2023-11-15 08:00:00 ET
Summary
- W. P. Carey Inc. is a REIT with a market capitalization of $12 billion and a diversified portfolio of 1,472 net lease properties comprising ~179 million square feet.
- Compared to other peers, WPC's total return got really obliterated YTD, already falling by more than -28%. Should investors buy the dip? Read on.
- I think WPC's actions to divest office assets seem justified, albeit too radical, which has had a big impact on shareholder value in recent months.
- WPC's future looks relatively good, but only after FY2024. WPC shares are not yet cheap enough compared to other peers to call them a "bargain" if we look at the prospective dividend yield next year rather than the TTM valuation figures.
- Most likely, WPC will fall even lower before the discount to its valuation, which I think is still missing, is absorbed. But no one can say exactly when this REIT will reach its bottom. I'm neutral on WPC.
Today I have decided to turn my and your attention to W. P. Carey Inc (WPC), a REIT with a market capitalization of $12 billion and a diversified portfolio of 1,472 net lease properties comprising ~179 million square feet, as well as a portfolio of 86 self-storage operating properties (pro forma for the spin-off), according to the recent 10-Q .
Compared to other peers, WPC's total return got really obliterated YTD , already falling by more than -28%:
This state of affairs raises some natural questions among income-seeking investors - especially if we consider recent events at the company.
- To what extent was the management's plan to restructure the business necessary and justified?
- Is WPC really that cheap now?
- Is it worth buying WPC's dip?
I will try to give at least a partial answer to these questions, based on my understanding of the current situation.
So, W. P. Carey recently completed the spin-off of Net Lease Office Properties (NLOP) on November 1st. As a result, approximately two-thirds of the company's office assets by ABR are now owned by NLOP, which operates as a separate publicly traded entity (WPC has no ownership interest in NLOP). Also, WPC is actively progressing with its Office Sale Program , having already completed sales of 4 office assets, generating $143 million in gross proceeds, based on the management commentary during the latest earnings call . Contracts have been signed for another ~$500 million in sales, including the largest office asset net lease to the Spanish Government, expected to close in January.
The firm sees its office exposure exit as a proactive move to avoid potential drags on earnings over multiple years and risks associated with large lease expirations and increased vacancies in the face of declining demand for office space. The company anticipates a challenging outlook for the office sector in leasing, financing, and investment sales markets and believes that the office assets may face worse outcomes than in the past.
After studying various third-party research reports , I can see that offices are not mentioned anywhere as a growth driver for REITs - on the contrary, this area of the market is the most obscure because expert opinions on its future development prospects vary widely . However, the one area of REITs that is cited as a driver of market growth is industrial REITs. This growth is primarily attributed to the rising demand for warehouse space in the industrial sector. Supply chain challenges have compelled industrial companies to rent additional warehouse space for the storage of their inventory, contributing to the expansion of industrial REITs, PRNews cites Technavio's research paper .
Therefore, from what I see, WPC's desire to focus on developing the industrial/warehouse parts of its business looks justified. The company anticipates a significant inflow of capital, including ~$2 billion in liquidity from the settlement of equity forwards, cash distributions from the spin-off, asset sales, and other divestitures. So WPC is going to have sufficient capital and liquidity to fund its anticipated investment activity and repay the 2024 debt maturities without needing to access the debt markets until late 2024.
Due to uncertainty over the timing of deal closings, W. P. Carey management lowered its previously lowered guidance for AFFO by $0.02 (to $5.20) for FY2023. For FY2024, management provided preliminary AFFO guidance of $4.60 to $4.80 per share, meaning AFFO is expected to decline ~9.16% year-over-year next year. Much of this is due to NLOP, whose spin-off will cost the company $0.5 per share in AFFO, as well as the completion of the Office Sale Program asset sales early next year, which will have a negative impact of $0.27 per share.
However, judging by Wall Street estimates , WPC's FFO should begin to recover as early as FY2025, which is logically due to the high demand in the market on which the company is now mainly focused.
Management has made it clear that "the dividend cut" that everyone has been talking about recently will be a one-off event and is going to occur only in Q4. This reset is expected to result in a one-time reduction of ~20% on the last declared dividend, with subsequent dividend growth linked to AFFO growth and targeting higher dividend growth than in recent years.
So does it turn out that the market has simply overreacted and WPC is now a cheap bargain?
Not everything is so simple here.
If we look at the TTM dividend values, which don't take into account how the payout is going, then WPC looks pretty cheap - in previous times with TTM yields as today, WPC was at its then-local lows suggesting a new rally:
A look at more recent information shows that WPC's yield next year is far from 8% - in the base case, which has been revised downwards several times in recent months, WPC will only pay out ~6.81% next year , which is only ~2.18% higher than you get for 10-year "risk-free" US treasury notes .
Seeking Alpha, WPC's estimated dividends, author's notes
This will improve in 2025 when the AFFO rises again for the reasons mentioned above. Here and now, however, the WPC impresses with its still quite low premium over the "risk-free asset", despite its colossal YTD decline.
In answering the question of whether WPC is cheap today, I believe that it makes no sense for investors to look at TTM valuation multiples as these do not indicate what's coming next. It's better to look at next year's dividend yield because REITs are bought by income seekers for that very reason. WPC's FY2024 dividend yield of 6.81% compares to 6.32% for Realty Income ( O ), 4.44% for STAG Industrial ( STAG ), 6.03% for NNN REIT ( NNN ), and 7.48% for EPR Properties ( EPR ). In my opinion, WPC doesn't have outstanding returns compared to its peers, and the company harbors more uncertainty, which could lead to an even bigger discount on its valuation.
The Verdict
If you remember, I asked myself 3 questions at the very beginning of the article, of which I had only answered the first two so far:
- WPC's actions to divest office assets seem justified, albeit too radical, which has had a big impact on shareholder value in recent months. The future looks relatively good, but only after FY2024.
- WPC shares are not yet cheap enough compared to other peers to call them a "bargain" if we look at the prospective dividend yield next year rather than the TTM valuation figures. I think WPC is close to being fairly valued today.
Last question: Is WPC's dip worth buying? Based on the above, I don't think so. Most likely, WPC will fall even lower before the discount to its valuation, which I think is still missing, is absorbed. But no one can say exactly when this REIT will reach its bottom. A relatively reasonable way to get an allocation to WPC, if you believe in the long-term future of the company, is dollar cost averaging or selling options. But again, I don't recommend you "load up heavily" on this dip, hence my "Hold" rating.
Thanks for reading!
For further details see:
W. P. Carey May Go Even Lower