Real estate investment trusts, or REITs, are often a favorite amongst income-seeking investors - and with good reason, as these stocks often have a very high dividend yield. These stocks can offer high yields because they are obligated under the law to pay out at least 90% of taxable income in the form of dividends.
Unlike the rest of the market, REIT stocks had a difficult end to last year. One high-yielding REIT that suffered at the end of 2019 is W.P. Carey (WPC, Financial). The stock finished more than 27% higher for 2019 but experienced a 10.6% decrease in value during the fourth quarter alone. In my opinion, this decline, plus a strong business and a dividend yield of 5%, make this a good time to buy shares of the W.P. Carey.
Company background and recent earnings results
With a market capitalization of $14.3 billion, W.P. Carey is one of the largest REITs in the world. The trust’s real estate properties are net leased to tenants, meaning the tenant pays property expenses in addition to rent. W.P. Carey has nearly 1,200 properties located primarily in the U.S. (64% of rent) and Europe (34%). The trust has a handful of properties in Canada, Japan and Mexico. Nearly all (99%) of the trust’s properties have annual rent increase built into the lease.
W.P. Carey also has an investment management segment that it is in the process of divesting to focus on its real estate business. The real estate segment accounts for approximately 82% of net income and 95% of funds from operating (or FFO), with the investment segment contributing the remainder of both in the most recent quarter.
W.P. Carey’s properties are diversified amongst property type and tenant industry.
Source: 2018 Annual Report
At 25.5% of all properties, Office is the largest property type in W.P. Carey’s portfolio. The other main property categories range from about 18% to 23%. This means that the trust isn’t overexposed to any one type of property.
Source: 2018 Annual Report
Tenant industry is also pretty diverse. The Retail industry is far and away W.P. Carey’s largest tenant base. This industry leases ~21% of the trust’s properties. The next largest tenant industry is Consumer Services, which accounts for 8.5% of the trust’s lease base. The trust’s five largest industries make up less than half of all tenants.
This diversified business model means that W.P. Carey isn’t over reliant on any one industry or tenant for rent. The trust’s top 10 tenants contribute just 22.6% of annualized base rent. No single tenant accounts for more than 3.5% of annualized base rent.
W.P. Carey reported third quarter earnings results on Nov. 1, 2019. The trust generated revenue of $318 million, which was slightly above analysts’ estimates and an improvement of nearly 52% from the previous year. FFO was $1.30 per share for the quarter, which was 15 cents higher than analysts had expected but marked a 12.2% decline from the previous year.
The decline in FFO on a year-over-year basis is primarily due to an increased share count. REITs often have to issue shares in order to fund acquisitions. W.P. Carey is no different. The trust’s weighted average share count was 172 million at the end of the third quarter, an 18% increase from the share count at the end of 2018. Adjusting for this, W.P. Carey actually saw an increase in both total net income and FFO.
Much of the real estate revenue increases were due to the $5.9 billion purchase of Corporate Property Associated 17, or CPA:17. CPA:17 was a leading net lease REIT that had an average cap rate of 7.5% and a weighted average lease term of more than 10 years at the time the acquisition closed. The CPA:17 was an all-stock transaction, leading to a significant increase in the trust’s share count.
The trust completed $62 million worth of sale-leasebacks during the third quarter that had a weighted average cap rate of 7.5%. The weighted average length of lease agreement was 23 years. Year-to-date, W.P. Carey has invested $520 million in new projects and was scheduled to complete another $115 million of capital investment projects during the fourth quarter.
W.P. Carey renewed or extended five leases during the most recent quarter, recapturing 107% of prior rent. The trust also signed 20 new leases with a weighted average lease term of 22 years. W.P. Carey finished the quarter with an occupancy rate of 98.4%, which was a 20 basis point improvement from the end of the second quarter. The trust had a weighted average lease term of 10.3 years at the conclusion of the third quarter. Leases expiring by the end of 2020 contribute just 2.5% of annualized base rent. This means that near-term leases don’t play a significant role in W.P. Carey’s revenue stream. The damage would be minimal if the leases were not to be renewed or were renewed at a lower rate.
W.P. Carey did lower its expected adjusted FFO to a midpoint of $4.98 for 2019. This would be a decline of 8% from the results for 2018. Again, much of this decline is due to a higher average share count. The trust was on pace at the end of the most recent quarter to produce higher net income than it did in 2018.
Dividend and valuation analysis
Dividends are usually raised once per year by most companies, but W.P. Carey has increased its dividend 75 quarters in a row and for 22 consecutive years, which means the trust is nearing "Dividend Champion" status.
W.P. Carey has increased its dividend by an average of:
- 2.1% per year over the last three years.
- 5.1% per year over the last five years.
- 7.7% per year over the last 10 years.
As you can see, dividend growth has slowed in each successive period of time. Dividends for 2019 were less than 1% above the total for the previous year.
Some investors might see this as a worrisome sign, concerned that the dividend may be in jeopardy, but I don’t believe this is the case given the state of the trust’s payout ratios.
The trust paid out $4.13 in dividends per share in 2019. Using expected FFO of $4.98 for full year 2019, the payout ratio is 83%. This payout ratio would be considered elevated for a normal C-corp. For a REIT, which is required to distribute almost all income as a dividend, this is fairly normal. For context, W.P. Carey had an average payout ratio of 76% over the last five years. The current payout ratio is higher than normal, but not excessively so.
Even better, the trust has seen its free cash flow payout ratio improve in recent years. W.P. Carey distributed $177 million of dividends during the last quarter while producing free cash flow of $249 million over the same period of time for a free cash flow payout ratio of 71%.
Over the last four quarters, the trust has paid out $636 million of dividends while generating $717 million of free cash flow. This equates to a payout ratio of 89%.
Going back even further, W.P. Carey distributed $1.3 billion of dividends while generating $1.5 billion of free cash flow from 2016 through 2018. This gives the trust an average payout ratio of 87% over this period of time.
Again, W.P. Carey’s free cash flow payout ratio is elevated, but this metric has improved in the short term. Part of this improvement is that the trust’s dividend increases have been below the longer-term average. Still, W.P. Carey yields 5% today, which is a solid trade-off for a lower average dividend raise. For context, the dividend yield is nearly three times that of the average yield of the S&P 500.
If there is a complaint regarding W.P. Carey, it is the stock’s valuation. Using the current share price of $83 and expected FFO for 2019, W.P. Carey trades with a price-earnings ratio of 16.7. This is higher than its five-year average price-earnings ratio of 12.4.
Shares of W.P. Carey are still cheap compared to the S&P 500, which trades with a price-earnings ratio of more than 24. The trust is a leader in its industry that continues to grow and has as an extremely high occupancy rate. A mid-teens price-earnings ratio doesn’t worry me given all the advantages that W.P. Carey has going for it.
Final thoughts
W.P. Carey closed 2019 on somewhat of a down note. The stock price declined into the end of December while the remainder of the market soared higher. The stock offers a dividend yield of 5% as of the writing of this article.
W.P. Carey offers a diversified business model amongst various geographies, property and industry types. The trust also raises its dividend every quarter and its payout ratios are in solid shape. In particular, the free cash flow payout ratio has been improving for the past few years, making future dividend growth a near certainty.
Because of these factors, investors looking for exposure to REITs might consider buying W.P. Carey.
Disclosure: I have no position in W.P. Carey.
Read more here:
- Pfizer Offers a Strong Combination of Growth and Income
- Why I Added General Dynamics to My Portfolio
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
