Realty Income's April Rent Collection Beats Peers But Is Still Problematic
On Monday, Realty Income (O) released earnings and reported that 83% of rent was collected in April. Given the circumstances, April rent collection was better than expected and beat that of all other retail REITs we've studied.
Source: Company Press Releases
The top four industries in Realty Income's portfolio have fared well during coronavirus-related shutdowns so far. Convenience stores (11.9% of rent), drug stores (9.0%), dollar stores (8.0%), and grocery stores (7.7%) all remain open and provide essential goods at low price points to consumers.
Source: Realty Income Investor Presentation
Tenant credit quality may also be playing a role. 48% of Realty Income's rent is from tenants with investment grade credit ratings, and nearly 100% of rent from these tenants was collected in April. Investment grade tenants are, in theory, better positioned to meet their obligations during downturns.
Furthermore, Realty Income's tenant base is comprised almost entirely of large national and regional operators, which have greater access to financial resources than mom and pop shops and are more likely to survive this rough stretch.
April's figures are still sobering, though. Realty Income has material exposure to several industries impacted heavily by the pandemic and social distancing, namely restaurants (9.2%), gyms (7.2% of rent), and theaters (6.3%).
Management is in discussions with tenants in these industries to potentially defer several months of rent payments. However, many of these businesses operate on thin margins and may never have capacity to pay back rent in full.
Moreover, some tenants may eventually be forced to close stores or altogether go out of business if conditions don't improve soon and government stimulus isn't enough. Vacancies will be difficult to fill in the current retail environment.
This is uncharted territory for Realty Income, who saw same-store rent actually increase 0.4% in 2009 in the midst of the financial crisis.
Based on Realty Income's pre-pandemic rental income and operating expenses (most of which are fixed costs), we estimate rent revenue could decline around 15% before cash flow (i.e. AFFO) would fall short of covering the dividend.
If rent collection doesn't improve in the months ahead, Realty Income's payout ratio will exceed 100%, and management will begin to question the dividend.
Due to the dividend's lower margin of safety following the firm's earnings report, we are downgrading Realty Income's Dividend Safety Score to Safe.
A further downgrade will be considered if conditions worsen or if it becomes clear that rent revenue won't return to pre-pandemic levels anytime soon.
Otherwise, we expect Realty Income to remain committed to its payout. Here's what CEO Sumit Roy said in a call with analysts regarding the dividend:
Yes, it is our brand. We are the monthly dividend company. It is very much part and parcel of how we operate our business. It is our mission.
And so [the dividend] is one of those tools that we certainly have available to us to manage liquidity but one that we feel, at least given the lay of the land today and despite all of the things that you've laid out, we do not need to pull on.
...
But at the same time, if this is a 2-year phenomena rather than a 6-month phenomena or a 9-month phenomena, then [the dividend] is a lever that one might need to lean on.
But it is certainly not one that we feel like we need to lead with, and it is a testament to the portfolio that we have created. It is a testament to the [credit] ratings that we have and the access to liquidity that we have and our ability to be a lot more patient than potentially some of our peers.
Essentially, management is able to take a wait-and-see approach given that cash flow is not projected to fall too short of covering the dividend.
Equally as important, Realty Income's financial position coming into this crisis is strong, affording management the flexibility to tap cash reserves or issue a modest amount of debt to cover a temporary shortfall in dividend's funding.
Realty Income has ample liquidity with $1.25 billion in cash on hand and access to another $1.1 billion through a revolving credit facility. For context, the dividend costs roughly $880 million annually.
Healthy leverage ratios and an A- credit rating from Standard & Poor's help ensure access to debt markets if needed, too.
Source: Simply Safe Dividends
Capital requirements appear minimal this year as well. Outside of a $250 million dollar term loan due in June, which can likely be refinanced or easily covered by Realty Income's liquidity, no other debt is due for repayment until 2022.
Management also expects to tread lightly with property acquisitions (which excess cash flow is often diverted towards) until there's more visibility into the pandemic's progression and its longer-term impacts on retail.
All said, the big unknown is what lies ahead for the most impacted industries (restaurants, theaters, gyms) in Realty Income's portfolio.
While Realty Income may be in the best position of any retail REIT to maintain its payout, the firm is not immune to the sector's challenges. At least some progress in rent collection must be made this summer for the dividend to remain safe.
The economic environment is evolving rapidly and can still go many directions, so investors need to be comfortable with the uncertainty ahead.
We will continue to keep a close eye on Realty Income's operating environment and provide updates as new information arrives.
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