STORE Capital Stock: approaching Warren Buffett’s entry points (NYSE: STOR)
If you are an avid Buffett follower like this author, you should know that he has a large position in STORE Capital (STOR). His STOR position is around $0.8 billion at the time of this writing – not the biggest deal in his massive portfolio. But given that A) STOR is the only REIT in its portfolio and B) its holdings represent about 10% of the total shares outstanding, you can see that the grandmaster position is a strong endorsement of STOR.
Buffett bought his shares near 13.2x FFO in 2017 and 2020 respectively at prices near $22 to $23, as you can see in the following chart. The stock price climbed to near $37 at the end of 2021. And the recent price correction has taken the valuation to around 15.2x FW FFO, which is still around 15% above the valuation that Buffett paid for his actions.
In this article, you will see that:
1. It is actually already priced quite attractively in terms of multiple FFOs.
2. From a completely independent point of view, its current valuation is even more attractive in terms of yield spread over risk-free rates.
3. Once adjusted for interest rates, the current valuation is much closer to Buffett’s entry points than on the surface.
Assessment 1: FFO valuation
Thanks to its quality and diversified real estate portfolios, STOR benefits from a solid and stable organic result. Its real estate investment portfolio has an occupancy rate of 99.4%, with 72% of tenants considered to be of superior or superior quality. In its most recent earnings report, it said that from January through September, its adjusted funds from operations (“AFFO”) totaled $402 million. And AFFO should continue its steady growth. Its forecast FFO for 2022 is around $2.1 per share, up around 13% from the 2021 level of $1.87 per share.
Through real estate investments and quality tenants, STOR has provided stable income to investors. Investors in STOR have been handsomely rewarded since its IPO through a combination of price appreciation and dividends, as you can see in the chart below. In terms of FFO multiples, as the following chart shows, STOR has been valued at an average of 15x to 16x historically.
Thanks to its robust and stable earnings, the chart also shows that whenever the price falls near or below 15x FFO, it has been a good time to buy. Buffett, with his extraordinary investment acumen, bought his shares at nearly 13.3x FFO in 2017 and 13.2x FFO in 2020 respectively, as the chart shows. It is difficult not to make a good profit on such transactions.
At its current price, the stock is valued at around 15.2x FW FFO. Admittedly, such a valuation is always about 15% higher than the prices paid by Buffett. However, it is already quite close to its historical average range of 15x to 16x FFO. In our experiences, “Buffett prices” are often too good to grab, and entry prices close to Buffett prices are already enough to provide a thick margin of safety and excellent chances of long-term returns.
Moreover, in this case, the valuation is actually much closer to Buffett’s prices when adjusted for interest rates, as explained in the next section.
Assessment 2: Performance Gap Assessment
Interest rates act as the gravity of any asset valuation, as Buffett himself pointed out. And interest rates are now different from when Buffett bought his stocks. So, to properly assess its valuation, we need to adjust it to changes in interest rates.
For bond-like stocks like STOR, an effective way to gauge their valuation with adjusted interest rates is to calculate the yield spread. Details of the calculation and application of the Yield Spread were provided in our previous article on Lowe’s (NYSE: LOW) (another stock with a stable dividend). The yield spread is an indicator that we check first before making investment decisions. Fortunately, we have had very good success with this indicator because of:
- Its simplicity – it relies only on the simplest and most reliable data points (Treasury rates and dividends). In investing, we always prefer a simpler method that relies on fewer unambiguous data points than a more complicated method that depends on more ambiguous data points.
- His timeless intuition – no matter how times change, the risk-free rate serves as gravity on all asset valuations and therefore the spread ALWAYS provides a measure of the risk premium investors pay over risk-free rates . A large gap provides a higher margin of safety and vice versa.
In this context, you will see below that when adjusted for interest rates, the current valuation is much closer to Buffett’s entry points than on the surface.
As the following graph shows, the dividend yield is currently around its historical average, around 5.1%. As you can also see from the chart, since its IPO, its dividend yield has remained more or less stable around this level. While at the same time, the risk-free rates (represented by the yield of the IEF) have steadily fallen. Interest rates act as gravity on all asset valuations. And when interest rates fall, the valuation of other assets such as STOR should also rise and their yield fall – but this is not the case in the case of STOR. As a result, the yield gap widened, as discussed below.
This next chart shows the yield spread between STOR and the 10-year Treasury. The yield spread is defined as STOR’s TTM dividend yield minus the 10-year Treasury bond rate. As can be seen, the spread is limited and treatable. The spread has been between around -1.5% and 3.0% most of the time, which makes sense for a stable and mature company like STOR. Which suggests that when the spread is near or above 3%, STOR is significantly undervalued relative to 10-year treasuries (i.e. I would sell treasuries and buy STOR) . In this case, the sellers of STOR are willing to sell it to me (again essentially a capital bond) at a yield 3% higher than a risk-free bond. So it’s a good deal for me. And you can clearly see the screaming buy signal during the pandemic panic selling of 2017 and 2020 when the yield spread rose to be near or above 3% – precisely the times Buffett bought.
And at the time of this writing, the yield spread is around 3.02%. This is near the broader end of the historical spectrum as seen and near the same level that Buffett bought his shares.
In addition, the limited traceability of the yield spread opens dynamic allocation opportunities to benefit from short to medium term price movement with good reliability, as shown in the following chart below.
This chart shows the upcoming 1-year total return on STOR (including price appreciation and dividend) when purchased with different yield spreads. As can be clearly seen, this is initially a positive trend, indicating that the probability and amount of total return increases as the return spread increases. The correlation coefficient is 0.45, suggesting a clear positive correlation. In particular, as shown by the orange box, when the deviation is around 3% or more, as mentioned above, the total returns for the following year have all been positive and sometimes very large (almost up to 60%).
Again, at the time of this writing, the yield spread is around 3.02% as shown, close to the middle of the historical spectrum, signaling low near-term risks and favorable chances for appreciation. short-term prices.
First, STOR (like any other typical REIT business) relies on debt financing and is therefore somewhat sensitive to changes in interest rates. STOR’s current long-term debt is approximately $4 billion. Thus, a 1% increase in its interest rate would result in $40 million in additional interest expense. Its operating cash is approximately $550 million in 2021. Therefore, additional interest expense represents approximately 7.3% of its operating cash, a significant portion and therefore a significant risk.
Second, the pace and degrees of economic recovery from the pandemic is also a risk. STOR has tenants that are directly exposed to the pandemic, such as restaurants, theaters and health clubs. With the new delta and omicron variants, pandemics can last longer and cause a slower and weaker economic recovery, which negatively impacts STOR.
Conclusion and final thoughts
The recent price correction has created an entry opportunity for STOR. This is a high quality company currently at an attractive valuation. And we confirmed the valuation using two independent approaches – both in terms of FFO and interest rate adjusted yield. Specifically,
1. STOR holds high quality and diversified real estate portfolios to provide strong and stable organic income. Its real estate investment portfolio has an occupancy rate of 99.4%, with 72% of tenants considered to be of superior or superior quality.
2. In terms of FFO valuation, the recent price correction has created an entry opportunity. The recent price correction has taken the valuation to around 15.2x FW FFO. Such a valuation is only about 15% higher than the price Buffett paid for his shares (nearly 13.2x FFO) and close to his historical average of 15x to 16x FFO.
3. From a completely independent point of view, its current valuation is even more attractive in terms of yield spread over risk-free rates. And at the time of this writing, the yield spread is around 3.02%. This is near the broader end of the historical spectrum as seen and near the same level that Buffett bought his shares.