2023-11-15 21:33:33 ET
Summary
- W. P. Carey's core real estate business performed well in Q3, indicating the market may be too bearish on the REIT.
- The spin-off of its office real estate portfolio repelled dividend investors, but it presents a turnaround investment opportunity.
- WPC's estimated new AFFO guidance suggests undervaluation and rebound potential for its shares.
Commercial REIT W. P. Carey ( WPC ) submitted its forecast for its AFFO when it presented earnings for Q3'23 at the beginning of November and since management has communicated what percentage of its AFFO it plans to pay out, dividend investors can now calculate a realistic forward dividend rate for FY 2024. W. P. Carey's core real estate business also performed well in the third-quarter, indicating that the market may still be too bearish with regard to the REIT. I believe that based on the estimated new AFFO guidance, W. P. Carey is undervalued and that shares have continual rebound potential.
Previous rating
I worked on W. P. Carey in September and issued a strong buy rating -- I Am Aggressively Buying The Lows -- as I believed the REIT's shares were widely oversold after it said that it would spin off its office real estate portfolio to Net Lease Office Properties. Given the clarity the company has provided with its AFFO guidance for FY 2023, I believe both W. P. Carey as well as Net Lease Office Properties are attractive turnaround investments right now.
Office spin-off has repelled dividend investors
On September 21, 2023, W. P. Carey announced a combination of a spin-off, including 59 of its office properties, and an office-related, accelerated sales program which included another 87 office properties. The completion date of the office sales program was expected to be in early FY 2024. W. P. Carey already sold four of its offices marked for the office sale program (one during the third-quarter, three after the end of Q3'23) which generated gross proceeds of $142.5M. The NLOP spin-off was already completed on November 1, 2023.
At the end of the third-quarter, W. P. Carey had just a little more than 15% exposure to office properties, a percentage that has declined from 30% in FY 2015.
Well-performing property portfolio for W. P. Carey
W. P. Carey owned 1,492 properties (mostly industrial, warehouses, retail and offices) in the third-quarter, plus 86 self-storage facilities. The portfolio was 98.9% rented and the properties generated positive cash flow, as expected.
The operating portfolio has generated consistently high occupancy in the last decade and even the COVID-19 pandemic didn't make a dent in W. P. Carey's lease metrics.
W. P. Carey generated $284.9M in funds from operations -- a key measure for REITs that corrects for non-cash expenses and income, real estate transactions and so on -- in Q3'23 compared to $238.7M in the year-earlier period… which calculates to a FFO Y/Y growth rate of 19%.
AFFO, which is based off of FFO and which makes additional corrections for merger expenses, stock-based compensation and amortization of deferred financing costs, was $284.4M, showing an increase of 2% Y/Y. Since the AFFO measure corrects for non-recurring accounting impacts, it is a smoother measure than FFO and more often used for the evaluation of a REIT's performance.
Dividend reset, implied future dividend payout ratio, updated FV estimate following office exit
Shares of W. P. Carey remain highly attractively priced after the REIT submitted its outlook for FY 2024 AFFO: following the spin-off and strategic exit of offices, the REIT expects to earn $4.60-4.80 per-share in AFFO, according to the third-quarter earnings release ( Source ). In FY 2022, W. P. Carey earned $5.29 per-share, so based off of the low-end of guidance and considering the full impact of the office portfolio spinoff/divestment, the REIT is set to realize a 13% AFFO drop next year.
This changes my expectations for the dividend cut which I previously assumed to be in the range of ~10%. I now expect a 20-25% dividend cut and I estimate that W. P. Carey will declare a new dividend of $0.80-0.85 per-share in Q1'24. A $0.80 per-share new quarterly dividend implies a 70% projected forward dividend payout ratio, based off of the low-end of W. P. Carey AFFO guidance for FY 2024. W. P. Carey's dividend payout ratio in the first nine months of the year (based off of AFFO) was 80.2%.
Although the dividend cut is now larger than I initially expected, the low valuation multiplier makes shares of WPC still attractive. Using the conservative low-range estimate of $4.60 per-share in AFFO, W. P. Carey's shares have an AFFO multiplier factor of 12X, compared to 11X last time I worked on the REIT.
The AFFO forecast, which is adjusted for the office exit, changes my fair value estimate, however: I still believe that W. P. Carey is a well-run REIT and could trade at 13-14X AFFO. But with $4.60-4.80 per-share in AFFO expected for FY 2024, the fair value of W. P. Carey falls to a range of $60-67.
Risks with W. P. Carey
W. P. Carey lost a bit of investors' goodwill which has considered the REIT to be a defensive, high-yield stock that generates steady dividend growth. The change in portfolio strategy and office real estate spin-off to NLOP shellshocked investors and it is likely that W. P. Carey's shares are trading at a depressed valuation multiplier largely because of that. There is a risk that office sales won't yield strong transaction prices going forward and there is a risk that investors remain cautious about W. P. Carey's FFO potential in FY 2024 and beyond. All these factors may continue to weigh on W. P. Carey's valuation and limit its recovery potential.
Final thoughts
W. P. Carey has provided some crucial clarity regarding its expectations for its FY 2024 AFFO and I am adjusting my estimate about the upcoming dividend reset. I get that management has surprised and shocked investors with the sudden strategic exit of the office market, but the deal does not, in my opinion, impair W. P. Carey's core value proposition for dividend investors. Shares of W. P. Carey trade below fair value and the REIT continues to be attractive from a rebound perspective!
For further details see:
W. P. Carey: Deep Value Despite Dividend Reset