This Exceptional Dividend Stock’s Buy Case Keeps Getting Better

Realty Income (O) is among the best dividend stocks. The real estate investment trust (REIT) has paid 632 consecutive monthly dividends. It has increased its dividend payment 119 times since its public market listing in 1994 — including for the last 101 straight quarters — raising it at a 4.4% compound annual rate.

The company is making more and more larger-scale deals, which improve investment returns and allow more income to flow through to its bottom line. These factors should enhance its ability to increase the dividend in the future.

A large-scale deal
Realty Income recently revealed its latest transaction. The company has agreed to acquire up to 415 single-tenant convenience store properties in the U.S. in a $1.5 billion sale-leaseback transaction with U.K.-based convenience store operator EG Group. Over 80% of the properties operate under the Cumberland Farms brand, with roughly the same percentage located in the Northeast. The properties have a weighted average initial lease term of 20 years.

Following the deal, 11.3% of Realty Income’s portfolio will be properties leased to the convenience store industry, while 2.9% of its rent will come from locations leased to EG Group.

Realty Income is acquiring the portfolio at an initial capitalization rate of 6.9%. That’s an attractive value. During the fourth quarter, the company acquired properties at around a 6.1% cap rate (a higher cap rate indicates a lower real estate valuation). Cap rates have been increasing along with interest rates, enabling Realty Income to continue making accretive deals. That has led to growth in adjusted funds from operations (FFO) per share, giving the business the incremental cash flow to keep raising the dividend.

Scale has its advantages
Realty Income has become one of the largest net lease REITs through a series of mergers and a steady diet of sale-leaseback transactions. Its $13.9 billion merger with VEREIT in 2021 has significantly enhanced its scale, making it possible for the company to complete larger deals.

The $1.5 billion sale-leaseback with EG Group is the latest example of Realty Income using its scale to complete bigger deals that enhance growth. Last year, it acquired the Encore Boston Harbor Resort and Casino in a $1.7 billion sale-leaseback transaction with Wynn Resorts. It also acquired a portfolio of up to 185 single-tenant retail and industrial properties from CIM Real Estate Finance Trust for $894 million in cash.

One of the advantages of completing larger-scale deals is that they often have higher cap rates than smaller one-off acquisitions because there’s less competition for these transactions. For example, Realty Income acquired Encore at a 5.9% initial cap rate (higher than the 5.6% average cap rate it paid for acquisitions signed in last year’s first quarter). Meanwhile, it’s acquiring the CIM portfolio for a 7.1% cap rate, well above the 6.1% average cap rate of deals signed during the fourth quarter. These larger deals are often more accretive than smaller property purchases because of the higher spread between the costs of the capital used for the acquisition and the net operating income the property generates.

As it expands, the company can complete large-scale deals without tilting the scale on diversification. As noted, despite the size of the EG Group deal, convenience stores and that tenant will remain a relatively small percentage of the company’s overall portfolio.

At the same time, deals can have a greater impact on the bottom line because Realty Income can spread its operating costs over a larger portfolio. The company’s general and administrative costs as a percentage of revenue have fallen to 4.4%, nearly half the rate of its net lease peers (8.1%). In turn, its margin has expanded to 94.3%, much wider than its net lease peers (90.1%). As it continues to scale, more income will flow to the bottom line, boosting its ability to raise the dividend.

This top-notch dividend stock keeps getting better
Realty Income has an exceptional track record of dividend growth. That should continue as the REIT’s growing scale allows it to complete bigger deals that are often more accretive because of the higher cap rates and its operating leverage. These factors make Realty Income an even more attractive dividend stock to buy and hold for the long term.

— Matthew DiLallo

Source: The Motley Fool