- Shares of W. P. Carey have plunged 28% since I last covered the stock, while the S&P 500 only declined 9% during that time.
- The fact that W. P. Carey has been hit harder than the S&P 500 since COVID-19 can be mostly attributed to W. P. Carey’s significant overvaluation just a couple months ago.
- Despite the uncertainty of COVID-19’s impact on W. P. Carey’s 2020 financial results, W. P. Carey will be a Dividend Aristocrat in 2023 and maintains an investment grade credit rating.
- Adding to the case for an investment in W. P. Carey, is the fact that the stock is trading at a 7% discount to fair value based on data sourced from I Prefer Income, as well as the DDM.
- Between W. P. Carey’s 7.1% yield, 3-4% annual AFFO growth potential, and 0.8% annual valuation multiple expansion, shares of W. P. Carey are positioned to deliver 10.9-11.9% annual total returns over the next decade.
As an investor that focuses about as much on yield as dividend growth, I prefer investing in beaten down industries that have a high probability of rebounding over the long term.
One such industry that has been significantly affected by the COVID-19 pandemic to date is the triple net lease REIT industry.
Using I Prefer Income’s filter above, I specified for a 7% yield and a market cap greater than $5 billion in the triple net lease industry, which narrowed the list of REITs in I Prefer Income’s database from 155 to just 1.
Today, I’ll be reexamining W. P. Carey’s (WPC) dividend safety and dividend growth potential for the first time since last December, discussing its recent operating results and risks associated with an investment in the stock, and the valuation aspect of an investment in W. P. Carey at the current price.
W. P. Carey’s Dividend Is Still Relatively Safe
Although it’s always wise to examine the safety of a stock’s underlying dividend, it is especially necessary to do so when a stock’s yield is over 3 times that of the S&P 500’s as is the case with W. P. Carey’s since the dividend will be driving the bulk of the total returns going forward.
In FY 2019, W. P. Carey generated $5.00 in AFFO/share against the $4.14 in dividends/share paid out during that time, for an AFFO payout ratio of 82.8%.
Moving to the current fiscal year, W. P. Carey was guiding for $4.86-$5.01 in AFFO/share (although this guidance will assuredly decrease as a result of the COVID-19 stay at home orders in place across the country once the company announces Q1 earnings this Friday).
Against the $4.172 in dividends/share slated to be paid out this year (assuming W. P. Carey continues with their $0.002 quarterly increases), this equates to an 85.8% AFFO payout ratio at the low end of W. P. Carey’s previous guidance.
While W. P. Carey’s payout ratios are at the very top of the 65-85% AFFO payout range that I prefer on REITs and AFFO is relatively flat, it’s important to note that W. P. Carey is in the middle of simplifying its business model to do away with the Investment Management segment, which is continuing to progress as I’ll discuss later in further detail.
As I noted in my previous article, W. P. Carey’s CFO Toni Sanzone expects the company’s long-term payout ratios to remain in the low to mid-80% range.
When I factor in the 3-4% AFFO growth that I am expecting over the long term, I am revising my dividend growth estimate down from 4.00% to a more realistic 3.00%.
W. P. Carey’s Operating Fundamentals Are Relatively Stable And The Balance Sheet Remains Investment Grade
W. P. Carey reported decent financial results during FY 2019.
Same-store ABR growth during the year came in at about 2%, which is primarily a result of the fact that 99% of W. P. Carey’s leases have contractual rent increases in place, with 63% linked to CPI.
As a testament to W. P. Carey’s stable fundamentals, W. P. Carey was able to improve its occupancy rating by 60 basis points from 98.3% in FY 2018 to 98.9% in FY 2019.
What’s more, W. P. Carey’s occupancy rating never dipped below 96%, even in the depths of the Great Recession.
Another positive development for W. P. Carey during FY 2019, was that the company was able to boost its ABR by 5% during the year as a result of 2019 net investment activity ($868 million of investments completed across all major property types leased to 29 tenants located primarily in the United States and Europe), the conversion of self-storage assets, and the aforementioned contractual rent escalations, according to CFO Toni Sanzone in W. P. Carey’s Q4 2019 recent earnings call.
Transitioning to the lease expiration front of W. P. Carey’s results, W. P. Carey expects less than a quarter of its ABR (24.1%) to expire through 2024 compared to 27.3% when I covered the company just a few months ago, which suggests that the company has been actively renewing and extending its leases.
Further evidence to support this hypothesis is reflected in the fact that W. P. Carey renewed or extended leases on about 2% of its ABR in Q4 2019 alone.
While W. P. Carey’s AFFO declined 7.2% from $5.39 in FY 2018 to $5.00 in FY 2019, this was entirely expected due to W. P. Carey’s gradual exit from the Investment Management segment to focus exclusively on the more stable Real Estate segment (accounting for 95% of the company’s total AFFO in FY 2019), which produced an 8% YOY increase in AFFO.
As illustrated above, W. P. Carey will be liquidating its Lodging/Hospitality non-traded investment programs in 2023, Student Housing non-traded investment programs in 2021, and Diversified/Net Lease non-traded investment programs in 2022.
Given that W. P. Carey has consistently seen positive results in its Real Estate segment, I believe the move to divest itself of its Investment Management segment will prove to be a beneficial simplification of the business model.
Adding to the case for an investment in W. P. Carey, is the fact that the company’s balance sheet remains strong.
As indicated by slide 22, W. P. Carey’s already healthy metrics on its unsecured bond covenants grew a bit stronger overall from Q3 2019 to the end of FY 2019.
W. P. Carey’s total leverage metric remained well below the less than or equal to 60% covenant requirement, at a healthy 40.0% at the end of FY 2019 compared to 39.0% at the end of Q3 2019.
Additionally, W. P. Carey’s secured debt leverage metric was well below the less than or equal to 40% covenant requirement, at a mere 9.6% at the end of FY 2019 compared to 11.3% at the end of Q3 2019.
Moving to W. P. Carey’s fixed charge coverage metric, this metric also improved from 5.0 times at the end of Q3 2019 to 5.3 times at the end of FY 2019, which is well above the covenant requirement of greater than or equal to 1.5 times.
Finally, the maintenance of unencumbered asset value metric of 242.9% at the end of FY 2019 was well above the covenant requirement of greater than or equal to 150%, though a bit less than the 244.8% at the end of Q3 2019.
From a debt maturity perspective, W. P. Carey faces no significant maturities until 2023 when $910 million or 15.2% of W. P. Carey’s debt comes due, at an interest rate of 2.7%.
This gives the company a bit of flexibility to meet its upcoming maturities, while enabling the company to reward its shareholders with dividends, and make future investments to fuel AFFO growth going forward once the company is fully divested of its Investment Management segment.
Given the discussion above pertaining to W. P. Carey’s debt profile, it should come as no surprise that Moody’s has assigned W. P. Carey a Baa2 credit rating on a stable outlook, while S&P has assigned a BBB credit rating on a positive outlook.
When I factor in that W. P. Carey’s operating fundamentals remain relatively intact, the balance sheet remains strong, and W. P. Carey’s exclusive focus on the Real Estate segment a few years from now will be beneficial to the company’s operating and financial results, I believe W. P. Carey is capable of being a satisfactory long-term investment if shares are acquired at or below fair value.
Risks To Consider
Although W. P. Carey has established itself as a blue-chip triple net lease REIT, that doesn’t mean the company isn’t exposed to its fair share of risks that investors would be prudent to occasionally monitor.
While I previously mentioned that less than a quarter of W. P. Carey’s leases will be expiring in the next 5 years, it is worth reiterating that if W. P. Carey is unable to release these properties, the company’s financial results may be adversely impacted (page 7 of W. P. Carey’s most recent 10-K).
Fortunately, W. P. Carey has proven to be masterful at renewing leases at favorable terms (historically in excess of 100% of recapture rates on expiring leases), which minimizes the probability of this risk materializing.
A set of risks facing W. P. Carey come about as a result of the company’s international presence and the fact that 36% of the company’s ABR was generated outside the United States (pages 7-8 of W. P. Carey’s most recent 10-K).
While owning real estate properties outside of the United States expands W. P. Carey’s addressable real estate market considerably and opens up growth opportunities, there are a variety of economic, regulatory/political, and geographical risks that arise due to the ownership of these international properties.
While the risk of unfavorable currency translations will largely be neutralized over the long term with favorable currency translations, the more notable economic risk is that of a localized or regionalized economic downturn in W. P. Carey’s key international markets.
Economic conditions and regulatory changes following the United Kingdom’s exit from the European Union could have an adverse impact on W. P. Carey’s operating and financial results in those markets, where W. P. Carey generated 4% and 30% of its total ABR in 2019, respectively (page 9 of W. P. Carey’s most recent 10-K).
Although the UK’s exit from the EU formally took place on January 31 of this year, the UK is in a transition period until the end of this year, during which time negotiations will take place on the UK’s future relationship with the EU. This uncertainty could result in a variety of unfavorable events, such as global economic uncertainty, currency exchange rate volatility, and unfavorable changes in regulations of the real estate industry.
In addition, W. P. Carey is exposed to geographic risks, such as natural disasters and terrorist attacks in its markets, which have the potential to disrupt operations, unfavorably impact consumer confidence and spending, and materially impact W. P. Carey’s financial results.
Yet another risk facing W. P. Carey, is the fact that the company’s success largely hinges upon the success of tenants as most of W. P. Carey’s properties are occupied by a single tenant (page 11 of W. P. Carey’s most recent 10-K).
Because 21.9% of W. P. Carey’s 2019 ABR was derived from 10 tenants as noted above, it is worth mentioning that any financial distress among these top 10 tenants could have a material financial impact on W. P. Carey.
Expanding upon this risk further, the bankruptcy or insolvency of W. P. Carey’s key tenants could result in both a reduction in the company’s revenue and an increase in W. P. Carey’s expenses due to the need to potentially renovate properties to attract new tenants (page 12 of W. P. Carey’s most recent 10-K).
Exacerbating this risk, is the fact that we have most definitely entered a severe recession as unemployment claims reached 26 million this past week (equivalent to a 15-20% unemployment rate).
As a result of the COVID-19 stay at home orders across the United States and around the world, some of W. P. Carey’s tenants will inevitably encounter financial difficulties and be unable to pay their contractual rent obligations to W. P. Carey.
If these orders are not lifted sooner rather than later across the world, the economic impact across virtually every major industry will be felt for several years to come, which could significantly impact W. P. Carey’s financial results in the medium term.
While I have discussed what I believe are several key risks associated with an investment in W. P. Carey, I haven’t discussed all of the risks. For a more comprehensive discussion of the risks facing W. P. Carey, I would refer interested readers to pages 6-22 of W. P. Carey’s most recent 10-K and my previous articles on the company.
W. P. Carey Is A Blue-Chip Trading At A Discount
While W. P. Carey is undoubtedly a REIT with an impressive track record, it remains important that investors establish a fair value for shares of the stock to avoid the negative long-term impact of overpaying for a stock, which includes a lower starting yield and the potential for valuation multiple contraction.
It’s the above rationale that provides the basis for my decision to use a couple of valuation metrics and a valuation model to arrive at a fair value for shares of W. P. Carey.
The first valuation metric that I’ll be using to determine the fair value of W. P. Carey’s shares is the yield to historical yield.
According to I Prefer Income, W. P. Carey’s current yield of 7.08% is well above its historical yield of 5.66%.
Factoring in a reversion in W. P. Carey’s yield to 6.00% and a fair value of $69.33 a share (to account for W. P. Carey’s increased size and scale working against it, as well as the detrimental impact of COVID-19), shares of W. P. Carey are trading at a 15.3% discount to fair value and offer 18.1% upside from the current price of $58.72 a share (as of April 26, 2020).
The next valuation metric that I will use to value shares of W. P. Carey is the price to non-GAAP earnings ratio against the historical price to non-GAAP ratio.
As illustrated above, W. P. Carey’s current price to non-GAAP earnings ratio is slightly below its historical average.
Assuming a reversion in W. P. Carey’s price to non-GAAP earnings ratio from the current 11.59 to its historical average of 12.10 and a fair value of $61.30 a share, W. P. Carey is priced at a 4.2% discount to fair value and offers 4.4% of capital appreciation from the current price.
The valuation method that I’ll be using to assign a fair value to shares of W. P. Carey is the dividend discount model or DDM.
The first input into the DDM is the expected dividend per share, which is another term for the annualized dividend per share of a stock. In the case of W. P. Carey, that amount is currently $4.16.
The next input into the DDM is the cost of capital equity, which is the rate of return that an investor requires on their investments. While this varies from one investor to another, I require a 10% rate of return on my investments because I believe that is an ample reward for the time and effort that I spend researching investment opportunities and occasionally monitoring my portfolio.
The third and final input into the DDM is the long-term dividend growth rate or DGR.
While the first two inputs into the DDM require minimal reflection from an investor, accurately forecasting the long-term DGR is the input that requires consideration of a variety of factors, such as a stock’s payout ratios (and whether those payout ratios are likely to remain the same, expand, or contract over the long term), future AFFO growth potential, industry fundamentals, and the strength of a stock’s balance sheet.
Because W. P. Carey’s payout ratios are positioned to remain the same over the long term, I expect 3-4% long-term AFFO growth from W. P. Carey, and the company’s balance sheet is investment grade, I feel comfortable projecting a 3.00% long-term DGR.
Plugging in the inputs above, I am left with a fair value of $59.43 a share.
This implies that shares of W. P. Carey are trading at a 1.2% discount to fair value and offer 1.2% upside from the current share price.
When I average the three fair values together, I compute a fair value of $63.35 a share, which indicates that shares of W. P. Carey are priced at a 7.3% discount to fair value and offer 7.9% of capital appreciation from the current price.
Summary: W. P. Carey Offers An Attractive Blend Of Yield And Total Return Potential
As demonstrated by its dividend increase streak that spans my entire life and an investment grade balance sheet, W. P. Carey is certainly a high-quality triple net lease REIT.
Despite the risks of COVID-19 adversely impacting W. P. Carey’s tenants and a detrimental financial impact in the short to medium term, W. P. Carey’s operating fundamentals were strong preceding the COVID-19 pandemic and I believe they will remain mostly intact coming out of the pandemic.
Unlike the last time I covered W. P. Carey, I believe the stock is attractively priced for the long term at the current price.
Based on data sourced from I Prefer Income, as well as the DDM, I believe shares of W. P. Carey are trading at a 7% discount to fair value.
Between W. P. Carey’s 7.1% yield, 3-4% annual AFFO growth potential, and 0.8% annual valuation multiple expansion, shares of W. P. Carey are positioned to deliver 10.9-11.9% annual total returns over the next decade.
Although I do believe W. P. Carey will see some additional downside pressure in the short term due to negative developments arising from the COVID-19 pandemic and ensuing shutdown of most of the United States, I rate shares of the company a buy at this juncture.
Author: Kody’s Dividends
Source: Seeking Alpha: W. P. Carey: This REIT Is Positioned To Deliver 11-12% Annual Total Returns