Stock Gumshoe is closed in honor of Dr. Martin Luther King, Jr. today, as the markets are also closed, but for those looking for a little reading… I’m sharing here a taste of the Friday File from a month ago.
What follows was the final section of the Friday File I published on December 18 (if you’re a paying member, you can see the original and the rest of that commentary here), at which time I was thinking about making some gradual shifts to reduce risk in my Real Money Portfolio. For those who don’t know, that portfolio is the lion’s share of my family’s investment portfolio, currently including about 50 different stocks as well as some mutual funds and some more speculative (and very small) options bets, and writing about what I buy and sell and how I position the portfolio is often the focus of my Friday File commentaries (I update the full portfolio most weeks, with updates on buys and sells, performance and allocations). I am hesitant to ever tell anyone else what to do with their money, and empty opinions about stocks are always of limited value, but I hope it is helpful to tell you what I’m doing with real money, and why.
I don’t see a reason for the market to crash in any given moment, and you shouldn’t believe my claims of prescience if I did, but with the market at almost unprecedented valuations I’m certainly finding a little bit more solace in cash flows and dividends than I am in speculative growth ideas. The companies I discussed when I was delving into these high-profile and high-growth dividend payers are today at roughly similar prices to where they were then. Indeed, despite the insanity of the past month, the S&P 500 is also essentially unchanged.
12/18/20: Innovative Industrial Properties (IIPR) increased its dividend again, by 6% to $1.24 for this next payout (in January, record date 12/31)… or, if you want to be a bit more fair and look at annual increases, by 24% over the fourth quarter dividend for 2019. That continues a remarkable string of dividend increases, even if it’s a bit less dramatic than the 100%+ annual increases we saw in IIPR’s first couple years… and it also means this is the third quarter in a row to have a sequential increase (meaning, the dividend was raised from the prior quarter, not just from the prior year). Companies that can raise their dividend every quarter, or almost ever quarter, let you compound your holdings even more quickly… and they tend to attract lots of loving shareholders.
“Buy rising dividends and reinvest to compound your holdings” is probably the single most effective long-term investment strategy out there over the past few decades… it’s not as sexy as buying hot growth stocks, and not always as effective at maximizing returns during good markets, but it can build wealth over time, and in pretty dramatic fashion if you’re patient. If you add on a strong growth market and a hot investor story, like IIPR or like American Tower (AMT) in cell towers (also an “every quarter” dividend raiser, though theirs doesn’t grow quite as fast and the dividend yield has usually been paltry), and you might really catch a tiger by the tail.
I haven’t added to my IIPR stake in quite some time, and in fact sold part of it during the initial pandemic collapse when it hit my stop loss (that was an error, in retrospect, but I was worried about their weaker tenants staying open during the shutdowns… and it wouldn’t have taken many defaults to really clobber IIPR’s share price), but the compounding has worked awfully nicely and my average cost is firmly negative so I’m not terribly itchy about taking profits here, even with a new all-time high share price and a valuation that is growing increasingly challenging.
The dividend yield for IIPR is just below 3% now, so it’s not entirely ridiculous, and the dividend is covered nicely by their FFO and cash flow, so the train could well keep rolling along… their deal growth is still hitting the income statement in pretty dramatic fashion, as deals signed early in 2020 will just begin paying rent now in many cases, so they keep posting near-100% revenue growth… and being a richly-valued REIT means that you can keep the game going, because then you can sell more shares at elevated prices, use that to buy more properties, and, since the deals they’re signing still have very large cap rates (even if not quite as high as a couple years ago — more likely to be 12% than 16% these days), they can still keep growing that dividend. Growing top line, growing bottom line, new deals at 12% cap rate, and raising capital from investors by selling shares at a 2-3% dividend yield, that’s a nice recipe for keeping the growth going.
It’s not without risk, to be sure, and I’d be very hesitant to go “all in” at prices like these (the stock is up almost 20% in a week)… but if you can nibble on bad days, and IIPR does seem to have bad stretches every now and then, the company is still doing quite well. If you want to imagine a more dramatic growth picture, just start to think about the potential if IIPR were to raise some debt capital as well as equity — if they could shift their cost of capital to roughly half debt at reasonably low cost, and half equity at very low cost, that would give them room, if they act like almost every other growth REIT, to explode the dividend growth higher still. That’s not likely to happen unless there’s some movement toward further legalization of marijuana in Washington, since debt financing is a stodgy business compared to equity, but if there is further legalization, and investors begin to worry about IIPR’s ability to prosper in a world with a lot more competition, then that opening up of the balance sheet could help to resolve any such worries.
Either way, these leases are long-term and the tenants, so far, have been holding up their end, with just the one small default in LA… if that continues, IIPR can work even at these prices. Crazy as that seems.
And speaking of steady dividend growth companies… we’re getting closer to the point where American Tower (AMT) could start to become more appealing than Crown Castle (CCI) again in the world of cell tower REITs, after a long period when AMT outperformed and has been valued much more richly. The general difference between the two has largely been that AMT is growing a bit faster, in part due to international expansion, and has consistently grown the dividend by a little bit each quarter, and had higher annual dividend growth, often 20%+, but has typically had a much lower current dividend yield and appealed more to growth investors than to income investors. Crown Castle is US-only, has focused on building out small cells in preparation for 5G installations that have been a drag on their income growth as they aren’t generating a lot of cash flow yet, and has paid out a much higher dividend but only grown that dividend at about a 7-8% pace, with guidance for investors to expect more of the same in the future.
So how do you measure the value of a current dividend yield and lower growth, versus a higher dividend yield and lower dividend growth? The math part of that is fairly straightforward, but if you don’t want to do it yourself there’s a financial planning site called Wealthtrace that offers up a calculator. So out of curiosity, I put my assumptions in: AMT has a 2.2% yield and is likely to grow the dividend at 15% a year going forward, while CCI has a 3.4% yield and is likely to grow the dividend by 7% a year.
We can argue about which company has better management, a better strategy, or might be more appealing to investors, but here’s how the math works out: the income will remain higher from CCI, and those dividends will create a compound return of 56% over ten years (versus 51% for AMT), but the yield on cost will break through for AMT and begin to outperform after about six years — meaning that relative to what you put in, your ongoing dividend yield will be higher with the dividend growth choice than with the higher current yield choice after about six years. And if they can keep up that dividend growth differential (which is not guaranteed, of course, both companies might be somewhat challenged to continue to increase the dividends at a rate much higher than their revenue growth rate), AMT becomes likely to outperform over about five years. If we assume they can continue to raise the dividend by 20%, which is what they did this year but is more aggressive than most analysts would assume, then the yield on cost leaps higher than CCI faster, within four years or so, and the compounding power for AMT outpaces CCI within about nine years.
Both of these companies are expensive, and both should do well with the 5G transition — partly because 5G is being added to 4G, not replacing it — and the math leads to pretty similar return expectations for those two models, so your guess about which company will best remain on track or have the best chance of posting growth that exceeds those historical levels, or become more beloved by investors, could be the differentiating factor. Over the past five years AMT has clearly done better, but with AMT’s share price coming back down a bit that outperformance has narrowed (total return of about 150% over five years, versus 120% for CCI — over the past three years, they’re about even), and AMT is starting to look relatively appealing for the first time in a couple years.
So that got me digging into American Tower again. AMT has seen its numbers for 2020 and 2021 come down a little bit following their renewed deal with T-Mobile a couple months ago that cut slightly into revenue forecasts, and that appears to be the biggest drag on the shares, which are down roughly 20% from their highs of the summer, making for the biggest and most persistent dip in AMT shares in years (other than the quick crash and recovery in the March COVID panic — only the comedown from the dot-com bubble in 2001 and the drop during the 2008 financial crisis come close). That follows a long period of strong performance — AMT has given shareholders a 150% return over the past five years, compared to 120% for Crown Castle (CCI), 100% for the S&P 500, or 30% for the average REIT (going by the Vanguard Real Estate Index (VNQ)). Does that outperformance continue, and does AMT finally merit a buy here with this latest dip?
Currently, AMT is expected to earn about $9 a share in Funds From Operations (FFO) in 2021. That would mean a valuation of roughly 24X forward FFO. Not cheap, but cheaper than it has sometimes been… and part of the reason why they have been able to grow a little faster is that they pay out less of their cash flow in dividends, so their expected dividend for next year would only be about half of that FFO number.
CCI is forecasting $6.69 in AFFO per share for 2021, so that’s an extremely similar Price/FFO valuation of about 23X… though they pay out a lot more of that cash, with their dividend for next year indicated at $5.32, about 80% of their AFFO. You can see why AMT’s dividend growth can also be quite a bit higher — there’s just more flexibility in their cash flow.
What are the growth drivers for these companies? More usage of the towers as 5G antennas are added to the still-needed 4G antennas, more installation or acquisition of new locations, and the smaller bets both companies have made on expanding the value of their infrastructure — CCI by building up a large fiber-connected network of small cells for urban 5G coverage, AMT by continuing its international expansion and by adding mini data centers at its tower locations for better “edge” connections, particularly for intensive content like video.
This miniature shock to the system for AMT is really the first scare we’ve seen in these stocks from the Sprint-T-Mobile merger since the first attempt at that merger was reported in 2013 — in general, the response from CCI and AMT management has been that demand is growing so fast, and the need to maintain the legacy Sprint networks is going to persist for some time, so any problems for the cell tower owners regarding lease losses as two customers become one are going to be minor. I think that’s probably still true, and we’re also not really accounting for the fact that it’s possible Dish Network will end up going in big with their planned launch of a wireless service, but it’s also true that we’re seeing a little speed bump here for AMT in 2020 and 2021. I expect that’s an opportunity for investors, I continue to like CCI and I’m not selling (selling a dividend compounder is almost always a mistake), but I am going to start building an AMT position here as well, to get that little dividend growth boost for my portfolio to go along with the higher current yield from CCI. I added a 1% AMT position in the Real Money Portfolio today, paid for in part by reducing my stake in the Benchmark Data & Infrastructure Real Estate ETF (SRVR) — AMT and CCI are the two largest components of the SRVR ETF, so this won’t immediately shake up the portfolio in any dramatic way, but I do like the big names more than the small ones in this space, and I’m happy to pay less of an ETF management fee and get more dividend compounding power with this relatively minor shift.
And since I’m posting this older note about American Tower, I should note that I also added to the stock more recently — here’s the brief note that appeared as part of last week’s Friday File:
1/18/21: American Tower (AMT) made a large acquisition this week — they’re buying up Telxius, the tower business owned by global telecom company Telefonica, for $9.4 billion. That provides 31,000 more sites, mostly towers, in Germany, Spain, Brazil, Chile, Peru and Argentina, and a pipeline of 3,300 new sites to be developed in Germany and Brazil. It’s an expensive deal, they expect $775 million in “property revenue” in the first year, with roughly half of that flowing through to adjusted EBITDA, so that means they’re paying about 12X revenue for these assets. That should have no real impact on AMT’s overall valuation, that’s roughly how the company is valued right now (based on 2020 estimated property revenues of about $7.9 billion, and their $96 billion market cap), but it will provide some more geographic diversification, with Germany in particular being a strong market for them, and there will be some margin expansion in the future as those towers are shared — the key to the tower REIT business model is that they are not beholden to one telecom tenant, once they own a site they can lease additional space on those towers for new services or for competing customers (ie, adding 5G antennae to supplement the still-necessary 4G antennae or, in Germany for example, leasing space to competitors Telekom or Vodafone on what had been Telefonica-only towers). I think this is an appealing deal to help juice future growth a little bit, and added slightly to my AMT position this week.
Food for thought. We’ll be back with more new teaser solutions and musings tomorrow… thanks for reading!
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