2023-09-22 08:04:40 ET
Summary
- Realty Income is a well-managed REIT with strong fundamentals, a sustainable dividend, and an attractive valuation.
- It owns and manages a diversified portfolio of commercial properties leased to single tenants on a triple-net basis.
- The company has a high occupancy rate, low tenant concentration, and a track record of consistent earnings growth and dividend increases.
Realty Income ( O ) has strong fundamentals, a sustainable dividend, and an attractive valuation, making it a great income investment right now.
Business Overview
Realty Income owns and manages a portfolio of commercial properties, well diversified across industries and tenants, being one of the largest REITs in the U.S. measured by its market value of about $38 billion. It has been listed since 1994 and trades on the New York Stock Exchange.
Its business model is to own a portfolio of retail and industrial properties leased to single tenants on a triple-net basis. It provides capital to middle-market regional operators and national retail chain store operators, by acquiring and leasing back their retail sites over long-term periods, usually in excess of ten years. Usually, these leases require the tenant to bear the vast majority of costs associated with the property (triple net lease), and Realty Income's current weighted average remaining lease term is about 9.6 years.
At the end of last June, Realty Income had more than 13,000 properties across the U.S., U.K., Spain, Ireland, and Italy, leased to some 1,300 clients across various industries. This means its asset and client concentration is rather low, being a positive factor for a sustainable business model over the long term.
Moreover, its occupancy rate is close to 99%, showing that it holds a quality portfolio, being also quite positive for recurring revenues in the long haul. By type of client, the vast majority of its rental income comes from retail (around 76%), with more than 90% of total rent being resilient to economic downturns. Grocery stores and convenience stores are the two largest industries, accounting for some 10% and 8.6% of the total annual rent, respectively.
Asset portfolio (Realty Income)
Geographically, Realty Income decided to expand to Europe in 2019, which now represents some 12% of its annualized rental income (10.5% generated in the U.K.), while the vast majority (88%) is still generated in the U.S.
Regarding its tenant diversification, Realty Income is well diversified given that its largest tenant, measured by annualized rent, is Dollar General ( DG ), accounting for some 4% of the company's annual rent. This is a relatively low weight, showing that Realty Income is not much exposed to potential financial distress from a single tenant, which bodes well for recurring and somewhat predictable revenues and cash flows over the long term.
Moreover, some 41% of its tenants are investment-grade credit companies, which should have a low risk of default, being another support for Realty Income's recurring business profile. At the end of last June, its tenants had a good capacity of paying contractual rents, given that the median EBITDAR/rent ratio was 2.8x, which is a good coverage ratio and a strong support for Realty Income to achieve a growing top-line in the near future.
While Realty Income already has a significant scale and large size, the company still has relatively good growth prospects ahead, both by entering new countries and industries. Over the past few years, Realty Income has taken some positive strategic decisions, such as divesting its office segment and entering European markets, giving it better growth prospects over the long term.
For instance, its recent expansion into Ireland or the acquisition of a stake in Bellagio in the leisure and gaming industry, are two examples of how Realty Income is diversifying further its asset portfolio and growing into new verticals. Going forward, Realty Income's strategy is not expected to change much, as the company is likely to continue to seek growth with a disciplined approach and into properties that fit well within its portfolio.
Financial Overview
Regarding its financial performance, Realty Income has a great track record supported by its high-quality portfolio and strong business model, enabling it to report relatively stable earnings throughout the economic cycle. Indeed, Realty Income has consistently delivered earnings growth over the past few years, which is a very good achievement.
Even during the pandemic, its performance was quite good, which is justified by its geographically diversified asset portfolio and concentration in essential and necessity-based retail, protecting it from major disruptions during the COVID-19 pandemic.
More recently, its financial figures were impacted by its merger with VEREIT, which increased its size and makes annual (vs. 2021) not really that meaningful. Nevertheless, Realty Income's revenues amounted to more than $3.3 billion in 2022, an increase of 60.7% YoY, while its net income was $869 million (+142% YoY). Its adjusted funds from operations (AFFO) were $2.4 billion, an increase of 61% YoY, but its AFFO per share of $3.92 represented a small increase of 9.2% YoY, as the company increased its total number of shares outstanding by resorting to its At-the-Market ((ATM)) program.
During the first six months of 2023 , Realty Income reported a positive operating momentum given that its total revenue amounted to $1.96 billion, an increase of 21% YoY. However, its expenses also increased significantly, especially interest costs due to higher interest rates, leading to a net income of $423 million in H1 2023, flat compared to the same period of last year. Due to higher depreciation expenses, which is a non-cash expense, Realty Income's FFO increased to $1.37 billion, representing an increase of 13% YoY.
Its AFFO was slightly lower at $1.32 billion in H1 2023 (+13.7% YoY), and its AFFO per share was $1.98, representing an increase of only 2.1% YoY due to a higher number of shares. Going forward, Realty Income's guidance is to report like-for-like rental growth over 1.25% in 2023, an occupancy rate over 98%, and AFFO per share in the range of $3.96-4.01.
Regarding its dividend , Realty Income has a great track record given that it has increased its dividend consistently for more than 25 years, being therefore part of the S&P 500 Dividend Aristocrats. Since its IPO in 1994, it has grown its dividend by a compounded annual growth rate ((CAGR)) of 4.4%, which is a very good dividend history and shows that delivering a growing dividend is one of management's main business goals.
Dividend history (Realty Income)
Beyond a growing dividend, Realty Income distributes a monthly dividend to shareholders, which is quite attractive because it leads to a recurring income stream. Its current monthly distribution is $0.256 per share, or $3.07 annually per share, which at its current share price leads to a dividend yield of about 5.8%.
Considering that the company's AFFO per share was $3.92 in 2022, its dividend seems to be well covered and sustainable over the long term, thus it's quite likely that Realty Income will continue to deliver a growing dividend over the next few years.
Indeed, according to analysts' estimates , Realty Income's dividend is expected to grow to about $3.46 per share by 2026, representing annual growth of around 4% during the next three years, which is close to its historical average. This dividend is expected to remain well covered by AFFO per share, given that this metric is estimated at $4.50 by 2026, thus its payout ratio is expected to be about 77%, a slight increase compared to 73% in 2022, but still a very reasonable ratio for a stable company like Realty Income.
Additionally, the company's dividend is also supported by its strong balance sheet and financial flexibility, given that it's a relatively low leverage ratio, a strong credit ratio, and good access to funding in the capital markets.
At the end of last June, its net debt-to-EBITDA ratio was 5.3x, which is lower than compared to its peers, and Realty Income has been able to issue new bonds in the capital markets at reasonable costs over the past few quarters. This has been impossible for other REITs due to very high yields in the bond market, as I've recently analyzed on Medical Properties Trust ( MPW ) for instance, showing that Realty Income's defensive profile and large size can be considered a competitive advantage in the REIT sector due to superior financial flexibility.
Moreover, its debt refinancing needs are well spread across the next few years, thus it should not have liquidity issues in the medium to long term, and most of its asset portfolio is unencumbered, providing further flexibility if it eventually needs to raise secured loans, being another support for the sustainability of its dividend over the long term.
Conclusion
Realty Income has strong fundamentals, and is a well-managed REIT, with a quality portfolio that is well-diversified by industry, tenants, and geography. This provides a strong foundation for a solid and recurring business model, plus its financial profile is also sound. Taking this background into account, it's not surprising its dividend history is very good, a trend that is expected to be maintained for the foreseeable future.
While there are other REITs that offer higher-dividend yields, Realty Income is a 'sleep well at night' investment income and should be part of all long-term income-oriented investors' portfolios. For me personally, Realty Income is not yet part of my personal income portfolio, but I'll certainly add it to my portfolio in the short term.
Despite this attractive backdrop, Realty Income is not immune to higher interest rates and its share price has been on a downtrend over the past year. In my opinion, long-term investors shouldn't be worried about this given that is mainly justified by external factors, and use this weakness to buy. Realty Income's current valuation is only 12.3x FFO, much lower than its historical average of 17.7x FFO over the past five years, making its valuation quite attractive for income investors right now.
For further details see:
Realty Income: Now Is A Great Time To Buy This Dividend Aristocrat