Over the last few years, the world of retail and related commercial property has been working to insulate itself from the advent of Amazon and the e-commerce movement it helped spur on. Building out a portfolio of businesses that were "future-proof" to digital disruption was the key, and many -- like commercial real estate investment trust (REIT) STORE Capital (STOR +0.00%) -- had great success in doing so.
But suddenly, Amazon-proofing a business model isn't good enough. With the coronavirus going from existential threat to very real economic disruptor in a matter of weeks, even businesses that rely on in-person visits are in danger. And that's what has STORE Capital shares down in the dumps. As of this writing, units of the REIT have backtracked roughly 46% since late February 2020.
Image source: Getty Images.
Punished, but for all the right reasons?
STORE Capital, which purchases single-tenant properties and leases them back to occupants, has had an incredible run in the last few years. As of the end of 2019, 99.5% of its 2,504 properties were occupied, with an average remaining lease term of 14 years. The real estate portfolio is also incredibly diverse, and highly dependent on consumers making visits -- in stark contrast with retailer-centric REITs that have been losing tenants as e-commerce continues to gobble up market share.
However, therein lies the problem. To combat the COVID-19 pandemic, social distancing and/or home quarantine has been put in place, with many businesses shuttered for the short term to slow down the spread of the virus. While essential businesses have remained in operation, a large portion of STORE's tenants don't meet that criterion.
|
STORE Capital Tenant Industry Group |
2019 Rent and Interest Income |
2017 Rent and Interest Income |
|---|---|---|
|
Restaurants -- full- and limited-service |
14.5% |
20.3% |
|
Movie theaters and family entertainment |
7.8% |
10.2% |
|
Metal fabrication, metal and plastic products |
6% |
5.6% |
|
Early childhood education |
5.7% |
6.6% |
|
Health clubs |
5.7% |
5.9% |
|
Furniture |
5.4% |
6.7% |
|
Auto repair and maintenance |
4.8% |
3.1% |
|
Farm and ranch supply, hunting, and fishing |
4.5% |
3.1% |
Data source: STORE Capital.
The good news is that STORE has been continuously diversifying its portfolio in recent years, but the heavy exposure to restaurants, theaters, and family entertainment -- already industries that operate on thin profit margins -- could mean rent payments are missed or delayed. In a worst-case scenario, some of these businesses might face bankruptcy or need to scale back the number of locations they operate. One tenant, in particular, the world's largest movie theater chain AMC Entertainment (AMC +3.46%), is of particular concern as theaters are facing prolonged closures and a wave of delayed new movie releases.
Incredibly cheap, but with an asterisk
Given the information shareholders currently possess, units of STORE Capital are trading dirt cheap. Shares of the REIT are currently going for just 9 times adjusted funds from operations per share based on 2019 numbers, and 8.6 times based on management's previous guidance for 2020.
There is sure to be some disruption this year, but STORE is in good shape. In addressing the crisis, CEO Christopher Volk wrote on March 17, 2020:
As of today we have received just a handful of calls representing well below 0.5% of rents from tenants stating that the COVID-19 pandemic will have a potential impact on their ability to meet their contractual obligations to us. Note that the heading of this paragraph is "Contract Quality" and not "Tenant Health." We have always been careful to draw a distinction between tenant credit quality and investment contract quality. Because we own profit center assets, with 92% of our multi-unit tenant investments bound by master leases, our contracts tend to be senior to other tenant payment obligations. In fact, at an approximate 2:1 rent coverage after overhead, we estimate that our average contract can tolerate an approximate 40% revenue reduction and still meet its rent obligations.
Volk also expounded on the bankruptcy of Art Van Furniture, which represents 2.5% of annual rent revenue. While early on, it is unclear how much of STORE's investment it will recoup from the store liquidations. However, STORE has a solid balance sheet with $100 million in cash and an unused $600 million line of credit. Its dividend payout rate was also only at 70% of funds from operations, which means its now high 8.4% dividend yield is on solid footing for the time being. For shareholders and prospective shareholders, Volk's letter is a must-read.
Based on all this, I'm cautiously calling this REIT a serious value play right now. The situation could change, as the coronavirus situation has moved with unprecedented speed, but given the massive pullback in price in the last month and STORE's diversified portfolio and high-quality lease terms, now looks like a good buying opportunity. Just bear in mind it is likely to be a very bumpy ride in the months and quarters ahead as businesses reopen and consumers start leaving the house again.
