NNN REIT Inc. (NNN, Financial), which changed its name from National Retail Properties in May, is in focus this week after financial advisory firm Janney Montgomery Scott opined that the real estate investment trust is undervalued.
Janney Montgomery Scott analyst Robert Stevenson wrote, "We believe that NNN's valuation remains too cheap, given its track record." He also added that "the stock's current implied 6.9% cap rate remains inexpensive within the retail-focused triple-net REIT universe."
Are Stevenson's comments about NNN RETI warranted? Let us traverse into a deeper analysis of the asset to find out.
Latest numbers
Retail numbers and real estate valuations have struggled in the past 12 months as higher interest rates and an economic trough dampened affairs. As such, most analysts expected NNN Reit to experience a trying first quarter. However, most expectations ended up being overly pessimistic as the company blitzed past estimates, beating its revenue target by $4.01 million.
The company achieved significant progress in its first quarter as its core funds from operations increased by 6.7%, driven by a sublime occupancy rate of 99.4%. Much of the REIT's high occupancy is due to its best-in-industry lease terms that average out at 12.9. Moreover, NNN REIT hosts credible tenants such as 7-Eleven, LA Fitness, Camping World (CWH, Financial) and Walgreens (WBA, Financial), allowing it to perform throughout the economic cycle.
Further, NNN REIT expanded its asset base during its previous operating quarter by acquiring 43 properties spanning 270,000 square meters of occupiable space. Additionally, the company offloaded six low-cap rate properties during the quarter, concurrently raising its aggregate capitalization rate.
Commenting on the fund's latest numbers, CEO Steve Horn said, "NNN had a solid start to 2023 with just over $155 million in property acquisitions with an initial cap rate of seven percent and a 19-year weighted average lease term. Additionally, NNN continued to maintain high occupancy levels in the portfolio. The 3.9 percent Core FFO growth over the prior year results, coupled with wider investment cap rates on acquisitions and steady balance sheet management, allows NNN to strive to provide long-term shareholder value as we progress in 2023."
Considering all factors, investors can be pleased with the REIT's first-quarter financial results as they convey resilience.
Key drivers
As previously mentioned, many economists were concerned about consumer strength leading into NNN REIT's first quarter. However, sampled data from the University of Michigan suggests consumer sentiment has ticked up in recent months, providing a helpful tailwind to the tenants of the real estate investment trust.
Source: Trading Economics; University of Michigan
Another contributing factor to the REIT's destiny is the interest rate environment. Higher and unstable interest rates typically impair investment property valuations as they diminish the current value of their future cash flows. However, U.S. inflation has stabilized, and the interest rate cycle looks set to pivot in early 2024, which could lend buying power to U.S. consumers and investors alike, subsequently raising the fair value of investment property.
Lastly, NNN REIT operates a triple-net lease strategy, allowing it to share much of its assets' running costs with its tenants. As such, the fund hosts an exceptional operating profit margin of 61.39%, which ranks in the 67th industry percentile. If inflation continues to taper, the company will realize lower maintenance costs, allowing for even wider operating profit margins.
Valuation and dividends
After an 8% year-to-date drawdown, some could argue that NNN REIT is undervalued. The real estate investment trust's price-to-funds from operations ratio of 13.38 is respectable, considering the scale at which its funds from operations are growing. In addition, the REIT has a forward dividend yield of 5.22%, providing income-seeking investors with a golden opportunity.
Noteworthy risks
Although most of NNN REIT's key indicators are positively aligned, the company possesses certain risks.
First, based on the company's recent disposals and Janney Montgomery Scott's latest comments, NNN REIT has a capitalization rate of approximately 6.6% to 6.9%. According to S&P Global, high-quality retail REITs typically possess a capitalization rate of 7.5%, meaning the company's portfolio provides a non-substantial yield.
Source: S&P Global
Further, NNN REIT suffered $2.64 billion in impairment losses during its latest operating quarter. This trend may continue into the next operating quarter as the high interest rate environment is causing impairments across the retail real estate arena.
Final Word
Despite its lingering risks, NNN REIT seems like a lucrative investment opportunity. The REIT's funds from operations are growing at scale, which is likely to continue amid an improvement in consumer sentiment within the U.S. Moreover, the company's asset base is expanding at scale, with long-term lease contracts central to its success.
Although questions about the company's moderate capitalization rate remain, most signs are positive.
