Warren Buffett Bags Quick 29% Return in Store Capital

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Warren Buffett's legendary stock-picking acumen has turned him into one of the richest people on the planet, and it appears he isn't losing his touch. Last quarter, the Oracle of Omaha's Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) gobbled up a nearly 10% stake in Store Capital (NYSE: STOR), a real estate investment trust (REIT) focused on stand-alone, service-oriented, retail businesses. With Store Capital's shares trading much higher than Berkshire Hathaway's acquisition price, the purchase is already panning out. Is there more room for this REIT's shares to run higher?

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A "smart" REIT

Traditional retail is losing sales to e-commerce, and that's causing a spike in vacant space at malls, yet Store Capital is humming along nicely because its tenants operate businesses that are more insulated against e-commerce's threat.

Store Capital specializes in leasing free-standing buildings to service-oriented businesses, including movie theaters, health clubs, and restaurants. It vets its tenants carefully, and it signs them to long-term contracts that build in annual rent increases. This has resulted in an occupancy rate north of 99% and predicted annual internal growth of greater than 5%.

The company builds or acquires its buildings in markets where it can do so below replacement cost, and then it rents those buildings at below-market prices so it can sign on the best tenants. Last year, Store Capital acquired 360 properties alone, and 75% of its lease contracts were with investment-grade businesses.

Its leases are unique because they often require tenants to provide store level profitability, giving Store Capital greater insight into vacancy risks. Additionally, its leases require tenants to pay variable costs, such as property taxes, insurance, and some maintenance expenses, which increases Store Capital's profitability.

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Because it rents to service-oriented businesses somewhat insulated against the threat of e-commerce, it buys its assets wisely, and it enjoys a steady flow of growing cash thanks to its rent escalators, Store Capital is perhaps the best REIT in its class.

Winning over Berkshire Hathaway

Warren Buffett loves predictable companies run by proven leaders that he can buy on sale, and it appears Berkshire Hathaway portfolio manager Ted Weschler agrees.

Since Buffett tends to focus on the bigger positions in Berkshire Hathaway's $150 billion equity portfolio, the decision to invest in Store Capital fell to Weschler, who was clearly won over by Store Capital's business model and the 35 years of commercial real estate experience in its c-suite.

According to Reuters, it took Weschler three years to cross his t's, dot his i's, and find the perfect opportunity to invest in Store Capital. During those years, Weschler tracked every move Store Capital made, and in the end, he came away impressed enough to reach out to Store Capital's management in June with an offer to buy about 10% of the company's stock.

Weschler's timing was perfect. After peaking last August at prices above $31 per share, Store Capital's share price was steadily dropping over worry that rising interest rates would increase costs of capital even as e-commerce dents retail space demand. By June, Store Capital's price was flirting with $20, a price Weschler viewed as too good to pass up. In the end, he was able to acquire 18.6 million shares at a price of only $20.25 per share, an unequivocal bargain based on where shares are trading today.

Is Store Capital still a buy?

Funds from operations are growing thanks to new properties and rent escalators, and that's allowing Store Capital to return more money to investors. Since its IPO in 2014, Store Capital's dividend has increased from $0.114 to $0.29 per share, and earlier today, it increased its dividend yet again to $0.31 per share. As a result, shares are yielding a Treasury-beating 4.7% now.

In the future, e-commerce will undoubtedly continue chipping away at traditional brick-and-mortar REITs, but Store Capital's focus on freestanding buildings and service oriented businesses should allow it to outperform, and if so, then owning its shares could be profit-friendly, at a minimum, thanks to income-producing dividend growth.

Certainly, Warren Buffett's Berkshire Hathaway could already sell its shares in Store Capital at a nice profit, but given his penchant for buy-and-hold investing, and Store Capital's best-in-class business model, I wouldn't be surprised if this investment sticks around in Berkshire Hathaway's portfolio for a while. If it does, then buying its shares now could still be smart.

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Todd Campbell has no position in any of the stocks mentioned. His clients may have positions in the companies mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.