It is good news all around for Realty Income Corp. (O, Financial) investors as the real estate investment trust's management team decided to increase the monthly dividend distribution rate by 0.2% to 25.50 cents on March 14.
In a recent note, CEO and President Roy Summit said, "I'm pleased that our Board has once again determined to increase Realty Income's monthly dividend. This decision is in line with our foundational commitment to pay stockholders a reliable monthly dividend that grows over time."
He went on to add the dividend is its 633rd consecutive monththly distribution in the company's 54-year history.
Headquartered in San Diego, Realty Income is nicknamed "the monthly dividend company" due to its sustainable distribution, which has lured dividend growth investors for the better part of three decades. Despite the upgraded dividend, however, systemic risks pertaining to the global economy are rife. Thus, the question becomes: Is Realty Income still investable given the unfavorable macroeconomic environment?
Operational review and recent news
On March 6, Realty Income announced it agreed to a sale-leaseback purchase of 415 single-tenant convenience store properties from EG Group. A sale-leaseback includes the purchase of assets that are immediately leased back to the seller. Moreover, a sale-leaseback is usually structured for the seller to gain access to liquidity, while the buyer benefits from an accretive acquisition.
I believe this type of agreeement is the first of many that will be made during the currently distressed macroeconomic environment. Many enterprises are struggling to cope with margin compression and fading demand, therefore raising the possibility that highly capitalized entities such as Realty Income will scoop up undervalued assets from companies seeking immediate liquidity.
A holistic operational review suggests Realty Income is on steady ground. Firste, the REIT hosts high-quality tenants, with over 40% of its leasees possessing investment-grade credit ratings. Additionally, the company is well diversified, with nearly 6,000 outstanding lease contracts covered by an Ebitdar/rent ratio of 2.9.
Source: Realty Income Corp.
Furthermore, Realty Income's portfolio is well constructed, with its core tenants belonging to non-cyclical industries. In addition, the company also operates a triple-net leasing program, which passes along a large portion of the operating costs to its tenants.
Source: Realty Income Corp.
A final operational consideration pertains to Realty Income's corporate strategy. As mentioned, the REIT hosts numerous high-profile tenants; however, it uses these brand names as core anchors, attracting smaller tenants at significant premiums.
Is Realty Income's dividend sustainable?
Realty Income has a stable dividend policy with an adjusted long-term dividend payout. Therefore, the fund is unlikely to alter its monthly dividend payout ratio relative to its interim results.
The fund's stable dividend policy is exceptionally beneficial to buy-and-hold investors as it results in non-cyclical dividend payments, which is a tailwind to the asset's market price.
Based on Realty Income's historical data, it has distributed nearly $10.7 billion in dividends at a compound annual growth rate of 4.4%. Moreover, the diagram below shows that the REIT has blitzed through multiple recessions while sustaining its dividends, indicating this year's systemic risk will have little effect on the vehicle's distribution policy.
Source: Realty Income Corp.
Although Realty Income has distributed dividends on a sustainable basis, a few risks persist.
First, a risk worth considering is the asset's valuation. Because of its low volatility characteristics, Realty Income's market price has remained stable over the years. However, it cannot be ignored that the security is trading at 15.72 times its funds from operations per share, which equates to a peer-based premium of 64%. On top of that, Realty Income's market price is at a premium to its tangible book value, signaling the REIT's lucrative asset base is already priced in.
Another noticeable risk relates to the company's cost of capital. Although Realty Income's 7.91% weighted average cost of capital is fairly respectable, the current macroeconomic environment has caused credit spreads to rise, providing obstacles to capital-intensive businesses. Therefore, instead of raising additional debt, the real estate investment trust will likely fund its acquisitions with internal capital for the time being, which might not be optimal for its balance sheet.
Technical analysis
Technical analysis should not be looked at in isolation, as past prices do not necessarily provide an indication of future ones. However, discovering a mean-reverting level is helpful in most instances.
Realty Income Corp.'s relative strength index is below 50, indicating that the REIT may be trading below its long-run mean-reverting level, which bodes well considering its robust fundamentals.
Final word
Realty Income has raised its dividend yet again, implying the management team is unconcerned by economists' bearish macroeconomic outlook. In my view, the real estate investment trust's dividend increase could coalesce with its robust operational prospects and the asset's technical levels to formulate a potentially lucrative investment opportunity.
