Published February 3rd, 2017 by Nicholas McCullum
With the arrival of 2017 in our calendars, it is now time for the new members of the Dividend Aristocrats to be inducted into the index.
The requirements to be a Dividend Aristocrat are:
- Be in the S&P 500
- Have 25+ consecutive years of dividend increases
- Meet certain minimum size & liquidity requirements
Being a Dividend Aristocrats is an important recognition.
The ability (and willingness) to raise dividends for 25 or more consecutive years demonstrates a wide economic moat, sustainable competitive advantage, and the kind of shareholder-friendly management that enjoys returning capital to shareholders.
Federal Realty Investment Trust (FRT) is one of two new Dividend Aristocrats, with February being its first month of inclusion.
FRT was kept from being a Dividend Aristocrat because they were not a member of the S&P 500 Index. Their dividend growth record is well in excess of the 25+ year requirement. In fact, they have the longest record in the entire REIT industry.
Source: FRT Third Quarter Investor Presentation, slide 62
FRT has actually raised dividends for 49 consecutive years, which makes them only 1 year away from being a Dividend King (50+ years of consecutive dividend increases).
FRT is now the only REIT to be a Dividend Aristocrat after HCP Inc. (HCP), a healthcare REIT, reduced their dividend due to a spinoff.
It is uncommon for REITs to have long streaks of dividend increases because they are legally obliged to pay 90%+ of their earnings as dividends. This leaves little retained earnings to fund future growth, which makes FRT’s dividend growth streak even more impressive.
Historically, FRT has delivered above-market returns to shareholders. The company’s total returns over the past decade are compared against the S&P 500 in the following diagram.
Source: Yahoo! Finance
This post will analyze the investment prospects of FRT in detail.
Federal Realty Investment Trust is a REIT focusing on commercial retail properties.
The REIT aims to differentiate themselves by targeting markets that are densely populated with affluent individuals.
This seems logical – large group of wealthy consumers should drive sales for FRT’s tenants, which reduces the risk of defaults and vacancies for the REIT.
The following diagram shows how FRT leads their peer group when it comes to median household income in the areas surrounding their properties (a measure of affluence), and households per square mile (a measure of density).
Source: FRT Third Quarter Investor Presentation, slide 9
This focus on high-demand locations is reflected in the rent that FRT charges their tenants. The REIT again leads their peer group when it comes to rent per square foot, coming in ~$10 above the peer group average.
Source: FRT Third Quarter Investor Presentation, slide 11
FRT benefits from a very high quality tenant base. This is no surprise, since many of these large companies seek exposure to the high-end markets that FRT is targetting.
A select group of FRT’s tenant base can be viewed in the following diagram.
Source: FRT Third Quarter Investor Presentation, slide 6
As with any other REIT, FRT is exposed to a number of non-cash charges (such as amortization and depreciation) that effect how it reports its financial results.
As such, this analysis will use alternative financial metrics compared to those used when analyzing other companies. Notable examples include funds from operations (FFO) rather than earnings-per-share (EPS) and the use of dividend yield to assess the company’s current valuation.
Growth Prospects & Competitive Advantage
Management divides growth prospects into five main categories for this REIT. These are outlined in the following diagram.
Source: FRT Third Quarter Investor Presentation, slide 2
FRT’s main competitive advantage comes from their high-quality real estate portfolio and their existing exposure to high-demand markets. The following slide outlines some of the major coastal cities that FRT has exposure to.
Source: FRT Third Quarter Investor Presentation, slide 7
Since many of these cities (San Francisco and New York perhaps most notably) are experiencing prolonged real estate booms, FRT benefits form exposures to these markets.
High property prices and intense competition creates barriers to entry for new market participants in these regions.
Since FRT is a Dividend Aristocrat and nearly a Dividend King, it is evident that the company has successfully raised their dividend through a wide variety of market environments. This includes the 2008-2009 financial crisis.
Fortunately, the company’s funds from operations (the equivalent of EPS for a REIT) also performed admirably during that recession. The company did not experience a single year of negative FFO growth during that period (though 2009 saw 0% growth).
- 2007: $3.63
- 2008: $3.87 (6.6% increase)
- 2009: $3.87 (flat)
- 2010: $3.88 (0.3% increase)
- 2011: $4.00
After two years of essentially flat FFO, the REIT returned to profitability growth in 2011.
Moving beyond FRT’s historical track record, there are numerous indicators that FRT is well-positioned in the event of another recession.
One of the most notable is the REIT’s capital structure. FRT has a noticeably lower amount of leverage than its peer group when measured by either debt to market capitalization or net debt to EBITDA.
Source: FRT Third Quarter Investor Presentation, slide 57
The composition of FRT’s liabilities is also attractive. The REIT benefits from a very long weighted average debt maturity with a middle-of-the-pack interest rate.
Source: FRT Third Quarter Investor Presentation, slide 58
Given that long-term bonds tend to have higher interest rates than short-term bonds, all else being equal, I am impressed with FRT’s ability to lengthen their average maturity without generating undue interest costs.
To conclude, the REIT’s high-quality portfolio, strong track record, and favorable debt metrics make me confident they will perform well when the next recession eventually arrives.
Valuation & Expected Total Returns
Because of the accounting treatment that REITs are subjected to, the simplest way to assess their valuation is by looking at their dividend yield.
High dividend yields represent attractive valuations, while low yields represent unattractive valuations, all else being equal.
According to YCharts, FRT’s dividend yield has traded in the range of 2.2% and 3.8% over the past five years with an average value of 2.9%.
FRT’s current dividend yield is 2.8%, which is only one tick below its five-year average. It is reasonable to assume the company is fairly valued right now. Valuation changes should not have a significant effect on FRT’s total returns moving forward.
The rest of FRT’s returns will be composed of growth in FFO and the company’s dividend yield. We can estimate future FFO by considering the REIT’s historical track record and integrating it with management’s forecast for future growth.
FRT’s management has stated that they aim to deliver FFO growth of 7%+ on average over a 10 year period.
Source: FRT Third Quarter Investor Presentation, slide 3
This expectation is actually higher than FRT’s historical growth.
Assuming the REIT matches analysts’ expectations for 2016 FFO of $5.65 per unit, FRT will have compounded FFO at a 5.6% CAGR since 2006.
Source: Value Line
My expectations are for 5%-7% annual FFO growth over the long term.
Thus, expected total returns for FRT unitholders will be composed of:
- 5%-7% FFO Growth
- 2.8% dividend yield
giving a base case for expected total returns of 7.8%-9.8%, which is unlikely to be changed much by valuation increases/decreases since the company is trading in-line with its historical dividend yield.
Despite having 49 years of consecutive dividend increases under their belt, FRT is one of this year’s new Dividend Aristocrats.
They are the only REIT to be a Dividend Aristocrat, replacing HCP after their dividend cut.
For investors looking for exposure to the commercial retail real estate industry through a REIT with a strong dividend record, consider Federal Realty Investment Trust. This REIT has the longest dividend increase streak in the industry.