Steve Christ, who I wrote about recently when he was flogging what he called “Safe Harbor Savings Accounts” (he also called them Safe Harbor Investment Covenants for a while), has a new teaser to offer as he tries to get you to subscribe to his Wealth Advisory newsletter.
He’s calling this next great idea from his porftolio the “Teflon REIT.”
The note begins with a bit of chatter about how poorly REITs have performed this year, with many different types in huge trouble — you can probably pick out a few owners of office buildings or malls or warehouses that have been clobbered over the last twelve months, but the example he provides is General Growth Properties (GGP). If we expand on the “stickiness” metaphor to say that one reit is rubber and another glue, this is not the one off of which the bad news bounce, this is the sticky one.
GGP owns megamalls that are hemmorhaging retail stores and seeing their remaining clients beg for customers even during the holiday season — and they carry a massive debt load, so the equity owners have just about gotten washed out completely (I owned GGP years ago when it was the consistently growing class of the industry … how times have changed).
So what’s the opposite of that? This brings us to our teaser company — the Teflon REIT, the company that takes the bad news about the economy in stride and recovers. Here’s some of Christ’s commentary:
“Of course, when the broader markets sell off so hard and companies like GGP tetter on the brink it takes the good down right along with the bad. That has been the case lately, with my own favorite real estate investment. It’s one I call the “Teflon REIT” because bad news simply doesn’t stick to it for long.
“That has given investors the chance to buy this REIT on the dips adding shares on the cheap. Again, this is not you’re average REIT.
“In fact, while GGP was going down the tubes and trying to refinance its debt, the Teflon REIT was retiring debt and paying dividends. Along the way it retired over $100 million in debt with cash on hand, pushing out its next maturing notes to 2013.”
Sounds pretty good, no? So what is this specific company, for those of you who are you itchin’ to buy shares?
A few clues, please:
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“its monthly dividend program just kept chugging along as the company declared its 461st consecutive monthly dividend in its 39-year operating history.”
It owns “2,355 freestanding properties all over the country leased to retail chains under long-term net-lease agreements. In total, the company owns properties containing some 18.5 million leasable sq. ft. in 49 states.”
“Their properties are 97% leased. ”
“And here’s the kicker. The company only employs 74 people. By comparison GGP has over 4,000.”
So who are these new friends of ours? The Thinkolator sez:
Realty Income (O)
This company will not be a stranger to those who have been wandering the halls here in Gumshoeland for more than a few months — I’ve written about them a couple times before. Realty Income is a REIT that owns local retail buildings like small shopping centers and fast food restaurants around the country, and they have a very strong focus on providing a growing monthly dividend to their shareholders — they even registered the trademark to call themselves “the monthly dividend company,” well before so many American investors acquired a fascination with the monthly yielding Canadian trusts. Realty Income’s website is clearly built for individual investors, and it contains a wealth of information and reassurances that this company’s management really does care about maintaining that monthly yield above almost all else.
If you’d like to see earlier comments that I’ve shared about Realty Income, the articles are still available — the most recent one was in April, when Tom Dyson was teasing these guys as a way to invest in a “Drive Thru Retirement Project.”
In that article, I noted that one of the appealing things about this company was the fact that although they rely on the capital markets to finance acquisitions and grow, they tend to refinance that short term debt quickly with new equity and they carry dramatically less debt than the big mall owners like General Growth Properties. That’s still the case, and that’s a big part of the reason why O has not fallen all that dramatically. The shares are certainly down from the highs that they hit a few months ago, when they raised their dividend in September and issued new shares to repay their near-term debt, but they have not fallen nearly as much as most stocks. During this year’s horrific market they have significantly outperformed the S&P 500, and they have dramatically outperformed the REIT index (over 12 months O is down about 25%, the REIT index is down about 50%).
The temptation with “Teflon” stocks in an awful market is to say that they’ve avoided the ax for now, but it will return — I don’t know of any particular reason why that should happen with O, but there is certainly every chance that they’ll have their challenges as we remain mired in a deep recession with falling unemployment.
Realty Income typically increases their dividend several times a year, and at the moment it looks like the dividend is getting awfully close to their Funds from Operations (it’s much higher than their income, but that includes all those non-cash things like depreciation, and FFO is typically used to value REITs based on their cash flow potential).
I don’t know what will happen to them in a truly awful recession, since the company hasn’t existed as a public firm through such an economic downturn yet (They’ve been publicly traded only since the early 1990s, I think), but they certainly look like they have the conservative balance sheet and cash management strategy that they claim, so the chances seem good that they will avoid a cataclysm even if they do end up having any trouble growing the dividend in the next couple years. And they haven’t had much trouble refinancing their debt this year so far, and have pushed back maturities, which combined with a relatively light debt load should protect them to some degree. It looks like most of their debt doesn’t start to mature until 2013 now, with the bulk of it coming due a few years after that, so they appear well situated debt-wise.
There are reasons for caution with O, regardless of its “Teflon” status or of their relative consistency — their net cash inflow from operations has gone down in the first three months of this year relative to last year, which should probably come as no surprise, and they’ve pared back and invested less during this year, too, which will probably soften growth when things recover.
They are admirably diversified across states, and across business and clients (they said in the last annual report that their customers were spread across 115 retail chains), but they are still subject, to at least some degree, to the cycles of the economy. Their biggest concentrations of clients are in restaurant chains and in convenience stores, and we think of those as being somewhat resilient (many of the restaurants are fast food), but not all of them will survive a big downturn, especially in retail centers in the floundering exurbs where foreclosures are really taking hold in some areas. They are, thankfully, not overexposed to auto dealerships (only about 3% of their rent came from that segment last quarter), but even great diversification can’t prevent declining earnings.
So … what do you think of our old friend O? It still looks relatively reasonable to me, even though I wouldn’t be surprised if 2009 was a year when they had to scale back on dividend increases or, if the economy sinks further, cut the dividend, though they would probably fight that. I like management a lot, I like their diversification and their focus on providing growing monthly income for shareholders, and the current dividend of 9% or so is looking a lot nicer than the 5% you would have gotten last year … I bet they’ll continue to outperform REITs in general, I just don’t know if they can keep that teflon coating and outrun the economy.