Store Capital Corp: A REIT With Great Upside Potential

Store Capital Corporation (NYSE: STOR) is a REIT which invests in Single-Tenant Operational Real Estate (STORE) such as chain restaurants, supermarkets, health clubs, education, retail, service, and distribution facilities. 

In February, STOR’s stock crashed along with the overall market. In the space of two months, the stock fell 63.5%, going from $40.05 in February to a low of $14.58 in April. The stock has since climbed 39.5% to reach a closing price of $20.34 on April 7th, 2020.

I believe this REIT still has massive upside potential: It has a growing real estate portfolio, a diversified tenant base, impressive financial performances, well managed debt, and an attractive dividend.

If the economy reopens and the virus is contained, STOR should eventually return to its former price of $40, which represents a potential upside of 96%.

source: Google

A Sizeable ‘NNN Lease’ Portfolio

As of March 31st, 2020, STOR’s real estate portfolio is worth $9.1 billion.

STOR owns 2,552 property locations spread out over 49 states: 94% are commercial real estate properties subject to long term leases and 6% are mortgage loans and financing receivables on commercial real estate properties.

STOR has has 491 clients spread out accross 113 industries, 75% of which are have investment-grade credit ratings. As of March 2020, its total occupancy rate is 99.5% and the weighted average non-cancelable remaining term of the leases is roughly 14 years.

99% of its portfolio is subject to triple net NNN leases. NNN leases are the most favorable for REITs because virtually all expenses are the tenant’s responsability.

Further, STOR’s lease contracts have lease escalations which are tied to the consumer price index and subject to a cap. This means that revenues increase automatically even if no new properties are added to the portfolio.

A Well Diversified Portfolio

STOR has a diversified client base: The largest single customer represents just 2.8% of annualized base rent and interest and the top 10 customers comprise 17.6% of annualized base rent and interest

STOR’s 2019 Annual Report, page 32

STOR’s customers are diversified across more than 100 industries. The portfolio is service-industry heavy, with restaurants representing a whopping 15% of that sector, but the full list of industries is very long.

The restaurant-heavy client base is slightly worrying given the current economic context but that concentration is offset by an incredible industry diversity.

Here’s the breakdown by main sectors and main subsectors:

  • Service: 64.8%
    • Restaurants: 15%
    • Early childhood education: 6%
    • Health Clubs: 5.4%
    • Automotive repair and maintenance: 4.8%
    • Movie theaters: 3.9%
    • Family entertainment: 3.9%
    • Pet care: 3.4%
  • Retail: 18.8%
    • Furniture: 5.3%
    • Farm and ranch supply: 4.5%
  • Manufacturing: 16.4%
    • Metal fabrication: 4.4%
    • Food processing: 2.6%.

In addition, STOR’s portfolio boasts great geographical diversification as it has properties in every state except Hawaii.

STOR’s 2019 Annual Report, page 34

Lastly, it is important to note that over 80% of STOR’s customers’ leases will expire after 2029. This means STOR’s revenues should increase steadily throughout the decade: First, because the tenants are staying long term and second, because most leases have automatic rent increases.

STOR’s 2019 Annual Report, page 34

Very Good Q1 2020 Financial Results Driven by Significant Real Estate Investments

The coronavirus is testing the resolve of just about every company in the USA. Investors were pleasantly surprised to learn that STOR’s Q1 2020 performance was very strong:

  • Revenues of $177.9 million compared to $156.6 million for Q1 2019,
  • Net Income of $62.7 million compared to $45.5 million for Q1 2019,
  • AFFO of $120.1 million compared to $107.8 million for Q1 2019,
  • Declared a quarterly dividend of $0.35 per share compared to $0.33 for Q1 2019.

STOR’s strong performance is driven by significant real estate investments which resulted in more locations, more clients, and more revenue.

Indeed, STOR originated $264.1 million of gross investments representing 57 property locations during Q1 2020. These investments resulted in the creation of 14 new customer relationships and an initial cap rate of 7.5% (The cap rate is the initial annual cash rent provided by the purchase price of the property). For Q1 2020 acquisitions, the weighted average stated lease escalation cap was 2.5%.

2015-2019 Financial Breakdown:
Income Statement

STOR’s 2015-2019 financial performances were very strong and the positive Q1 2020 results indicate this will continue.

From 2015-2019, all key metrics increased:

  • 2015-2019 Revenues increased at average annual rate of 23.5%
  • 2015-2019 Net Income increased at average annual rate of 35.5%
  • 2015-2019 Dividend per share increased by $0.34
  • 2015-2019 Total real estate investments more than doubled
  • 2015-2019 FFO increased at average annual rate of 26.5%
  • 2015-2019 AFFO increased at average annual rate of 25.4%
  • From 2015-2019, number of investment property locations increased to 2,504 from 1,325. In just five years, STOR almost doubled their number of properties.
  • Occupancy rate >99% every single year.
STOR Q1 2020 Results

2015-2019 Financial Breakdown:
Balance Sheet

REITs are notorious for having very high leverage. Indeed, since they are legally obligated to pay out 90% of their taxable income in dividends, they usually only have 10% of their earnings available to invest. Thus, they take on significant debt to finance real estate acquisitions.

At first glance, STOR had great financial ratios:

  • Current Ratio is 6.30 which is exceptional: Short term assets more than cover short term liabilities.
  • Debt Ratio is 0.48 which is very good: No discernible debt problem.
  • Debt/Equity Ratio is 0.95 which is decent: Reasonable leverage.

However, the Net Debt of $3.5 billion is 5.25x revenues, which is quite high. Analyzing STOR’s debt structure reveals this is actually quite reasonable and, ultimately, sustainable.

source: yahoo finance

Indeed, STOR’s 2019 Annual Report says that only 40% of its real estate portfolio is subject to secured debt. This leaves 60% of the investment portfolio, estimated to be worth $5.3 billion, available to serve as collateral if for future debt long-term debt.

STOR also states that they are managing their debt maturities to avoid significant portions of their debt maturing the same year. One of its strategies consists in refinancing the maturing debt as it comes due or choosing to repay it using cash and cash equivalents or its unsecured revolving credit facility. For info, STOR’s maximum borrowing capacity under the revolving credit is $1.4 billion, which is significant. This provides the company good flexibility to finance its operations and service its debt.

The weighted average debt maturity is 6.9 years with a weighted average interest rate of 4.3%. Here is a table summarizind the outstanding balance of the borrowing and the portion of the portflio that is pledged as collateral or is unencumbered.

STOR’s 2019 Annual Report, page 43

In sum, STOR’s debt is reasonable and they have significant flexibility to borrow if need to.

2015-2019 Financial Breakdown:
Cash Flow Statement

STOR’s Cash Flow statement reveals a lot of positives:

  • From 2016-2019, Operating Cash Flow increased by 86%.
  • From 2016-2016, Free Cash Flow increased by 86%
  • In 2019, STOR paid off $1.185 billion of its Debt
  • From 2016-2019, Dividends Payments increased by 88%.

In sum, all the key metrics are increasing at a rapid rate.

The Dividend is Very Attractive

The last reason to be excited about STOR is the attractive dividend:

  • Annual payout of $1.40 per share
  • Dividend yield of 7.42%
  • Payout ratio of 71.26%, which has plenty of room to rise
  • 5 consecutive years of dividend growth
source: seekingalpha

The dividend is growing at an annual growth rate of more than 6% per year. This is very positive and indicates that STOR will eventually reach the legally required payout ratio of 90%+.

source: seekingalpha

I also like the historically high yield. One should not chase yields but, given STOR’s financial performances, the current yield is unjustifiably high.

source: seekingalpha

Conclusion

In sum, here are my reasons for concluding that STOR is a solid REIT:

  • A rapidly growing real estate portfolio
  • Great industry diversification of its tenants
  • 99% of its lease contracts are NNN
  • Occupancy rate is >99%
  • The majority of leases won’t expire until 2029
  • Very strong financial performances since 2015
  • The debt is sizeable but manageable
  • Investment-grade credit rating ensure access to capital
  • Cash flows are increasing year after year
  • Great dividend payment per share
  • Historically high dividend yield
  • Dividend payout ratio has room to grow
  • Potential capital gains are significant.

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