STORE Capital Stock: Undervalued REITs in Uncertain Times (NYSE: STOR)
Strong REIT hits harder than its peers
STORE CAPITAL (NYSE: STOR) is a triple net leasehold REIT with over 2,800 properties in 49 US states. Last year I endorsed STOR because of its strong business fundamentals and portfolio, but warned investors on entry as it was trading near fair value. Year-to-date, STOR has seen its share price fall more than 23%, underperforming all of its major triple net rental peers. However, STOR’s fundamentals remain strong and their business continues to grow at a healthy pace. In this article, I’ll outline why I think STOR is currently undervalued and why it’s a good defensive stock to own in the uncertain microenvironment we live in today. For a deep dive into the fundamentals of STOR, you can read my previous article here: STORE Capital: A great REIT to keep on your watch list
A brief summary of STOR’s strengths
Before I continue, I would like to briefly explain why I consider STOR to be a fundamentally strong triple net lease REIT.
First of all, STOR is extremely well diversified. In terms of customers, the first 10 customers represent 18% of the rent, while the largest customer brings only 3%. From an industry perspective, no single industry accounts for more than 7% of rents, and STOR tenants are well distributed across the United States, with no state contributing more than 13% of rents.
Second, STOR management adopts a very disciplined and conservative underwriting methodology, assessing profitability at the individual unit level. This allows STOR to gain a better understanding of each company’s operations and needs in order to better determine their financial situation. In FY21, STOR’s average unit FCCR, which measures a company’s coverage of its fixed costs such as rent, increased to 3.6x from 3.0x pre-COVID, meaning that its tenants can cover their rent expenses by more than 3.6 times based on EBITDAR. This reinforces STOR’s strong underwriting standards which have steadily improved even in the face of a pandemic.
STOR is focused on organic growth with over 80% of new leases coming from direct origination. Even during the pandemic, STOR has been able to continue to grow the size of its portfolio which today stands at $13 billion. This has translated into steady revenue growth since launch, as well as an FFO/share that grew up until the pandemic and is currently recovering nicely.
With strong revenue and FFO growth, STOR has also increased its dividend by 6.2% per year since inception. This reflects the highest growth rate developed among its triple net lease counterparts and STOR has a comfortable AFFO payout ratio of 74% which provides downside protection and the potential for increases in the future.
STOR provides downside inflation protection
With inflationary concerns plaguing investors, STOR could be a good defensive position as it provides inflation protection. First, rental income can be considered recurring, so investors don’t have to worry about falling demand and income, which might be a bigger concern for consumer-related stocks.
Then, STOR also has rent indexations linked to the CPI for 85% of its contracts. Although recently signed rent increases are capped in the 1.8% to 1.9% range, which certainly does not exceed the high levels of inflation currently seen, it still means that STOR will be able to increase its income by at least 1.8% over the coming year. without do something else. In fact, STOR itself has indicated that lease reviews are expected to result in at least a 2.5% increase in AFFOs over the coming year. With reinvestment returns of around 3%, this means that STOR will be able to generate >5% internal returns, which is a good hedge against inflation.
Coupled with an extremely attractive dividend yield of 5.8% currently, this gives investors an almost “guaranteed” minimum return of 11%, which slightly beats inflation and will be very welcome in the uncertain investment landscape of ‘today. Additionally, STOR’s dividend yield is currently the highest among its peers, and a revaluation to its normal range of 4-5% will provide greater potential for capital appreciation relative to its competitors.
STOR is well positioned to withstand a recession
Another concern surrounding the market would be the possibility of an impending recession. Likewise, for the reasons mentioned above, I believe that STOR will be able to provide above-average returns even in the face of an economic downturn. However, let’s now assess STOR from a business perspective to show why they will be able to hold their own and even thrive in a recession.
- STOR’s conservative underwriting means their tenants can lose up to 40-50% of income on average before they have trouble paying rent
- The strength of STOR’s tenants has been demonstrated during the COVID pandemic, as occupancy from 2019 to 2021 has remained stable and very high at 99.5%
- The weighted average lease term is over 13 years, with only 0.5% of leases expiring in the following year. We can therefore expect recurring revenue to remain stable even during a recession.
- STOR’s financial position is strong, as evidenced by its investment grade debt offerings
Finally, looking more closely at the distribution of STOR’s tenants by industry, I notice that many of them are defensive in nature and are unlikely to experience revenue declines of tens of percent. The most volatile categories would include restaurants, theaters, entertainment venues, home furnishings and new car dealerships – in total contributing just 30% of rent. Therefore, I would ensure that the bulk of STOR’s tenants are well through a recession and therefore management would be able to strike deals with underperforming tenants, just like during the pandemic.
STOR’s philosophy remains the same despite the change in management
Another specific STORE concern would be the sudden departure of co-founder Christopher Volk, and that caught many investors off guard. However, since we are unlikely to discover the real reason, we should take a forward-looking approach.
New CEO Mary Fedewa is also a co-founder of STOR and has similar experiences and successes to Volk working on previous triple net rental projects. Additionally, there have been no other departures of key management figures, signaling that there is unlikely to be any major management feud or instability. Next, Fedewa also owns a sizable share of STOR shares, about half of those in Volk, and other senior executives have also bought shares in recent months, suggesting they view the stock as underpriced. evaluated.
I believe investor confidence will gradually return over the next few quarters if STOR continues to post strong operating results while continuing to align with its conservative underwriting philosophy. So far, there is no indication that the company is deviating from this path.
Net asset value
First, I performed a NAV valuation of STOR using its FY21 NOI and a projected growth rate of 0%, 5%, and 7% where the base case is aligned with their internal growth rate. The capitalization rates used remain the same as in my previous articles.
With a 20% margin of safety, I get an average entry price of $30.77 which is well above the current stock price. Excluding the MOS, an average target price would be $38.46.
Dividend discount model
To quickly check my NAV valuation, I made a very simple DDM. I increased the dividend yield to 7% from Y1 to Y5, which is reasonable as STOR still has room to increase its payout ratio. Thereafter, from Y6 to Y10, the growth will decrease to 5% and eventually to 2% for the terminal growth rate.
On a discount rate of 9% (15% return with 6% dividend), this gives a $32.27 target price and a target entry at $25.81 with a 20% MOS.
By combining the two methodologies, I reach a TP of $35.37, which is a 36% upside from a price of $26. With my 20% MOS, a good entry price would be $28.3that STOR is currently trading below.
In total, STOR remains a fundamentally strong triple net rental REIT that is over 36% undervalued. Its well-diversified and protected portfolio, solid business model and internal growth will help it weather the inflation and recession challenges ahead, while delivering stable recurring rental income to investors as well as a dividend yield. attractive 6%. So, for investors looking for a defensive position, STOR stands out as a solid company.