We previously covered Realty Income (NYSE:O) in November 2023, discussing why it remained a Buy, with the SRC deal projected to be AFFO accretive without having to rely on expensive debt financing as the management continued to deliver competent growth during an uncertain macroeconomic outlook.
We believed that the pessimism embedded in the stock provided opportunistic income investors with the chance to load up, especially given the stable dividend thesis.
In this article, we shall discuss why we are maintaining our Buy rating for the O stock, with the REIT remaining well capitalized to fund its debt and dividend obligations, thanks to the elevated inflationary environment and the slower cap rate adjustments.
Combined with the healthy balance sheet and secure payouts, we believe that dividend-oriented investors may still consider O as a viable long-term income strategy in a well-diversified portfolio.
The REIT Investment Thesis Remains Excellent For Opportunistic Dividend Hunters
For now, O has reported a top-line beat in the FQ4'23 earnings call, with total revenues of $1.07B (+3.8% QoQ/ +21.4% YoY) and Normalized FFO per share of $1.00 (-3.8% QoQ/ -4.7% YoY), with FY2023 numbers of $4.07B (+21.8% YoY) and $4.09 (+0.7% YoY), respectively.
The REIT's bottom line miss is mostly attributed to the accelerating growth in the total expenses to $841.28M (+4.3% QoQ/ +22.5% YoY) in FQ4'23 and $3.18B in FY2023 (+25.1% YoY).
This is on top of the dilutive nature inherent to most REITs, with the management reporting 724.60M shares by the latest quarter (+15.06M QoQ/ +91.23M YoY).
On the one hand, it is apparent that O's focus on aggressive growth has taken a toll, with its reliance on long-term debts increasing to $20.13B (+4.7% QoQ/ +15.2% YoY/ +162.4% from FY2019 levels of $7.67B).
This naturally triggers the REIT's expanding annualized interest expenses of $833.24M (+13.1% QoQ/ +58.6% YoY) and slower annualized FFO growth of $2.89B (-2% QoQ/ +8.7% YoY) by FQ4'23.
On the other hand, we believe that O's debt reliance remains somewhat reasonable, with it well balanced by the stable debt-to-EBITDA-ratio of 5.25x by FQ4'23. This is compared to the leverage ratio of 5.15x reported in FQ3'23, 5.59x in FQ4'22, and 5.68x in FY2019.
O's Portfolio Profile
At the same time, its portfolio profile remains well diversified, with no one tenant comprising over 4% of the annualized contractual rent, insulating O's rental collection and consequently, top/ bottom lines, no matter the uncertain macroeconomic outlook.
With the January 2024 CPI rising by +0.3%, up from the +0.2% reported in December 2023, it is also apparent that the elevated inflation remains a temporal tailwind for the REIT.
This is because 82.2% of O's portfolio provides for increases in rent tied to inflation, fixed increases, and percentage of tenants' gross sales, with the latter representing less than 1% of the rental revenue in FY2023.
This implies that the REIT may still enjoy excellent revenue growth over the next few quarters, with the management highlighting that "it takes ~12 months for cap rates to adjust to changing interest rates," depending on when the Fed pivots and the macroeconomic outlook normalizes.
As a result, we believe that readers should not be taken aback by O's supposedly lower FY2024 FFO per share guidance of $4.23 at the midpoint (+3.9% YoY), compared to the consensus estimates of $4.25, with the bottom-line headwind mostly attributed to the rising inflationary pressure on its operating expenses and higher interest obligations.
Readers must also note that approximately 94% of its total debt is at fixed rate, at approximately weighted average interest rate of 3.83% (+0.68 points YoY), lower than the FY2019 weighted average interest rate of 5.05%.
These numbers imply that O's aggressive growth plans remain under control, with the management still executing competently and delivering growth despite the headwinds.
The Consensus Forward Estimates
Thanks to the recent closing of the Spirit Realty acquisition, the consensus has also moderately raised their forward estimates, with O expected to generate a top/ bottom line CAGR of +0.6%/ +3.6% through FY2026.
This is compared to the previous estimates of +2.2%/ +1.9% and the historical growth of +20.8%/ +21.2% between FY2016 and FY2023, respectively, with the decelerating top/ bottom-line growth mostly attributed to the projected decline in the CPI over the next few years.
O Valuations
The same pessimism has also been embedded in O's stock valuations at FWD Price/ FFO of 12.32x, nearing the REIT sector median of 12.55x, compared to the 1Y mean of 13.66x and 3Y pre-pandemic mean of 19.23x.
With the REIT sector likely to be painfully impacted as the macroeconomic outlook normalizes, it appears that these discounted valuations offer great entry points for opportunistic dividend hunters looking for monthly payouts.
So, Is O Stock A Buy, Sell, or Hold?
O 5Y Stock Price
Based on the FY2023 FFO per share of $4 and the FWD Price/ FFO valuations of 12.32x, it appears that O is trading near our fair value estimate of $49.20.
Assuming an upward rerating in its Price/ FFO valuations nearer to the 3Y pre-pandemic norm of 19x, we may see the stock offer an impressive upside potential of +64% to our bullish long-term price target of $86, when combined with the FY2026 consensus FFO estimates of $4.53.
At the same time, the O stock offers an excellent annualized dividend payout of $3.078, with the recent correction bringing forth an expanded forward yield of 5.89%. This is compared to its 4Y average of 4.64%, the sector median of 4.76%, and the US Treasury Yields of between 4.16% and 5.37%.
While it is uncertain when the Fed may pivot, it is undeniable that the Fed "remains resolute to returning inflation to 2 percent over time," with the normalization process being a matter of when, not if.
Combined with the stable Interest Coverage Ratio of 2.36x and FFO Payout Ratio of 74.23%, we believe that dividend-oriented investors may still consider REITs, such as O, as a viable long-term income strategy in a well-diversified portfolio.
We maintain our Buy rating for the O stock here.
Juxtaposed Ideas
I am a full-time analyst interested in a wide range of stocks. With my unique insights and knowledge, I hope to provide other investors with a contrasting view of my portfolio, given my particular background.Prior to Seeking Alpha, I worked as a professionally trained architect in a private architecture practice, with a focus on public and healthcare projects. My qualifications include:- Qualified Person with the Board of Architects, Singapore.- Master's in Architecture from the National University of Singapore.- Bachelor in Arts from the National University of Singapore.If you have any questions, feel free to reach out to me via a direct message on Seeking Alpha or leave a comment on one of my articles.
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