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Why I AM Buying American Realty Capital Properties

April 28, 2014 | About:

The stock market in general isn’t offering a lot of spectacular individual values out there, and why would it? There’s just not many other asset class out there that are all that attractive right now.

Bonds are offering historically low yields; you’d have to go back to 1952 to find 10-year Treasury notes with yields like you see today. So odds are not on your side as a long-term bond investor right now.

Gold offers no cash flow, so anyone seeking financial independence via rising passive income is just likely not going to take a shiny yellow metal very seriously. I sure don’t! I think there are some gold connectors inside my laptop somewhere, but other than that I own no gold.

Then you have real estate. Sure, rental income can be a nice way to cash flow your freedom, but who wants to deal with the proverbial leaking toilet? Even worse is the real-life leaking toilet!

And then there’s cash. This is probably the worst investment of all as inflation will surely invisibly tax your cash pile and lead to a loss of purchasing power over time.

Equities, on the other hand, offer you a piece of real-life thriving businesses that share a piece of their rising profit with you as a part-owner (if you’re investing in dividend growth stocks like me). As such, this is the asset class I continue to load up on, and currently have almost 100% of all my worldly wealth allocated to. And my recent stock purchase is just an extension of that enthusiasm and confidence.

I purchased 70 shares of American Realty Capital Properties Inc. (ARCP) on 4/23/14 for $13.28 per share.

American Realty Capital Properties is a real estate investment trust that acquires, owns, and operates primarily single-tenant freestanding commercial real estate which it net leases to tenants with high credit quality.

This was my second purchase of shares in ARCP, with the first one coming back in August 2013 for slightly less cost per share. This was a rather small purchase for me based on my historical transactions, but this is due to capital being rather tight for me right now.

Since then a lot has changed for ARCP. They are now the world’s largest net lease real estate investment trust after completing the merger with Cole Real Estate Investments. The company now boasts 3,732 properties spread out across 49 states, plus Washington, D.C. and Puerto Rico. They have 1,071 high-quality tenants in 71 different industries with an average remaining lease term of 11 years. They have also become internally-managed, which should align well for the long-term interests of shareholders and be more cost-effective.

Some of their largest tenants (by % of rent) are Walgreen Company (WAG), AT&T Inc. (T), CVS Caremark Corporation (CVS), Dollar General Corp. (DG), and FedEx Corporation (FDX). Four out of five of these tenants have a credit rating of BBB or higher, and none of their top-ten tenants have a credit rating lower than BBB-. 83.1% of their tenants are investment grade rated.

Their portfolio of properties is spread out between four major types: single tenant retail (51.1%), single tenant office (23.9%), single tenant industrial/distribution (13.9%), and multi-tenant retail (11.1%). However, ARCP has announced that it will spin off its multi-tenant power and shopping center business, which is valued at approximately $2.2 billion. This spin off will give existing ARCP shareholders 1 share in the new business (ARCenters) for every 10 shares they currently own in ARCP. This spin off is expected to close in the second quarter of 2014. This transaction will allow ARCP to focus on its core business.

ARCP’s growth, as I discussed previously, has been incredible and almost unbelievable. The driving force behind this growth has been Nicholas S. Schorsch, the energetic and dynamic CEO – an industry veteran. And while it remains to be seen how well this company can navigate and manage this explosive growth, I see nothing so far that points to concern.

ARCP is obviously a bet on continued economic prosperity here in the U.S., as well as commercial real estate. And since I can’t go out and buy my own commercial building and rent it out due to limitations, ARCP gives me the opportunity to not only expose myself to this market, but also do so in a heavily diversified manner.

Since being founded in 2011, rental revenue grew from $3.970 million at the end of FY 2011 to $238.796million at the end of FY 2013. And adjusted funds from operations grew from a negligible amount at the end of FY 2011 to $0.86 per share at the end of FY 2013. And management is guiding for AFFO of $1.13-$1.19 per share in 2014 on revenue of $1.433 billion.

Since I only invest in companies that regularly pay and raise dividends, let’s take a look at ARCP’s dividend history. Dividend growth has been impressive, and continues to be so. The dividend was initially set at $0.0729 per share monthly when the company was founded in late 2011. The dividend is now$0.0833 per month per share as the dividend was raise to $1/share per year on the back of the Cole merger. This is growth of 14.3% over the course of a little more than two years. However, this growth is even more impressive when you consider the size of that monthly dividend. Furthermore, the company has raised the dividend a total of eight times since their initial dividend payment in late 2011. The entry yield on shares based on my price is 7.53%, so even very moderate dividend growth leads to a rather attractive total return.

The balance sheet looks stable; however, it’s changing rapidly as ARCP pro forma comes fully on line.Moody’s has assigned a rating of Baa3, with a stable outlook.

The valuation on shares right now is quite attractive, in my opinion. Based on TTM AFFO/share you’re looking at a P/AFFO ratio of 15.44, and based on forward guidance you’re looking at a P/AFFO ratio of~11.17. That’s pretty solid stuff considering that everyone is concerned with the supposed dearth of attractively priced stocks in today’s market. As I always say, I’m not buying the stock market; I’m buying stocks in individual businesses, and must value those ownership stakes accordingly. I once heard it’s not a stock market, but rather a market of stocks. I tend to agree with that.

I also valued shares using a Dividend Discount Model analysis. Using a 10% discount rate and a 5% long-term growth rate shares are fairly valued at $21.00. Even lowering the growth rate down to 3% (in line with long-term inflation) you’re looking at shares being fairly valued $14.71. It would appear that I received a comfortable margin of safety on these shares, as I think ARCP should be able to grow the dividend above the rate of inflation based on rent increases and acquisitions. And even if they don’t, this should be a solid investment for me.

I usually like to include analyst valuation opinions on my purchases, but neither Morningstar nor S&P Capital IQ track this stock.

I’ll update my Freedom Fund in early May to reflect my recent addition.

Full Disclosure: Long ARCP, T

How about you? A fan of ARCP at these prices?

Thanks for reading.

About the author:

Dividend Mantra
Trying to retire by 40 by investing in dividend growth stocks and living frugally, valuing time over money.

Visit Dividend Mantra's Website


Rating: 5.0/5 (1 vote)

Voters:

Comments

SeaBud
SeaBud premium member - 5 months ago

DM,

I like your articles so I'll just give you my opinion - I am very familiar with NNN leases, own commercial NNN leases and actually invested in ARC before it went public.

A quality NNN McDonald's, CVS (or other AAA credit) has a cap rate of 5-6% (and has for years). This stock is paying over 7% in dividends. How is this achieved? Leveraged debt. When interest rates rise and this debt has to be refinanced, these companies will suffer huge shareholder exodus (exacerbated by more attractive investments caused by rising rates and by a rush to exit commercial NNN leases as this bubble bursts). Be careful on this one - the train is not in sight for these commercial dirt reits... but it is coming.

For what it is worth....

turnkeyusa
Turnkeyusa - 5 months ago

Nothing about governance issues which have depressed this stock. Now ex-CEO promised not to dilute existing shareholders, promised not to do so at 14, 13 and 12/share....and did exactly that at $12/share. Also nothing here about the cluster of inside buys. Analyzing a business just by the numbers ignores the people who are the stewards of your capital and the activist investors who target them when they're not good stewards of your capital. That's the real trigger here, whichever direction ARCP goes in.

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