Realty Income Corp. (O, Financial), less formally known as "the monthly dividend company," has shed an additional 4% of its market value in the past month as uncertain consumer spending continues incentivizing bearishness in the retail real estate investment trust arena.
Excluding dividends, the REIT's year-to-date losses have extended beyond 15%, suggesting an urgent analysis is necessary. As such, I delved into the latest events surrounding Realty Income and constructed an outlook.
Here are a few factors worth considering.
Systemic concerns relating to the retail REIT industry
Most U.S. retail REITs have shed value since the turn of the year. Thus, an argument could be made that Realty Income's year-to-date woes are due to an asset class issue instead of an idiosyncratic weakness.
Source: Investing.com
Much of the headwinds for retail REITs have stemmed from cyclical factors such as disinflation and rising credit risk among consumers. In addition, as illustrated by the diagram below, U.S. consumer sentiment remains lackluster despite signs of a recovery in July.
Although Realty Income possesses a high-quality tenant portfolio, its stock could face systemic challenges if broad-based industry numbers do not align soon.
Source: Trading Economics (U.S. Consumer Sentiment Index)
Capital raises sending the wrong signals
Another reason why Realty Income shed value in recent months relates to its latest capital raises.
As revealed by its second-quarter financial results, the real estate investment trust recently raised $2.2 billion through an at-the-market common stock program, adding to its concurrent $1 billion debt raise.
Raising capital can be accretive to REITs as they require the necessary dry powder to expand. However, I believe the market is doubting the feasibility of Realty Income's latest capital raise as its unsecured debt offerings were priced at a weighted average coupon of 4.82%, which is only slightly below the national capitalization rate for U.S. REITs.
Source: NaREIT
As if its second-quarter issuance was not enough, Realty Income issued a subsequent 1.1 billion euros ($1.17 billion) in unsecured senior debt.
The weighted average cost of the issuance is 5%, with a weighted average maturity of nine years. And, as with its previous offering, the repayments are excessive.
Investors often view external project financing as a negative event. Even though Realty Income is an asset-heavy vehicle, I believe expensive debt issuance at the peak of an economic cycle is a risky move.
Bellagio investment suggests intent
Although Realty Income's capital raise might be considered risky, its portfolio remains solid, as illustrated by its second-quarter revenue, which amounted to $995.29 million, a 24.29% year-over-year gain.
Due to its robust results, Realty Income possesses the ability to invest throughout the economic cycle.
In one of its latest moves, the company decided to commit approximately $950 million to a partial ownership of the Bellagio in Las Vegas. At face value, the rationale of the acquisition is to capitalize on the reopening activity present within the hotel and casino business while leveraging the hotel and casino's triple-net lease program.
In my view, the deal offers diversification benefits. However, cyclicality risk must be considered by investors. I base this on the fact the Bellagio's existing rental escalation agreement is at 2% for the next six years, which is lower than the U.S.'s current inflation rate. Therefore, income from royalties will ultimately determine whether the acquisition will be profitable.
Another dividend hike
As stated in the introduction, Realty Income is known as the monthly dividend company by many investors because it has consistently distributed dividends on a monthly basis since listing as a public entity in 1994.
The REIT's latest monthly dividend, which is payable on Oct. 13th, was increased by 0.2%, translating into a forward dividend yield of approximately 5.7%.
Realty Income's 122 dividend increases since 1994 mean it is a best-in-class dividend growth asset, which would suit most portfolio goals.
Valuation
A relative valuation of a REIT is usually best conducted by observing the vehicle's price-to-funds from operations and price-to-adjusted funds from operations metrics, whereby the prior communicates a generally accepted cash flow analysis while the latter dials in on a REIT's true economic value.
Realty Income's ratios are generally within respectable territory. Its price-to-funds from operations multiple is in the 51st industry percentile, suggesting most of the asset's positives are already priced in. Therefore, it is unlikely that Realty Income presents relative value at this stage.
Final Word
Realty Income's business model remains robust, as illustrated by its latest operating results and continuous dividend payments. However, a substantial capital-raising spree coupled with a questionable acquisition means the asset is struggling to find alignment in the market.
Although the REIT seems priced in and lacks tailwinds, it seems unlikely that additional downside will occur for the time being.
