Published on April 5th, 2018 by Josh Arnold
Federal Realty Investment Trust (FRT) has the longest streak of consecutive dividend increases in the entire REIT sector, a group of companies that is known for its dividends. FRT has paid increasing dividends for 50 consecutive years, making it a member of the exclusive Dividend Kings club. You can see the full list of all 25 Dividend Kings here.
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FRT is one of the finest dividend payers in its sector and a recent selloff has made the stock look attractive for dividend growth. Dividend Kings are the best of the best when it comes to returning cash to shareholders and this article will examine FRT’s valuation and dividend outlook.
Business Overview
FRT was founded back in 1962 and has paid consecutive dividends to its shareholders since its founding, which an impressive streak in its own right. It has also managed to increase those dividends for 50 consecutive years, an amazing accomplishment for any business, but particularly one that is in a highly cyclical sector like real estate. FRT is truly in a league of its own, sporting a market cap of $8.6B and a current yield of 3.4%.
The company’s stated strategy is to be the leader in the ownership, operation and redevelopment of high-quality retail-based properties located primarily in major coastal markets like Boston, Los Angeles, San Francisco and Washington, D.C. FRT’s heaviest concentration of properties is in California, followed by the company’s home state of Maryland.
Source: Investor roadshow presentation
It focuses on densely populated, affluent communities where retail demand exceeds supply, offering FRT favorable pricing and strong long term demand. FRT has achieved its high levels of success by investing in properties that combine shopping, dining, living and working to provide a destination experience to patrons.
The company’s portfolio is well-diversified in terms of locations, property types and tenants. FRT boasts more than 100 properties and 24M square feet, making a true giant in its field. It uses a variety of leasing techniques to achieve long term success including its core business of retail, dining, residential, specialty leasing as well as mixed use development.
It has very specific criteria when going after new properties that outline areas it will operate in, population density and income levels as well as the size of potential acquisitions. This strategy has certainly served it well in the past 56 years and will continue to do so going forward.
Source: Investor roadshow presentation
Revenue mix is very strong as well as FRT has no more than 9% exposure to any one sector of retail. It also counts restaurants, office space and entertainment among its customer base but make no mistake; FRT is a retail-heavy business. That reliance upon retail in general is FRT’s principal risk going forward but as its 50-year long streak of dividend increases shows, its diversification has allowed it to weather any economic storm that has come up during its history.
Growth Prospects
FRT’s fourth quarter and full-year 2017 results were reported in mid-February and the company’s long track record of moderate growth continued. FFO per share was up to $5.74 for 2017 against $5.65 in 2016 despite fourth quarter FFO that was basically flat. The company’s same-center property operating income grew 3.4% for the year and 2.6% for the fourth quarter.
In addition, FRT signed leases for 300k square feet of comparable space during the quarter at a very high average rent of $34.75psf and achieved cash basis rollover growth on those comparable spaces of 15%. Finally, management guided for 2018 FFO of $6.08 to $6.24, which would represent roughly 6% to 9% FFO growth over 2017’s results.
How does FRT continue to grow in just about any environment and how will it do so in the future? Part of the reason why FRT continues to grow is through its disciplined acquisition strategy. The company is highly discerning when it comes to selecting new properties to take on or develop – as mentioned earlier – and the strategy has certainly worked well.
It is even meticulous about its financing as equity raises are used as a last resort and low-cost debt is the preferred method. This helps improve margins and keeps shareholders from experiencing constant dilution; a key to strong returns over the long term.
The company’s stated growth strategy is to maximize income and increase property value by redevelopment and remerchandising. That can mean anything from a façade renovation to a more comprehensive reconfiguration but the end goal is the same; higher occupancy and rental rates.
In addition, FRT has significant expertise in the master planning, design, development and operations of mixed-use properties. In other words, FRT has meaningful and proven experience in a variety of property development methods and this is key to its continued growth and success going forward.
To this end, FRT always has a robust pipeline of new properties in flight and today is no different.
Source: Investor roadshow presentation
This snapshot of FRT’s mixed-use development pipeline shows its 300+ acres of commercial, residential and hotel space that is currently in process. It all adds up to 4.5M square feet of commercial space, 2,300+ apartments and 552 hotel rooms. However, the potential for future growth is enormous at roughly 17M square feet. FRT is certainly opportunistic when it comes to acquiring properties but apart from that, its expertise in terms of developing beautiful, functional properties that lessees actually want to rent space in has been a key to FRT’s growth over the long term.
FRT stays in its lane, so to speak, in terms of growth as it has some key, core markets it wants to dominate and works everyday towards that end. FRT doesn’t want to be everywhere; it just wants to be really good in the places it thinks it can achieve outsized returns and the formula obviously works.
FRT’s relentless focus on quality in developing new properties has also led to class-leading rents and further, much higher new lease rents than the rest of the sector.
Source: Investor roadshow presentation
FRT’s new leases far and away exceed its existing leases in terms of pricing, not only boosting revenue growth but margins as well. FRT has found the sweet spot for new properties via its targeted development strategy and the results are undeniably good. This strong growth in new lease rents will continue to move the needle over time as more and more of FRT’s portfolio sees higher rent levels. This is an important growth lever that is not to be missed by investors.
The proof is in the numbers as we can see here that by any growth measure one can throw at FRT, it has succeeded. The company’s real estate assets at cost have grown roughly 60% since the end of 2012, its rental income has expanded by 45% and its POI has moved 37% higher during this time frame.
While property management and development certainly has its ups and downs from an economic perspective – and FRT isn’t immune from those – the growth this company has seen over the long term is unequivocal and that looks set to continue moving forward. FRT has a variety of growth avenues – including lots of properties in development and a prudent acquisition strategy – and it has the expertise to take full advantage of them.
Competitive Advantages & Recession Performance
Possessing competitive advantages in real estate is tricky because the sector is so very competitive. However, the strategies that FRT uses to acquire and develop its properties have proven highly successful over time and one key way to quantify that is via its average rent numbers.
Source: Investor roadshow presentation
FRT’s average cash rent in 2017 was roughly 60% higher than the peer group average and head-and-shoulders above second place. The reasons for this have been discussed but they include the demographics of the areas where FRT chooses to compete and its property acquisition and development strategies.
There is no reason to doubt the continuation of this trend going forward and that is certainly a competitive advantage for not only FRT, but its shareholders. This company has proven to be one of the best in its sector over the long term.
Speaking of demographics, this chart sums up why FRT is able to charge more than everyone else. It finds properties with superior demographics and exploits those opportunities to the fullest.
Source: Investor roadshow presentation
In this chart, the farther a company is towards the upper right, the better, and FRT is about as far as one could get. It shows that median household incomes are very high where FRT chooses to operate and that population density is very high as well. This is a big reason why FRT can charge more than its competitors on average, providing it with that pricing advantage. It has used this strategy to grow its portfolio to more than 24M square feet and sports an occupancy rate of 95%.
The company’s exposure to the top 20 US markets is also terrific at 77.1% versus its peer average of just 53.9%. FRT’s competitive advantage is that it knows exactly where the most desirable properties are located and works tirelessly to develop them.
Even with its enormous size FRT has a tremendously diversified portfolio of customers. No single customer is responsible for more than 3% of its total annualized base rent and that means that should one or more of them suddenly cease operations, FRT isn’t going to be put into any sort of economic hardship as a result. Most of its customers are less than 1% of its total portfolio and that diversification will go a long way during the next economic downturn.
Speaking of downturns, FRT’s FFO-per-share during and after the Great Recession are below:
- 2007 FFO-per-share of $3.63
- 2008 FFO-per-share of $3.87 (6.6% increase)
- 2009 FFO-per-share of $3.87 (flat)
- 2010 FFO-per-share of $3.88 (0.3% increase)
The company’s property portfolio and rental income actually grew every year during this time frame, a testament to FRT’s superior strategy. Operating margins did fluctuate, however, producing flat FFO in 2009 but all things considered, this is an exemplary performance during the worst recession in many decades.
All of the things that FRT does well allow it to perform like this and, importantly, become an opportunistic acquirer during tough economic times, setting up long term future growth.
Valuation & Expected Returns
ValueLine analysts expect FFO-per-share of $6.20 in 2018. As a result, the stock trades for a price-to-FFO ratio of approximately 19.1. In the past 10 years, FRT held an average price-to-FFO ratio of 22.3, which indicates that the stock is slightly undervalued.
Source: ValueLine
FRT has put together a track record of superior returns against its peer group over the long term and this is why it is widely considered one of the best REITs in the market.
Source: Investor roadshow presentation
This chart shows the company’s FFO per share growth since 2005 and apart from the enormous outperformance overall, FRT managed to see just a small blip in its FFO during the Great Recession while others struggled mightily and quite frankly, haven’t recovered fully. This is an important piece of the total returns picture as you know that when you own FRT, even a deep recession isn’t going to wreck your returns for years to come.
FRT possesses strong financials despite its meaningful rates of growth as the three ratings agencies have the company’s credit at A3, A- and A-, respectively. That’s unusual in the REIT world as debt is king and companies often have too much of it in order to fuel growth.
FRT hasn’t needed to unnecessarily strain its balance sheet to grow and that is part of what allows it to boost FFO over the long term as well as opportunistically acquire properties, particularly when others are struggling. This includes things like refinancing debt when possible, as was done last December with the issuance of $175M of 3.25% senior unsecured notes that replaced notes at 5.9%, lowering its cost of funding.
The company is trading for 19 times this year’s FFO guidance so it isn’t particularly cheap, but class leaders rarely are. In addition, FRT’s metrics are simply better than its peers, leading to a higher valuation.
Source: Investor roadshow presentation
FRT is superior in terms of its capital structure as well as its long term growth rates against its peer set. It also has a very reasonable 68% FFO payout ratio so again, it isn’t straining its finances to produce returns for shareholders. This is all very important in making the case for FRT for long term returns, a case that is very easy to make when you see how the dividend has performed.
The company’s dividend has experienced a 50-year CAGR of 7%, a track record that is outstanding to say the least. Consider the enormous economic events that could have derailed the company’s dividend during this period; FRT’s dividend performance is second to none in its class and this is a big reason why investors assign it a high valuation.
From a total return perspective, FRT looks much better than it did two years ago as the stock was hitting its highs. It has steadily declined since then while FFO has continued to chug higher, making its valuation much more attractive than it has been in the past. A moderate amount of multiple expansion could then be expected given that it continues to grow FFO and that the valuation is pretty reasonable by historical standards after the selloff.
In addition, the dividend is obviously a big draw at its current 3.4% but also considering its long term growth. The chart above shows just how good FRT is at boosting its dividend in good times and bad and there is no reason to think that will cease considering the bright future the company has today.
Adding all of this up, we can reasonably expect the dividend to remain in the 3% to 3.5% range while growing at ~7% annually on average, while FFO growth remains in the mid-to-high single digits. Total returns are thus expected to be close to double-digits each year, assuming the valuation multiple doesn’t expand.
Final Thoughts
FRT has made itself into a world-class leader in the REIT field over the past 50+ years. The company’s focus on high-quality, high-income, densely populated areas has worked and should continue to work for the long term. Its capital structure allows it to be flexible and opportunistic as well as paying that ever-growing dividend.
This is one Dividend King that offers a strong current yield as well as the almost certainty of a growing payout every single year.