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Realty Income: 3 Takeaways From The Q2 Earnings Call

If you had to sum up Realty Income Corp's (NYSE:O) second quarter, it would be one simple word: Good. And for long-term holders, that may be enough information. But there are a few things that are worth knowing about the first six months of the year, and here they are...

We done good
There are numerous ways to say Realty Income had a good quarter (and first half). For example, occupancy was 98.2%, up slightly from the first quarter. Of the 80 properties that reached the end of their leases this quarter, the company managed to release them all -- and one more, a holdover from a previous period, for a total of 81 releases. Historically speaking, the company manages to retain about 98% of the rents from expiring leases by either releasing to current tenants or quickly finding new ones.

Realty saw a rental increase average of 1.4% through the first half of the year and 1.5% for the quarter. Management believes 1.4% is a good number for "the foreseeable future."

Four properties were sold in the quarter with 14 sold in the first six months of the year. (Realty Income doesn't like to let weak properties sit around, which is really nice to see.) And the real estate investment trust, or REIT, had its "...second-highest quarterly volume and property level acquisitions..." ever, according to CEO John Case. And the purchases were at a reasonably solid cap rate of 6.3% with an average lease term of 18 years. It also made positive moves on the debt side of the capital structure, and remains a solid credit.

So, operationally, it was a good quarter. Long-term investors should be pleased with this industry leading triple net lease REIT.

We got voted in!
The second notable event was the fact that Realty Income was included in the S&P 500 Index during the second quarter. On the one hand, that's a testament to the REIT's industry position and long history of success. On the other, it could change the dynamics of the company and stock in important ways.

For example, Realty Income took advantage of the S&P inclusion to sell $276 million worth of stock since demand from index funds allowed a window of opportunity. Indeed, such funds now have no choice but to own Realty Income. However, that also means a very different shareholder base.

This should increase the efficiency of the market for Realty Income stock. But you may have to be more concerned with a broad market sell-off. Why is that? Because when S&P-linked products see outflows, they have to sell stocks -- all of them in proportion to their weighting in the index. It doesn't matter if they are good companies or bad, they have to be sold. Of course the reverse holds, too, in an up market. The takeaway is that, at times, fundamentals may take a back seat to broader market action now that Realty Income is in the S&P 500.

You can look at this as a glass half full or a glass half empty. Just don't let this fact slip from your mind because it could change the way the shares of Realty Income act compared to their historical trends.

Good things ahead
That said, Realty Income raised its guidance for the rest of 2015. It upped its funds from operations number from $2.67 to $2.72 a share to a range of $2.72 to $2.77. Its adjusted funds from operations number, the statistic that tells you how much it can pay out as dividends, inched up to $2.69 to $2.73 a share from $2.66 to $2.72. FFO and adjusted FFO were both $1.36 in the first half, so it's basically halfway there and easily on track to hit the new targets.

Dividends, meanwhile, were increased again this quarter, extending the REIT's impressive streak of over 70 quarterly hikes. The jump was typically modest, at 4% year over year. That's a little above inflation and just a touch below the company's 5% historical growth rate. Essentially, investors get a monthly paycheck that has a history of keeping up with inflation. That's hard to beat, and there's no reason to suspect a change in the dividend trend.

So what about the sell-off?
Year to date, Realty Income's shares are up about 1% or so. That's pretty close to the gain in the S&P 500. But looking at the drop from the REIT's early-year high tells a different story -- O is down 12% from its highest point this year. Over that same span, the S&P is down just about 1%. While that's an improvement from the nearly 20% decline O was sitting at earlier, it doesn't seem to go with the underlying performance of the company.

And that has everything to do with investor sentiment. For a long-term owner with no plans of selling the Monthly Dividend Company, there's no reason to think twice about this. Keep holding on; just know that it could be choppy ahead and it has little to do with fundamentals.

The prices of dividend-paying securities like REITs have been driven up by the continued low interest rate environment fostered by the Federal Reserve. This has left several sectors with high valuations that, if history is any guide, will come back down to more normal levels. That's noteworthy because the Fed is talking about raising rates.

The real problem is that the market doesn't just move from overvalued to fairly valued. The pendulum of investor sentiment usually goes from overvalued to undervalued, swinging through fairly valued on its way between the two. And if you have a shorter timeframe, know that the drop so far this year may not be the final stanza of this story.

In the end, Realty Income is a great company and it had another good quarter. But the stock has been a bit volatile so far this year. And that could continue if investors get spooked by a rate hike. Plus the added complexity of its inclusion in the S&P 500 potentially shifts the valuation story away from historical trends as well. In other words, there's more to think about here than just earnings...


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