Realty Income (NYSE: O) has long been a favorite of income-oriented investors given its monthly dividend payment, robust yield, and history of increasing its dividend. Meanwhile, the real estate investment trust (REIT) has delivered steady, consistent results over the years.
However, with a number of its tenants facing pressure and closing stores, the question becomes, is trouble brewing?
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Let’s take a closer look at Realty Income’s most recent quarterly report, the safety of its dividend, and how the REIT plans to deal with a number of struggling tenants.
Realty Income turned in another steady quarter, although investor attention was certainly focused on what is going on with its pharmacy, convenience store, and dollar store customers. All three concepts have been under pressure, with companies experiencing credit pressures and closing stores.
Realty Income management pointed to tenants that have recently gone through bankruptcy and how it has been able to get high recapture rates. Regarding Red Lobster restaurants, it said that it had 216 assets of which nine were rejected in bankruptcy court, with it getting a 91% recapture rate. It said that with Rite Aid, which has recently emerged from bankruptcy, it was able to get an 88% recapture rate.
Addressing Walgreens and its store closures, Realty Income said it has had 13 renewals come up this year, and that all were renewed, with a 100% recapture rate. Meanwhile, management noted the REIT has historically had over 100% recapture rates for lease renewals with CVS, Dollar Tree, and Family Dollar.
At the end of the quarter, Dollar General and Walgreens each accounted for 3.3% of its total annualized rent, while Dollar Tree/Family Dollar was 3.1% and CVS was 1.2%.
Meanwhile, Realty Income said it was looking to create a private capital fund to help it take advantage of the opportunities it is seeing across various verticals, including retail, industrial, data centers, and gaming. It said the fund would provide long-term stable capital while also providing it with recurring management fees.
Turning to the REIT’s third-quarter results, its revenue climbed 28% to $1.33 billion as new properties acquired through its acquisition of Spirit Realty in January and new investments bolstered results. Same-store rental revenue increased 0.2% in the quarter, while its occupancy rate was 98.7%. It said it had 170 lease renewals in the quarter with a 105% recapture rate.
Realty Income’s diversification strategy continued to pay off in the quarter, as retail same-store rental revenue slipped 0.3%, while industrial same-store rental revenue grew by 1.9% and gaming increased 1.7%. Other properties, which include data centers, saw a 4.7% jump in same-store rental revenue.
The REIT invested $740 million into new properties in the quarter with a 7.4% weighted-average cash yield. It also sold 92 properties for proceeds of $249 million.
Its adjusted funds from operations (AFFO) per share, which is a measurement of the cash flow a REIT can generate from its operations, increased by 3% to $1.05.
Realty Income increased the low end of its full-year AFFO guidance, taking it to a range of $4.17 to $4.21, up from prior guidance of $4.15 to $4.21. It now expects to invest $3.5 billion in new properties, up from a previous expectation of $3 billion.
Image source: Getty Images.
Despite the recent pressure on some of its tenants, Realty Income’s dividend looks safe and should continue to grow.
The REIT increased its dividend by 3% to $0.789 in the quarter. It has now raised its dividend 108 consecutive quarters.
The dividend was easily covered by the $1.05 in AFFO it produced in the quarter, good for an AFFO payout ratio of 75.1%. This robust coverage gives Realty Income plenty of room to continue to raise its dividend moving forward.
Realty Income stock is facing both headwinds and tailwinds at the moment. While the REIT is confident recapturing any lost rent from store closures, the struggles of Walgreens, CVS, Dollar General, and Dollar Tree/Family Dollar need to be monitored, as these four tenants make up about 11% of its annualized contracted rent. They obviously won’t be closing all of their stores, but it should be some type of headwind.
Meanwhile, a lower interest rate environment should be good for the stock and the value of its properties. Realty Income stock has struggled despite steady results in recent years, largely due to higher capitalization rates (cap rates), which cause commercial property valuations to decrease. However, as the Fed has started to lower interest rates, cap rates have started to come down, increasing commercial property values.
Overall, I think the interest rate environment should be the bigger driver of the stock in the years ahead, as Realty Income has proven to be able to navigate customer credit issues and store closures in the past. Meanwhile, its foray into private funding looks like it should be a positive for the REIT, and would likely be for a buyer of the stock on this dip.
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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Realty Income. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.
