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Leading freestanding retail real estate investment trust Realty Income (NYSE: O) is known among dividend investors for producing a stable, consistently growing income stream. This may come as a surprise, since retail businesses are perceived to be inherently risky by many people. However, Realty Income is different, and is one of the most reliable dividend stocks in the market.
The difference is the type of retail properties in Realty Income's portfolio. Specifically, Realty Income primarily invests in three different kinds of retail businesses. Here are the major categories, along with examples from Realty Income's own portfolio.
One of Realty Income's major tenant categories is non-discretionary retail, which refers to businesses that primarily sell items that people need, not things that they want. These businesses are inherently less recession-prone, and tend to be less vulnerable to online competition.
Walgreens (NASDAQ: WBA) is a good example of this, and is Realty Income's single largest tenant, accounting for 7.3% of the company's revenue. Drug stores like Walgreens certainly sell items that people need, whether there's a recession going on or not -- after all, if you take, say, a blood pressure medication, you're probably not going to stop taking it just because the economy isn't doing well.
Service-based businesses are retail establishments that people have to physically go to. Restaurants, gas stations, movie theaters, and fitness centers are good examples of this type of business. And you might notice that some businesses actually fit into more than one of the categories. For example, gas stations can be considered non-discretionary and service-based.
AMC Theaters (NYSE: AMC) is one example from Realty Income's portfolio. Even with the surge in popularity of streaming video services like Netflix, there is no substitute for going to the movies.
Plus, the trend over the past decade or so has been toward a higher-revenue experience at the movies, with higher-end food options, more premium features such as 3-D, IMAX (AMC is the largest IMAX operator in the U.S.), and more luxurious seating. In other words, not only are movie theaters facing little threat from online competition, but people are actually spending more when they go.
AMC has said that 2017 and 2018 have the potential to be record-setting years in terms of revenue, and if current trends continue, there could be more growth ahead for the movie business.
The third type of business Realty Income focuses on is deeply discounted retail, which includes categories such as dollar stores and warehouse clubs. These businesses offer bargains even the biggest and most efficient online retailers generally cannot match. In fact, in this era of e-commerce, dollar stores are the fastest-growing type of retail.
Dollar General (NYSE: DG) is one of Realty Income's largest tenants, and there is plenty of reason to be excited about this relationship. Dollar General has grown same-store sales for 26 consecutive years, with especially strong growth during the great recession and the years following the dot-com bust. The company plans to grow by 6-8% this year, and sees the opportunity for an additional 13,000 store locations, which would more than double the company's current footprint.
That's not all...
In addition to the low-risk business types discussed here, there are a few other factors that add to the company's stability, such as its geographic diversification and excellent long-standing relationships with investment-grade tenants.
Finally, another major factor is the company's long-term net lease structure. Tenants sign leases with 15-20 year initial terms, typically with annual rent increases built right in. Not only does this minimize portfolio turnover, but it also allows the company to passively increase its rental income over time. And a "net" lease means that the tenants are responsible for paying property taxes, building insurance, and most maintenance expenses -- eliminating the variable expenses of property ownership.
In a nutshell, all Realty Income has to do is acquire a property occupied by a strong tenant, and collect a predictable rent check each month. And with the recent sectorwide dip in REITs, now could be a great time to load up on this long-term winner at a discount.
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Matthew Frankel owns shares of Realty Income. The Motley Fool owns shares of and recommends Netflix. 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.