Motley Fool Canada launched a new dividend-focused newsletter service called Dividend Investor Canada earlier this year, and they’re now promoting it using a promise that they’re finding retail’s “next generation of ‘hidden millionaires.”
And, of course, the bait that they dangle to entice you to subscribe is a report with some “secret” stocks that they recommend.
So what’s the story, and what are the stocks? If you don’t feel like ponying up $200 to learn the “secret,” stick with me and we’ll take a look. Here’s a taste of the intro:
“Retail’s Next Generation of ‘Hidden Millionaires’ Is About to be Born
“But these savvy investors won’t make their fortunes by buying shares of Amazon… Canadian Tire… eBay… PayPal… Shopify — or any other well-known company you’ve probably heard of.
“Instead, he predicts they’ll quietly snap up a handful of under-the-radar companies (just like the ones I’ll introduce you to in a moment) ….
“And, if everything plays out like this investor expects it to, they may even be able to collect steady ‘retail royalty cheques’ each year in amounts like $660… $1,320… or even $3,300 — all while the underlying value of their investments climbs steadily higher over time.”
Royalty checks while your investment climbs steadily over time? That sounds lovely… and it also sounds like a pretty typical dividend investing strategy. So what are the stocks?
The ad goes off on a long tangent about the history of successful retailers of the past, like Melvin Simon, Ted Lerner and, particularly, Alfred Taubman, who pioneered the early shopping malls and made billions…
And we’re told in the ad letter that the “five rules of striking it rich” in retail were, as I sum them up for you (and probably oversimplify): eliminating threshold resistance (making it easier for shoppers to get into the store and buy something); tapping the explosive megatrend of automobiles and suburban sprawl by making shopping convenient to cars and suburbanites; providing convenience and selection in one easy-to-access spot; locating your shopping mall in the most convenient place to enable you to drive traffic and charge premium rents; and staying fashion-agnostic — don’t try to ride fashion or pop culture trends, just own the space and get the customers there and let other companies worry about merchandising (and pay you rent).
Which is when we get to the specific opportunity that they begin to hint at: Location.
But not shopping center locations — locations for e-commerce, the trend that is arguably killing the shopping mall (and at least culling the weaklings from the herd). Here’s a bit more from the ad:
“… what many people forget is that when it comes time to deliver you the goods you bought online, e-commerce companies have no choice but to depend on actual physical locations in the good old ‘real world.’
“You may already know that I’m talking about the humongous distribution centres where companies like Amazon, Canadian Tire, and Wal-Mart store the massive amounts of inventory they sell online…
“But what you may not know is that these distribution centres are seldom — if ever — owned by the companies themselves.
“Instead, the online retailers merely lease space in these giant centres in much the same way that stores used to lease space in a shopping mall…
“Which makes the location of these distribution centres incredibly important — especially given the recent push by companies like Amazon and Wal-Mart to get the items you buy online to you within a few days time.”
OK, so if we add all that up — smallish companies, own distribution centers, pay “royalty cheques,” that means we’re almost certainly looking at some industrial REITs — companies that own industrial, logistics and distribution warehouses and lease them out to operators (yes, like Amazon and all their competitors, but also to any company that requires warehouse space or distribution services). It’s a fast-growing business, and there have been several REITs trying aggressively to expand in this space ever since ProLogis (PLD) pioneered the “warehouse REIT” sector about 20 years ago.
So which stock, specifically, does Bryan White like in this sector? Here are our clues:
“Offers Canadian investors unique access to the rapidly growing U.S. consumer and industrial market — yet still trades on the TSX…
“Enjoys an incredible 98.4% occupancy rate across all of its properties — meaning it’s collecting rent on almost every last square metre of space it owns…
“Recently renewed the vast majority of its expiring leases — which will help ensure those occupancy rates stay sky high well into the future…
“Was even able to increase the rent on its fifth largest tenant, Zulily, by 12.4%… with 2% annual escalators built in over five years — demonstrating just how willing e-commerce companies are to pay top dollar for access to this company’s locations…
“Has a high level of insider ownership — a strong indicator that top management will make decisions that are in shareholders’ best interests…
“And currently pays a healthy 5.6% dividend yield — in U.S. dollars no less, making this an intriguing investment option for an RRSP…”
If you’re not familiar with an RRSP, those are are Registered Retirement Savings Plans — essentially the Canadian equivalent of an IRA or 401(k) here on the warmer side of the border. And yes, stocks like REITs that throw off taxable income in the form of dividends often make sense in these kinds of tax-deferred accounts, because letting that income reinvest and compound without being taxed increases the total return (and because you won’t have to pay income taxes on those relatively high dividend payments each year).
But which investment is this, specifically? Well, the company White is referring to with these clues is WPT Industrial REIT (WIR.U.TO in Canada, WPTIF OTC in the US). Interstingly, this is one of those “odd” stocks that trades primarily in Canada, but is priced in US$ even for its Toronto-traded shares.
WPT industrial is a small REIT, with a market cap below $500 million, and it does indeed have a few things going for it — it’s got a strong dividend, with the forward yield expected to be about 5.8% that makes it far more generous than US-listed comparables like PLD, DCT, DRE or STAG; and it’s cheaper than most of the US-traded industrial/logistics REITs on most metrics (EV/EBITDA, EV to Free Cash Flow, price to book value).
So that’s pretty interesting, and it makes me want to take a closer look — one thing that has stopped me from investing in the big US warehouse REITs, despite the obvious secular growth story from booming e-commerce, is that they’re generally too expensive to take seriously, and have been for some time. (That doesn’t mean they can’t keep going up, of course, it just means there’s less room for error.)
Does that mean we can get a piece of that kind of growth potential and also enjoy a 5% yield instead of a 2% yield? That might make me stand up and pay attention — but with that kind of differential, there has to be a downside or a reason, even if it might not be a good reason. What might the reason be for this relatively cheap valuation?
Well, it’s a new company. They’ve only been around for a couple years and went public in 2016. And they’re externally managed, so they have fees incurred for property management and acquisition management that eat into profits to some degree (though such agreements often aren’t terrible, since they effectively mean that you just are paying that fee instead of having employees yourself).
And the properties are encumbered, with a meaningful amount of mortgage debt and a company that is, overall, pretty indebted — though the debt is all fixed-rate at an average cost of 3.8%, and the maturities seem manageable (as do the lease expirations, which are pretty well spread out over the next decade). WPT Industrial has a capital structure that is more dependent on debt than is the larger DCT Industrial, for example, but both have roughly comparable debt levels in comparison to their assets, with debt at about 40% of asset value. Which indicates to me that the bondholders are in a stronger position with WPT Industrial if things get ugly, but that their overall level of debt is reasonable (and similar to peers) as a percentage of the value of their real estate portfolio.
They also have recently had substantial insider selling, with Welsh Property Trust offering up $40 million of their shares in a secondary offering that also raised $86 million for WPT (Welsh Property Trust, or WPT Advisors, is the external manager for WPT Industrial). That offering, just announced as closed today, was at a decent price — so that’s not a particular red flag (they didn’t have to discount to get the shares sold).
But really, probably the fact that they’re skating at a pretty close to their maximum dividend payout, and have not been able to increase their funds from operations per share, is the most worrisome negative. Their growth focus and their several equity raises have meant that the FFO per share number actually shrunk last year, since the share count rose, and that brought the payout ratio up to a pretty high 90%+ (meaning that they’re paying out dividends that equal more than 90% of their adjusted funds from operations, which means there’s not a lot of extra cash flow to help fund growth or reinvest in the business — not unheard of for REITs, to be sure, but it keeps a lid on expectations of dividend growth).
And that also means they need to generate a pretty strong return on their capital investments or get good rent increases if they’re ever going to increase the dividend per share meaningfully — selling more stock means paying out that same relatively high dividend to those new shareholders, which means that their cost of capital is well over 5% even if they also use some debt… and that means they’ll probably struggle to really grow meaningfully, because the average cap rate for industrial properties in the US is probably right around 5%.
“Cap rate” is just the cash earning capacity of a property, the capitalization rate — if you bought a building for a million dollars and it throws off $50,000 in cash income each year (not counting depreciation or amortization, just deducting actual operating costs), then that building has a cap rate of 5%. So if it costs you 5% a year to finance the money you’re using to buy the building… well, you can see where that puts you, you’re just breaking even and any future growth will have to come from increasing income from the property.
That may well come, rents are rising and, by all reports I see, demand is still growing for industrial and logistics space… but if that sector does eventually get overbuilt, it could be that some of these players end up in trouble if rents stay flat or fall. And WPT Industrial, as a fairly small player, may not have a lot of bargaining power to keep rents high unless their assets are particularly unique or fantastically located (and while location is key, of course, warehouses are not generally expensive or unique unless they happen to be in congested urban areas — I don’t have any great insight into WPT’s property portfolio).
The biggest risk, perhaps, is that the sector’s popularity over the past couple years could lead to serious overbuilding — mostly because the buildings themselves are relatively quick and inexpensive to put up, and there’s lots of institutional capital chasing even 5% capital returns from real estate and other “hard assets.” I don’t know how big that risk is, but I like what I see from this first look at WPT’s relative valuation compared to the other industrial REITs I’ve looked at recently.
So I find this one pretty interesting, since it’s a relatively inexpensive REIT in a sector that is filled with pricey stocks — the relatively costly management fees and the high payout ratio are of some concern, and mean that dividend growth might not rev up anytime soon, but with a 5%+ current yield they’re already paying a much higher dividend than many of their competitors, which could provide some balm to those worried about growth prospects.
If you’re curious about what it takes to get those “royalty cheques” they note, I do always like to do that math just to provide some context — they hinted at “$660… $1,320… or even $3,300” in annual payments. The current dividend is a total of 76 cents per year, so those annual payments would be expected from an investment of, respectively (and roughly), $11,000, $22,000, or $55,000. So the promise is not quite so hyped as some ads are, you don’t have to put up a million dollars to get their hinted at returns… but, then again, $1,300 a year isn’t likely to change your life very much, either.
That’s just my quick impression after looking this one over for an hour or two, though, and I can’t say I’ve found all the skeletons (or all the buried treasure) — and it is, of course, your money… so it’s your opinion that matters. What do you think of WPT Industrial or the other industrial and warehouse REITs? Let us know with a comment below. Thanks!
P.S. Yes, the Foolies did pitch a second stock in a similar space in this ad — but I got a little sucked in to looking at WPT Industrial… so I’ll dig into that other stock for you tomorrow (assuming that the Mightly, Mighty Thinkolator is up to the task.
P.P.S. If you’re one of the folks who has subscribed to the relatively new Dividend Investor Canada, please click here to share your opinion of that service with your fellow investors.
Disclosure: I own shares of Amazon. I am not currently invested in any of the other companies mentioned above, and will not trade in any covered investment for at least three days following publication, per Stock Gumshoe’s trading rules.