The market had a good start to February, and that may not be a welcome sight for value investors looking to increase their capital. The beauty of the market, however, is that there is always at least one sector that is out of favor and up for sale. Sometimes it’s pharmaceuticals, other times it’s energy, and right now net lease REITs seem to be attractive.
This brings me to net lease stalwart, National Retail Properties (NNN), which is now offering an attractive yield. I’m highlighting recent results and what makes NNN a worthy buy for a solid long-term income, so let’s get started.
NNN: one of the safest 5% returns you can buy
The net rental industry has seen a number of new entrants, but National Retail Properties stands out with scale and a track record that new entrants simply don’t have. This includes 32 consecutive years of annual dividend increases, making NNN a dividend aristocrat and one of only 3 REITs to reach this milestone.
Currently, NNN’s portfolio includes over 3,000 properties in 48 US states and over 370 tenants. Despite the word “retail” in its name, NNN is actually rather resistant to e-commerce. This is evidenced by the fact that convenience stores, auto services, restaurants (full and limited service) and entertainment centers form its top 5 tenant sectors, as shown below.
Moreover, NNN is known for its stability, as its occupancy rate has never fallen below 96.4% since 2003 and has an average occupancy rate of 98.1% over this period. Additionally, NNN has one of the longest debt-weighted average maturities at 14.7 years and maintains strong margins due to the triple net nature of its leases.
This is reflected in the fact that NNN has maintained an operating margin (with additional depreciation) of 90% over the past two years despite the effects related to the pandemic. It also involves economies of scale, as NNN is able to spread its overhead over a large asset base. Notably, NNN is getting a new CEO as the current one is retiring. The new CEO is Steve Horn, a company veteran who has been with the company since 2003, holding various positions at NNN.
NNN continues to post strong results in the fourth quarter, with a rent collection rate of 99.4% and an occupancy rate of 99.0%. It also maintains a long weighted average remaining lease term of 10.6 years, putting it on par with industry standard bearer Realty Income (O).
Also encouraging, NNN was able to take advantage of low interest rates by issuing $1.25 billion of senior unsecured notes at interest rates ranging from 3.0% to 3.5%. Part of the proceeds enabled NNN to redeem all 13.8 million Series F Preferred Shares, which carried a coupon rate of 5.2%. At the same time, 99.8% of NNN’s properties are free of secured mortgage debt, giving it the financial flexibility to grow.
Growth for the full year 2021 includes $555 million in real estate investments, including the acquisition of 156 properties with a very long remaining lease term of 18 years and an initial cash yield of 6.5 %. This compares favorably to NNN’s weighted average cost of debt, which I estimate at 4.7%, based on the aforementioned interest rates on new notes, and NNN’s P/FFO of approximately 16x at during the fourth trimester.
Risks for NNN include higher interest rates, which could increase the cost of its debt. Additionally, NNN could experience some headwinds to growth in 2022 as competition for offerings combined with low inventory compresses cap rates, as noted by management during the Q&A session of the recent conference call :
Q: A question about the cost of capital. So obviously it’s moved higher here. Have you seen a change in capitalization rates in the acquisition market that will preserve spreads? Or does the 2020 guide assume that spreads will simply be tighter on a similar asset base?
A: Definitively. Cap rates, I mean, they compressed even more if we kind of saw the second half of the year, and that was a result of more supply in the market. It doesn’t feel like there’s a lot of inventory. I mean there’s still enough inventory than acquisitions, but the cap rates are compressed. There are a lot of capitals choosing the offers. As for our forecast, we don’t give a cap rate guide, but 6.5 was the cap rate for 2021, and we see it compressing a bit for 2022.
Meanwhile, NNN maintains a strong BBB+ rated balance sheet with a safe net debt to EBITDA ratio of 5.2x, which is now the same as the more preferred net debt to EBITDA, as NNN no longer has any preference after the redemption of Series F in the fourth quarter. Additionally, NNN offers strong interest coverage and fixed charge coverage ratios of 4.6x and 4.4x, respectively.
This supports the dividend yield of 4.9%, which is well covered by a core FFO dividend payout ratio of 74%. Notably, NNN has achieved 32 consecutive years of annual dividend increases and has a 5-year dividend CAGR of 3.2%.
I see value in NNN at the current price of $43.40, especially after falling from the $48 level reached in early January. Currently, NNN has a P/FFO of 15.4 and analysts expect 5-7% growth in FFO/share this year. Although NNN is not cheap, I find it reasonably priced considering the quality and track record of the company. In Buffett’s words, NNN can be a “wonderful company that trades at a fair price.”
Analysts on the sell side have a consensus rating of Buy, with an average price target of $51.33, implying a potential total return of 23% over one year, including dividends.
Key takeaway for investors
National Retail Properties is a strong net lease REIT that has been increasing dividends for 32 years. It continues to perform well with strong trading fundamentals and is growing the portfolio. At the same time, it maintains a strong balance sheet and recent share price weakness has brought the dividend back to an attractive level. I find NNN currently has attractive value for revenue and long-term growth.