Realty Income Stock (O) was added to the S&P 500 Dividend Aristocrats index; a prestigious group of companies that have not only paid dividends for 25 years consecutive years but also grown them each year, without missing a single one. The companies should also have a minimum $3 billion market capitalization and be included in the broader market S&P 500 index.
Management last raised its dividend from $0.2275 per share in December 2019 to $0.2325 in January 2020, a healthy 2.1% growth. Realty Income is a monthly dividend stock and has so far paid 594 consecutive monthly dividends, which is essentially 50 years.
In this article, we review the firm’s business operations, latest financials as of 3rd Quarter, 2019, inspect dividend growth history and the stock’s valuation versus the broader market S&P 500 and the Real Estate Sector (XLRE).
Table of Contents
This article is broken down in to sections, feel free to jump to the area that interests you.
- Overview of Business Operations
- Revenue Analysis and Share Buybacks
- Growth Outlook for Realty Income Stock
- Dividend Growth History
- Measuring the Dividend Payout Ratio of Realty Income Stock
- Long Term Performance
- Stock’s Valuation versus S&P 500 Real Estate Sector
Realty Income is structured as a Real Estate Investment Trust (REIT) that has a 51 year history of paying consistent monthly dividends backed by free cash flow generated from over 5,900 freestanding commercial properties. As a matter of fact, the company now has a nickname, “The Monthly Dividend Company.”
The company is a net-lease real estate owner, meaning its commercial tenants pay most of the operating expenses and maintenance of the properties. It is a low-risk business model and Realty Income pockets the difference between its cost of capital on mortgages versus its rents.
Since going public on the New York Stock Exchange in 1994, the company has grown from 630 properties to 5,964 properties as of February 2020. These properties are located across 49 states, Puerto Rico and UK. There are 274 commercial tenants diversified across 49 industries and the average term remaining on long term leases is 9.3 years.
Chart above shows the company receives $1.4 billion in annualized base rent, has A3/A- credit rating from Moody’s and S&P and 49% of all rent is from investment-grade rated tenants.
Examples of investment-grade rated tenants include Walgreens, 7-Eleven, FedEx, Dollar General, Sam’s Club, Kroger, CVS Pharmacy, Circle K and the Home Depot. Chart above shows how much of total rent each tenant brings in; as an example Walgreens generates 5.7% of annualized rent followed by 7-Eleven at 5.1% and FedEx at 4.4%.
Revenue Analysis and Share Buybacks
For the first 9 months ended September 30th, 2019, Realty Income generated $1.094 billion in rents and earned $307.2 million in net income, implying a healthy 28% net profit margin. Revenue grew 11% from the same period last year (Sept 30th, 2018) with revenues of $985.3 million.
Over the last decade, management has grown revenues from $333.3 million in 2010 to $1.094 billion in 2019, representing a compounded annual growth rate (CAGR) of 12.6%. This is a very strong rate of return and investors have rewarded the company’s stock with huge price gains.
In fact, over the last 23 years, Realty Income has grown its earnings per share at a 5.1% historical annualized average versus other REITs that have grown at 3.6%.
The company has achieved positive earnings growth in 22 out of the past 23 years, which is a phenomenal track record. Attached chart below shows a screenshot from the company’s Investor Fact sheet page.
Trading on the New York Stock Exchange under the ticker “O”, Realty Income sports a $26 billion market capitalization and pays a 3.5% dividend yield. This yield is 170 basis points higher than yield on the S&P 500 at 1.8% or XLRE ETF’s yield of 2.8%.
Management has taken steps to make this a low-risk business by lowering annualized volatility in rents’ collections. Occupancy levels have never dropped below 96% according to this diagram from the company’s fact sheet. Also, same-store rent growth has averaged 1% since 2013, which is quite a good track record.
To achieve the highest returns and rents from each store, management carefully screens each tenant based on their profitability, industry trends and selective underwriting.
What is the secret sauce behind the company’s success as measured by its rapid advance in stock price and out performance to the S&P 500? The company acquires well located commercial properties that are essentially “Amazon proof.” Next, it leases to tenants that are “service oriented” businesses, are non-discretionary and have low price points.
Think of 7-Eleven or Circle K convenience stores or the Dollar Store, Family Dollar or Dollar Tree. What’s common among these tenants is they are service oriented and quick to shop. A customer cannot wait to buy Gatorade drinks from Amazon, they will pop in to a 7-Eleven or a Dollar Store for their shopping needs.
The company also rents to non-discretionary businesses like CVS Pharmacy and Walgreens. Again, it is difficult to shop your prescription in Amazon, so consumers will most likely like to receive advice from a Pharmacist and pick up their prescriptions from a retail pharmacy.
Other service oriented tenants that are Amazon proof include AMC Theatres and Regal Cinemas as well as fitness clubs like Lifetime and LA Fitness.
Realty Income maintains a solid 28% net profit margin due to it’s weighted average mortgage rate being 3.9% while the net lease properties it acquires come at a capitalization rate between 6% to 7%. The difference between the two is what drives profitability.
Dividend Growth History
Realty Income (O) has grown its dividend payments from 91 cents a share in 1995 to $2.71 as of December 2019. This represents a compounded annual growth rate of 4.65% which is a respectable track record for a REIT. As a matter of fact, an average Real Estate Investment Trust (REIT) in the S&P has grown its dividend at a CAGR of only 2.9% during this period.
Attached chart below shows year over year % growth in dividend payments from Realty Income. We can decipher from the chart that the company aims to maintain a low single-digit growth rate in dividend payments over the long term.
Measuring the Dividend Payout Ratio
By law, Real Estate Investment Trusts (REITs) are required to distribute 90% of their taxable income to shareholders in the form of dividends. In the case of Realty Income, the dividend payout ratio is 82.5% as shown in the attached screenshot from the company’s 3rd Quarter, 2019 Financial Results.
For year to date in 2019, the company paid total dividends of $2.03 per share. The AFFO per Share is $2.46. Dividing $2.03 in to $2.46 sums in to an 82.5% payout ratio.
AFFO stands for Adjusted Funds from Operations and is a non-generally accepted accounting principle measure consistent with the National Association of Real Estate Investment Trusts’ (NAREIT’s) definition.
It calculates as net income available to stockholders plus depreciation/amortization of real estate assets plus any impairments minus capital gains resulting from the sale of properties.
Since depreciation and amortization of real estate is a non-cash expense, it should affect the company’s operating cash flows, hence it is eliminated from the AFFO calculation. Investopedia has a very good article on adjusted funds from operations and how they relate to real estate investment trusts.
Due to strong operational performance and solid dividend growth history, investors are paying a premium to own Realty Income stock. For full year 2019, analysts expect Realty Income to earn $1.37 in net income or earnings per share.
If we divide the current price of Realty Income Stock at $80.25 in to $1.37, we get a price to earnings ratio of 58.6 times 2019 earnings.
A price to earnings ratio of 58.6 times is too excessive. However in this case, this includes depreciation and impairment expenses which are non-cash expenses. If we instead use the company’s guidance of $3.34 in Adjusted Funds from Operations (AFFO) per share, we get a price to earnings ratio of a more reasonable 24 times.
Stock Performance Over the Long Term
Over the last decade, Realty Income Corp. Has gained 395% over a 10 year period. During this time, the S&P 500 is up 203%. In summary, Realty Income has doubled the performance of the S&P 500 which is phenomenal performance!