Summary

• Realty Income is the largest real estate investment trust in the Free Standing retail REIT sub-sector, with over 5,800 properties.
• The company has increased its monthly dividend for 27 consecutive years and has a Standard & Poor’s credit rating of A-.
• Realty Income recently announced its first international deal to buy a dozen Sainsbury grocery stores in the United Kingdom.

Introduction to Realty Income Corporation

Real estate investment trust Realty Income Corporation (O) leases, generally for 10-20 years, typically stand alone properties in prime locations with good access and visibility to 261 tenants operating in 48 industries in 49 states and Puerto Rico. The company recently announced its first international deal to buy grocery stores from, and lease them back to, Sainsbury in the United Kingdom.

Realty Income owns over 5,800 properties, is the largest REIT in the “Free Standing” retail sub-sector and has an A- credit rating from Standard & Poor’s. The company pays a monthly dividend of $.2265 ($2.718 annually). The dividend has increased for 27 consecutive years and at a closing price of $71.78 on June 24, 2019, Realty Income yielded 3.79%.

Walgreens (WBA) is the largest tenant, providing 6.1% of revenue. The largest category is convenience stores, providing 12.2% of revenue. 82.2% of revenue is from traditional retail properties and almost 12% comes from industrial properties. Adjusted funds from operations in 2018 was $3.19 per share, and AFFO guidance for 2019 is $3.28 to $3.33.

Strengths

Realty Income’s competitive advantages include their size, scale, breadth of industry relationships, diversification and strong balance sheet.

• O’s equity market capitalization is $20.682 billion, by far the largest REIT in the Free Standing sub-sector that includes ten other peers, giving Realty Income 42.7% of the sub-sector’s $48.455 billion equity market cap.
• Realty Income’s history, reputation, size and broad geographic footprint make the company a desired landlord for many large retailers.
• O’s first international deal, with Sainsbury in the UK, was “relationship-driven,” and negotiated off-market.
• Realty Income’s diversity is reflected in 261 tenants representing 48 industries. The eight largest are convenience stores (12.2% of rental revenue); drug stores (9.8%); health and fitness (7.7%); dollar stores (7.4%); quick service restaurants (6.4%); theaters (5.2%); grocery stores (4.8%); and transportation services (4.8%).
• S&P upgraded O’s credit rating in August, 2018 to A- from BBB+, citing “the company’s highly consistent track record of strong operating performance and demonstrated commitment to fund acquisitions conservatively … and … to maintain debt to EBITDA in the mid-to-high-5x area.”

Weaknesses

Challenges and uncertainties faced by retailers, such as the rise of eCommerce, are passed on to retail REITs through lessee bankruptcies, smaller rent increases, shorter lease durations and more vacant commercial property.

• Realty Income recognizes that bricks and mortar retail is a challenged sector. In the Q1 2019 earnings call, CEO Sumit Roy said, “Within our overall retail portfolio, approximately 95% of our rent comes from tenants with a service non-discretionary and/or low price point component to their business….to compete more effectively with e-commerce….”
• At year-end 2018, the average lease term was 9.2. This number has been steadily dropping: 2017 (9.5); 2016 (9.8); 2015 (10.0); 2014 (10.2); 2013 (10.8); 2012 (11.0); 2011 (11.3); 2010 (11.4).
• Because REITs are required to pay 90% of income in dividends, REITs tend to regularly borrow through lines of credit, bonds or commercial paper and/or to issue common or preferred equity. This business model makes REITs vulnerable to rising interest rates, and it is amplified for retail REITs since their lessees may also be weakened by rising rates.
• An oversupply of bricks and mortar retail in some markets can give tenants a stronger position to negotiate leases with retail REITs like Realty Income.
• In the Q1 2019 earnings call, CEO Sumit Roy identified several types of properties for desired reduced exposure due to relatively weak potential: child care centers, small kiosk convenience stores and discretionary stores like furniture and sporting goods.

Opportunities

In a late economic cycle, Realty Income’s several competitive advantages give it opportunities to select and execute the best investments with equity as a potentially strong currency for acquisitions, partnerships and expansion into other sub-sectors or countries.

• One upside of current difficulties among retailers is that Realty Income’s size and strong financial position provide an opportunity to buy the best properties, choose the best tenants and negotiate the best lease terms relative to its retail REIT peers and independent property owners.
• Realty Income is relatively well-positioned for a recession that could make it a potential buyer for select properties from REITs or other owners who are less well capitalized and need to sell.
• Almost 12% of O’s revenue comes from industrial properties. O’s size and strong finances give it the option to grow the percentage of industrial properties or to expand into other REIT sub-sectors.
• Realty Income’s move into the UK opens new opportunities for expansion beyond the $4 trillion US market to the $12 trillion international market, described by CEO Sumit Roy in the Q1 2019 Earnings Call.

Long-term outlook for Realty Income Corporation

S&P’s August 2018 credit upgrade of Realty Income to A- puts O in position to continue to grow its property portfolio in the most advantageous retail categories, to broaden its investment in other REIT sub-sectors, such as expanding its industrial portfolio and to grow internationally.

The credit upgrade and O’s continued growth in size and scale means the company is prepared to survive and thrive during the next recession, relative to weaker retail REITs. In an economic downturn, O’s equity could become a valuable currency, enabling it to issue accretive shares rather than incurring burdensome debt.

Look for the company to decrease exposure to some areas of retail by becoming more selective about small, kiosk-style convenience stores, and retailers that are less well positioned to grow in a changing economy.

Look for the Sainsbury acquisition to be the first in a series of international investments that could transform Realty Income’s footprint and perhaps reduce retail’s percentage of company revenue.

Our SWOT analysis is meant to serve as a baseline for doing research on companies that we might invest in at certain prices. As Warren Buffett has repeated many times, only by getting to know a company’s business, can we start to understand whether or not to invest our hard earned money.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article was written by Ted Leach (Dividend Sleuth) with input from Kirk Spano and David Zanoni. The article is for informational purposes only (not a solicitation to buy or sell stocks). Ted is not a registered investment adviser. Investors should do their own research or consult a financial adviser to determine what investments are appropriate for their individual situation. This article expresses my opinions and I cannot guarantee that the information/results will be accurate. Investing in stocks involves risk and could result in losses.