In Part 1 of this series, I highlighted why I like the REIT space today with a higher-level discussion. In Part 2, I outlined my bullish thesis for beaten-down Federal Realty Investment Trust (FRT). In Part 3, I explained the rationale behind my recent Realty Income (O) purchases. In Part 4, I will be focused on STORE Capital (STOR), which is an up-and-coming dividend growth name that has the Warren Buffett stamp of approval.
STORE Capital (STOR)
STORE Capital is a very interesting name (in my opinion, at least) in the triple-net REIT space.
As I’ve said, I like this industry so much because of the incredibly high margins that these landlords can generate. When you pass off nearly all real estate-related expenses – maintenance, insurance, and property taxes – onto the tenant, there is quite a lot of money to be made. Really, this business model relies on the landlord’s ability to maintain a high occupancy ratio. And the best-in-class management teams have proven their ability to do so (for instance, STOR’s Q2 occupancy ratio was 99.5%, which is in line with pre-pandemic levels).
What’s more, a hallmark of the triple-net space is not only the high margins and reliable profits, but also the reliable profit growth due to the rent escalators that are typically built into the very long-term leases that these companies use with their tenants.
For instance, at the end of the second quarter, the aforementioned Realty Income had finalized $640 million worth of investments across the U.S. and the U.K., with an average initial lease term of 13.6 years.
STOR had put roughly $399 million to work during the first two quarters of the year, which had average weighted lease durations of 16 years in Q1 and 17 years in Q2. The company’s deals included 2.5% average rent escalators in Q1 and 1.8% rent escalators in Q2. Since becoming publicly traded, STOR has been known for maintaining industry-leading average weighted lease durations. This, combined with the rent escalations, has provided investors with a nice, predictable stream of income.
What’s more, since becoming publicly traded, STOR’s AFFO growth has outpaced its peers (including the market darling, Realty Income). While many of its blue-chip peers have generated low- to mid-single digit AFFO growth over the last 5 years or so, STOR has made a habit of generating 7-8% bottom line growth.
This strong bottom line growth has translated directly into industry-leading dividend growth (STOR has grown its dividend by about 40% overall since becoming publicly traded in 2015). And what’s even more impressive from a reliably increasing dividend standpoint is the fact that the company’s strong AFFO growth has allowed it to maintain a low payout ratio as well (generally speaking, STOR has paid out ~70% of its AFFO to shareholders).
What makes STOR so interesting to me is the difference mindset that it has taken, when compared to Realty Income’s, with regard to its middle market strategy.
While Realty Income has focused a lot of its attention on investment grade tenants in recent years (which, as I mentioned, has paid off during the pandemic), STOR, on the other hand, has focused on value. The company believes that it can make better deals with lower-quality tenants, while still achieving strong/investment grade metrics, on a building-by-building basis.
In other words, when working with the best-in-grade tenants with the most reliable cash flows and, therefore, the most reliable rent checks, those checks are likely to be smaller over time, because the blue-chip tenant has a lot of bargaining power. When making middle market deals, STOR retains most of the bargaining power and can use its strong management style and investment selection protocols to ensure reliability while generating higher cash flows.
This value-oriented mindset (alongside the cheaper historical multiple that the market has placed on STOR as opposed to names like Realty Income or National Retail Properties (NNN), which is another triple-net player with a much longer dividend growth history) is likely why STOR is one of the few REITs to achieve the Warren Buffett stamp of approval.
Berkshire Hathaway bought an initial stake in STOR a few years and then recently added to that position in 2020. It now owns roughly 10% of STORE Capital shares, which provides peace of mind to someone like me who respects the Buffett/Munger investment style.
It’s worth noting that STOR’s middle market approach has underperformed thus far in 2020 during the COVID-19 era. STOR also has exposure to fitness (roughly 5.3% of its current portfolio) and movie theaters (roughly 4% of its portfolio). The company’s lower tenant quality has led to more delinquencies and deferrals. STOR collected 86% of rent in August and 88% in September, which still trails Realty Income’s 93.5% August rent collection figures.
However, like both O and FRT, STOR’s rent collection continues to improve on a month-over-month basis as the COVID-19 recovery takes place, and this provided management with enough confidence to recently increase the dividend by 2.5%.
I was actually concerned that STOR would be forced to freeze its dividend for a year or so because of its 2020 weakness. Analysts are expecting its AFFO to fall 8% this year. That compared rather unfavorably to O’s expected 2020 AFFO performance (current consensus for O is 2% AFFO growth this year). However, this relative weakness has resulted in a lower valuation, which creates opportunity.
With regard to that cheaper valuation, we see that STOR shares are trading for just 14.3x blended AFFO and 13.99x forward AFFO expectations. STOR’s long-term average multiple is 15.4x, so both of these current multiples imply a discount.
(Source: F.A.S.T. Graphs)
STOR’s current dividend yield is 5.37%, and this, combined with a return to mid-single digit AFFO growth in 2021, mean reversion back to the ~15x area, and dividend re-investment means that investors buying STOR today in the $26.80 area are setting themselves up for double-digit total return CAGRs (assuming such mean reversion does occur).
To me, this is more of an aggressive, value-oriented play. I added to STOR early on in the pandemic sell-off, but I haven’t done so in recent months because of the threat of a dividend freeze. However, it appears as though my fears here were misplaced, and now that the company has once again increased its dividend (the 2.5% increase in 2020 lagged recent performance, but in a year like this, any increase is a good increase, in my book), I am looking to continue to pick up shares at these bargain barrel prices.
I plan to add more in early October when I make my monthly selective dividend re-investments. I would also be happy to dip into my cash position if STOR were to trade down to the ~$24/share area again, which would allow me to average down from my most recent purchase at a double-digit click while taking advantage of a 6% dividend yield.
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Disclosure: I am/we are long STOR, O, NNN, FRT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.