2023-11-06 12:52:15 ET
Summary
- W. P. Carey Inc. stock fell to lows last seen in May 2020, as investors worry about higher execution risks, given its recent office assets' spinoff.
- The market wants to know whether W. P. Carey can recover its AFFO per share in time, given the uncertain macroeconomic headwinds as it looks to reinvest its proceeds.
- Management adjusted its FY24 AFFO guidance, and investors must manage potential dilution from divestments through 2024. WPC also recalibrated its dividend payout ratio.
- I assessed that the concerns of market participants are justified, worsened by the headwinds from the surge of long-term bond yields.
- Despite that, the rapid downward de-rating of WPC suggests that it could be at or near peak pessimism. It's time to catch the falling knife again.
Investors in leading REIT W. P. Carey Inc. ( WPC ) suffered a steep selloff following the company's plans to offload its office assets in a spinoff to improve its earnings clarity and help with a valuation re-rating. Management expects most of the asset sales to be completed in early 2024. Investors should recall that the office portfolio now trades as Net Lease Office Properties ( NLOP ). I last updated WPC holders in August, as I anticipated the peak of the 10Y Treasury yield ( US10Y ). However, that thesis has failed to pan out, as the US10Y surged above 5% in October. Also, market participants seemed to have de-rated WPC downward after management announced its NLOP spinoff.
While I applaud management's decision to potentially untether the headwinds of the office market from its core business, the critical question is whether it could have come earlier, given the already well-battered real estate sector ( VNQ ) ( XLRE ).
BMO Capital Markets highlighted in a commentary in late September, articulating the move could be detrimental to holders, " suggesting that it would likely trade at a significant discount." The firm added that "existing shareholders of W.P. Carey would bear the transaction costs associated with the spinoff, as well as the underperformance of NLOP."
The collapse of NLOP to its post-spinoff low of $9.50 last week corroborates the lack of confidence in market participants about the timing of W. P. Carey's strategic move. Also, the significant drop in WPC from its September 2023 high of $64.40 to its recent October 2023 low of ~$50 suggests that the market is likely concerned about the value derived from the asset disposition on its cash flow and dividend stability.
Accordingly, management adjusted its AFFO guidance at its recent earnings call to reflect the spinoff of its office assets. The revised FY23 outlook indicates an AFFO range of between $5.17 and $5.23 for a midpoint metric of $5.20. Given the spinoff, the FY24 AFFO outlook has been lowered to between $4.60 and $4.80 for a midpoint metric of $4.70. Management stressed that the revisions contemplated several considerations, including the "expected completion of the Office Sale Program, investment environment, disposition activity, and liquidity positioning."
As a result of the reduced annualized base rent or ABR from its office assets, investors will now need to manage the potential AFFO per share dilution from its divestments through 2024. Furthermore, management acknowledged that there could be a near-term "timing lag," leading to "some dilution due to the timing of property sales and reinvestment." However, management accentuated that the company regards "2024 as a new baseline, and the timing of dispositions, particularly in Q1, will have an impact."
As such, "the run rate for AFFO will be reestablished, providing a foundation for future growth." With that in mind, the company's more cautious AFFO payout ratio in the "low-to-mid 70% range" makes sense, as it restructures its asset exposure without its office ABR. Despite that, I believe the adjustments didn't placate investors' worries about a possibly slower dividend per share growth cadence as WPC restructures its business.
WPC buyers were hammered over the past two months, suggesting a lack of confidence over the company's decision to spin off its office base. As a result, WPC re-tested its May 2020 lows in early October, completing a remarkable round trip that likely stunned REIT investors.
Notwithstanding the battering, I believe it wasn't unexpected, given the surge in long-term bond yields, leading to broad real estate market weakness. As a result, the market needs to reflect these challenges, although WPC's recent move has likely compounded the market's perception of its execution headwinds.
However, the downward de-rating has also been swift, as WPC last traded at a forward dividend yield of 6.7%. Also, it attracts an appealing "B+" valuation grade from Seeking Alpha's Quant, corroborating its relatively inexpensive valuation.
I have confidence that the constructive bottoming process over the past four to five weeks suggests dip buyers have returned to stem a further decline. As such, investors must overcome their fear if they want to buy the dips in WPC.
It's time to catch the falling knife again with conviction, as WPC has potentially reached peak pessimism.
Rating: Upgraded to Strong Buy.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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W. P. Carey: Shares Plunge To A Three-Year Low, Unveiling My 'Strong Buy'