There’s More Inside This STORE Than You Think
Yesterday I wrote an article Kimco Realty (KIM), a leading shopping center REIT that appears to
be mis-priced, providing REIT investors with attractive risk-adjusted returns. While the company
is exposed to significant retail headwinds, the management team is doing an excellent job of
mitigating risks by focusing on internet-resistant tenants and improved balance sheet
fundamentals. As I wrote,
“KIM has spent years preparing for the changes, and the balance sheet is now in the best shape
ever.”
Let me be clear, I’m not recommending for investors to load up on retail REITs, instead I am
suggesting that investors take a more tactical approach, paying very close attention to the
underlying revenue generators.
It can be extremely dangerous placing a bet on a cheaply priced REIT, like Spirit Realty (SRC),
when there is potential for a dividend cut. In other words, the margin of safety applies to both
price, and also the overall quality of the dividend. In the case of Spirit, it’s obvious that the
shares are “cheap for a reason”.
Surveying the list of Net Lease REITs, that demonstrate a “margin of safety” in both price and
dividend safety, I find STORE Capital (STOR) to be the most attractive. Taking a look at the most
recent price performance, you can see that STOR has under-performed Realty Income (O) and
National Retail Properties (NNN) month-to-date:
In addition, STOR’s Price/AFFO multiple is 12.0x, much lower than the leading Net Lease peers,
O and NNN.
While the market is suggesting that STORE is unpopular, I find this Net Lease REIT attractive,
especially when compared with the fundamental elements of value creation (more on that
below).
As noted above, SRC appears to be attractive based on its deeply-discounted share price and
P/AFFO valuation; however, when compared to dividend safety, the company is HIGH RISK. As
you can see below, SRC hast the highest AFFO Payout Ratio in the peer group (and STORE has
the lowest). Arguably, SRC has escalated into a high-risk alternative, arguably a sucker yield
(and not a STRONG BUY whatsoever).
Simply put, STORE checks all of the boxes and at the conclusion of this article you will see that I
have upgraded the company a STRONG BUY. There’s more inside this STORE than you think!
This STORE Is Different From The Others
STORE recently filed an updated Investor Presentation that summarizes the company’s unique
investment platform.
This presentation contains enhancements made subsequent to filing the year-end presentation
with the SEC, such as the trend of property median fixed charge coverage ratios over time and
the trend of investment-grade contract percentages.
STORE also decided to more to completely describe its top ten tenants, including greater sector
investment descriptions, as well as more color on historic performance running this and prior
public companies. Here are the Top 10 Tenants:
STORE has 1,750 properties with 369 customers (~ 17 net new customers quarterly) that
represent ~ 590 contracts (~ 30 transactions closed quarterly) with an average transaction size
below $9 million.
The new presentation is divided into three parts:
(1) The foundational attributes that make STORE stand out from other net lease companies,
(2) The performance that STORE’s foundational attributes have delivered,
(3) Enhanced disclosure, including full distribution of tenant default probabilities. STORE
provides a credit metric where the unit coverages are aligned with the default
probability of each lease contract to arrive at a base contract credit rating, STORE calls
this the “STORE Score”.
No other REIT provides this level of granular credit risk management. It takes a lot of captured
data and a potent information system to accomplish. Uniquely, 97% of STORE’s leases require
the delivery of property-level financial statements, which is unprecedented and enables such
disclosure.
The unprecedented credit metrics are designed as a base to inform investors of the quality of
the investment portfolio and how it is performing, and trending. Since lease contracts always
determine risk, STORE’s contract disclosure gives investors a window into the portfolio
investment quality and performance trends that is unavailable anywhere.
For a Net Lease REIT, STORE is definitely providing the most transparency, and I like the fact
that I can now not only see STORE’s dividend payout ratio, but also the impact of that ratio on
the company’s long-term internal growth.
Also, has also purposely directed its investments into retail real estate that is be defensible
from other modes of consumer goods distribution. In the process, STORE has generally stayed
away from commodity retailers, even if the goods that they purvey are non-discretionary. Also
STORE has stayed away from service providers not requiring human interaction (i.e bank
branches).
STORE has intentionally weighted its portfolio heavily to service industries, including
restaurants, movie theaters, fitness clubs, early childhood education, veterinary clinics and
more. The result is that only 3% of the company’s entire investment portfolio is within close
proximity (a quarter mile in any direction) to ANY Sears, JC Penney, Macy’s, Kmart or hh gregg
store.
In other words, STORE believes that the performance of the investment portfolio should not be
impacted by traffic pattern disruptions caused by sales declines suffered by most other major
retail chains.
Given STORE’s desire to weight its investment portfolio away from retail, STORE did something
unusual for a REIT when it publicly listed in 2014. It did not disclose tenant diversity by property
type, but by business type.
STORE does this by NAICS codes, much as a bank or federal agency would do. So, a health club
becomes a service business and not a retail property. The performance of net lease companies
will be more driven by tenant success than by underlying vacant real estate fundamentals. SO
STORE is better off illustrating investment diversity by tenant business sectors than by real
estate property types. Using STORE’s approach, there’s just 17.7% of exposure to retail.
Of this amount, five tenants are in the top 10: Art Van Furniture, Gander Mountain, Mills Fleet
Farm, Dufresne Spencer Group, and Camping World (CWH). Altogether, these tenants amount
to 9.3% of the 17.7% in retail.
Other tenants who are STORE customers that have previously been in our top ten list include
Hill Country Furniture (the largest Ashley Licensee), Conn’s (CONN), and At Home
(HOME). Apart from this list, a few hobby stores, dollar stores, farm supply, home flooring,
used merchandise, used car dealerships, supermarkets and furniture stores round out the
company’s retail investments. Most of the furniture stores are Ashley, which amounted to 3%
of tenant exposure as a percentage of revenues across 25 stores at the end of the quarter.
The Highly Predictable Profit Center
As noted above, STOR is that the company is more focused on granular property-level
investments. While many of the bigger Triple Net REITs focus on traditional credit-based
fundamentals, STOR's tenants typically don't have credit ratings. Most of these unrated
companies either prefer to be unrated or are simply too small to issue debt rated by a
nationally recognized rating agency in a cost-efficient manner.
STOR's approach is more of a risk management one, and so, instead of herding hundreds of Net
Lease deals through the door every year (like many of its peers), the company takes a more
granular approach to ensure there is a critical piece of real estate attached to a profitable
business operation.
As far as I’m concerned, this is the "secret sauce" for STOR; as you will see below, the company
provides many key metrics that you will not see in the filings of many of its peers. For example,
I don't think any of the Net Lease REITs provide weighted average annual lease escalation data
(STOR's is 1.7%), and of course, STORE is proud of its internal growth platform.
STOR has only 2% of "flat leases," and a majority (74%) of the leases are contractually CPIbased. Around 67% of the REIT's leases have "annual" rent escalations and around 28% of the
leases have "5-year" rent bumps
STOR's targeted internal AFFO growth per share is between 3% and 5%, driven primarily by the
company's differentiated focus on signing leases with middle market companies.
By obtaining quarter sales reports from most (98%) tenants, STOR can measure performance of
each individual property. This communication channel provides it with an advantage with which
the company can mitigate risk and provide a higher degree of predictability.
The Balance Sheet
During the first quarter, Fitch Ratings raised STORE’s rating outlook to positive, which is in line
with its BBB- credit rating with a positive outlook from S&P. STORE continues to target an
unencumbered asset ratio of over 50% of its total portfolio.
During the first quarter, STORE raised more than $270 million in new equity with most of that
from a $220 million overnight sale and the remainder from its ATM.
At the end of Q1-17 STORE’s total long-term debt outstanding was $2.6 billion with a weighted
average maturity of 6.2 years and a weighted average interest rate of 4.5%. All of the
borrowings are long term and fixed rate. In addition, STORE’s debt maturities are intentionally
well-laddered with no meaningful near-term debt maturities.
At quarter end, STORE’s gross investments totaled $5.5 billion, of which approximately $2.9
billion had been pledged as collateral for secured debt. The remaining $2.6 billion of real estate
assets is unencumbered.
This growing pool of unencumbered properties provides STORE with increased financial
flexibility, which adds to its overall financial strength. At the end of Q1, STORE’s leverage was
right in line with its target at a conservative 6x net debt to EBITDA on a run rate basis or roughly
45% on a debt-to-cost basis.
The Latest Results
For the first quarter, STORE’s AFFO increased 25% to $70 million or $0.43 per basic and diluted
share from $55.8 million or $0.40 per basic and diluted share last year. This represents an
increase of 7.5% on a per-share basis.
STORE’s dividend is an important component of its overall stock return.
Since the IPO STORE has increased its dividend per share by 16% while maintaining a low
dividend payout ratio. For the first quarter, the company declared a cash dividend of $0.29 per
common share, representing approximately 67% of AFFO per share. As mentioned above, the
low payout ratio and attractive lease escalators generate excess cash flow that STORE can
invest in new acquisition opportunities to generate strong internal growth.
On the !1-17 earnings call STORE affirmed its 2017 AFFO per share guidance in the range of
$1.74 to $1.76. The AFFO guidance is based on a weighted average cap rate on new acquisitions
of 7.75%.
Although STORE does not give guidance on capital markets activities, it is targeting leverage
based on a run rate net debt to EBITDA of approximately 6x, plus or minus 25 bps.
The STRONG BUY Upgrade
STORE is attractive based on all metrics, and I especially like the dividend yield today:
The market is not giving STORE credit for constructing the economics of its business to have
substantial margins for error, or to place this idea in a more positive light, margins of safety.
Having margins of safety is the reason that STORE has never generated a negative rate of return
in any portfolio, private or public, it has ever managed since 1980. Having margins of safety has
consistently outperformed the broader REIT benchmarks over time and with less risk through a
myriad of economic and interest rate climates.
I would be remiss not to mention the fact that most of STORE’s management team also the
troubled REIT known as Spirit. As many know, Spirit recently relocated (last year) from
Scottsdale to Dallas. Given the uncertainty regarding a possible dividend cut at Spirit, I would
not be surprised to see STORE enter the picture at some point. Clearly Spirits needs a
management team and STORE is the “top of mind” candidate!
As you can see, STORE is forecasted to generate strong AFFO/share growth and when you
combine that with a modest payout ratio, you can see that there is more inside of STORE.
I am upgrading shares in STORE from a BUY to a STRONG BUY.