Published February 25th, 2017 by Bob Ciura
Since the end of the Great Recession, real estate investment trusts have been one of the hottest asset classes in the entire market.
Take National Retail Properties (NNN) as a perfect example.
Since bottoming out at $13 in October 2008, the stock has steadily rallied to its February 23 closing price of $45.37 per share.
Not only have share prices risen across the REIT space, but they have also rewarded investors with high dividend yields.
NNN has a 4% dividend yield. And, itis a Dividend Achiever, a group of 272 stocks with 10+ years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
In the low interest rate environment, high-yield REITs with steady dividend growth—such as NNN—are in high demand.
While NNN stock no longer appears to be undervalued, investors can still count on reliable dividend growth for the foreseeable future.
NNN is a REIT that owns single-tenant, net-leased retail properties. Its properties are predominantly structured under long-term leases.
NNN’s properties include movie theaters, gas stations, fitness clubs, restaurants, and more. It is structured similarly to Realty Income (O), another high-quality REIT focusing on retail properties.
NNN owns more than 2,500 locations across 48 U.S. states.
Its portfolio has an excellent occupancy rate of 99.1%. Since 2003, NNN’s occupancy never fell below 96.4%.
Source: Investor Presentation, page 13
NNN leases to more than 400 tenants in 38 different retail categories. Its largest tenants include:
- Sunoco: 5.5% of Base Rent
- Mister Car Wash: 4.2% of Base Rent
- LA Fitness: 3.9% of Base Rent
- Camping World: 3.4% of Base Rent
- Couche-Tard (Pantry): 3.4% of Base Rent
- 7-Eleven: 3.3% of Base Rent
- SunTrust: 3.1% of Base Rent
- AMC Theatre: 2.9% of Base Rent
It has chosen to focus on retail properties because it believes retail offers competitive advantages over a multi-property approach.
First, NNN management states that retail customers have higher probability of renewing leases.
Established restaurants, for example, do not want to risk disrupting their customer experience by moving, just to save a little money on rent.
Furthermore, NNN believes office and industrial properties are more susceptible to tenant turnover. According to NNN, those types of tenants are driven more by price, and less by location.
These qualities served the company well in 2016. Revenue and adjusted funds from operation (FFO) rose 11% and 6.2%, respectively.
Instead of using GAAP earnings-per-share, REITs typically report earnings in terms of FFO. That is because earnings-per-share includes non-cash charges like depreciation.
Due to continued acquisitions and rent increases, FFO is expected to increase again in 2017.
Acquisitions are an important part of NNN’s growth strategy.
Source: Investor Presentation, page 16
In 2016, NNN invested $847 million in 313 properties, at an initial cash yield of 6.9%. This year, the company expects $500-$600 million of acquisitions.
The company can pursue an aggressive acquisition strategy, thanks to its conservatively managed balance sheet.
It is critical for a REIT to maintain an investment-grade credit rating, since the business model relies heavily on raising external capital for financing property acquisitions.
NNN holds a BBB+ credit rating from Standard & Poor’s.
Source: Investor Presentation, page 23
Its unsecured debt has a weighted average maturity of 6.2 years, and a weighted average interest rate of 4.5%.
NNN has a balanced maturity schedule, with less than $256 million of debt maturing through 2020.
Source: Investor Presentation, page 27
It also has sufficient liquidity metrics. As of the third quarter 2016, the company maintained a debt-to-EBITDA ratio of 4.5. This was down from 5.3 in 2011.
NNN’s balance sheet improvements over the past several years has resulted in an appropriate level of debt on the balance sheet.
Keeping a strong balance sheet will allow NNN to continue growing revenue and FFO going forward, even if interest rates rise.
The company’s acquisition cap rates have averaged 8.1% since 2010. This is well above its cost of capital, thanks in large part to its sound debt metrics.
As a result, interest rates would have to rise considerably, before NNN’s acquisitions are no longer accretive.
For 2017, NNN expects adjusted FFO is estimated to be $2.46-$2.52 per share. This forecast represents 2%-5% FFO growth from 2016.
This should be enough growth to justify another dividend increase in 2017.
Valuation & Expected Total Returns
Based on 2016 performance, NNN stock trades for a price-to-FFO ratio of 18.8. Its valuation multiple has expanded over the past several years.
For example, at year-end 2011, NNN stock held a price-to-FFO ratio of 15.8.
Valuation impacts total return potential in two ways. First, investing at a high valuation point makes it less likely the stock will see further expansion of the valuation multiple.
Second, a rising share price causes a dividend yield to fall. The prolonged rally in NNN stock has lowered its dividend yield to 4%.
During the depth of the Great Recession, NNN’s dividend yield briefly spiked above 10%. It has steadily declined since then.
Investors who bought during 2008 have been richly rewarded. Those buying at present levels are likely to earn satisfactory, but not Earth-shattering, total returns.
A breakdown of potential returns is as follows:
- 3%-5% FFO growth
- 4% dividend yield
This would theoretically result in 7%-9% total returns, not including expansion or contraction of the valuation multiple.
It is reasonable to question NNN’s current valuation. But income investors more concerned with reliable dividend growth should continue to be pleased with NNN.
The company has an excellent record of consistently growing its dividend each year.
Source: Investor Presentation, page 32
According to the company, NNN has increased its dividend for 27 consecutive years. This gives it the fourth-longest dividend growth streak among all REITs.
Continued dividend growth is likely, as the company maintained a 76% payout ratio in 2016, based on adjusted FFO.
NNN stock may not experience further expansion of its valuation multiple, but it is not unusual for high-quality companies to enjoy premium valuations.
That is because the company continues to grow at a steady pace. It also has a strong business model and balance sheet, with enough cash flow to continue raising its dividend each year.
Investors should not buy NNN with the expectation of rapid share price appreciation. That being said, it remains a solid pick for its 4% yield and consistent dividend growth.