O is in stage #4. Realty Income (O) is a dividend darling of many investors, and it has paid and increased dividends for more than 25 years. The company went public in 1995 and survived many downturns the biggest in 2000, 2009, and 2020. It increased the dividend during those periods of time. It also survived high interest rates back in 1995 (the FED rate was 6% in 1995) and it survived the rates in 2000 and 2009 too. Yes, the stock declined during those years but if you were not panicking and bought, you ended

 

 

rewarded with nice gains as the stock moved higher from the lows and even the pre-crash highs.

 

 

Today, we have a similar situation. The rates are rising due to high inflation (but there are signs of it easing and thus FED most likely ending its hiking despite the media hysteria) which would bring the stocks like REITs and Realty Income back to rising trajectory.

In the meantime, we see investors panicking and many retail investors are asking a question: “What shall I do?” It is unfortunate seeing people investing in the market and not having a clear plan and not staying the course just because the market or a sector is in decline. They want quick profit, and they are not willing to give their companies time to adjust and grow. Despite any odds, Realty Income got out of any mess victorious. What makes you think this time will be different? If it wasn’t different in 2009 during the worst financial crisis in the US history, why would it be different today, because of a bit higher interest rate?

The weekly chart is discouraging. I am not saying otherwise. But it is not the end of the world. It is in fact a great opportunity!

If you bought at 70s and today you are sitting on losses, ask yourself a question: “Why did you invest in Realty Income in the first place?” If you asked me that question, my answer would be clear – “I invested to collect dividends and not to worry about the stock price. I do not plan on selling. I plan on holding forever and enjoy income.”

My cost basis is different in different accounts. In my IRA account, my cost basis is $27.30 per share, in my Roth IRA account, my cost basis is $40.31 per share, and in our business account, the cost basis is $64.82 a share. But if I include dividend income and premiums from selling covered calls, my overall cost basis is $54.62 a share. So yes, I am sitting on a loss. But a small one. And I do not have a problem adding more shares to this dividend king.

 

 

Is the panic justified? Is Realty Income a bad business? Or just a victim of the market and economic conditions? I say, it is just a victim of the market conditions. When interest rates go up, REITs perform badly. One reason is that because of the current law, REITs are required to distribute 90% of their taxable income to their shareholders. That leaves very little cash for reinvestments. So, REITs are using two sources of obtaining cash – they issue new stocks, or they issue bonds or borrow money. In a higher interest rates environment, borrowing money is more expensive. Bad REITs go under, well managed stay afloat. As Warren Buffett says, when the tide goes down, everybody will see who was swimming naked. And Realty Income is one of the better managed REITs. Their revenue keeps growing at a rapid move. A 1-year revenue growth is 25.76%, and a 5-year growth stands at 25.36%. That is definitely not bad for a REIT.

 

 

Realty Income shows growing free cash flow. We saw a rapid move up in 2021. In 2022 and 2023 it stalled but givenmt the economic conditions, this can be expected. Overall, the free cash flow saw a contraction on a 1-year basis (-1.10%) and impressive growth on a 5-year basis by 22.75%:

 

 

Realty Income’s EPS is somewhat steady. It is declining a bit but it is not yet a concern. In 2023 the decline was large (-21.62%) but I say it is not because of bad management but because of the economic situation. When the rates start going down again, O will rise.

 

 

O has a rising debt, and the rate of the debt is concerning. Servicing and refinancing this debt will be a problem if the rates stay elevated. In my opinion, this is one of the main reasons investors are dumping stock.

 

 

Realty Income is a dividend king. It has paid the dividend since 1995 and increased the dividend for 25 consecutive years. The company’s management made it a goal – to be a dividend company investors can rely on. And so far, they keep their promise. Of course, anything can happen and O can cut the dividend or go bankrupt. But given their promise and commitment, I think it is unlikely.

 

 

The company also dilutes investors as it is issuing new shares and constantly growing its shares outstanding. It dilutes by 12.35% on annual basis, a 5-year average is at 18.84%. Rising debt and huge dilution can force the management to take measures to improve their balance sheet. And the measures can be drastic, such as dividend cut. I hope the management takes this seriously, proceeds carefully and not recklessly.

 

 

Even Realty Income wasn’t spared from hiring frenzy in 2021 and 2022. They too were hiring anyone who could identify a house on a map. This is one of the reason we see the strong labor market and resilient economy. We simply have overemployment!

 

 

Assessing REITs valuation is not as simple as with regular stocks. One method I use is comparing the price to AFFO. And based on that the Realty Income is currently undervalued:

 

 

The stock is currently trailing the index, thanks to the recent selling. But on the income field, it beats the market three times. This makes the current selling pressure a great opportunity.

 

 

The stock is now AGGRESSIVE BUY
 

This post was published in our newsletter to our subscribers on Saturday, September 16th, 2023. If you want to learn more about our stock technical analysis subscribe to our weekly newsletter.