W.P. Carey: A Low-Risk Bellwether That Yields 6.6% (NYSE:WPC)

This article was coproduced with Nicholas Ward.

We’re monitoring all of the REITs in our coverage spectrum with an emphasis on selecting the Crème de la Crème. This simply means that our strategy for picking REITs, given the COVID-19 pandemic, is to only allocate capital to the very best names.

Better put, we’re primarily targeting bellwether REITs that are best-in-class dividend growers who enjoy the widest moats with fortress balance sheets.

On Thursday, we added W.P. Carey (WPC) to the “Cash Is King” portfolio. The company also was one of my “Nick’s picks” on this week’s edition of The Dividend Kings vodcast, which was focused on identifying safe and reliable dividend yields in today’s volatile market.

In this article, we wanted to take some time to highlight why we believe that WPC is one of the best REITs to own.

Source

The Bellwether Dividend Payer

First and foremost, let’s start off with the dividend.

As you can see, WPC doesn’t offer the highest yield amongst its peer group. However, in today’s market, we think it’s much more prudent to stay conservative and stick with high quality names rather than reach for yield.

With that being said, it’s not as if WPC’s 6.6% yield is unattractive. In a world where bond yields are hovering near record lows, income-oriented investors could certainly do worse than locking in yields above 6.5%.

And what’s more, the income that WPC generates for your portfolio is likely to increase over the long term. This company has a 23-year dividend growth streak.

Source: WPC Q4 ER Presentation

WPC isn’t one of the fastest dividend growers that we track in the REIT space. In recent years, the growth has been in the low single digits. WPC is known for making several very small dividend increases throughout the year, which add up over time.

The most recent dividend declaration that WPC made on March 12 included a 0.2% raise. These might not seem like much in the short term, but seeing any sort of raise in this environment is wonderful news being that we’ve seen so many dividend cuts and suspensions across various areas of the REIT space.

We continue to believe that WPC’s dividend is safe. During its most recent quarter, WPC provided 2020 AFFO guidance with a mid-point in the $4.90 area. The current forward dividend is $4.16, meaning that the forward looking AFFO payout ratio currently stands at approximately 85%.

This is a bit higher than some of is peers, yet it’s not so high that we worry about sustainability. We do expect for the current guidance to be revised down, but WPC maintains headspace with regard to the dividend and expected cash flows.

Diversification, Diversification, Diversification

In the commercial real estate business, you oftentimes hear the phrase, “location, location, location” when talking about the value of physical assets. Without a doubt, this is true.

That nice corner at the intersection of two prominent thoroughfares is likely to generate a lot of traffic (and therefore, cash flows), whereas a store front in an out-of-the-way, rough part of town that doesn’t offer parking… well, no matter how wonderful its product/services may be, the business is likely going to struggle.

When making investments in the REIT space, we can track the quality of a company’s holdings by looking at portfolio-wide data such as occupancy ratios, sales per square foot, and comparable same store sales growth. And, as you can see below, WPC posted reliable growth in this regard.

Source: WPC Q4 ER Presentation

Yet, in this environment, we find ourselves more focused on the industry exposure that a company has, more than anything, because of the social distancing measures that have been put into place that have shuttered doors of certain types of businesses, no matter how wonderful their location may be.

And, when it comes to offering investors a well-diversified portfolio with relatively little retail exposure in the triple net space, it doesn’t get any better than W.P. Carey.

Unlike most triple net REITs that we follow, WPC offers investors significant international exposure. Realty Income (O) recently made headlines as it made a move into the European markets, yet WPC has been there for years. The United States only makes up about 63.5% of WPC’s property portfolio. Europe accounts for roughly 34.4%.

With regard to avoiding the COVID-19 crisis, geographic diversification isn’t likely to save the company from potential financial headwinds. COVID-19 knows no boundaries and is wreaking havoc on economies across the world. Yet, it’s important to note that with more than 1,200 locations spread across the world, WPC is likely to be sheltered from many of the most severe local shutdown ordinances.

Furthermore, we like to point out WPC’s exposure to Europe because we continue to believe that there’s a large commercial real estate market there which is relatively untapped by triple net players and having the capability to make investments in a variety of markets enables names like WPC to lock in the best potential value for shareholders when making acquisitions.

With regard to diversification, what we list best about WPC’s portfolio is its well balanced exposure across the industry spectrum. When investors think about triple net REITs, their minds often go to retail. Obviously, these properties are struggling to generate sales right now and this has lead to a lot of fear throughout REITdom with regard to rent not being paid.

However, when we look at WPC’s portfolio, we don’t foresee major issues in this regard, or a massive drop in short-term FFO, because of the high quality and relatively stable tenants that we see across WPC’s portfolio.

As you can see below, retail only accounts for 17.7% of WPC’s portfolio. And while retail stores are the company’s largest tenant industry exposure, we’re still looking at less than 21% from a tenant industry diversification standpoint.

Source: WPC Q4 ER Presentation

We like seeing a lot of the industrial and warehouse exposure here. And while office REITs have been struggling recently, we think it’s important to note that being a triple net player, WPC’s office portfolio is made up of high-quality single tenants with long-term leases, so we’re not talking about a WeWork sort of downfall here.

Taking a step back, we note that WPC has maintained a high occupancy ratio across its well-diversified portfolio for years now. Even during the Great Recession period, we see that WPC’s occupancy ratio fell to just 96.6%, which is well above many of its peers.

Source: WPC Q4 ER Presentation

Across WPC’s portfolio, its average weighted lease length is 10.7 years. The long-term deals that we see in the triple net space are why we remain bullish on many of these names. We like predictable cash flows and it doesn’t get much better than these long-term relationships. In WPC’s case, the 99% of its leases have rent escalations built into them contractually, with 63% of them tied to CPI.

Source: WPC Q4 ER Presentation

Oftentimes, when talking about passive income, we highlight the important of regular dividend increases protecting our investors’ passive income streams from inflation and these CPI-based escalations give us peace of mind in that regard.

Something else that provides peace of mind when it comes to WPC is the fact that the company has very few short-term lease expirations.

Source: WPC Q4 ER Presentation

Obviously, in today’s COVID-19 environment, we can’t be totally certain that rent will be collected. We’ve heard CEOs across the REIT space talk about potential deferral plans and/or re-leasing properties in an effort to get tenants through the crisis (because, as Realty Income CEO Sumit Roy recently told us, these sort of maneuvers are in the best interests of both parties in most situations. In short, the REITs that we track want to be good partners with their tenants to help facilitate and nurture the long-term relationships that lead to reliable cash flows).

But, for the most part, we don’t expect to see a lot of short-term turnover throughout WPC’s portfolio, and the fact that just 4.7% of ABR is set to expire in the next couple of years gives credence to our opinion that WPC offers a relatively safe harbor for investors in the REIT space.

And lastly, we arrive at the balance sheet. WPC maintains strong debt ratios and even in these fire economic environments, we don’t believe that WPC is likely to violate and of its debt covenants.

Source: WPC Q4 ER Presentation

WPC’s debt maturity schedule also looks attractive in the short term. As you can see on the image below, the company has very little debt coming due in the next several years, with less than 16.5% of the company’s overall debt outlook coming due by the end of 2022.

Source: WPC Q4 ER Presentation

Also, as you see above, it’s important to note that WPC’s European exposure has helped the company to lock in very low rates on its debt. The average interest rate across its entire debt portfolio is less than 3.5%, meaning that financing the company’s leverage has a relatively small impact on its cash flows.

Now, as I mentioned, WPC is not completely immune to the COVID-19 issues. For instance, one of the company’s largest tenants is Pendragon PLC, an automotive dealership in the United Kingdom. WPC owns 69 of these dealership locations, which represents roughly 2% of the company’s total base rent. Obviously car sales are hurting during a shelter at home environment.

Yet, Pendragon is a major corporation and we feel relatively confident in saying that well-known brands like this are likely to survive the COVID-19 crisis and continue to pay rent long term. The average lease on those 69 dealership locations is 10.4 years and barring a major bankruptcy event (which we don’t foresee at the moment) we continue to believe that it’s best to focus on the long term rather than get caught up in the negative short-term sentiment.

Furthermore, WPC has 3.9% exposure to hotel, leisure, and gaming, which is obviously an issue in the short-term. We expect to see losses here due to the fact that cash flows have been completely turned off in these industries. Yet, 3.9% exposure is not going to be destructive to WPC’s cash flows, even if 100% of these properties go under (which isn’t our expectation in the first place).

Simply put, it’s unrealistic to assume that a company in the real estate business is not going to experience some losses in today’s COVID-19 environment. However, when looking for durable income, we continue to like WPC, especially when investors have an opportunity to buy shares at a discount.

Valuation

Throughout 2019 we saw WPC’s P/FFO ratio expand significantly as the company got out of the investment management business with the merger of CPA-17. We suspected that the heightened focus on the higher-quality triple net lease revenues would lead to a higher premium on shares. Not only does the market view the triple net revenues are more reliable and predictable, but they’re also higher margin, and the merger has garnered more institutional interest in WPC shares.

As you can see on the F.A.S.T. Graph below from 2013 to early 2019, WPC shares found strong resistance in the 15x P/FFO area. However, the company recently pushed past that level, with P/FFO ratios rising to more than 20x at its peak toward the end of 2019. At that level, we argued that shares were overpriced. However, due to the COVID-19 sell-off, WPC has lost all of the premium that it gained in 2019 (and more), once again trading towards the bottom-end of its 5-year range, in the 13x area.

Source: F.A.S.T. Graphs

At this valuation level, we find WPC to be attractively priced. Granted, it’s difficult to predict exactly FFO levels for 2020 in today’s volatile environment, though as previously stated, due to the high quality and well diversified nature of WPC’s real estate portfolio, we don’t expect to see a drastic decline in FFO in 2020.

On Feb. 21, management provided 2020 guidance, which called for 2020 AFFO to be in the $4.86-$5.01 range. Being that this guidance was provided prior to the COVID-19 sell-off and the accelerating economic impacts that we’ve seen throughout the months of March and April thus far, we expect to see management revise this range lower in the coming quarters.

However, even if 2020 AFFO falls 10-20% due to the COVID-19 impact, we’re still taking about results in the $4.00-$4.50 range at today’s ~$63 share price, which would imply a forward looking P/AFFO multiple in the 14-16x range, which isn’t an overly ambitious price to pay for a blue-chip name like WPC yielding roughly 6.6%.

Conclusion

We should mention that WPC shares have been volatile over the last month or so. During the height of the recent sell-off, WPC experienced immense intra-day volatile that pushed shares down to new 52-week lows of $38.62. This meant that shares fell nearly 60% from their highs.

However, this weakness was very short lived and it appears that the market quickly realized its folly with regard to the very low valuation that it had placed on WPC for a momentary period of time.

We don’t expect to see WPC test those $40 lows again in the short term, though all of this is being said to point out that even high quality names like WPC has experienced abnormal volatility in today’s market and investors thinking about owning REITs right now need to acknowledge the risks and maintain a high degree of intestinal fortitude to get through the short term until the medical community finally solves the COVID crisis.

Source: FAST Graphs

At those recent lows, WPC shares were trading for just 8x FFO and yielded more than 10%. Obviously, in hindsight, that was a fantastic time to buy. However, even today, after a 60%-plus rally off of the lows, we still find WPC to be attractively priced for conservative, income-oriented investors.

WPC remains one of our highest-quality picks in the triple net REIT space. As you can see above, WPC has the fourth-highest Rhino Rating in the net lease space. This high quality score combined with the stock’s recent weakness is why we’ve added shares to the Cash Is King portfolio. It’s why we give WPC shares a BUY rating. And, it’s why we continue to sleep well at night holding onto shares of this blue chip name.

Author’s note: Brad Thomas is a Wall Street writer, which means he’s not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.

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Disclosure: I am/we are long WPC, O. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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