Thursday, November 21, 2013

Stock Bought: O

Yesterday I bought shares of Realty Income (O), an equity REIT with a geographically diverse collection of over 3,800 properties. The company owns free-standing properties that are leased primarily to retail businesses, typically under triple-net leases (tenants pay taxes, maintenance, and insurance). Its properties are 98% occupied and major tenants (by rental revenue) include FedEx, Walgreens, Family Dollar, LA Fitness, AMC Theatres, and Diageo.

Realty Income bills itself as "The Monthly Dividend Company" due to its track record of having paid 520 consecutive monthly dividends. The company is a Dividend Contender, having increased its dividend for 19 consecutive years. In fact, there have been 73 dividend increases since the stock was listed on the NYSE in 1994. With the exception of a 19% dividend increase earlier this year (reflecting the acquisition of American Realty Capital Trust), the dividend growth rate tends to be low, with 5- and 10-year rates of 1.5% and 4.2%, respectively. However, the high dividend yield (over 5.5%) helps to compensate for the weak dividend growth. The company's payout ratio (based on funds from operations, FFO) is about 92%.

The company has a stable balance sheet that should support continued dividend payments and modest growth. Debt/capital is 44% and interest coverage is 2.2x. Notably, 100% of Realty Income's debt is fixed-rate, so its interest payments will not be affected by rising interest rates. However, the company is still sensitive to rising interest rates because it often issues new debt to help fund acquisitions; this is a common practice among REITs and represents the main reason why the entire sector has fallen over the past several months. Debt issuance is affected by credit ratings (companies with higher investment grade ratings can issue debt at lower interest rates) and S&P recently upgraded the company's credit rating to BBB+. In addition, Value Line increased their financial strength rating to A (with a safety rating of 2).

I think O is fairly valued at the current price. It has a P/FFO of 16.5 (using the low point of the company's FFO guidance for full-year 2013), which matches Value Line's estimate of the average annual P/FFO for the next few years. Other useful valuation metrics include a P/S of 10.1 (vs. a 5-year historical average of 9.4), P/B of 1.8 (vs. 2.5), and dividend yield of 5.55% (vs. 5.6%). Using a Dividend Discount Model with a dividend growth rate of just 1.5% (matching the 5-year historical rate) and a discount rate equal to the current yield plus the dividend growth rate, I calculate a fair value of $39.91. Morningstar gives a fair value of $44.00 and a 3-star rating. The average of those two estimates is $41.95, which implies a 6% margin of safety at my purchase price. Overall, I think it is reasonable to conclude that O represents decent value in the current market, but not a bargain.

I bought 55 shares of O at the price of $39.32 per share (no commission paid due to a free trade), giving me a 5.55% yield on cost. The fact that the stock price promptly fell another 1% after I made my purchase shows why I am not a day trader. At the current dividend rate, I can expect to receive monthly dividends of $10.00 from this purchase, which will add a total of $120.00 to my annual dividend income. The stock goes ex-dividend next week, so the first dividends from this purchase will be paid in December. This purchase was made in my Roth IRA using rollover money. Realty Income becomes the 32nd stock in my portfolio and the 2nd REIT (the other being HCP), giving me a bit of diversification in the real estate sector. My forward 12-month dividend total increases to $3,231.

This month I have made two purchases in my Roth IRA and one purchase in my taxable account, consistent with the plan I laid out in a previous post. If O's stock price falls a few more percentage points, then I would consider increasing my position. However, I am also on the lookout for other REITs that might be good candidates for my Roth IRA.

In case any readers are wondering why I did not write a Seeking Alpha article about O (given that I wrote articles when I started my positions in HCP, WMT, and XOM), there are two reasons. First, I simply do not have much spare time at the moment, especially with the fall semester coming to an end. Second, O is one of the most-covered REITs on SA, and I am not sure how much useful information I would be able to add. Hopefully this blog post partially compensates for the absence of an article.

14 comments:

  1. O is very much a buy right now.

    Enjoyed the post.

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  2. DGM,

    O is a very compelling stock today, especially since many others are reaching new highs. Love that the div is monthly. Now is the time for REITs. I also picked up some HCR recently. We may be waiting a while for rates to rise, Fed isn't in any hurry it seems.

    -RBD

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    1. RBD: I agree. Given the current market environment, REITs are some of the only attractively valued stocks out there. I'll continue to keep my eye on various names in the sector.

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  3. Good move, DGM. I am considering adding to my Real Estate position with either O or HCP.

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    1. R2R: Thanks, and I think both stocks are good choices.

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  4. O is a great purchase!
    I think I will buy two REITs in 2014: O and HCP.
    This are the best two REITs in my opinion.

    Best regards
    D-S

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    1. D-S: Thank you -- I think you've selected two good REITs for 2014!

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  5. DGM, I currently own PSA (Public Storage) and its dividend gorwth is impressive at close to 10% annually for the last ten years, sports a yield north of 3.5% and has around an 18+% annualized return (w/Dividends reinvested) for the last ten years.

    Regards,
    Joe

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    1. Joe: Thanks for drawing my attention to PSA. It hasn't been on my radar, but maybe it should be! I'll check it out.

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  6. "The fact that the stock price promptly fell another 1% after I made my purchase shows why I am not a day trader."
    LOL I hear you on this one. Don't know how many times that has happened and I cursed a "Oh come on!"

    O is a solid pick.

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    1. PMU: Yep, it's happened to me on a few occasions. I tend to have an immediate, negative emotional reaction, but then my rational side takes over and I soon forget about it. Besides, there are other occasions where I've managed to buy a stock near the intraday low, so I think it all evens out in the long run.

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  7. I like the buy, and I like the price. As for the day trading, I'm in the same boat. I couldn't time something even if you told me ahead of time what would actually happen. I think this will be a solid holding for you over the next few years.

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    1. w2r: Thanks for the feedback. I think O represents a nice addition to my portfolio and I look forward to collecting those monthly dividends.

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