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A Closer Look Into REITs: STORE Capital


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Written by Mark Roussin

Big Ticket Fund
Managers

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Since we recently went over what REITs are at a high-level, I figured I would introduce to you a name I have been high on for quite a while. Also, might I mention, Warren Buffett has backed this REIT as well, so that is telling you something.

The REIT I will introduce to you today is STORE Capital (STOR). STORE Capital is a triple-net lease REIT that went public in November 2014.

When investors think of REITs within the Net-Lease sector, the two that most commonly come to mind are Realty Income (O) and National Retail Properties (NNN). Rightfully so, as they are the two largest and have dominated the sector for some time. Realty Income is a favorite stock for many income-minded investors, as they offer reliable, growing dividends with lower risk. STOR is often looked at as the little brother to O, but they pack a big punch and have been performing quite well over the years.

Net-Lease REITs

So, what is a net-lease REIT?

First, we need to define “net lease” real estate, which is a type of rent agreement between a property owner and a tenant where the tenant is responsible for paying all property maintenance expenses. The most common type of net lease is a “triple net,” where tenants pay all property expenses, including insurance and taxes. Net leases tend to be for terms of 10 years or more and stipulate the initial rent and escalators for rent increases. Any type of property (i.e., office, retail, industrial) can be net leased.

As a result, the “net lease” contract makes cash flows extremely predictable over a long timeframe, with the majority of costs and uncertainty shifted to the tenant.

It follows, then, that a net lease REIT is a real estate investment trust that owns a portfolio of net leased properties.

A Look Inside The STORE

STORE Capital is one of the fastest-growing net-lease REITs on the market today, as they have been trading for only four full years. The company targets single-tenant operational real estate, or “STORE” Properties, as the company calls them.

As of their most recently filed 10-Q, ending 3/31/2019,  the company has a real estate portfolio totaling $8.0 billion representing 2,334 property locations leased to 447 customers. Of the $8.0 billion portfolio, 96% is related to commercial real estate properties subject to long-term leases, and the remaining 4% relates to mortgage loans and direct financial receivables.

What separates STOR from the large net-lease REITs mentioned above is the fact they focus much of their attention on middle market and large non-rated companies who have limited sources to raise capital at favorable terms. As noted in the company’s Q1 investor presentation, the median tenant revenue is just $53 million, with 72% of STOR’s tenants having revenues exceeding $50 million.

STOR has differentiated itself by focusing on this niche market, which has ample opportunity to gain higher lease rates, longer-term leases, and greatly diversify their portfolio. This platform allows tenants to gain access to favorable alternatives to commercial mortgage debt. Tenants would be able to lower their cost of capital by not having their capital tied up in real estate, which is important for middle market companies looking to grow.

Due to the fact STOR acquires single-tenant operational real estate, this provides a sense of stability for the company and lowers risk as the company is able to evaluate the tenant in depth by reviewing not only their credit history, but also their historical financial performance both before they become a tenant and while they are a tenant. In addition, the long lease terms, with an average of 14 years, provides a level of confidence for investors as we enter uncertain times in the near future.

A Look At The Portfolio

Much like their competition, STORE Capital has built a defensive portfolio able to withstand any economic backdrop, which is even more important considering the fact many analysts/economists are starting to mutter the words “recession.”

Management has done a fine job diversifying the portfolio with no single tenant accounting for more than 2.7% of base rent revenues, which is down from over 3% a few quarters ago. The company is also not heavily invested in retail that is susceptible to the threat of e-commerce, namely Amazon (AMZN), by investing primarily within the service industry, which has been the company’s primary focus industry.

Here is a look at the breakdown of tenants within different industry groups is as follows:

  • Service: 65%
  • Retail: 18%
  • Manufacturing: 17%
Source: Q1 Investor Presentation

The Service industry is primarily made up of restaurants, early childhood education, movie theatres, and health clubs.

Retail is made up of furniture stores, farm and ranch supply, and hunting and fishing stores. As you can see, many of the retailers are protected from the threat of Amazon, to a degree. For example, Amazon has begun to sell furniture, but consumers still want to touch and feel these types of products before buying online.

In addition to management building a highly diverse group of tenants, the company also has the longest average lease term amongst large triple-net lease REITs. Their near-term exposure is also the lowest in the next 5-10 years and every category to follow, by a wide margin.

Source: Q1 Investor Presentation

A Look At Valuation

STOR stock currently trades at $34.63, which is near its 52-week high of $35.59. With the stock trading so high, one might be asking themselves if the stock is a quality buy at this time or if we should take a patient approach.

REITs had a roller coaster 2018, with the VNQ ending the year down roughly 11%. However, STOR strongly outpaced the broad real estate sector with a return of roughly 10% in 2018.

Let’s take a look at how net-lease REITs have fared in 2019 thus far:

Chart created by author

As we mentioned earlier, STORE Capital is one of the newcomers to the list, having completed their IPO in November 2014. At the same time, they are one of the fastest-growing net-lease REITs with FFO growing 26% as of Q1 2019.

STORE’s adjusted funds from operations have grown substantially each year since even before its IPO. Although the “cash from operations” is not quite equivalent to AFFO, it’s a very close approximation. It has grown over 25% in each of the last 3 years:

STOR cash flows from operations approximates adjusted funds from operations

Based on their strong growth since going public, the company has started becoming more well-known in the investing community, thus demanding a premium when compared to their peer group:

Chart created by author

The premium comes along with having continued strong FFO growth, a relatively recession-proof tenant base, and the backing of one of the greatest investors of all-time in Warren Buffett. Warren Buffet, by way of Berkshire Hathaway (BRK-B) made a 9.8% investment in STOR totaling $377 million, in June 2017. The Oracle of Omaha has since held the shares, neither increasing or decreasing his investment, which gave the stock a big boost at the time. 

Next, let’s see how STOR compares to its peer group as it relates to the dividend yield:

Chart created by author

As we can see from the charts above, STOR has had a pretty solid first half in 2019, thus the reason we are seeing them at the upper half of the P/FFO and the lower half in terms of dividend yield. This is how I like to start looking, but the next step is to see how these valuation metrics compare to recent history.

The stock currently trades at a P/FFO of 19.4x, which is close to the highest valuation the stock has traded at. Normally this would be a quick turnoff for me as an investor, but with little trading data, the stock is yet to establish a true trading range just yet. For example, O has a 5-year P/FFO high of about 26x, and STOR is still a long way from that.

Over the last four years, STOR has traded at an average P/FFO of 17x, which suggests the stock is grossly overvalued, but again, it’s a small sample size of data. Looking at the projected FFO for 2019 of $1.94, the stock is trading at a forward P/FFO of 15x, which is below their four-year average we discussed.

In terms of dividend yield, the company currently sports a 3.8% yield. Over the course of the last four and a half years, the company has averaged a dividend yield of 4.1%, suggesting the stock is currently overvalued.

However, for those with a long-term outlook, the valuation may not bother you as much, as the data we have is light and the company’s growth is currently backing up its premium, so the average is expected to rise in the coming years.

From an income perspective, the company has consistently paid and raised its dividend on an annual basis every year since going public. Since introducing a dividend when the company went public in 2014, STORE has increased its dividend by 32% all while maintaining a low dividend AFFO payout ratio, which currently sits at only 74%.

Investor Takeaway

Now that you have been able to digest some data regarding STORE Capital, you can clearly see the company is growing at a strong clip and is continuing to build out their portfolio. The portfolio is assembled with a diverse set of high-quality tenants immune to the threat of e-commerce and stable enough to withstand any economic backdrop.

This high-yield dividend play is primed to continue growing their FFO and dividend for the foreseeable future, but I do suggest being patient as we look for a better entry point.

The second half of the year will be met with uncertainty, which could spook the market, making STOR a more attractive value. As I always suggest my readers do, buy in tranches and NEVER all at once. I feel very confident in the management team’s ability to lead STORE Capital into a major player in the net-lease space for years to come.

Author’s Disclaimer: This article is intended to provide information to interested parties. I have no knowledge of your individual goals as an investor, and I ask that you complete your own due diligence before purchasing any stocks mentioned or recommended.

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