Spirit Realty Capital (NYSE: SRC) likely offers one of the better investment cases for investors seeking income in the retail real estate space. This real estate investing fund has a large portfolio, and due to the stock’s high 6.5% yield, investors have a great total return visibility, which should be meaningful considering the ongoing uncertainty in the markets. Despite certain risks, many investors and analysts consider SRC a Buy.
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Investors have grown increasingly cautious of retail REITs. This is likely because of the tough macroeconomic situation hurting consumers’ purchasing power, reducing overall foot traffic, thus reducing the value and rent potential of these properties. In contrast, SRC appears to be posting robust metrics, while its 6.5% dividend yield is covered by the company’s funds from operations. Nonetheless, I am neutral on the stock.
What Does Spirit Realty Capital Do?
Spirit Realty Capital is a net-lease REIT focused on investing in single-tenant retail properties. Spirit Realty’s portfolio has expanded over the years, becoming increasingly diversified. It currently comprises 2,078 properties in 49 states. These properties are leased to 342 tenants who serve 35 different industries.
Spirit Realty’s investment case has some alluring characteristics. The first is that stockholders can enjoy wide exposure in all retail industries, with cash flows spread across hundreds of tenants in nearly every state, thus enjoying a lower-risk stream of rental cash flows.
However, every company in the world is subject to risks, and Spirit Realty is no different. One such concern is that the company has to manage thousands of relatively undersized properties in a fairly risky real estate sector (retail). This could lead to rental collection problems during times of financial restlessness.
Still, in general, Spirit Realty should be well-positioned to produce rather robust results over the years as retail locations remain essential for various types of products and services.
Improving Financials, Despite Macroeconomic Concerns
Elevated inflation levels and an all-around shaky macroeconomic environment have sustained the subject of sinking consumer confidence and, therefore, falling consumer spending. This could lead to a tough climate for retailers and, thus, retail REITs.
Such considerations are indeed valid. Nevertheless, consumer spending in the United States was sustained at record levels during the second quarter of 2022. Therefore, retail locations performed resiliently, as Spirit Realty’s latest results illustrate.
Spirit Realty’s Q2 results were quite assertive, with revenue and funds from operations (FFO)/share coming in at $174.9 million and $0.92, suggesting an increase of 6.3% and a decline of 8%, respectively. The expansion in revenues was powered by property acquisitions and record levels in occupancy rates, which remained at a tremendous 99.8% by the end of the quarter.
While the decline in FFO/share may sound concerning, one has to note that it was mainly attributable to a 16.6% boost in the number of outstanding shares year-over-year. In fact, FFO actually grew by 6.7% to $123.4 million. If we employ AFFO/share, which gets rid of particular one-off items and non-cash compensation expenses, the metric actually grew by four cents to $0.90. This makes for a more meaningful comparison.
During the quarter, Spirit Realty continued to develop its asset base, purchasing an additional 56 properties. These properties came in with an average cash yield of 6.37% and should additionally expand Spirit’s portfolio diversification.
With the company’s performance coming in line with expectations, Spirit Realty’s management reiterated its prior Fiscal Year 2022 guidance, forecasting adjusted funds from operations (AFFO)/share between $3.52 and $3.58. At the midpoint, it suggests an AFFO/share increase of 8.8% compared to Fiscal 2021.
Spirit Realty’s Dividend Should Remain Well-Covered
After increasing its dividend annually since its IPO, Spirit Realty cut it four years ago. The company declared a dividend per share of $3.20 in 2017. Then, Spirit Realty cut the dividend, paying 11 consecutive $0.625 quarterly dividends, indicating an annualized dividend rate of $2.50. It’s worth noting that the dividend was not cut again during the pandemic despite retail locations suffering at the time.
However, with results improving last year, the dividend-per-share was boosted by 2.08% to a quarterly rate of $0.638. At its present annualized rate of $2.55, the stock’s forward yield is ~6.5%.
Further, based on the midpoint of management’s AFFO/share outlook and the current annualized rate of $2.55, the payout ratio stands at a rather comfortable 72%. Thus, the dividend should be well-covered for the time being.
SRC Stock Looks Reasonably Valued
Spirit Realty has posted volatile FFO results, and so the stock’s valuation has mostly drifted in the high-single to low double-digits. The stock is now trading at roughly 11.4x the midpoint of management’s guidance, which displays investors’ cautious outlook on the industry.
I find the current valuation quite fair, as the 6.5% yield offers a powerful margin of safety to investors’ total return potential. It should somewhat shield investors against any modest capital losses assuming shares were to undergo an additional multiple compression.
Is SRC a Good Stock to Buy?
Turning to Wall Street, Spirit Realty Capital has a Moderate Buy consensus rating based on five Buys, six Holds, and zero Sells assigned in the past three months.
At $47.33, the average Spirit Realty Capital stock forecast implies 17.3% upside potential.
Conclusion – Spirit Realty is a Decent Retail REIT
While there are dangers attached to retail REITs, and while Spirit Realty’s dividend cut a few years ago was certainly not cheery, income-oriented investors are likely to find value in SRC stock. With a 6.5% yield, a fine payout ratio, and the latest modest but welcoming dividend increase, the company’s income-generation prospects remain quite attractive.
