From Amoss’ latest report to his readers:
“Yesterday, Realty Income (O) announced an agreement to acquire $269 million worth of Napa, Calif., winery and vineyard properties under long-term, triple-net lease agreements with Diageo Chateau & Estate Wines. This is essentially Realty Income providing financing to Diageo; it’s exchanging a $269 million payment for a 20-year stream of rental income.
“Baird estimates that this sale-leaseback deal has an initial cash yield of 7.5%. The deal was largely financed by the closing of a 10-year $250 million bond offering, which was priced to yield 5.8%. So Realty Income continues its carry trade strategy: borrow at about 6%, invest the proceeds at 8-9%, and use the spread income (net of tenant defaults) to pay dividends. This strategy works beautifully in the bubble-era economy, but won’t work well at all going forward.
“That being said, with the stock still at $31, the market clearly doesn’t agree that Realty Income’s legacy rental income portfolio — full of second-rate strip mall operators — carries much risk. It seems all that matters to Realty Income’s overly confident shareholders is today’s dividend yield — not the sustainability of that yield, which I question.
“O stock remains near its all-time high, despite the May and June market weakness. And management has yet to properly address how it’s dealing with the planned liquidation of Movie Gallery, a tenant that accounted for 1% of revenue. Maintaining investor confidence is clearly more important to management than healthy disclosure of risks.”
Dan Amoss describes that much will still depend on how July 28 earnings pan out. Realty Income has been effective at maintaining investor confidence to date, but still needs to hit the right numbers to support management’s position.
The Daily Reckoning
[Nothing in this post should be considered personalized investment advice. Agora Financial employees do not receive any type of compensation from companies covered. Investment decisions should be made in consultation with a financial advisor and only after reviewing relevant financial statements.