In a nutshell, Morgan Stanley feels that Spirit Realty Capital (NYSE: SRC ) is going to be able to move the needle by acquisition much easier than National Retail Properties, (NYSE: NNN ) and Realty Income (NYSE: O ) .
A Morgan Stanley analyst noted that Spirit Realty acquisition guidance had increased by $100 million for the second half of 2014 -- and upgraded the stock to overweight, with a $13 price target. Spirit Realty currently has a market cap of ~$4.6 billion, and pays shareholders an annual dividend of $0.67, currently yielding ~5.9%.
National Retail Properties was viewed in a neutral fashion, with a $38.50 price target, and equal weight recommendation. The company stock has steadily increased during 2014, and is up ~26% year-to-date. National Retail is currently paying a dividend yielding ~4.5%.
Perhaps the most shocking news was the revised price target for industry stalwart Realty Capital of $38 per share. This represents a 16% drop from the $45.26 closing price of July 16, 2014, and of course, Morgan Stanley logically downgraded Realty Income to underweight. Realty Income is up over 24% so far in 2014.
The single-tenant triple-net business model
These REIT landlords own large portfolios of mostly free-standing buildings, which are typically occupied by corporate tenants on a long-term lease. In addition to rent, these tenants pay for: insurance, taxes, and the vast majority of repairs. There are often contracted increases, or bumps, in the rent over the term of the lease -- typically in the 1% to 2% range.
Why is Morgan Stanley such a hater?
Realty Income -- also known as The Monthly Dividend Company -- was dinged partially because of a negative outlook for large portfolio acquisition deals moving forward. There were also concerns regarding using "higher leverage with lower pricing benefit than peers."
Realty Income has demonstrated a 45 year history of being able to manage its balance sheet while acquiring a portfolio of 4,200 triple-net assets. Realty Income has paid shareholders 529 consecutive monthly dividend payments including 76 dividend increases since listing on the NYSE in 1994.
The Monthly Dividend Company currently pays investors a dividend of $0.1827917 per month, or $2.194 annually. In the event that Morgan Stanley analysts are truly prescient, based upon their downgrade target price of $38, Realty Income's dividend would yield 5.77% assuming no increases, or taking into account monthly compounding.
Speaking of analysts
In late June, 2014 a Bank of America analyst who covers the triple-net REIT sector also came out with an upgrade of Spirit Realty Capital. Part of the B of A rational was that consolidation trends in the triple-net REIT sector may make Spirit Realty an acquisition candidate. Who would be a likely buyer?
Newly crowned industry leviathan $11.7 billion American Realty Capital Properties, or ARCP, has recently come under fire for pursuing a perceived growth at any cost strategy. ARCP has recently announced a change in executive management, and a moratorium on major mergers and acquisitions for the balance of 2014.
Another large player in the triple-net lease world is $6.6 billion W.P. Carey. Although nearly 50% larger than Spirit Realty, I don't believe W.P. Carey would not be a serious bidder. Why not? Frankly, W.P. Carey does not have a very high opinion of the U.S. triple-net retail sector.
The Spirit Realty asset portfolio is highly concentrated in the U.S. retail sector. Its top 10 holdings include: Shopko, Walgreens, 84 Lumber, Church's Chicken, and Circle K.
Who else could B of A analysts have in mind?
My sense is the next most logical buyer could be $10 billion market cap Realty Income. It has the size and the financial clout to pull off a deal of this size. One stumbling block would be if a deal could be structured so as not jeopardize Realty Income's incredible track record of paying and increasing dividends to its shareholders. Realty Income is not in the habit of diluting its existing shareholders.
The possibility of Realty Income acquiring Spirit Realty would tend to contradict the Morgan Stanley "negative outlook for large portfolio acquisitions in the future."
Analysts make assumptions in building their discounted cash-flow models. They are often revised, and recommendations can vary from quarter to quarter. Prudent investors should take all of the facts into consideration, and not make investment decisions solely upon a single Wall Street analyst upgrade or downgrade.
On the face of it, there is nothing wrong with Spirit Realty Capital. However, depending upon your investment goals and tolerance for risk, many long-term investors might opt for owning shares of rock-solid REITs such as Realty Income and National Retail Properties with a long-term history of paying and increasing dividends for shareholders.
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