Realty Income Earnings: Another Solid Quarter

By Markets Fool.com

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Retail REIT Realty Income (NYSE: O) reported its second-quarter earnings on Wednesday, July 27, and as we've grown to expect, the company had another solid quarter. Revenue slightly beat expectations and FFO slightly missed, but there were no major surprises reported. The report was just the latest chapter in a long history of low-risk growth and excellent shareholder returns.

Realty Income's second quarter

Realty Income generated $271 million in revenue during the second quarter, a 6.7% year-over-year increase and slightly ahead of analysts' estimates of $270.4 million. The company's FFO (the "earnings" of REITs) grew by 4.4% to $0.71 per share, short of expectations by a penny.

Beyond the top and bottom line numbers, however, there was nothing too surprising about Realty Income's second quarter. FFO guidance didn't change, and the company's dividend continues to grow as expected, with a 1% declared dividend increase, to begin with the September monthly dividend payment.

While this may not sound like much of an increase, keep in mind that Realty Income increases its dividend quarterly, not annually, as most companies do. On an annual basis, the September 2016 dividend will be 6.1% greater than that of September 2015. In fact, Realty Income is such a consistent dividend-raiser that the announced dividend hike represents the company's 76th consecutive quarterly dividend increase.

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The biggest "surprise" was on the acquisitions front, and it was a positive one. The company announced $310.3 million in investment activity for the quarter, and increased its full-year acquisitions guidance to $1.25 billion, a significant 39% revision over the prior estimate. Essentially, the company is seeing a better-than-expected pipeline of investment opportunities, and the company's cost-of-capital advantage is creating record-high investment spreads. So, why not take advantage?

A rock-solid business model

There's a good reason that we don't ever see any major surprises in Realty Income's earnings the entire business model is designed for consistent growth with minimal downside risk.

For starters, the portfolio is designed to be recession- and competition-resistant. The majority of the company's retail tenants operate in one of three distinct business types:

  • Non-discretionary businesses such as drug stores, grocery stores, and automotive service businesses. These are businesses that sell goods people have to buy, no matter what the economy is doing.
  • Low price point businesses such as dollar stores, wholesale clubs, and quick-service restaurants. Not only do these businesses offer better deals than can be found online, but they actually tend to do better in bad economic times.
  • Service-oriented businesses like fitness centers and movie theaters are businesses that consumers need to physically go to. These business types have virtually no threat from e-commerce competition.

Tenants sign net leases, under which they pay variable expenses such as property taxes, building insurance, and maintenance. Initial lease terms are generally 15 years or more, with annual rent increases built in. All Realty Income does is collect a rent check.

This business model has been highly effective. Occupancy is at 98% and hasn't ever fallen below 96% no matter what the economy was doing. Revenue and FFO grow year after year. As a result, since its 1994 IPO, Realty Income has produced 18.2% annualized total returns for investors. To put this in perspective, investors who bought in on the ground floor have seen their Realty Income holdings rise by about 3,850% over that 22-year period.

The bottom line

Although its share price is up 35% year-to-date and may look a bit expensive, Realty Income continues to represent one of the best risk-reward investments in the market. The company is doing an excellent job of taking advantage of the low-interest environment to acquire attractive properties at extremely favorable profit margins, and there's no reason to believe it won't continue to do so going forward.

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Matthew Frankel owns shares of Realty Income. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.