W.P. Carey Remains a Top Choice for Income Investors

Yields remain stubbornly low, so income investors might be tempted to reach for yield, but should stick with quality

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Jun 14, 2021
Summary
  • Low yields persist, so finding sources of income is a challenge.
  • Investors should stick with quality companies whose business model supports high yields.
  • W.P. Carey has an industry-leading occupancy rate and aggressive investment volumes that should support the more than 5% yield currently offered.
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Finding sources of income is becoming much more of a challenge in the current environment. The yields on long-term bonds and the S&P 500 are in the mid-1% range, meaning that neither bonds nor stocks are much of a source of income at the moment.

Investors looking for income could be tempted to reach for higher yields, but if those yields aren’t safe, then the downside could be harsh.

Therefore, investors need to be careful in selecting high-yielding names to own. High-yielding stocks that offer sound business models and protected dividends could be an excellent way to find income in an otherwise low-yield environment.

One of my favorite safe, high-yield stocks remains W.P. Carey Inc. (WPC, Financial).

A look at earnings highlights

W.P. Carey reported first-quarter earnings results on April 30. Revenue grew 0.7% to $311.17 million, which was the trust’s best year-over-year result since the first quarter of 2020. Revenue was also $6.1 million above Wall Street analysts’ expectations. Adjusted funds from operations per share, or AFFO, of $1.22 was down 3 cents, or 2.4%, from the prior year, but was a 7-cent beat of estimates. Much of the AFFO per share decrease was due to a higher average share count for the quarter. AFFO attributable to the trust was essentially flat compared to the prior year.

Of the trust’s 1,261 properties, 98.3% were leased as of the end of the quarter. While better than many peers, this was a 20-basis point decrease from the prior year. First-quarter rent collection was 98% of annual base rents. For comparison, rent collection totaled 99% in the fourth quarter, but in line with the prior year’s figure.

The real estate portfolio continues to perform well. The portfolio occupancy rate was 98.3%, though this was down 20 basis points from the prior year. The weighted average lease term was 10.6 years. Same-store rents were up 1.6% from the prior year and represented a 10-basis point improvement from the fourth quarter.

Investment activity has begun to pick up as well. 2020 saw lower investment volumes than normal due to the unknown regarding the Covid-19 pandemic. The trust closed the year with $310 million of investment activity in the fourth quarter, which was more than a third of the total for last year.

With some of the uncertainty surrounding Covid-19 disappearing as restrictions have begun to be relaxed in many areas and the number of people getting vaccinated growing, W.P. Carey has returned to its pre-pandemic aggressiveness in investment. The first quarter saw $214 million of investment activity, with an additional $186.1 million in investments made in April. The initial cap rate is 6.6% for these investments with built-in rent escalators that average 2.25% with an average term lease of 23 years.

W.P. Carey also offered revised guidance for the year. The trust now expects AFFO of $4.87 to $4.97 per share for 2021, up from prior guidance of $4.79 to $4.93.

Takeaways

Compared to many of its peers, W.P. Carey has a very strong business model. While portfolio occupancy did decrease slightly sequentially, the trust does lead the industry in this area even after this decline. Leadership said on the conference call that the trust was in negotiation on approximately 30% of vacant square footage and expects the occupancy rate to climb back into the 99% range, a range that W.P. Carey has typically enjoyed throughout its history.

W.P. Carey also benefits from a very long-duration lease agreements, with a weighted average lease term of nearly 11 years. This is an incredibly long time and many of these contracts include automatic rate escalators. In fact, nearly every lease signed has some sort of rate increase built in over time. More than 60% the trust’s rate base is tied to inflation as well. While there are concerns in the market regarding higher inflation, W.P. Carey looks to be somewhat immune from this. For leases not tied to inflation, the average annual rate increase is around 2%.

Furthermore, W.P. Carey is able to augment this growth with investments in new properties. As discussed above, investment activity picked up significantly at the end of last year and continued into the first quarter to the point where the trust has already exceeded its initial guidance on investment volumes for the year. Leadership stated that it is advanced talks on deals worth more than $500 million and expects to close on much of volume in the second quarter of 2021.

The cap rates on the new investments were solid and the length of the average lease term shows how in demand the trust’s properties are by clients. The bulk of these deals were for industrial and warehouse properties, two areas that have seen sequential improvements in rent collections over the past few quarters.

W.P. Carey also took steps to shore up its balance sheet during the quarter. The trust used the proceeds from two long-dated unsecured notes with coupons of 2.25% and 0.95%, respectively, to pay off $400 million worth of mortgages with a weighted average interest rate of more than 5% and for the early redemption of a 500 million euros ($606.02 million) bond with a 2% coupon that was set to mature in 2023.

W.P. Carey has now addressed nearly all of its debt due before 2025 and extended its weighted average debt maturity by more than a year to 5.9 years. In doing so, the weighted average cost of debt is now 2.7%, a 20-basis point reduction from the prior period.

The trust has also capitalized on its share price gains of arond 9% since the start of the year by issuing new shares to raise funds. W.P. Carey raised $140.5 million in the first quarter by issuing two million shares at an average price of $70.26. In the first month of the second quarter, W.P. Carey raised an additional $31 million by issuing 443,000 shares at an average price of $71.67. The trust announced on Jun. 8 that it had commenced a public offering of 5.25 million shares that would generate proceeds of more than $400 million at current share prices.

While not usually a fan of share dilution, REITs in general use share issuances as a way to raise capital to further their investment goals. W.P. Carey’s share issuances this year haven’t led to decreased demand from investors so far this year as the stock’s current price is well above the average prices of the two prior offerings. Even with a considerably higher share count, AFFO guidance for the year was still hiked higher and the midpoint for revised guidance would be a 7% improvement from last year’s results.

Finally, one of the most attractive features of W.P. Carey to me is the diversification of its business model. Top 10 tenants make up less than 22% of the total portfolio and consist of mostly investment-grade businesses. This group also has a weighted average lease term of more than 12 years, which is above the length of the total portfolio.

W.P. Carey also benefits from geographic diversification with more than a one-third of annual base rents coming from Europe. No property type accounts for more than a quarter of rent and no tenant industry contributes more than 22% of rent.

Valuation and dividend analysis

W.P. Carey closed Friday’s trading session at $76.92. Using updated guidance from the trust, shares of W.P. Carey are trading with a forward price-AFFO ratio of 15.6. This is a premium to the stock’s five-year average price-AFFO ratio of 13.6.

Shareholders are paid a 5.5% yield to own the stock at the current price, which is lower than the five-year average yield of nearly 6%. However, with the average yield of the S&P 500 index hovering around 1.4%, W.P. Carey’s yield, which is nearly four times the index average, looks incredibly attractive. This is especially true for those hunting yield and wish to avoid riskier methods of finding income.

W.P. Carey has raised its dividend for 24 consecutive years, usually raising it every quarter. The dividend has successfully navigated the last two recessions as well, with shareholders seeing growth throughout both time periods.

The annualized dividend of $4.19 would result in a FFO payout ratio of 85% using gudiance, which is just above the five-year average payout ratio of 80%. Real estate investment trusts tend to have higher payout ratios, so the projected payout ratio, while elevated, is likely not a sign of a potential dividend cut.

Final thoughts

W.P. Carey started the year on a high note, posting revenue growth for the first time since before the Covid-19 pandemic. AFFO was down a bit, but mostly due to a higher share count. The trust maintains an industry leading occupancy rate with leadership predicting a return to the 99% level.

The trust is also well diversified both by tenant type and geographic region. This enabled W.P. Carey to perform well during the pandemic as the occupancy rate barely budged last year, a sign of incredible strength for the trust.

The stock’s valuation is at a premium to its historical average, but W.P. Carey’s stock has earned this premium in my opinion due to the trust’s business performance. The yield is lower than usual, but the dividend is still very generous and likely safe from a dividend cut.

For these reasons, W.P. Carey is a strong option for those looking for income. As such, I added to my position in the stock on May 14 at a price of $73.63.

Disclosures

I am/ we are currently short the stocks mentioned. Click for the complete disclosure