I don’t necessarily have a time frame in mind for when I purchase stocks throughout the month, but I do tend to let my cash flow situation materialize a little bit while I review my portfolio and watch list for potential opportunities.
However, this month has allowed me to be a bit opportunistic with a little cash on the side and an idea that struck me right away.
The stock purchase I decided to open the month with is an addition to an existing position. It’s down almost 9.5% over the last 30 days, and it appeared to me that an opportunity came down the pike for me. Mr. Market seems to be throwing me a fast ball, so I decided to take a swing here.
I purchased 110 shares of American Realty Capital Properties Inc. (ARCP) on 10/1/14 for $12.01 per share.
American Realty Capital Properties is a real estate investment trust that acquires, owns, and operates single-tenant and multi-tenant commercial real estate.
They are the world’s largest publicly traded net lease REIT by enterprise value.
ARCP was founded in 2011 by Nicholas S. Schorsch, the former CEO and current executive chairman. So there’s limited history to go by. One aspect of this REIT that is particularly interesting is the immense growth it has experienced in its short history, as I’ve discussed before. The company has grown extremely quickly between 2011 and now through a series of large mergers and acquisitions, so there is some uncertainty there as far as how well the firm will manage that growth moving forward.
To give some perspective, the REIT’s market cap stood at $178.5 million at the end of fiscal year 2011. It’s now just under $11 billion.
So let’s take a look at just what that kind of growth looks like. Their fiscal year ends December 31.
Revenue has grown from $3.97 million at the end of FY 2011 to $241.52 million at the end of FY 2013. That’s a compound annual growth rate of 679.98%. Obviously, this is skewed heavily by their M&A activity. Furthermore, their revenue for just the last six months was $672.1 million, so you can see where things are going here.
However, one aspect of REITs is that they commonly issue shares to raise capital. Adjusting for share issuance, the revenue grew at a compound annual rate of 119.36% over this time frame.
We use funds from operations (or adjusted FFO) to determine profitability for REITs by adding back depreciation and amortization to earnings. REITs are forced to depreciate properties, but typically they appreciate over time. So FFO or AFFO is a more accurate picture of their cash flow.
AFFO/share increased from a negligible amount to $0.86 from fiscal years 2011-2013.
And they are currently guiding for $1.06 to $1.08 in AFFO for FY 2014, which was actually reduced to this amount recently after announcing the sale of its private capital management business to RCS Capital for $700 million. This sale reduced AFFO over the short-term, but simplified ARCP’s business model (to focus more on real estate) while ensuring long-term fee sharing.
Although ARCP hasn’t been around long enough to build up a substantial dividend growth record, they have been regularly paying a dividend and increasing it since it was formed. I count eight dividend increases since they initiated their dividend back in 2011. The last dividend increase came earlier this year when ARCP raised its monthly dividend from $0.0783 to $0.0833, which was a 6.4% increase. The new dividend is $1.00, annualized.
I fully believe ARCP will continue to increase the dividend annually, although the payout ratio, at 93.4% of midpoint 2014 AFFO/share guidance, is a touch high. The 2015 dividend may be just marginally higher than what it currently is, as 2015 AFFO/share guidance is $1.11 to $1.14. However, the stock currently yields 8.32%, so very little dividend growth is necessary to provide a satisfactory total return and income proposition, as long as the dividend is sustainable, which it appears that it is.
As of the second quarter of 2014, ARCP owned 4,429 properties across 49 states, as well as Washington, D.C. and Puerto Rico. They have 541 tenants spread across 94 different industries. Their portfolio occupancy is 99.8%, and 46% of their tenants are investment grade. The average remaining lease term is 12.2 years. Their property portfolio appears to compete with the best of the best in this industry, with lengthy lease terms in place, great diversification, and an extremely high occupancy rate.
62% of their properties are retail and restaurant; 23% office; and 15% industrial/distribution.
Their top tenants include Red Lobster, Walgreen Company (WAG), CVS Health Corp. (CVS), and Dollar General Corp (DG).
I see one potential issue in that Red Lobster accounts for 11.3% of rents right now, after a $1.5 billion sale-leaseback transaction on approximately 500 Red Lobster restaurants in late July. This move is somewhat controversial, as Red Lobster has long struggled.
However, Red Lobster was sold by Darden Restaurants, Inc. (DRI) to private equity firm Golden Gate Capital. So there’s some hope for a long-due turnaround in this business. In the meanwhile, there are some positives and negatives to this deal. The positive side is that the leases are lengthy (average lease term of 25 years) and the properties are still valuable, even if RL falters. The negative side is that the leases have 2% annual compounded contractual rent escalations, which may lag inflation over the long haul.
Their balance sheet is rated Baa3, with a stable outlook by Moody’s.
I think we can all understand how real estate works. The wonderful thing about an investment in ARCP is that it gives an average retail investor like myself exposure to high-quality commercial real estate that’s diversified across the US and already leased out. It would obviously be impossible for me to replicate this on my own, and ARCP deals with all the headaches. They acquire property, obtain financing, find tenants, and take care of the paperwork. All I have to do is sit back and collect a check. I like that!
There has been a few changes in the business since I last added to my position, back in April of this year. The aforementioned Red Lobster deal occurred, as did the sale of its private capital management business.
Perhaps most notably was the exit of Nicholas S. Schorsch as CEO; he was replaced by David S. Kay. As far as I understand it, Schorsch was the mastermind behind ARCP, and brought it to the forefront of major REITs. However, had has been criticized as of late for a secondary offering below what was initially expected, the Red Lobster deal, and certain compensation concerns. So he remains chairman, but David Kay, who appears to be more than capable, is now CEO.
There’s obviously a lot to like here. ARCP focuses on long-term leases at the corner of “Main and Main” – strategic and well-trafficked locations, which provides stable rental revenue and clear long-term operational visibility. Although they’ve grown perhaps too quickly, they have an enviable portfolio of commercial real estate that should enrich shareholders with monthly “rent checks” in the form of monthly dividends for years to come.
As previously mentioned, they’ve grown incredibly quickly. So there is operational risk there. It remains to be seen, because of their short history, how well they can manage their growth and portfolio.
In addition, one of their tenants accounts for a substantial portion of rents. I find this transaction a bit puzzling, but no matter what happens to the Red Lobster chain, these properties should remain in demand.
Finally, a majority of their property portfolio is focused on retail and restaurants, both of which are challenging industries right now. Retail in particular faces continuing issues with increasing online shopping.
Using the midpoint of 2014 AFFO guidance, shares are trading hands for a P/AFFO ratio of 11.22. That’s substantially lower than major peer, Realty Income Corp. (O), which is trading for a P/AFFO ratio closer to 17. There’s no doubt there is a significant spread here, but is it warranted? It’s hard to say, but I’d reckon once this growth is digested and ARCP ages a bit it should trade closer to its peers. I believe a REIT with a track record like Realty Income’s should trade for a premium to a relative newer player like ARCP, but comparing their portfolios shows that ARCP is definitely in the same league, and in some ways superior.
I valued shares using a dividend discount model with a 10% discount rate and just a 3% long-term growth rate. I think that growth rate is rather conservative, and compares well to long-term inflation. This gives me a fair value on shares of $14.71, which is about 20% higher than where shares are priced today. So I believe there is a margin of safety here.
Investing in ARCP gives one broad and diversified exposure to commercial real estate spread across the United States. Their portfolio compares extremely well to peers, with long-term leases locked up. The yield is so high now that even a modicum of dividend growth, which should be achievable based on guidance, means that the income and total return prospects are quite bright.
This stock gives a great monthly “rent check” in the form of its rather robust monthly dividend. This certainly allows the snowball to roll downhill at a rather remarkable rate.
Though there are risks involved, I find the potential rewards to outweigh them. There would have to be a complete collapse in the broader economy or multiple tenants would have to fail in order for this investment to turn out badly. In addition, a complete mismanagement of the trust is possible, albeit unlikely.
This purchase adds $110.00 to my annual dividend income, based on the current monthly dividend of $0.0833.
I still have 50 positions in my portfolio, as this was an addition to an existing investment.
I usually include popular analyst valuation opinions to concentrate my valuation conclusion, but neither Morningstar nor S&P Capital IQ track this stock.
I’ll update my Freedom Fund in early November to reflect this recent purchase.
Full Disclosure: Long ARCP and O.
What do you think of this recent purchase? Does it seem like a good value with bright prospects?
Thanks for reading.
Photo Credit: Stuart Miles/FreeDigitalPhotos.net
Edit: Corrected dividend payout and Cole Capital sale information.