Thursday, May 7, 2015

W.P. Carey (WPC): Recent REIT Investment

Buying high-quality dividend growth stocks is just really one of my favorite pastimes. Much like someone might love to engage in a shopping spree at the local mall, the stock market is my “mall” and stocks that pay and grow dividends are my “merchandise”.
I foreshadowed this stock purchase, like I usually do, when I published my watch listearlier this month. I leave nothing for surprise, so I guess this blog isn’t quite as suspenseful as it could be. But it’s all in the name of providing an honest look into the journey to financial independence in real-time.
I purchased 20 shares of W.P. Carey Inc. (WPC) on 4/9/15 for $67.15 per share.

Overview

W.P. Carey Inc. is a global real estate investment trust that provides services including long-term sale-leaseback and build-to-suit financing solutions.
As of December 31, 2014, the company has 219 tenants across 783 properties in 18 countries. The occupancy rate is 98.6% and the average lease term is 9.1 years.
They operate in two segments: Real Estate Ownership (71% of fiscal year 2014 revenue) and Investment Management (29%).
They were founded in 1973 but reorganized as a REIT in 2012.

Fundamentals

WPC might not be a well-known stock, but this belies their impressive nature.
First up is growth. We’ll see what they’ve been able to do over the last decade across the top and bottom lines.
WPC has increased revenue from $174.117 million in fiscal year 2005 to $906.193 million in FY 2014. That’s a compound annual growth rate of 20.12%.
However, it’s important to keep in mind that REITs, due to their unique tax structure, routinely issue shares to help fund operations and growth – WPC has more than doubled their share count over this time frame, from approximately 39 million to 100 million (most of this exclusive to the period after 2012).
As such, looking at results on a per-share basis is much more worthwhile and relevant. Revenue on a per-share basis has grown at a compound annual rate of approximately 8.20%.
In addition, because REITs like WPC consistently have rather significant depreciation and amortization charges that aren’t truly reflective of the company’s profitability, we’ll look at the growth of funds from operations (FFO adds depreciation and amortization back into earnings) on a per-share basis.
FFO per share has grown from $2.53 to $4.56 over this period, which is a CAGR of 6.76%.
Really solid results here. Any REIT that can grow its per-share revenue and profit in the upper single digits over a long period of time should do quite well for its shareholders.
Now, a stock’s dividend metrics is one of the very first areas I look at before buying a stock. And in this regard, WPC absolutely does not disappoint.
Check it out:
They’ve increased their dividend for the past 18 consecutive years, which is an excellent streak that’s actively improving.
But it gets better. The dividend growth rate over the last decade is a stout 7.5%, which has actually been increasing with even higher dividend growth over the last five years.
And that’s particularly attractive when considering the stock’s yield is a pretty monstrous 5.67%.
Assuming a static valuation, the sum of a stock’s yield and dividend growth rate is an approximation of long-term total returns. So a yield near 6% with a long-term growth rate over 7% is obviously incredibly appealing.
The payout ratio is moderately high at 83.6% of TTM FFO, but that’s not uncommon across REITs. And management’s guidance for FY 2015 adjusted funds from operations of $4.76 to $5.02 gives even more support to the dividend and the growth of it.
The balance sheet has expanded in recent years due to the company’s ability to continue accumulating revenue-generating assets. Nothing to dislike here, however, with total liabilities of $4.7 billion against $3.8 billion in total shareholders’ equity. Their credit rating as of the end of FY 2014 is BBB/Baa2.
As aforementioned, WPC is accumulating assets at a rather rapid rate in order to fuel growth. During FY 2014 alone, they closed on just over $900 million in total acquisitions for the real estate portfolio. And 2015 is off to a great start already, as they’ve closed on $390 million in acquisitions YTD (as of February 24, 2015).

Qualitative Aspects

What I really like about WPC is that they bring something new to my portfolio. I own three other REITs currently: Digital Realty Trust, Inc. (DLR)Omega Healthcare Investors Inc. (OHI), and Realty Income Corp. (O). Each one of these REITs provides something unique in terms of their properties, exposure, expertise, and area of focus.
WPC brings international exposure, diversified operations between advisory services and managed real estate, and a unique property portfolio to the table.
Their top 10 tenants include the diverse likes of Hellweg, State of Andalusia, and Marriott International Inc. (MAR). So you’re looking at exposure to industries across international retail, government, and hospitality right there. But the diversity across their properties is actually pretty incredible, especially considering the size of their portfolio.
Although their exposure to retail is quite high at near 20% of the portfolio, government (6.3%), automobile (5.3%), and healthcare, education, and childcare (6.1%), for instance, also account for significant exposure. All in all, WPC lists 25 different industries in which their properties are purposed and used for.
They’re also diversified geographically, with most of their revenue (~65%) generated from properties located in the US, but Northern and Western Europe contributing significantly as well. Major markets in Europe include Germany, France, and Spain.
Commercial real estate is one of those areas that is obviously incredibly difficult for a retail investor like myself to invest in individually, but is also quite attractive. And that’s where a REIT like WPC comes in.
Physical real estate is absolutely necessary for most businesses across the world, and WPC fills that need. They sign tenants to long-term contracts with most of these contracts (94%) providing for rent increases that are either fixed or tied to CPI. So, essentially, WPC acts as a landlord. They scout properties, acquire assets, lease the properties to tenants, handle the management, and collect a check.
And then I, as a shareholder, then later collect a portion of that check via the dividend. In addition, I participate in any increase in the value of the underlying properties through the value of equity in the REIT. So this gives me almost instantaneous exposure to international commercial real estate on a large scale with liquidity, which would otherwise be impossible.
As long as global population and wealth rises over time, the need to conduct business across the 25 different industries that WPC is exposed to will also likely continue to persist and grow. As such, there should be future deals that WPC can make which can grow the trust, FFO, and the dividend.
What’s really unique about WPC is that they’re diversified in so many ways. So when one industry, economy, or market is perhaps temporarily troublesome, the REIT has many other avenues to continue growing and producing revenue to capitalize on. And they also earn a rather large portion of their revenue through management fees, which can potentially buoy any short-term slowdowns in the real estate portfolio.

Risks

WPC is truly international, so they face currency risks like any other company doing business globally. In addition, they face interest rate risk in the sense that as rates rise the cost of capital increases. Though this is also true for almost every business out there that relies on some debt to conduct business and grow, this is exacerbated for REITs because of their structure.
Another risk is that 25% of WPC’s leases expire within the next five years. Any issues with renewals could be problematic.
Furthermore, only 26% of their tenants are investment-grade.
Lastly, although they have substantial experience in their field dating back decades, their operating history as a REIT is rather short.

Valuation

WPC’s P/FFO is 14.73, which I view as attractive. The P/FFO is similar to the P/E ratio for most other stocks, so you can see why a ratio below 15 is notable. In addition, the P/B is below its five-year average as is the yield.
I valued shares using a dividend discount model analysis with a 8% discount rate and a very conservative 4% long-term dividend growth rate. That’s almost half the DGR over the last decade, which gives a rather large margin of safety to account for rising rates and some of the other unique risks I touched on above. The DDM analysis gives me a fair value of $99.06.
The stock could be significantly undervalued here as it exhibits a rare and elusive combination of yield anddividend growth that are both quite high. It’s just not particularly often that you can buy a stock with a yield near 6% and growth in the upper single digits.

Conclusion

This is a really interesting REIT. I love the diversification across the business as it relates to revenue sources, geographies, and industries. This should provide them an ability to manage through temporary crises, as we can see over the last 10 years.
The fundamentals across the board are excellent. And the stock’s combination of yield and growth is just extremely rare. Even if the dividend growth rate is cut in half permanently, the stock is still a great deal right now.
This purchase adds $76.20 to my annual dividend income, based on the current $0.9525 quarterly dividend.
I usually include current valuation opinions from other analysts, but neither Morningstar nor S&P Capital IQ follow this stock.
I’ll update my Freedom Fund in early May to reflect this recent purchase.
Full Disclosure: Long WPC, DLR, OHI, and O.
What do you think of WPC here? Like the fundamentals? Is the valuation attractive? 
Thanks for reading.

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