W.P. Carey: Feeling Greedy Or Fearful?

0
39

Summary

While some of the so-called market traders have attempted to read the tea leaves, we continue to ignore them by focusing on fundamentals.

The present price is based on a mix of unpredictable factors, many of which pertain more to emotion and mass psychology.

There’s no guarantee that WPC will merge CPA:17 but, as far as I’m concerned, it’s not a matter of “if” but “when”.

In case you missed it, I recently wrote on Realty Income (NYSE:O) and National Retail Properties (NYSE:NNN).

While they are both Net Lease REITs, I thought it would be interesting comparing my sentiment (bullish or bearish) with regard to these two highly predictable dividend growers.

Realty Income was the subject of my greedy article in which I explained:

I like doing the exact opposite of what the majority thinks is conventional wisdom, and that means that I am now a greedy Realty Income investor!

National Retail Properties was the subject of my fearful article in which I explained:

I am not willing to initiate a BUY. I’ll be become greedy when (or if) the dividend yield approaches 5.0%.

To be perfectly clear, I’m a big fan of Net Lease REITs, and in the upcoming edition of the Forbes Real Estate Investor, I explain to my subscribers the success we have had in handpicking the top Net Lease REITs (+16.5% YTD).

Had we invested in “nothing but net (lease), we would have done well in 2016; however, we all know that it’s important to maintain adequate diversification across other property sectors.

In hindsight, most of our top Net Lease picks have been a result of careful research and due diligence. While some of the so-called market traders have attempted to read the tea leaves, we continue to ignore them by focusing on fundamentals.

But we all know that sentiment moves markets, and ultimately, it’s the emotion that drives the shares price up or down. After all, the present price is based on a mix of unpredictable factors; many of which pertain more to emotion and mass psychology than anything else, how could anyone expect to predict future prices accurately?

W.P. Carey: Feeling Greedy or Fearful?

As I said, I have provided you with my sentiment as it relates to O and NNN, and now it’s time to take a closer look at W.P. Carey (NYSE:WPC).

All 3 REITs (O, NNN, and WPC) have demonstrated success by increasing annual dividends on a predictable and consistent basis. NNN has increased annual dividends for 27 years in a row, O has increased annual dividends for 23 years in a row, and WPC has increased annual dividends for 19 years in a row. (source: David Fish)

Although WPC is a Net Lease REIT, it’s important to understand the differences – not all Net Lease REITs are the same.

In 1973, Bill Carey started W.P. Carey & Co. with a focus on putting shareholders first, and by delivering sound risk management practices, Carey believed that “over the long run” investors would enjoy stable, risk-adjusted returns.

As a pioneer in sale/leaseback financing, Carey was one of the first companies to build a Net Lease vehicle to assist global companies to monetize free-standing real estate. Over the years, Carey has evolved into one of the largest Net Lease landlords in the world with a successful track record of investing through multiple economic cycles (since 2013).

In 2012, Carey converted from an MLP (W.P. Carey & Co. LLC) to a REIT (W.P. Carey, Inc.) to boost scale and to simplify tax reporting for shareholders (no longer used K1s). By merging W.P. Carey & Co. and Corporate Property Associates 15, Inc. (a non-traded REIT) the combined company (structured as a REIT) produced enhanced dividend payments and better flexibility to access capital.

Today Carey’s total capitalization is ~$10.86 billion, ranking the company as the 3rd largest net lease REIT. Here’s how the company compares to the peer group:

Source: S&P Global Market Intelligence

Bill Carey passed away in 2012, and over his lifetime (and beyond), the real estate legend provided investors with very stable returns that led to philanthropic activities aimed to improve access to high-quality education.

By focusing on his “long run” investing mantra, Carey made sure that his vision, drive and passion would become lasting contributions – Carey made significant contributions to the W.P. Carey School of Business at Arizona State University ($50 million), The Carey Business School at Johns Hopkins University ($50 million) and the University of Maryland’s Francis King Carey School of Law (named for Carey’s grandfather and graduate of the school).

Beyond Bill Carey’s philanthropic activities, it’s clear that his vision and approach to “intelligent investing” have continued to thrive and to provide lasting results, specifically through the power of compounding.

Carey recognized decades ago that owning high-quality real estate would not produce out-sized returns over short cycles; but instead, the best way to create wealth is to own shares that would generate durable dividends by always “investing for the long run.”

See my Forbes article on Bill Carey (January 25, 2012).

A Differentiated Net Lease REIT

When we filter out these higher-quality names (investment-grade rated with a long track record of dividend growth), we see even fewer opportunities.

WPC is one such REIT that we consider to be attractive. Based upon our thorough fundamental research, we believe the company is a particularly compelling opportunity based on a number of reasons, all addressed in this article (below).

First, let’s begin with the history and composition of the portfolio.

WPC is a leading global net lease REIT that provides long-term, sale-leaseback and build-to-suit financing solutions for companies worldwide. The company is “self-managed” (always a good sign) and operates two business platforms: (1) owned real estate portfolio (92% of AFFO), and (2) investment management platform (8% of AFFO).

As referenced above, prior to converting to a REIT in 2012, Carey was structured as an MLP, and since that time, the company has evolved into a diversified enterprise focused on six key priorities: (1) Organic growth – through acquisitions for Owned Real Estate portfolio, and new and existing Investment Management products, (2) Diversification – of income, capital sources and within real estate portfolios, (3) Operational efficiency and excellence, (4) Balance sheet strength and flexibility, (5) Proactive asset management, (6) Transparency – through disclosure and investor outreach.

At the end of the third quarter, WPC’s owned real estate portfolio consisted primarily of 910 properties across 19 countries comprising 92 million square feet.

As you can see below, the company is diversified with a majority of industrial (28%), office (25%), warehouse (18%), retail (16%) and self-storage (5%).

As you can see below, Carey invests in a variety of real estate categories:

With over 900 properties in the portfolio, Carey has a diversified model in which no one tenant accounts for more than 5% in revenue.

One primary differentiator with Carey is its international exposure – the company has been investing internationally for 19 years, primarily in Western & Northern Europe.

As you can see, around 37% of revenue is generated outside of the US, and the focus internationally has been in Germany (9%), France (6%), United Kingdom (5%), Spain (4%), Finland (3%) and Poland (2%).

Carey has a long history of investing in Europe (since 1998), and the platform (built over the last two decades) requires expertise and experience that generates a flow of attractive deals.

At quarter end, roughly 63% of ABR came from our properties in the US and 34% from our properties in Europe. On the recent earnings call, WPC’s CIO explained”

In Europe cap rates continue to compress and it is becoming increasingly challenging to secure attractive investments with adequate yields and long-term sustainable value… Although capital inflows have led to increased competition, our established presence and reputation for reliable execution across the continent continues to give us access to deals that are not heavily marketed. Following the Brexit vote, UK cap rates rose moderately in certain sectors of the market and lenders were initially cautious.”

Other Key Differentiators

One key differentiator for Carey – as I noted above – is the company’s exposure internationally, and another unique quality for the company is the growth drivers. Approximately 95% of leases have either fixed or CPI-based contractual rent increases with virtually no exposure to operating expenses.

As mentioned above, another unique feature for the Carey business model is its Investment Management business.

For many investors and analysts, multiple business models create confusion, and oftentimes that leads to underperformance in the organization. One of the primary reasons for the confusion relates to conflicts of interest that can distract the goals and objectives creating blurred management responsibilities.

One way that Carey has been able to successfully operate its two lines of business is because of its long track record. Mark DeCesaris (the CEO) explains on a recent earnings call”

We let our reputation and our track record stand on its own. While there have always been and in any industry I think you see bad actors that come and go in that industry. We’ve stayed the course throughout it and our investors have benefited for it. Our investors in W. P. Carey have benefited from that business as well.

By raising equity through the non-traded REIT channels, the company has been able to build an impressive collection of assets and then merge them with the public business, W.P. Carey. Since 1973, Carey has aggregated hundreds of properties for the purpose of forming entities that would ultimately be sold or merged with W.P. Carey. Here’s a snapshot of Carey’s Investment management products:

The non-traded REIT industry is adapting for the better, with lower fees and back-end loads rationalizing the cost consistent with improving governance at the fund level. Also, Blackstone launching its first non-traded REIT validate the continued improvements in the non-traded sector.

Carey has generated asset management fees, structuring fees and general partnership interests of $120 million-$180 million in recent years. Accordingly, the company has been able to spread costs over a larger asset base. More recently, Carey has expanded its offerings by filing a registration statement for CPA®:19 – Global, a diversified non-traded REIT.

Two of Carey’s entities, CPA 17 and CPA 18, own Net Lease buildings and it is likely that CPA 17 will liquidate in the near term. The $5.8 billion portfolio (CPA:17) was established in 2007:

CPA 18 is smaller ($2.095B AUM) and the property portfolio commenced raising equity just three years ago (in 2013). Carey plans to also include some Net Lease investments in its newly created CPA 19 fund.

As I referenced in the past, I believe that it’s highly likely that CPA 17 will eventually merge with Carey’s public REIT. As mentioned above, on February 3, 2014, Carey merged with CPA 16 in a deal valued at around $4 billion upon closing; the combined company had an equity market capitalization of about $6.5 billion and a total enterprise value of approximately $10.1 billion.

At the time of the merger, Carey’s FFO jumped from $2.78 in 2013 to $4.56 in 2014, and the dividend grew from $3.39 per share to $3.69 per share.

Remember, CPA 17 will look to monetize the portfolio and there will likely be other bidders; however, it is doubtful that a third party will have the inside knowledge of the portfolio and infrastructure to invest internationally that Carey has. Most importantly, I view this unique platform as an asset and catalyst going forward.

Arguably, there are conflicts of interest that should be recognized, but the benefits outweigh the disadvantages. Unlike the RMR controversies I addressed in a recent article (HERE), WPC management does not receive any compensation from the managed funds, no performance incentive, or any participation in acquisition or M&A fees. WPC shareholders receive all of these benefits!

The Balance Sheet

In September, Carey completed an underwritten public offering of $350 million of 10-year unsecured notes at a coupon of 4.25%. Net proceeds were used primarily to reduce amounts outstanding under the credit facility revolver.

At the end of the third quarter, Carey’s net debt to enterprise value stood at 40.7%, total consolidated debt to gross assets was 49.2%, and net debt to adjusted EBITDA was 5.3x.

Carey’s total liquidity at quarter end was $1.3 billion, which includes cash and cash equivalents and undrawn availability on the $1.5 billion credit facility revolver.

Carey continues to execute on its unsecured debt strategy, which provides three key benefits: (1) the credit profile continues to improve as the company improves its unencumbered pool of assets (S&P upgraded the unsecured notes earlier this year from BBB- to BBB with a stable outlook). (2) Carey generates interest expense savings as it replaces higher cost secured debt with lower cost unsecured debt, and (3) Carey is lowering the balance sheet risk by extending debt maturities through issuing long duration bonds (the company’s weighted average debt maturity increased from 4.4 years at the end of Q2 to 5.0 years at the end of Q3.

Clearly Carey is focused on improving the quality of the portfolio, enhancing its credit profile, maintaining the flexibility of the balance sheet, and running as efficiently as possible. In October, Moody’s affirmed all of its ratings on WPG such as its Baa2 senior unsecured notes and long-term issuer rating. The other affirmed ratings are its (P)Baa2 senior unsecured shelf and (P)Baa3 preferred shelf. The ratings outlook is stable.

Moody’s said that the affirmation reflects the company’s success in executing its investment strategy, its highly diversified portfolio and its ability to maintain a strong occupancy rate in the mid- to high-90% range through market cycles. The stable outlook, meanwhile, is because of the rating agency’s expectation that the company will simultaneously reduce its secured debt levels, increase its unencumbered asset portfolio and sustain its current operating performance.

The Latest Earnings

In Q3-16, Carey generated AFFO per diluted share of the $1.34, which is up 13% compared to $1.19 for the prior year period. This is due primarily to lower general and administrative expenses as a result of the cost reduction initiative implemented earlier this year as well as growth in assets under management within the managed funds, which generated both higher asset management fees and higher distributions.

In terms of the contribution from each business segment, Owned Real Estate generated AFFO of $1.22 per diluted share and Investment Management generated AFFO of $0.12 per diluted share.

Carey expects to generate AFFO per diluted share for the 2016 full year of between $5.05 and $5.15, which narrows the previous range. Carey expects acquisitions for the year to be between $400 million and $600 million, of which the company has completed $386 million to-date (Q3 earnings call).

Also as part of the Nord Anglia Education sale leaseback (see below), Carey announced in April that it had agreed to provide up to $128 million in build-to-suit financing to fund the expansion of existing facilities over the next four years, which will effectively extend the overall lease terms of these assets up to four years past their initial 25-year term.

In early December, Carey’s board increased the company’s quarterly cash dividend to $.99 per share, up from the previous quarter’s payout of $.985 a piece. The dividend is payable Jan. 13, 2017, to stockholders of record as of Dec. 30.

Here’s a snapshot of WPC’s AFFO growth for 2016 (includes our estimate):

Source: S&P Global Market Intelligence

Withstanding the possibility of a CPA:17 merger in 2017, we are forecasting modest AFFO growth for WPC (in 2017). The company has disposed of $481 million through Q3-16 and asset recycling could cause short-term dilution as the company seeks to invest in new assets.

Source: S&P Global Market Intelligence

Carey’s payout ratio is sound, but it’s important to remember that 8% of AFFO is generated from the Investment Management business and 37% of the wholly-owned real estate revenue is generated Internationally.

Source: S&P Global Market Intelligence

How Long Is The “Long Run?”

As I have explained above, Carey is a uniquely-positioned Net Lease REIT and it’s quite clear that the market is fearful. Take a look at the YTD performance:

Source: S&P Global Market Intelligence

With modest AFFO growth forecasted in 2017, some could question whether or not Carey should be held for the “long run.”

Yet, a greedy investor could look at Carey and argue that shares are cheap and that eventually the notable risks (Europe and Investment Management operations) become opportunities, rather than complications.

Source: S&P Global Market Intelligence

Clearly Carey has an advantage in its Investment Management business in that the company can create internal M&A opportunities. Of course, there are separate Boards, but by merging CPA:17 into WPC, there could be outsized earnings (and dividend power) that the market is not seeing.

Source: S&P Global Market Intelligence

Understand, there’s no guarantee that WPC will merge CPA:17 but, as far as I’m concerned, it’s not a matter of “if” but “when.”

I’m not suggesting that Carey will move 6 turns and become a 18x multiple overnight, but I suspect that Carey could easily do 3 turns in 2017, making the P/FFO multiple something with an 15x handle.

In summary, you decide whether you’re feeling fearful or greedy. I look forward to your feedback…

When asked what keeps most individual investors from succeeding, Benjamin Graham had a concise answer:

The primary cause of failure is that they pay too much attention to what the stock market is doing currently.

We will be publishing our top picks for 2017 in the upcoming edition of the Forbes Real Estate Investor.

Author’s Note: I’m a Wall Street writer, and that means that I am not always right with my predictions or recommendations. That also applies to my grammar. Please excuse any typos, and I assure you that I will do my best to correct any errors, if they are overlooked.

Finally, this article is free, and my sole purpose for writing it is to assist with my research (I am the editor of a newsletter, Forbes Real Estate Investor), while also providing a forum for second-level thinking. If you have not followed me, please take five seconds and click my name above (top of the page).

The only guarantee that I will give you is that I will uncover each and every rock I can, in an effort to find satisfactory investments that “upon thorough analysis promises safety of principal and satisfactory return. Operations not meeting these requirements are speculative”. (Ben Graham).

Sources: F.A.S.T. Graphs, S&P Global Market Intelligence, and WPC Filings.

Disclosure: I am/we are long O, DLR, VTR, HTA , STAG, GPT, ROIC, HCN, OHI, LXP, KIM, WPC, DOC, EXR, MYCC, TCO, SKT, UBA, STWD, CONE, BRX, CLDT, HST, APTS, FPI, CORR, NHI, CCP, CTRE, WPG, KRG, SNR, LADR, PEB, BXMT, IRM, CIO, LTC, DEA, NSA, HASI, VER, SRG.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.