2023-09-19 12:00:24 ET
Summary
- Spirit Realty Capital is a sizeable REIT with a yield of nearly 7.4% and a fundamentally healthy business model.
- The company owns and leases out single tenant real estate under long-term, triple net leases, with a 99.8% occupancy rate.
- Spirit Realty Capital has diverse industry exposure and geographic distribution, and has shown growth in revenue and profitability metrics.
In the search for attractive yield, many investors inevitably come across a class of prospects known as REITs, or real estate investment trusts. Due to their own corporate structure and pass through nature, not to mention their business model that usually involves the ownership and leasing out of real estate, they often provide investors with distributions that, relative to the price paid to participate in the investment, are higher than what traditional stocks offer. One interesting example that deserves some attention here is Spirit Realty Capital ( SRC ). Though it is far from being the largest player on the market, it is a sizeable REIT and it currently boasts a yield of nearly 7.4%. Digging deeper, we find a company that is fundamentally healthy. Shares are also trading at levels that, by some respects, can be considered fairly low. Given these factors, I would say that the company makes for a decent ‘buy’ prospect. However, it isn't necessarily the right fit for everybody. And that is something I would dig into shortly.
An interesting REIT
For those not familiar with Spirit Realty Capital, a brief description is probably in order. According to the management team at the firm, the company operates as a net-lease REIT that focuses primarily on buying and leasing out single tenant real estate. The assets in question are almost always leased out under long term, triple net leases. This means that, in addition to locking in years' worth of cash flow, the company requires that its tenants pay for nearly all relevant property expenses.
As of the end of its most recent quarter, Spirit Realty Capital had an ownership interest in 2,083 properties, 2,064 of which it owns entirely. Across these properties, it has 345 different tenants and the locations that it owns are spread across 49 states in the US. Even though it may seem difficult to keep so many properties occupied, it boasts a 99.8% occupancy rate, with a weighted average lease term remaining of 10.3 years. Unlike some REITs that I have seen in the past, Spirit Realty Capital does not have to worry too much about any one tenant comprising a material amount of its business. In fact, as measured by annualized base rent, its top ten tenants make up about 22% of its operations, with its top 20 comprising only 35%. Its largest tenant, Life Time Fitness, accounts for only 4.2% of its rent on an annualized basis.
In terms of industry focus, the firm is also incredibly diverse. Having said that, its greatest exposure is to the distribution space, accounting for 11.6% of its operations. A close second would be manufacturing at 11.2%. Other major areas include health and fitness, convenience stores, car washes, and quick service restaurants. I understand that one area in real estate that many investors have been concerned about recently is the office space. The good news is that office properties account for only 2.9% of the firm's operations. So even if all of that would disappear, it would barely impact operations at the end of the day. In general, though, I would argue that the probability of significant trouble for any part of the firm would be small. I say this because about 85% of the company's revenue comes from customers that collectively generate annual sales of $100 million or more. Larger companies tend to be more stable.
Spirit Realty Capital also doesn't have any outsized exposure from a geographic perspective. Its greatest exposure is to the southeastern portion of the US, where it receives 26.5% of its rent. However, it also gets 18.9% from the southwest, 11.5% from the Pacific southwest, and 14.8% from the Mid-Atlantic region. The Midwest which, when combined with parts of the Mid-Atlantic, are probably some of the weakest for business because of economic issues in those regions. And it is worth noting that 19% of its rent does come from the Midwest.
Over the past few years, management has done a really good job of growing the company's top and bottom lines. As you can see in the chart above, revenue has grown from $483.6 million in 2020 to $709.6 million in 2022. All of the company’s profitability metrics have also increased during this window of time. Those are also shown in the aforementioned chart. This overall growth has been driven in large part by an expanding physical footprint. The company went from owning 1,860 properties in 2020 that added up to 40.68 million square feet of space, to owning 2,115 properties for a combined 59.42 million square feet.
When it comes to the current fiscal year, growth has continued. But that comes with a bit of a caveat. You see, management has no problem engaging in asset sales and other interesting financial transactions. So as of the end of the most recent quarter, it actually owns 2,083 properties. However, that is up from the 2,078 that had in operation one year earlier. Despite this decrease relative to the end of 2022, revenue is still up on a year over year basis. For the first half of the year, it totaled $377.6 million. That represents an increase of 10% compared to the $343.3 million reported one year earlier. Operating cash flow, adjusted operating cash flow, FFO (funds from operations), adjusted FFO, and EBITDA have all increased on a year over year basis as well.
For the current fiscal year in its entirety, management only provided significant guidance when it came to adjusted FFO per share. They expect that to be between $3.56 and $3.62. At the midpoint, that should translate to adjusted FFO of $503.6 million. This increase over the $480.7 million generated in 2022 should be driven in large part by between $700 million and $900 million worth of asset purchases. In addition to the company using debt and cash flows in order to grow, it is funding some of this expansion with around $400 million worth of asset sales. No guidance was given when it came to other profitability metrics. But if we assume that they will increase at the same rate that adjusted FFO is forecasted to, then we should anticipate FFO of $517.3 million. Adjusted operating cash flow should be around $516.2 million, while EBITDA should come in somewhere around $686.8 million.
Using these figures, we can easily value the company. As you can see in the chart above, Spirit Realty Capital is trading at a forward price to adjusted operating cash flow multiple of 10.2. The forward price to FFO multiple should be 10, while the forward price to adjusted FFO multiple is a bit higher at 10.2. And finally, the EV to EBITDA multiple for the REIT comes in at 13. These numbers are all slightly more attractive than if we were to use the figures from 2022.
On an absolute basis, I would say that shares are fairly attractive. But whether this makes sense for you to buy into is a more difficult question to answer. I say this because there are other REITs that might make more sense. One that I have recently written about is Realty Income ( O ), which also focuses on a diverse portfolio of net-leased properties. I won't rehash all the details of that analysis here. Instead, I will explain some ways in which the two companies are different. For starters, as you can see in the chart above, the profitability margins of Spirit Realty Capital are noticeably lower than what they are for Realty Income. Even though this may not seem like that much of a difference, if we were to take, for instance, the adjusted operating cash flow margin of Realty Income and apply it to Spirit Realty Capital, it would translate to the latter having generated an extra $71 million worth of cash flow in 2022.
There are other reasons why investors might prefer Realty Income over Spirit Realty Capital. For instance, it has a much faster track record for growth. From 2020 through 2022, revenue for Realty Income jumped by 103%. That compares to the 46.7% growth seen by Spirit Realty Capital. Over the same window of time, Realty Income saw the amount of capital it allocates toward common share distributions soar by 88.1%. That compares to the 33.8% seen by our prospect. It is true that Realty Income does have higher leverage than Spirit Realty Capital does, with a net leverage ratio of 5.78 compared to the 5.51 reading that we get using data from 2022 for Spirit Realty Capital. But those numbers are not so far apart that it makes a difference. This is true even if we use the forward estimate for Spirit Realty Capital of 5.26.
Of course, the extra growth and margins do come at a cost. For instance, the price to adjusted operating cash flow multiple, using results from 2022, for Realty Income is 14.8. By comparison, that number is only 10.7 for Spirit Realty Capital. Meanwhile, the EV to EBITDA multiple of Realty Income comes out to 17.3. That is 27.2% higher than the 13.6 reading that we get for Spirit Realty Capital. In addition to being cheaper than its larger rival, Spirit Realty Capital does have Realty Income beat out in another way. Between the lower trading multiple that it's going for and the fact that it is paying out 72.3% of its adjusted operating cash flow as distributions compared to the 69.8% for Realty Income, its yield is higher at about 7.4%. For Realty Income, that reading is about 5.7%.
Takeaway
Based on the data provided, I would say that Spirit Realty Capital is a solid prospect. In fact, I don't have a problem rating it a ‘buy’ at this time. Having said that, I recognize that it might not be the best prospect for everybody. Shares are cheaper than what you would get if you bought Realty Income instead, and the yield is definitely higher. Leverage is also slightly lower. However, the company is growing at a slower pace than what its larger rival is and the distribution growth seen by Realty Income is far more impressive. Those focused on long term growth, most certainly would opt for Realty Income, while more traditional value investors should view Spirit Realty Capital as a better opportunity. Interestingly, I could also see a scenario where Realty Income steps in to acquire Spirit Realty Capital. It would be an incredibly logical transaction, but betting on that is speculative.
For further details see:
Spirit Realty Capital: A Solid Prospect For Value-Oriented, Yield-Seeking Investors