2023-03-06 16:01:13 ET
Summary
- VICI has performed well as a company and even better as a stock.
- While they are still finding pockets of growth, I think bottom-line growth will moderate.
- This article will explore VICI's valuation in relation to fundamental outlook.
VICI Properties ( VICI ) has become the number one owner of casinos in the U.S. and its stock market performance has been stellar. Its success was due to a combination of rapid growth and resiliency. In fact, VICI never had a revenue dip in the pandemic recession. I feel comfortable with VICI as a company and have great respect for how swiftly Ed Pitoniak has acted to transform and grow the company.
Going forward
I think VICI will be a fine performer in the long run, but I would not expect a repeat of its recent impressive performance. Often when a company achieves such success so quickly it will get swept up in a momentum trade, especially when the 4Q22 conference call repeatedly mentions VICI being the top REIT performer.
It is easy to just sit back and root for the company that has done well for us but my process is about continually re-evaluating each position. Is VICI at today’s valuation and today’s fundamental outlook still worth owning?
The hold thesis
The two factors which facilitated VICI’s run are no longer in play. A few years ago these factors were:
- Cheap valuation
- An overlooked casino market which facilitated cap rates above the proper level
VICI briefly traded at a single digit AFFO multiple but was largely in the 10X-13X range which made it higher cashflow yield than the average REIT. Today, it sits at about 16X guided 2023 AFFO which is roughly in-line with the REIT average.
Thus, the outperformance from the valuation component is gone.
Much of VICI’s growth has come from acquisitions. Its acquisition volume has been tremendous with the company going from a mid-cap to one of the largest REITs at close to a $45B EV.
Beyond the volume, VICI had access to remarkable spreads as casinos were not yet an institutionally accepted asset class. A few years ago, cap rates for casinos were around 8%-11% while other forms of real estate were closer to 4%-7%. I wrote more extensively about the mispricing of casino assets and the opportunity afforded to VICI back in 2019.
VICI was ahead of the curve in recognizing the mispricing in casinos. They had a near monopoly on gobbling up the premier casino assets in the U.S. including trophy assets like the Venetian.
However, largely due to VICI’s success, casinos are now recognized by institutional real estate investors as a strong asset class. As such, the cap rate spreads have closed.
So while it used to be casinos at 8%-11% while other real estate was 4% to 7%, today it is closer to casinos at 7%-8% with other real estate at 5.5%-8%. Casino cap rates have come down even as rising interest rates have driven cap rates up in the rest of real estate.
The enhanced spread is over. They are now acquiring at a regular real estate spread of about 100-150 basis points over cost of capital as per David Kieske on the conference call:
David Andrew Kieske
“I mean we always want to generate 100, 150 basis points spread to our cost of capital. It's kind of what we set as a preliminary benchmark, now that can be higher at times or it can be lower at times depending on the quality of the asset, the operator or a riskier asset and riskier operator locations in the country.”
VICI runs a tight ship. they can absolutely make a 125 basis point spread work. It just won’t be explosive accretion like they have in the past.
The blessing and curse of size
Size is well known to be advantageous in the stock market and I think it is true to a greater extent for REITs. Large REITs almost universally enjoy a lower cost of capital and greater efficiency ratios in terms of overhead as a percentage of revenue.
VICI will be able to fully utilize each of these advantages going forward, but there is also a difficulty to size in that it takes more to move the needle. While the casino market is not fully controlled by REITs at this point, I don’t think there will be enough deal flow to provide sufficient growth to a company VICI’s size. Thus, VICI is getting creative in finding new growth avenues.
It is rebranding itself from a casino REIT to a leisure REIT and is dabbling in a variety of property types.
- A financing relationship with Great Wolf Lodge
- A few golf courses
VICI is also exploring going global with its casino ownership having recently purchased a portfolio of casinos in Alberta.
The cap rate looks accretive relative to VICI’s cost of capital and what I particularly like about the deal is it continues with VICI’s signature tenant paid capex. Each year, the casino operators must spend 1% of their revenue on improving/maintaining the property.
This makes the 8% cap rate more of a true cap rate whereas we often have to deduct a certain amount of capex from the stated cap rate.
Both the international and non-casino leisure properties are small and fairly new at this point. I can see the potential but it also introduces new risks.
Slow and steady growth going forward
VICI has strong escalators and long lease terms throughout its portfolio. In total these provide a natural growth rate of 2%-3%. I think this provides a healthy base from which to experiment with new forms of growth. Since the company can just sit there and collect cashflows there is no need to rush. VICI is free to reject any opportunity that doesn’t meet their underwriting standards on a risk adjusted basis.
AFFO/share has been growing nicely.
The growth looks to continue in 2023 with guidance of $2.10-$2.13 which is well above the 2022 run rate. This guidance is in-line with sell-side consensus.
Valuation
Overall, I think VICI is fairly valued. It looks somewhat attractive from a cashflow valuation but somewhat overvalued from an asset value standpoint. Let us look at the NAV first.
At $33.68 VICI trades at a slight premium to NAV using a 6.4% cap rate.
While 6.4% is an aggressive cap rate for casinos broadly, I think it is about right for their mostly trophy portfolio. There is also significant value in ROFRs, and land which is not presently contributing to NOI and thus not properly included in a cap rate based NAV calculation.
Valuation looks better from an AFFO perspective.
Gaming and Leisure Properties ( GLPI ), its closest peer, trades at 14.67X 2023 AFFO while VICI is at about 16X AFFO. I find this to be a fair premium given that VICI is both higher quality and bigger. In most REIT sectors we see a significantly larger premium for the higher end REITs.
The average REIT trades at 16.2X 2023 AFFO so VICI is right in line with the REIT average. In my opinion, a slight premium could be warranted due to its reliable escalators and tenant paid capex.
Overall I think it is fairly valued with the premium to NAV balancing out the mildly attractive cashflow valuation.
How to trade it
By my estimation, buying VICI today would result in forward annualized return of about 8%. It is a good company trading at fair value.
That said, I don’t like the idea of buying at fair value when there are so many quality REITs that can be bought at discounts. I still own some of my former position in VICI, mostly because I don’t want to pay capital gains and it is in a taxable account.
I think there will be opportunities to buy VICI at a better valuation. In particular, look for equity issuance as VICI repeatedly taps the equity market to finance growth.
ATM activity usually will not have a big impact on market price, but the lumpier blocks of share issuance will. There will likely be opportunities during these issuances to get shares at a roughly 3%-4% discount to the unaffected market price.
For further details see:
VICI: Even Great Companies Don't Grow To The Sky