Can Retaining Realty Income (O) Protect Your Portfolio?

With changing consumer preferences, downsizing of the bricks-and-mortar operations with store closures are on track. Meanwhile those failing to cope with stiff competition are turning bankrupt. These in turn, caused turbulence in the retail real estate market, forcing structural changes. Even the likes of Simon Property Group, Inc. (NYSE:SPG) , Kimco Realty Corporation (NYSE:KIM) and Macerich Company (NYSE:MAC) were not immune to this instability and made aggressive attempts to adapt to the changing scenarios.

Among these, Realty Income (NYSE:O) has been able to differentiate itself by deriving more than 90% of the company’s annualized retail rental revenues from tenants with a service, non-discretionary, and/or low price-point component to their business. Such businesses are less susceptible to economic recessions as well as rivalry from Internet retailing.

The company’s solid underlying real estate quality and prudent underwriting at acquisition helped it maintain high occupancy levels consistently. In fact, since 1996, the company’s occupancy level has never dropped below 96%. Additionally, as of Dec 31, 2019, its portfolio occupancy was 98.6%, denoting an increase of 30 basis points from the prior quarter. Management expects occupancy to be approximately 98% this year.

Realty Income focuses on external growth by exploring accretive acquisition opportunities. In fact, solid property buyout volumes at decent investment spreads aided the company’s performance. In 2019, the company invested $3.7 billion in 789 properties and properties under development or in expansion including $797.8 million in 18 properties across the U.K. An amount worth $1.2 billion spent on fourth-quarter acquisitions was related to the CIM portfolio buyout.

The acquisitions of conveniently-located commercial properties add to the company’s scale, lending a competitive edge to its net lease industry. Moreover, with a robust investment pipeline, both on the domestic and international front, the company expects to invest $2.25-$2.75 billion in 2020, based on present market conditions.

Realty Income has a modest leverage, enjoys low cost of capital and ample liquidity, which provide financial flexibility. The company recently closed 9 million common stock offering, leading to net proceeds after underwriting discounts and commissions of roughly $677 million. Particularly, the company plans to use the proceeds to repay borrowings outstanding under its $3-billion unsecured revolving credit facility. Moreover, it has a well-laddered debt maturity schedule and exited 2019 with net debt/adjusted EBITDAre ratio of 5.5.

Furthermore, solid dividend payouts are arguably the biggest enticement for REIT shareholders, and Realty Income remains committed to this area. The company enjoys a trademark on the phrase “The Monthly Dividend Company” and has witnessed a CAGR of 4.6% since its listing on the NYSE.

However, despite Realty Income’s efforts to diversify the tenant base, its tenants in the convenience as well as drug stores industry accounted for 11.6% and 8.6% each of the company’s rental revenues for the quarter ended Dec 31, 2019. This makes the company’s performance vulnerable to any adverse changes in these industries. Moreover, the choppy environment and tenant credit issues persist as headwinds to the retail real estate industry.

In addition, Realty Income has substantial exposure to single-tenant assets. Notably, single-tenant leases are prone to massive risks associated with tenant default. Thus, in case of financial failure or default in payment by a single tenant, the company’s rental revenues from the property as well as its value suffer significantly.

In the past six months, shares of the company have outperformed the industry. The stock has inched up 2.8% against the industry’s decline of 11%. However, the Zacks Consensus Estimate for current-year funds from operations (FFO) per share moved southward over the past week. Therefore, given the above-mentioned concerns and downward estimate revisions, there is limited room to run for the stock.

Realty Income currently carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Note: Funds from operations (“FFO”), a widely used metric to gauge the performance of REITs, is obtained after adding depreciation and amortization and other non-cash expenses to net income.

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Kimco Realty Corporation (KIM): Free Stock Analysis Report

Macerich Company (The) (MAC): Free Stock Analysis Report

Simon Property Group, Inc. (SPG): Free Stock Analysis Report

Realty Income Corporation (O): Free Stock Analysis Report

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