STORE Capital Stock: Buffett’s favorite high-yield REIT (NYSE: STOR)

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Thesis article

STORE CAPITAL (NYSE: STOR) is a triple-net leased REIT that invests primarily in single-tenant operational real estate. The REIT offers an attractive yield of nearly 6%, trades at a cheap valuation, is partly owned by Buffett’s Berkshire Hathaway (BRK.A) (BRK.B), and offers strong inflation protection due to the real nature of its business. Overall, STORE Capital appears to be an attractive choice at current prices.

Insight

Triple-net leased REITs have the advantage of very low ongoing expenses, as the tenant is responsible for almost all costs, including maintenance, insurance and taxes. Almost none of the cash flow generated by these REITs therefore goes back to their properties, except for improvements that increase future rental income. This allows them to either pay out a significant portion of their cash flow to investors, preferably via dividends, or to invest aggressively in new assets without diluting shareholders too much. STORE Capital uses this business model successfully. The company invests almost exclusively in single-tenant operating real estate and focuses on properties that are profit centers for its tenants. This means that the tenant will probably want to stay in the property even if they are having financial problems. The “critical” nature of these properties for STORE tenants explains why there is little counterparty risk for STORE. Even if one of its tenants is having difficulty, it will not divest itself of high-performing and important assets and will instead focus on reducing unnecessary expenses, for example.

Presentation STORE

Presentation STORE

With an average rent coverage of almost 5x, there is very little risk for STORE when it comes to collecting contractual rents. Indeed, even during the pandemic, STORE was able to collect almost all the rents due and maintain very high occupancy rates, which enabled it to grow its turnover in both 2020 and 2021:

Chart
Data by YCharts

Revenue growth was a bit below average in 2020, but nonetheless, revenue grown up despite the pandemic. That’s a feat, considering many claimed at the time that the pandemic would hasten the “death of retail.”

STORE Capital’s resilience is also due to its strong diversification among tenants and industries. Not a single tenant accounts for more than 3% of the contractual base rent, and no industry is responsible for even 10% of the rent:

Presentation STORE

Presentation STORE

Restaurants, education, manufacturing, health clubs, auto repair, farm supply sales, building materials sales, etc. are not threatened by e-commerce or digitization. While soft line retailers that sell clothes are under a lot of threat from Amazon (AMZN), STORE tenants don’t have to fear the “Amazon threat”. Health clubs, early childhood education, etc. will remain in physical environments for a very long time, thus almost guaranteeing a very reliable flow of rental income into the pockets of STORE Capital.

Recent Results

The company released its latest quarterly results in early May. During the first quarter, the company acquired just over 100 new properties at an average capitalization rate of 7.1%, with a weighted average lease term of 17 years. This is the highest level of buying activity in the last two years in terms of properties acquired. STORE now has around 3,000 properties, meaning the growth rate was north of 10% on an annualized basis.

Thanks to a cost of new debt of around 3.5% during the quarter, STORE’s gap between the rent it can charge tenants and the interest it must pay to service its debt remains very attractive, at more than 3.5%.

The company was able to achieve a solid double in the quarter:

SAVE results

Looking for Alpha

FFO per share rose to $0.57 for the quarter, beating estimates by almost 10%, thanks to revenue 5% higher than analysts had expected. The company also shifted to a high acquisition pace for the remainder of the year and raised its FFO per share forecast to a midpoint of $2.22. Based on the results that the company delivered in the first quarter and considering that the company has a history of under-promising and increasing forecasts over time, one could argue that actual results will be stronger than that. If the pace of the first quarter continues, that is, without taking into account new acquisitions throughout the year, STORE could earn $2.28 per share this year.

High yield with compelling growth and some inflation protection

Like many other REITs, STORE Capital is a solid income choice. At current prices, its dividend offers a yield of 5.7%. This is about double the yield offered by Treasury bills today, with one important difference being that Treasury bill payments do not increase over time.

STORE Capital, on the other hand, has increased its dividend by 6.4% per year since 2015, which is the highest level of dividend growth among its peer group. National Retail Properties (NNN) and Realty Income (O), for example, increased their payouts by around 4% per year during this period, respectively. And yet, STORE Capital has a surprisingly low dividend payout ratio:

STORE dividend

Presentation STORE

Not only has payout decreased over the past two years due to strong FFO growth, but STORE’s payout rate is also the lowest of its peer group, just under 70%. Given the very stable cash flows in the industry, this rather low payout ratio results in very little risk of a dividend cut, in our view.

Considering in isolation the company’s return of nearly 6% and the dividend growth rate of just over 6%, one can assume that future returns will be in the order of 12% annually. If dividend growth can be sustained indefinitely at the current level and if there is no change in STORE’s valuation, that would indeed be the case. To be on the safe side, we can check what happens when future dividend growth is only half of what it was in the past. In this case, with dividends increasing by around 3% per year in the future, total returns would likely reach around 9%. It’s still quite attractive for a resilient business with below average business risk and doesn’t have to worry about inflationary pressures, I believe.

In fact, STORE Capital could be a beneficiary of inflation. Its expenses, mostly interest charges, are relatively fixed, as the tenant is responsible for all operating expenses of the property. At the same time, STORE’s debt swells over time, while the value of the properties the company owns is expected to climb, all else equal. While inflation, due for example to high energy and transport costs, is a problem for many companies, STORE (and its peers) do not seem to be significantly threatened.

Inexpensive valuation following the decline

STORE Capital has traded as high as $37 per share over the past year, but is down about 25-30% from those recent month highs. This is somewhat surprising, as the underlying fundamentals of companies are strong. In fact, they are stronger than expected, as STORE easily exceeded estimates and raised its orientations for the current year. STORE’s business model is also resilient to recessions; thus, the recession worries that have plagued other businesses do not appear to be too great a headwind for STORE Capital – its long lease terms, contractual rent increases and the critical nature of its properties for its tenants should provide a Solid protection in case the US economy slips into a recession over the next few quarters.

Based on STORE’s median forecast (potentially too conservative), stocks are trading today at 12.2x FFO. Compared to how STORE’s peers are rated, this is a pretty cheap rating. Realty Income and National Retail Properties, for example, are trading for 17.4x and 14.4x this year’s FFO, respectively. STORE has seen stronger growth in the past and offers a higher return at a lower payout rate, so it looks comparatively undervalued today I believe. This was not the case when STORE was trading in the $30 range, but over the past few months STORE has become quite an attractive price.

Carry

STORE remains in growth mode, offers an attractive yield, trades at an inexpensive valuation, is backed by Buffett’s Berkshire Hathaway, and isn’t too threatened by inflation and/or a possible recession. Overall, at current prices, STORE Capital appears to be a very solid income pick that could offer high single-digit or low double-digit returns over the long term.

Sallie R. Loera