Realty Income Corp.
The Allure of Rising Magic Dividends: Realty Income (“O Realty” or “the Company”) promotes itself as “The Monthly Dividend Company®” and preaches“The Magic of Rising Dividends” – it even goes so far as to market itself differently to retail investors vs. sophisticated institutional investors. The Company is very dependent on issuing stock at inflated prices to fund its acquisitive growth strategy, keep its cost of capital low, and consistently raise its dividend. The model has worked well for years when times were good, but we believe this magic cycle is about to break down as investors reassess O Realty’s growth profile amidst deteriorating tenant quality, rising interest rates, and a more volatile and discerning capital market backdrop.
Deceptive Same Store Property Reporting: Our forensic accounting work indicates that the true underlying economic performance of O Realty’s properties, as measured by Same Store Rents (SSR) are declining vs. the company’s promotion that it is growing. The Company disclosed its SSR growth rate of 1.2% in 2016. Our industry normalized definition of same store property performance suggests that that SSR declined by 0.8% in that period – an astounding 2.0% overstatement. Once investors come to grips with our irrefutable conclusion, we expect a major revaluation in O Realty’s share price. There are ample case studies to show 40%-50% share price declines when investors revalue a REIT’s declining performance. For example, Wall Street has penalized a few REITs (DDR, BRX, KIM) that own retail properties where the same store growth profile has swung from positive to negative growth. We believe that O Realty is the next REIT that is going to be penalized for a deteriorating growth profile by investors.
Investors Should Be Concerned By Background of Management and Audit Committee Oversight By Board: We find that O Realty’s executive management team is comprised almost entirely of ex-investment bankers, trained in the art of financial engineering. It should, therefore, come as no surprise that O Realty could use financial magic to embellish its performance. We have little faith in the Company’s audit committee raising any objections or concerns about management’s practices. We find that the audit committee is comprised of a PGA golf professional, and former executives from Wells Fargo and KPMG, two of the most scandal-ridden financial and accounting organizations in recent history. Given all the factors we have noted, it makes sense that insider ownership trends are at all-time lows, and lowest amongst its REIT peers.
Tenant Quality Deteriorating As Retail Landscape Changes: We conducted a deep dive into the tenant quality and find that O Realty has outsized risk exposure to drug stores, grocery stores and movie theaters — three retail subsectors facing disintermediation. Drug stores (O’s largest sector exposure) are consolidating their retail footprint (i.e. Walgreens purchase of +2,000 Rite Aid stores), while SSS performance at the store front is down. Even worse, headlines such as Amazon teaming up with Berkshire Hathaway and JPMorgan to disrupt the healthcare business present a now tangible long-term risk that the traditional drug delivery value chain through a retail footprint could move increasing online.