The new COVID variant Omicron and the fear of new lockdowns caused the market to drop a little over 4% in a few trading days. This significant drop has also brought down the stock prices of high-quality Real Estate Investment Trusts (REIT) because of the fear of lockdowns. In 2020, REITs suffered due to local government restrictions and declining rental collections. Today’s article will discuss a REIT that has been downtrading the past two weeks and brought down further because of the Omicron fears. This high-quality REIT is STORE Capital stock.
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Overview of STORE Capital Stock
The REIT that we will cover today is STORE Capital Corporation (STOR). STOR is an internally managed net-lease REIT leader in the acquisition, investment, and management of Single Tenant Operational Real Estate, or STORE Properties, its target market and the inspiration for its name. The REIT is one of the largest and fastest-growing triple net lease REITs and owns an extensive, well-diversified portfolio that consists of investments in 2,788 property locations in 49 states, or $10.3 billion in gross investment dollars, as of September 30, 2021. The REIT had total revenue of $694.3M in 2020.
A company that operates as a net lease REIT puts the tenants who are leasing the property responsible for most of the expenses of the properties they occupy. For example, the tenant will be responsible for paying the taxes, insurance fees, and maintenance costs of the property in addition to rent. This fact keeps operation costs very low for a REIT like STORE Capital. The company estimates that the market share of STORE properties to approximately $3.9 trillion in market size. Warren Buffett’s Company, Berkshire Hathaway, invested $377 million in STORE Capital stock, representing 9.8% of total shares outstanding.
STORE Capital Dividend History, Growth, and Yield
STORE Capital is up over ~3.8% year to date, as of this writing. The stock price is lagging against the overall market and is still lower than pre-COVID-19 levels, as seen in the chart from Stock Rover*. However, I think the stock is attractive at the current price, and we will examine this later in the article.
We will now look at STORE Capital stock’s dividend history, growth, and yield and determine if it’s still a good buy at current prices.
STORE Capital has been growing its dividend for six consecutive years, making the REIT a Dividend Challenger. However, it has a small dividend growth history because it was listed on the New York Stock Exchange in 2014.
STORE Capital has had an average dividend growth rate of approximately 6.43% in the last five years, as seen in the chart from Portfolio Insight*. I love it when a company increases its dividend at a rate greater than the inflation rate, as this will provide an investor with buying power for years to come. STORE’s most recent quarterly dividend increase was 6.9%, much higher than its five-year average, which is very inspiring. Furthermore, during the COVID-19 pandemic, the company increased its quarterly dividend rate by 2.9% in 2020.
It is very significant to note is that STORE Capital paid and increased its dividend during the most challenging time in recent times for dividends. Many businesses and industrials were cutting, suspending, or omitting their dividend payments the previous year during the COVID-19 pandemic. Yet, the REIT continued to pay its dividend and increased it, maintaining its streak. This fact tells me all I need to know about the dividend policy and dividend safety focus.
The REIT has an excellent dividend yield equal to 4.69% as of this writing. This value is an excellent starting dividend yield for income-driven investors, especially those leaving the bond market looking for higher yields. Income investors may want a 4.0% yield or higher. So, STORE Capital stock meets that criterion easily.
STORE Capital stock’s current dividend yield is higher than its own 5-year average dividend yield of 4.57%. I like to look at this valuation metric because it gives a good idea if a company is undervalued or overvalued based on the current and 5-year average yield. This point is because the stock price and dividend yield are inversely related. If the stock price goes higher, the dividend yield goes lower and vice versa.
Is the dividend safe? An investor should always ask this question if they are looking for an undervalued dividend growth stock to buy. Sometimes undervalued dividend growth stocks can be a “value trap,” and the stock price can continue to head lower, and the dividend cut.
Since STORE Capital stock is a REIT, we do not look at earnings to evaluate it or determine if the dividend is safe. Instead, it is essential to look at the dividend payout based on Funds from Operations (FFO) and Free Cash Flow (FCF).
Analysts predict that STORE Capital will earn an FFO of $2.00 per share for the Fiscal Year (FY) 2021.
Analysts are pretty accurate when predicting STORE Capital’s future FFO. The REIT is expected to pay a dividend of $1.49 per share in 2021, giving a payout ratio of 74.5% based on consensus FFO. Having an 80% or lower dividend coverage with a dividend yield of over 4.5% gets me very excited. Most REITs tend to have a dividend payout ratio above 80% on an FFO basis. On a Free Cash Flow basis, STORE Capital stock has a dividend payout ratio of 74.5%. Thus, the dividend is well covered by operational and free cash flow and not at risk for a cut.
STORE Capital Revenue and Earnings Growth / Balance Sheet Strength
This section will look at how STORE Capital has grown FFO and revenue throughout the years. These two metrics are at the top of my list to think about when evaluating a REIT. A REIT can’t have sustainable FFO or FCF growth without revenue growth and cannot continue paying a rising dividend.
For the past seven years, STORE Capital’s revenues have been growing very nicely at a Compound Annual Growth Rate (CAGR) of about 20.9%. The growth is driven by increased rents and adding new properties to the portfolio. Net income also has been growing very well during these seven years at a rate of around 34.8% per year.
However, FFO has seen a much better growth rate than revenue and net income. The FFO has grown roughly 6.4% annually for the past seven years, and over the past five years, FFO had a CAGR of ~2.9%. Hence, FFO has gradually slowed down over the past few years. However, analyst predicts that the company will grow FFO at a 7% – 8% rate over the next five years.
Last year’s FFO was up from $1.83 per share in 2019 to $2.00 per share for 2020, a nice increase of ~9%. Considering that 2020 was a challenging year because of the COVID-19 pandemic, the increase in FFO was pretty good. In addition, analysts expect STORE Capital to have an FFO of $2.15 per share for the fiscal year 2021, which would be an ~8% rise compared to 2020.
Also, The REIT has a solid balance sheet. Currently, STORE Capital has an S&P credit rating of BBB, an investment-grade rating. Also, the company has a debt-to-equity ratio of 0.80, which is very good considering that the REIT is capital-intensive. In addition, the interest coverage ratio of 2.6X is fair and better than most REITs. Thus, the REIT has a solid balance sheet to overcome significant economic downturns like the COVID-19 pandemic last year.
STORE Capital Stock’s Valuation
One of the valuation metrics that I like to look for is the dividend yield compared to the past few years’ histories. I also want to look for a lower P/FFO based on the past 5-year or 10-year average. In addition, I like to use the Dividend Discount Model (DDM). I use a DDM analysis because a business is ultimately equal to the sum of all the future cash flows that that business can provide.
Let’s first look at the P/FFO ratio. STORE Capital has a P/FFO ratio of 16.8 based on Fiscal Year (FY) 2021 FFO of $2.00 per share. The P/FFO multiple is very low compared to the past 5-year P/FFO average of 16.9. If STORE Capital stock were to vert back to a P/FFO of 16.9, we would obtain a price of $33.80 per share.
Now let’s look at the dividend yield. Like I mentioned, the dividend yield currently is 4.62%. There is a good potential for upside looking at STORE Capital stock’s 5-year dividend yield average of 4.57%. For example, if STORE Capital were to return to its dividend yield average in the past 5-years, the price target would be $33.70.
The last item I like to look at to determine a fair price is the DDM analysis. I factored in a 10% discount rate and a long-term dividend growth rate of 6%. I use a 10% discount rate because of the high current dividend yield. The projected dividend growth rate is slightly lower than its past 5-year average. This estimate gives us a fair price target of $39.48 per share.
If we average the three fair price targets of $33.80, $33.70, and $39.48, we obtain a reasonable, fair price estimate of $35.66 per share. This fair value estimate gives STORE Capital a possible upside of around 8.1% from the current price of ~$32.98 per share.
Conclusion on STORE Capital Stock: High-Quality REIT
STORE Capital stock is a high-quality REIT. This point is a good reason why Warren Buffet owns about 9% of the REIT’s outstanding shares. The company is a fast-growing REIT with revenue growth and FFO growth. They are also growing their free cash flow and dividends. Its tenant base is also well-diversified across industries. Less than 5% of the leases expire in the next five years. Overall, the company is a sound and stable REIT that did well during the COVID-19 pandemic. The durable nature of the dividend, growing earnings, and good shareholder returns make this company a buy at the current price level of ~$32.98 per share.
If you are interested in reading about another dividend growth stock, please read Is Verizon a Good Dividend Stock.
Disclosure: Felix is long STOR
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My name is Felix Martinez, and I am a Dividend Growth Investor who has invested in dividend growth stocks for the past seven years. I also run a YouTube channel called FiscalVoyage. I have written for SeekingAlpha.com as well as SureDividend.com. I focus on undervalued dividend growth stocks with capital return and dividend income potential. Make sure to follow me on my YouTube Channel. See you there.