W. P. Carey (WPC) is a REIT that operates in an attractive, low-risk niche of the industrial real estate sector. The company has generated solid growth in the past, and should be able to grow its funds from operations going forward as well. It offers reliable dividend growth and an attractive dividend yield of close to 7%, while shares also have upside potential of up to 50% over the next couple of years. The combination of these factors makes WPC worthy of a closer look.
Compared to its peers in the triple-net space, WPC has a below-average valuation (in terms of cash flow and EV/EBITDA), while also providing an above-average dividend yield. Last but not least, its valuation is on the lower end of the 5-year range, whereas many of its peers are trading above the historical valuation median.
WPC Is A Strong Triple-Net REIT In The Industrial Space
WPC is a triple-net REIT, but unlike many peers such as Realty Income (O) or National Retail Properties (NNN), it is not focused on retail real estate. Instead, the REIT mainly owns warehouses, industrial properties, and some office buildings, which naturally don’t have to worry about the impact that online retailers have on the brick-and-mortar retail space.
WPC is active in both the US (63%) and Europe (35%). This results in some geographic diversification, although it adds some currency rate exposure.
Source: WPC presentation
WPC has some advisor business on top of managing its own properties, but with just below $3 billion of AuM, this side of the business does not provide a large portion of revenues and cash flows.
The company owns more than 1,200 properties, and there is a lot of diversification across tenants, with more than 350 tenants in total. The top 10 tenants make up just above 20% of base rent proceeds, thus WPC is not too exposed to any single tenant at all. Its top overall tenant is self-storage player U-Haul, which makes up 3.4% of ABR. WPC also sports very high lease terms – the weighted average remaining lease term was 10.7 years at the end of Q2; cash flows on many of its properties are thus more or less locked in through 2030. This results in two benefits, as the company has very plannable, steady cash flows. At the same time, the fact that the company does not have to put a lot of effort on releasing properties means that its operating costs are rather low, which leads to attractive profit margins – the EBITDA margin stands at 90%, for example, which is even slightly ahead of high-quality pick Realty Income (89%).
WPC follows a strategy of investing in “mission-critical” properties that its tenants rely on, which means that rents will be paid, no matter what. Should any tenant get in trouble, the tenant will likely try to get out of leases of less-important properties. But the key distribution facilities, data centers, top-performing retail stores, headquarters, etc. that WPC chooses to invest in will remain in place, which means that the company owns a relatively low-risk asset portfolio. Due to investing in such critical properties and negotiating long lease terms, occupancy across the REIT’s portfolio has always been very high and stood at 99% at the end of the second quarter – despite the fact that the pandemic was raging in both the US and Europe during Q2.
Typical for net-lease REITs, WPC has negotiated contractual rent increases that are mostly CPI-linked or fixed with its tenants. Thus, even without acquiring any new properties, the company’s revenues will continue to grow, no matter what. Through these already negotiated rent increases that cover 99% of its assets, WPC has generated same-store rent growth of 1.5-2.0% in the recent past, including a 1.9% increase during Q2, which shows the resilience during the current pandemic.
Source: WPC presentation
When it comes to developing new properties, WPC can pick among top tenants, such as healthcare players Astellas (OTCPK:ALPMY) and Fresenius Medical Care (FMS). Newly built properties come with lease terms of up to 20 years, or even longer in some cases, which means that growing cash flows are locked in over decades whenever WPC builds out such assets.
WPC also is looking great when it comes to its balance sheet and how the company is financed. Based on its current stock price, the equity is valued at around $11 billion, while the company has another $6.2 billion in net debt on its balance sheet. The majority of that consists of unsecured notes, made up of $1.6 billion and €2.6 billion, respectively. Due to its European operations, WPC can easily access European debt markets, where it benefits from the fact that interest rates are, on average, even lower than they are in the US. Overall, the company’s weighted average interest rate is just 3.2%, with a weighted average time to maturity of 5 years.
WPC’s debt maturity schedule is looking good as well:
Source: WPC presentation
WPC has almost no debt coming due in H2 of 2020 and 2021, and not a lot of debt will come due in 2022, either. In 2023-2026 there is a larger amount of maturities, but that is when the current pandemic will have passed and the economy should easily be back to normal. During the current crisis, the company should thus not have any trouble refinancing the small amount of debt that comes due.
Strong Dividend Track Record And Upside Potential
Since we have now established that WPC is a lower-risk quality pick in the REIT space, the question is whether the stock is also an attractive investment. Since quality criteria are easily met, the attractiveness is mainly decided by its shareholder returns and valuation. On that front, the company is looking good, too.
Shareholders get a dividend yielding 6.6% at current prices, which alone provides for solid returns already. WPC has raised its dividend every year since 1998, with two big dividend hikes in 2012 and 2013, when it converted to a REIT. Since 2014, the company has increased its dividend regularly, although not at an overly high pace, as annual dividend growth averaged just slightly above 2% in that time frame. And yet, the combination of a 6.6% yield and a 2% annual dividend growth rate should theoretically allow for annual returns in the 8-9% range, all else equal. For a very resilient, low-risk investment such as WPC, that does not seem like a bad proposition.
There is, however, also potential for additional share price gains thanks to multiple expansion. WPC was trading in the $90’s before the current crisis, at a valuation that was way higher than it is right now. Since it is weathering the current crisis quite well – rent proceeds continue to climb, occupancy remains at 99% – there isn’t any good reason why shares couldn’t climb back up to pre-pandemic highs over the next couple of years. Were WPC to rise to $94 again, shareholders would get a 49% share price gain on top of the attractive dividend yield.
Apart from the fact that the company traded at that level earlier this year, there is another reason that could make its share price rise to such levels eventually.
When we look at the yield spread between US Treasuries and WPC’s dividend yield, we see that it stands at 10-year highs right now (backing out the March selloff). Historically, the yield spread has mostly been in the 3-4% range, whereas it stands at 5.9% right now. If that yield spread declined back towards a historical norm of 3.5%, WPC’s dividend yield would have to stand at 4.2%, which would equate to a share price of $99 – 57% upside from the current level. The Fed has made it clear that they will not increase interest rates anytime soon, so a normalization between the yield spreads of Treasuries and WPC’s dividend would have to come from share price gains.
Since income investors can’t get any meaningful yield from bonds any longer, it would not be too much of a surprise to see them rushing into REITs such as WPC once this crisis has passed, which could drive substantial share price gains. It is, of course, not guaranteed that the stock will trade in the $90’s a couple of years from now, but if we take history as a guide, it wouldn’t be too much of a surprise, either.
WPC is not a high-growth name, but it still generates very reliable growth in both rent proceeds, same-store rents, and its dividend. The REIT is very resilient versus downturns, and sports solid fundamentals and a strong balance sheet. Due to the fact that its dividend yield is historically high, it looks like buying here could be opportune. Not only will investors lock in a solid yield of close to 7% that looks quite safe, but they will also benefit from meaningful upside potential once income investors start hunting for yield and move into stocks such as WPC.
Over the coming years, once COVID-19 is behind us and things normalize, it will not be an extraordinary surprise if the company’s share price rises back to the $90’s, based on the fact that shares were valued at that level pre-pandemic, but also based on its historical yield spread versus Treasuries. Overall, investors thus get a low-risk dividend with an attractive yield and meaningful potential for share price gains from high-quality REIT WPC at the current price.
One Last Word
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Disclosure: I am/we are long O. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.