Published by Nick McCullum on July 3rd, 2017
Warren Buffett made headlines last week when he purchased 9.8% of STORE Capital (STOR) for $377 million on behalf of his conglomerate Berkshire Hathaway (BRK.A) (BRK.B).
Buffett is the most iconic – and most successful – investor of our time. Through decades of profitable business and investment, he has grown Berkshire to a market capitalization of $400+ billion.
Thus, when he buys a stock, I tend to pay attention.
Warren Buffett’s investment portfolio is full of high-quality dividend stocks, which is surprising for many that know Buffett primarily as a value investor.
STORE Capital is the newest addition to Buffett’s portfolio. A closer look reveals that there are many reasons why Buffett might like this stock. Although it is a young real estate investment trust (REIT) that IPO’d in 2014, the trust has expertise in middle-market real estate solutions.
The REIT also has a very high dividend yield. STORE Capital yields 5.1% at today’s prices, making it a member of the short list of stocks with 5%+ dividend yields.
STORE Capital’s exceptionally high dividend yield and stamp of approval from Warren Buffett are two reasons why investors might take an initial interest in this stock.
This article will analyze the investment prospects of STORE Capital in detail.
STORE Capital is a triple-net lease REIT with a market capitalization of $3.9 billion. Triple-net lease REITs pass onto their tenants the three major costs of owning/operating real estate:
- Insurance expenses
- Maintenance expenses
- Property tax expenses
STORE Capital’s name is an acronym which stands for Single Tenant Operational Real Estate. STORE Capital’s IPO was in November of 2014, making it a relatively young company by most standards.
The trust differentiates itself from other triple-net lease REITs by focusing on the middle market of the real estate industry, a group of tenants that would typically rely on expensive bank financing to purchase properties (rather than securitized debt instruments).
Because bank financing is so expensive for these middle market companies, they are highly incentivized to lease properties via REITs like STORE Capital.
Source: STORE Capital First Quarter Earnings Presentation, slide 5
STORE Capital – like many REITs with retail exposure – has experienced downwards pressure on its stock price in recent months because of fears that the traditional retail shopping model is broken.
However, STORE Capital actually has a rather limited exposure to retail properties (although its stock price would suggest otherwise). This may have been one of the reasons why Buffett took an interest in this stock, as he likely interpreted it as a buying opportunity.
“The best thing that happens to us is when a great company gets into temporary trouble…We want to buy them when they’re on the operating table.”
Even if retail shopping dies completely, STORE Capital will be far from ‘on the operating table’.
The trust has only a ~18% exposure to retail properties. In fact, the majority (67%) of STORE’s properties are in the service industry, which is resistant to disruptive pressure from companies like Amazon (AMZN).
Source: STORE Capital First Quarter Earnings Presentation, slide 17
STORE Capital also benefits from a considerable amount of geographic diversification.
While the trust arguably lacks a presence on the West Cost, its highest geographic concentration occurs in Texas.
A map including STORE Capital’s property locations can be seen below.
Source: STORE Capital First Quarter Earnings Presentation, slide 19
STORE Capital’s growth will be executed in a slightly different manner than most other REITs.
Traditionally, REITs pay out the vast majority of their cash flows as dividend payments, and have to issue additional units to raise the capital required to buy more properties.
STORE Capital has a much more organic growth strategy. Namely, the company aims to avoid the issuance of additional units, as they dilute existing shareholders. This should be seen as a positive by prospective STORE Capital shareholders.
STORE Capital’s growth will also be driven by its impressive investment pipeline.
The trust has a current pipeline of approximately $9 billion, and its pipeline has been growing at a pace faster than the trust can review deals. For context, STORE Capital has a current market capitalization of ~$4 billion, which means its current pipeline is more than twice the size of the trust’s equity valuation.
Source: STORE Capital First Quarter Earnings Presentation, slide 21
STORE Capital’s impressive investment pipeline allows it to be highly selective when reviewing real estate deals, a benefit for the trust and its unitholders.
Competitive Advantage & Recession Performance
STORE Capital’s most important competitive advantage is its leadership in the middle market segment of the real estate industry.
The trust also has an exceptionally skilled and unified leadership team. Altogether, STORE Capital’s management team has been working together for between 10 and 35 years, and has invested over $15 billion across 9,100+ properties.
Source: STORE Capital First Quarter Earnings Presentation, slide 12
STORE Capital’s skilled leadership team means that the trust is well-positioned to capitalize on its impressive investment pipeline.
STORE Capital was not a publicly-traded real estate investment trust at the time of the last recession, so it can be difficult to estimate how well the company will perform during the next economic downturn.
With that said, the company has ample liquidity and holds a BBB- investment-grade credit rating from S&P.
The trust also has a well-laddered debt maturity profile, with no significant debt maturities in the next two years.
Source: STORE Capital First Quarter Earnings Presentation, slide 9
These factors mean that STORE Capital is well-positioned to endure through any incoming recessions.
Valuation, Dividends, & Expected Total Returns
Looking ahead, STORE Capital’s total shareholder returns will be composed of valuation changes, dividend payments, and growth in the company’s adjusted funds from operations per unit (AFFO/unit; the equivalent of adjusted earnings-per-share for a REIT).
STORE Capital currently pays a quarterly dividend of $0.29 per share which yields 5.1% on the company’s current stock price of $22.75.
The following diagram compares STORE Capital’s current dividend yield to its long-term average dividend yield.
Although Buffett’s purchase of this stock has driven its stock price upwards (and its yield downwards) in a typical ‘Buffett bump’, STORE Capital’s dividend yield is still noticeably elevated from its long-term average.
Thus, this REIT still has appeal for those looking for exposure to a high-quality middle-market REIT. Furthermore, the company’s ~5% dividend yield has tremendous appeal for investors looking to generate current portfolio income.
STORE Capital’s dividend is also very safe. The company’s current $0.29 quarterly dividend (or $1.16 annually) represents a payout ratio of just 70.7% using 2016’s AFFO/unit of $1.64, which is quite low for a REIT.
The remainder of the company’s growth will come from profit growth, namely growth in its adjusted funds from operations per units (AFFO/unit).
STORE Capital targets long-term growth in AFFO/unit of 3%-5%. The trust’s long-term AFFO growth can be seen below.
I believe the company is capable of achieving 3%-5% long-term growth in AFFO/unit for two reasons.
First, as shown above, the trust has compounded this metric at ~10% per year over the past four years. Even if this growth rate is cut in half, the trust will still grow profits at the top end of its target range.
Secondly, STORE Capital has a well-defined plan that will allow it to achieve ~5% AFFO/unit growth.
Unlike most REITs, STORE Capital aims to grow its business without issuing additional units, which eliminates the possibility for existing investors to experience value-destroying dilution.
To hit 5% annual growth, the company aims for 2.75% organic AFFO/unit growth and ~2.6% reinvested cash flows, which should allow them to achieve 5%+ AFFO/unit growth if the reinvested cash flows do not experience any diminishing marginal returns.
Source: STORE Capital First Quarter Earnings Presentation, slide 11
Altogether, STORE Capital’s long-term shareholder returns will be composed of:
- 5.1% dividend yield
- 3%-5% growth in AFFO/unit
For reasonable long-term total return expectations of 8.1%-10.1% over full market cycles.
STORE Capital made the news over the past week after Warren Buffett’s Berkshire Hathaway accumulated ~10% of its outstanding units.
Some due diligence has revealed that there’s a lot to like about this company.
It is shareholder-friendly, avoids unitholder dilution (which is rare for a REIT), and has a noticeably high dividend yield. The trust is also trading at a discount to its normal levels, based on dividend yield.
Thus, this REIT merits investment for investors looking for a high-quality, high-yield security marked with the stamp of approval from perhaps the most insightful investor in history.