A safe yield and solid growth prospects are a must for any investor in real estate investment trusts -- and Spirit Realty Capital not only has these qualities but it's much cheaper than rivals. Here's why it's an attractive purchase today.
For the last year and a half, investors have seriously discounted Spirit Realty. The company used to own a series of stores leased to Shopko, a physical retailer suffering some tougher times. But in a bid to move these assets off its own balance sheet, the company spun them out to investors as Spirit MTA (NYSE: SMTA). The spinoff company also includes other "workout assets," those that the company may monetize in the future. Instead of owning those properties directly, now Spirit Realty takes a management fee.
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So just how cheap is Spirit Realty?
Spirit compares favorably on key metrics against three rivals in the retail landscape.
On the basis of price to funds from operations (FFO), Spirit is notably cheaper than rivals, while having a similar portfolio composition, and its forward payout ratio is at a sustainable level. Spirit languishes at 12.3 times FFO, while industry bellwether Realty Income trades at a high 18.2 times and even rival Store Capital trades at a relative discount of 15.8 times. Part of this discrepancy is due to company size, since small REITs tend to trade at lower valuations than larger REITs. (That's one of the reasons that buying small, well-managed REITs is a loophole to finding long-term outperformance.) Regency Centers is on the larger end so its valuation looks more like Realty Income's.
Let's look at Spirit's properties and then compare them with those of Realty Income.
Spirit's tenant roster is well diversified, especially among its largest tenants. Its top 100 tenants comprise 88% of its properties. Now here are Realty Income's top 10 tenants.
As a film's bad guy often says to the hero: "You know, we are not so different, you and I." So it is with Realty Income and Spirit, which have similar exposures to high-quality tenants. Realty Income is a bit more concentrated in its top five and top 10 tenants, at 22.9% and 37.2%, respectively. But note the similarities. For both REITs, Walgreen (NASDAQ: WBA) is their largest tenant and Spirit adds CVS (NYSE: CVS), too, for comparable drugstore coverage, at least in this top 10. Both REITs have the same exposure to convenience stores (10.8%) as well as to BJ's Wholesale Club (NYSE: BJ).
On other key measures, Spirit's portfolio looks solid, too. Spirit is reasonably diversified across the U.S., though with a notable concentration of nearly 50% in the south and southeastern states, some of the fastest-growing ones. Occupancy is now greater than 99%, while 85% of leases provide for periodic rent escalations. The average remaining lease term is nearly 10 years. The company also has some decent insight into how tenants are performing, with 42% of tenants providing store-level financials.
And debt? Debt maturities are well staggered, and 85% of debt is fixed rate. Total debt has a low average rate of 3.95%. As of the end of the second quarter, Spirit net debt to EBITDA was 4.8, and management said that it was targeting a range of 5.2-5.4 times. As of early August, the company had more than $800 million free on its credit facility, so expect it to announce some acquisitions.
And what about the spinoff?
Although it spun off Spirit MTA, the former parent also has a stake in the company's success, because its earning management fees for that portfolio. It's important to recall that Spirit Realty's ownership of Shopko-tenanted stores didn't just go away entirely. The company still has some indirect exposure via Spirit MTA, though it's working to sell those Shopko stores. The proceeds of those sales will be rolled into more real estate at the spinoff.
The preferred stock has a $150 million par value, huge relative to Spirit MTA's market cap of just $470 million. The stock pays Spirit Realty a 10% dividend, and there's enough cushion in cash flow that Spirit shouldn't have trouble getting paid if Spirit MTA runs into some temporary setbacks.
One final thing
When I think a stock is significantly undervalued, I like to see the company step up and buy shares aggressively. Spirit Realty has certainly done that following the stock's swoon in 2017. New CEO Jackson Hsieh, who only took the reins in May 2017, has steered the company to retiring shares: more than 11% of its outstanding stock since the end of the first quarter 2017. That's an aggressive level for a REIT, where cash flow is usually reserved for hefty dividends.
Then in May, the company announced another repurchase authorization, for $250 million. That would be good for 7% of the stock, if executed at today's price. I think repurchases are a good use of capital at this valuation. If Spirit can achieve the Store Capital's valuation multiple -- the companies are similar in size -- it would be worth more than $10.70 per share, a 29% gain, not factoring in dividends. And it's also not factoring in any growth that Spirit might achieve as it acquires more properties.
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