Is This Popular Dividend Stock a Buy?

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Written By Nathan Goldstein

Realty Income Corporation (NYSE:O), a prominent real estate investment trust (REIT), has navigated a turbulent market over the past few years.

Despite a notable 5.8% decline in its stock price over a five-year span, the company has demonstrated resilience, underpinned by a strong dividend yield that contributed to a positive overall return.

This performance stands in contrast to the company’s robust fundamentals, which seem to suggest a potential for a more favorable stock performance.

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Is Realty Income Stock About to Reverse?

In a recent turn of events, Realty Income’s stock appears to be reversing its downward trajectory. After plummeting to a low of $46.22 in November 2023, the stock has rallied impressively by more than 20%, raising prospects of a sustained recovery.

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Despite the disheartening performance in the stock market, Realty Income’s operational metrics tell a story of robust health. Analysis indicates significant revenue growth across various time frames, including the past three, five, and ten years.

Although the growth in earnings has been moderate, the increase in free cash flow, exceeding 16% across these periods, is noteworthy. The company boasts healthy margins, earning an A+ in profitability from Seeking Alpha’s rating system.

Company well-positioned for future expenses

Additionally, a strong balance sheet characterized by a low debt-to-equity ratio and substantial cash reserves positions the company well for future expenses.

The paradox of Realty Income’s declining stock value over the past five years, despite solid company performance, prompts a deeper examination. A significant factor in this downturn was the impact of the COVID-19 pandemic in 2020, which saw the REIT’s stock price plummet by 47%.

The pandemic’s restrictive measures led to widespread closures of non-essential businesses, adversely affecting many REITs, including those specializing in malls. Realty Income, being a commercial REIT, was not immune to these market dynamics.

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Realty Income’s Strong Resilience

However, its fundamentals remained relatively stable during this challenging period. Notably, in the second quarter of the pandemic – the most restrictive phase – the company’s revenue increased by 5.2%, with a slight 2.3% decrease in adjusted FFO per share, showcasing the company’s resilience amidst market volatility.

Despite a substantial recovery from the pandemic lows, Realty Income’s stock has not returned to its pre-pandemic highs. This is intriguing, considering that the company’s fundamentals, including earnings and cash flow, have improved compared to pre-COVID levels.

Looking forward, the valuation and future prospects of Realty Income require a thorough analysis. Key metrics over the last five years reveal significant growth in revenue, property expenses, and other operational costs.

Imminent Refinancing Challenges

Surprisingly, interest expenses have not risen as sharply as other expenses, a favorable outcome given the Federal Reserve’s aggressive interest rate hikes in 2022. However, the company faces imminent refinancing challenges in 2024, with $1.8 billion in debt maturing, which could lead to increased interest expenses.

Realty Income’s growth drivers are multifaceted. The company’s top clients, including Dollar General, Walgreens, and Dollar Tree, have strong credit ratings, contributing to nearly perfect collection rates.

The recent acquisition of Spirit Realty Capital is expected to bolster AFFO by 2.5% over the next year. Additionally, projections for commercial office rent suggest modest growth, complementing the company’s strong balance sheet, which allows for further strategic acquisitions.

Analysts concur with a forecast of approximately 10% annual revenue growth and 9.9% earnings growth in the near term. However, past equity dilutions, such as the Spirit Realty deal, might temper the growth rate in EPS compared to net income growth, estimated at around 5% annually.

How is Realty Income’s Valuation?

In terms of valuation, Realty Income’s stock presents a mixed picture. While the sales and earnings multiples appear high for a REIT, the FFO and AFFO multiples are comparatively lower. Given that FFO and AFFO are more indicative of a REIT’s dividend-paying ability, these figures suggest a moderately valued entity.

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A discounted cash flow analysis, assuming a conservative 5% growth rate over the next five years and a 7% discount rate, aligns with a fair value estimate of $75 per share.

In conclusion, Realty Income Corporation emerges as a REIT whose market performance has not fully mirrored its operational strength. Over the last five years, the company has seen a 25% growth in FCF per share, yet its stock price has witnessed a decline.

Currently valued at modest multiples relative to its FFO, AFFO, and book value, Realty Income faces risks, notably from potential fluctuations in interest rates. However, its solid fundamentals, coupled with a reasonable valuation and proven resilience in challenging times, present a compelling case for investment consideration.

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