2023-11-27 19:30:09 ET
Summary
- W. P. Carey irked income investors with a spinoff and a lower dividend percentage, causing the stock price to decline.
- Despite the decline, the company has investment grade rated debt and better prospects after the spinoff.
- Management needs to fulfill promises with business growth and market revaluation. If that happens, the stock has the potential for a bigger total return.
- The debt refinancing challenges are likely being dealt with by management.
- The current situation exposes the risks of paying more for consistency.
W. P. Carey Inc. ( WPC ) aggravated income investors when they announced the spinoff of the office properties and suggested that they would set the dividend at a lower percentage of AFFO than was the case in the past. Offsetting some of that was a large amount of cash generated as announced in the third quarter report and the exit announcement plan. The income investor group was upset enough (by the pending dividend cut) to send the stock price lower. Does that mean it's time to invest elsewhere by selling the stock? Usually, that sets up a contrarian opportunity for patient investors as management still has a very far above-average record even if it's not considered a "dividend king" anymore.
Current Situation
Admittedly, the dividend will be lower in fiscal year 2024 than it was in fiscal year 2023. However, I would expect growth to accelerate because the properties spun off were considered to be a drag. Since my last article , management has pretty much executed the plan. But the stock is still in the doghouse. In fact, it's probably far in the back of the doghouse because management found a reason to anger the market at a time when this part of the market already was out of favor.
W. P. Carey Inc. Common Stock Price History And Key Valuation Measures (Seeking Alpha Website November 26, 2023)
The current stock price has declined by more than 25% from the high point shown above. However, for a current investor, a 25% decline is fixed by a 33% increase to get back to where the stock began. This is a company with investment grade rated debt. After the spinoff, that debt is probably even more secure than it was before the spinoff because management likely kept the best properties.
But any management that does a spinoff like this one did likely see better prospects ahead the way the company is now organized compared to before action was taken. The bad news is now out of the way.
Yes, it's time for management to make good on their promises. That can be done with a combination of business growth and market revaluation of the stock once the bad news fades into the past. In fact, this stock probably has a larger total return potential over the next five years than it has had for some time.
Was The Deal Bad?
To start off with Warren Buffet's line of thinking: Why was the stock a buy at $85 and a sell at $58? The answer, of course, is that investors were willing to pay far more for a dividend king with consistently rising dividends and earnings. There was a belief that a company with a long record of rising dividends (like clockwork too) would continue to do more of the same.
Yet this points out a dividend king risk. History demonstrates that many of these companies become victims of their own success. Any of David Dreman's books show this in chart form. I actually covered it in my finance class when I was studying for my MBA. Many good basic finance books cover this issue. The lesson here is similar for all those tech companies at fancy price-earnings ratios (if they even have earnings). At some point, the party is over and that's the risk of paying for certainty. Clearly, the tech crowd paid for "a pot of gold at the end of the rainbow" or at least somewhere in the future. But that party also comes to an end as well.
Some managements can produce great results for an unusually long period of time. They make it look easy too. This was one of those managements. However, in any group of companies (like all those with ten-year record earnings histories, for example) there will be some that will not continue their consecutive record. Less and less companies go forward with yet another consecutive year. Companies and dividends have a finite limit. Usually, that limit is related to the ability of management.
It should make sense to investors that companies can only grow to a finite size of the marketplace. Usually, they don't get there because companies get passed to another generation to manage and that generation does not have the talents of the founders or the management before.
Adding to this argument is the idea that management will try their best to exceed the previous record income in the future. Should management establish another series of record years and consistent dividend increases, the market will eventually forget this "hiccup" and return the stock to its former glory. There are plenty of managements out there that have a bad year and then the record of each year being better than the last continues.
Management does not have to be right about every single argument it made for the spinoff in order to be successful in the future. It just has to be right enough (as in more right than wrong) for success to be assured. Given the management track record prior to the spinoff, it's very likely to succeed.
Challenges Ahead
Many investors are worried about the debt schedule. That's likely priced into the current stock price. However, if management stumbles, it could be a risk.
W. P. Carey Debt Due Schedule (W. P. Carey Corporate Presentation Third Quarter 2023)
That's certainly an imposing debt due schedule. But management with a debt rating of investment grade likely will surmount the issue shown above.
Most investors generally believe that disaster is around the corner because management will "sit there and take it." But management probably has a few ways around this.
One of the key ways management is ready for this is the cash generated by the spinoff and planned sales. That should get management off to a good start. Even in a normal year, management generates cash through sales. Maybe there's a possibility that management can generate some more cash in the future through sales.
The other likely consideration is that management is likely doing new business taking into account the high interest rates and inflation. That new business is likely to be profitable for some time in the future. Let's not forget inflation escalator clauses as well that are possibly in at least some contracts.
When that's combined with the leases that are expiring, the effect of higher interest rates is likely to be at most one-half of what many investors believe. Therefore, instead of half the debt coming due being rolled over at higher rates (with no offset) we're likely down to a quarter of the debt (with no offsetting factors) before we get into the harder work.
Also, interest rates have to stay high all three years for the worst to happen. But the Federal Reserve is now acting independently once again and offsetting the inflation threat with higher interest rates. The result is that inflation is coming down. One of the prime drivers of inflation, the federal budget deficit in the general fund, is likewise coming down. This all points to lower inflation and less pressure to raise rates in the future. Maybe those rates do not come all the way back down. But they're likely to be far more comfortable in the near future.
Another way out for management would be a suitable merger to mitigate the effect of higher interest rates. Above-average growth rates in the near future could help as well.
But as an investment grade entity, the ability to refinance the debt is not an issue. If the properties spun off were a drag as many believed, then the company is facing the debt due challenges with a much-improved situation.
Conclusion
Every year, there's a risk that any "dividend king" or consistently growing company will have its streak come to an end. The streak of W. P. Carey was unusually long . The market mistakenly believed that the string would continue for an unusually long period of time into the future. In fact, investors were willing to pay more for that belief.
But that is the mistake of investors, not management. Investors can be as angry with management as they want. They can even sell their shares. If they do, it's very likely that they sold low (when you are supposed to sell high).
Contrarian investing is built on the idea that the market mistakenly believes that bad news will continue in the future because that's what happened in the past. Instead of an efficient market, you have an emotional market that goes to periodic extremes.
W. P. Carey still has a darn good record that exceeds many managements out there. For decades , the dividend increased every year and the stock price increased a little. That record will likely resume its above-average achievements in the future. That for me makes this a strong buy consideration on the recovery potential and the likelihood that management will exceed the recovery and get the stock to new highs because it's good enough to do that. The stock has now fallen from $85 (approximately) to the $50s. It will likely return to old highs and surpass them as management resumes growing the company.
But if you're just so angry that you need to sell your stock (and toss or burn the annual reports) and distance yourself from this management, there are a lot of other good choices out there for you as an investor to succeed.
For further details see:
W. P. Carey: What Happens After Stock Decline