyers' market.
The consistency here throughout the downturn is an advantage that W. P. Carey will have to work to recapture. But the reward to investors is more return after upsetting the market more. For the investors with the proper temperament, both companies offer recovery rewards followed by long-term growth well into the future.
Realty Income will likely continue to grow the business right through the current industry downturn of the stock pricing. The company itself appears to be doing just fine. At some point, Mr. Market should recognize this by returning the stock to a more historical valuation level. But, by then, the business will be larger and probably more profitable.
For further details see:
Realty Income: Calling All Contrarians