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Spirit Realty Capital: Building Stable Income
Stock Analysis & Ideas

Spirit Realty Capital: Building Stable Income

Story Highlights

Spirit Realty’s diversified portfolio performed well during the pandemic, while its latest results indicated further improvements and growing FFO/share. The company’s performance was rather volatile in the past, which along with operating in a rather unattractive real estate sub-sector, has caused the stock to trade at a relatively discounted valuation.

Spirit Realty Capital (SRC) is a net-lease REIT specializing in investing in single-tenant retail properties. Spirit Realty’s portfolio has grown well diversified over the years, currently including more than 2,000 properties in 48 states. These properties are leased to 334 tenants who serve 35 different industries.

The company’s investment has some attractive characteristics. One such is that investors can achieve exposure in every single retail sub-sector, with cash flows scattered across hundreds of tenants in almost every state, thus enjoying a diversified stream of revenues. However, there are risks attached to Spirit Realty. Regarding the previous point, for instance, having to manage thousands of small properties in a relatively risky real estate sector (retail) could result in rental collection issues during times of economic downturns.

Overall, the company appears well-positioned to generate rather resilient results moving forward, while the current dividend appears adequately covered, supporting the 6.1% yield. Thus, while risks are not absent, the stock could serve income-oriented investors rather adequately.

I am neutral on Spirit Realty.

Resilient Performance, Portfolio Expansion

Inflationary pressures and an overall uncertain macroeconomic environment have supported the case of declining consumer confidence and thus declining consumer spending. This could result in a challenging environment for retailers.

While these concerns could materialize at some point moving forward, consumer spending in the United States remained at record levels during the first quarter of 2022. Consequently, retail locations continued to perform resiliently, resulting in a robust performance for Spirit Realty.

The company’s Q1 results for the period ending March 31st, were quite strong, with rental income and funds from operations (FFO)/share coming in at $168.4 million and $0.95, suggesting increases of 24.6% and 90%, respectively. Revenues growth was driven by property acquisitions and record levels in occupancy rates, which stood at a remarkable 99.8% by the end of the quarter.

Spirit Realty also collected nearly 99% of rent due during Q1, which is quite remarkable considering its vast tenant base. This indicates that its tenants’ financials have remained healthy.

The company continued to expand its asset base, purchasing an additional 41 properties during the quarter. These properties featured an average cash yield of 6.42% and will further increase Spirit’s portfolio diversification.

Following a study performance, Spirit Realty’s management reaffirmed its prior FY2022 outlook, estimated adjusted funds from operations (AFFO)/share between $3.52 and $3.58. At the midpoint, it implies year-over-year AFFO/share growth of 8.8%.

How Much Should you Pay for the Stock?

While the company’s recent performance was rather promising, Spirit Realty’s AFFO/ share has failed to rise meaningfully over the past several years. In fact, it has declined over time, standing at $4.39, $3.75, and $3.44 in 2016, 2019, and the last twelve months, respectively. This has been the case mainly due to the challenges fronted by retail REITs as a result of the rise of e-commerce, several uninspiring acquisitions/dispositions, and, most recently, the COVID-19 pandemic.

Partly due to Spirit Realty’s volatile FFO results, the stock’s valuation has historically hovered in the high-single to low double-digits. Shares are currently trading at around 11.8 times the midpoint of management’s guidance, or 11.7 times consensus AFFO estimates. This implies a discount of around 32% from the sector average, which illustrates investors’ expectations for below-average growth and performance overall.

However, it’s also worth noting that the stock is offering a sizable yield, which could, on the other hand, ignite investors’ interest in Spirit Realty. Let’s examine.

After growing its dividend every year since its IPO, Sprit Realty slashed it in 2018. The company paid an annual dividend per share of $3.20 in 2017. Additionally, the firm made 11 $0.625 quarterly dividend payments following the cut, implying an annualized dividend rate of $2.50. Notably, the dividend remained stable during the pandemic.

Following improving results last year, the dividend was raised by 2.08% to a quarterly rate of $0.638. At its current annualized rate of $2.55, shares of Spirit Realty yield 6.1%. This is 54.9% higher than the sector’s average of nearly 4%.

Overall, it makes sense for the stock to trade at discounted valuation and with a hefty yield attached, as investors demand to be compensated adequately for the underlying risks that come with its investment case. In my view, a P/AFFO multiple below 12, which implies a yield north of 6% at the current DPS, makes for a fair valuation. This is due to a 6% yield providing a substantial margin of safety to investors’ total return prospects. It should also be enough to compensate against any capital losses assuming shares were to experience a further multiple compression, however unlikely.

Wall Street’s Take

Turning to Wall Street, Spirit Realty Capital has a Moderate Buy consensus rating based on five Buy and four Hold ratings assigned in the past three months.

At $51.53, the average Spirit Realty Capital stock projection implies 22.34% upside potential.

Takeaway

Spirit Realty is one of the better retail REITs, with its asset portfolio and tenant base being incredibly diversified. While the company’s performance has historically been a bit shaky, financials remained robust during the pandemic and improved further in its latest quarterly results.

While there are risks attached to Spirit Realty’s investment case, and 2018’s dividend cut was certainly not pleasant, income-oriented investors are likely to appreciate the stock. Featuring a 6.1% yield, a payout ratio of 72% at the midpoint of management’s guidance, and the recent humble but welcoming dividend hike, Spirit Realty’s income-generation prospects are rather attractive.

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