Warren Buffett loves dividends. Most stocks that he adds to the Berkshire Hathaway (BRK.A +0.05%) (BRK.B +0.36%) portfolio make regular cash payments to their shareholders. And right now, many of them are offering enticing yields.
I'm not a dividend-focused investor, and most of Buffett's highest-yielding stocks don't interest me. However, there is one exception.
I've had my eye on STORE Capital (STOR +0.00%) for a long time. This company is currently trading near the lowest price in its history, and at those levels, its dividend yield has risen to more than 8%. While this is a very risky stock right now, I've decided that the time is finally right to add it to my portfolio. Here's why.
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Buffett's only REIT
STORE stands for "Single Tenant Operational Real Estate." The company is a real estate investment trust (REIT) that focuses on owning free-standing buildings that are primarily leased to retailers.
STORE has grown rapidly since its founding in 2011, and now owns more than 2,500 properties leased to 478 unique customers in 110 different industries. This makes it well diversified.
STORE's management knows that the biggest long-term risk facing most retailers is the rise of e-commerce. But they have done a remarkable job of protecting their REIT from that threat.
How?
- STORE's tenants sign triple-net leases, which means that customers are required to pay all property-specific costs themselves (taxes, insurance, maintenance, utilities). STORE just cashes rent checks.
- STORE focuses on service businesses that are naturally resistant to online competition -- restaurants, fitness centers, auto repair shops, daycare centers, and the like.
- STORE insists that its tenants be located near their target customers, which increases convenience.
- Tenants are required to sign long-term leases. The average contract length is 14 years.
- Tenants are required to send regular financial reports to STORE that demonstrate their solvency. This helps it spot issues before they become acute and take action accordingly.
- Few of STORE's customers are small upstarts. Its median tenant has over $50 million in annual revenues.
- Most of its leases feature annual rent escalations, which are a source of predictable growth for the company. The current built-in annual rent escalation is 1.9%.
These factors have allowed STORE to maintain occupancy rates that exceeded 99% for years. That, in turn, has given it the ability to consistently boost its payouts to investors by at least 6% annually since it came public.
STOR Dividend data by YCharts
These are among the attributes that attracted Buffett's attention -- or at least, the attention of one of his investing lieutenants. Berkshire Hathaway purchased $377 million worth of the company's stock in 2017 -- about 7.8% of STORE's current shares outstanding.
The pandemic
None of STORE's operating attributes matter to investors right now. The uncertainties about how much damage the COVID-19 pandemic will do to the economy, and how long this downturn might last, have caused plenty of traders to head for the exits. That fear makes sense given the stay-at-home orders that remain in place for the large majority of the U.S. population.
STORE's shares are currently down about 54% year to date and trade near their all-time low. The decline has pushed up the company's dividend yield up to near its all-time high of 8.1%.
You wouldn't be wrong for assuming that traders have a point. There's no doubt that STORE's stock is incredibly risky right now given the state of the U.S. economy. There's simply no telling how bad things will get, nor what kind of impact the crisis will have on the REIT's tenants from here.
However, CEO Christopher Volk made an interesting comment about STORE's valuation on April 17: The company's investments are trading at a greater than 20% discount to their replacement cost.
Now that's cheap.
Reasons for hope
The pandemic is creating unprecedented uncertainty, but there are reasons to believe that this business will survive and eventually thrive.
STORE's management team provided investors with an update in the middle of March that should give investors some comfort:
- Only 0.5% of tenants had called STORE saying that the pandemic would impact their ability to meet their contractual obligations.
- STORE has very little exposure to real estate markets that are highly dependent on energy prices. This means that extremely low oil prices won't hurt the company much.
- STORE had $100 million in cash on hand and also has an unused $600 million fully committed line of credit. These figures do not include another $150 million in the capital that was raised from a stock offering in January at $36 a share.
- The company is significantly reducing its new investment activity for the rest of the year.
- STORE's debt maturities are laddered.
- The dividend payout ratio is only 70% of adjusted funds from operations, which provides it with some cushion.
- STORE requires its tenants to maintain business interruption insurance, which may help offset the near-term weakness.
- Management estimates that its average tenant can tolerate a 40% reduction in its revenue and still meet its rent obligations.
Management also held an updated call with Morgan Stanley on April 17 to provide some additional light on the situation. They reiterated that they see the COVID-19 situation as temporary, and that the company's real estate plays a central role in its customers' lives.
Here are some other noteworthy tidbits from the call:
- As of the time of that call, 64% of its tenants had paid rents in April.
- Of the remaining 36% of tenants that couldn't make their April payments, 90% of them have agreed to deferral agreements.
- Most of the delayed payments will be received later this year or in early 2021.
- In total, only 3.5% of the rent that is due in April isn't accounted for.
- As of the end of March, the company had $630 million in cash.
- The company expects to remain in compliance with all of its debt covenants.
- The CARES Act, Paycheck Protection Program, and Main Street Lending Program should help to soften the blow to its tenants.
If you're starting to believe that STORE's stock is attractively priced today, you're not alone. Many members of its management team purchased the stock in March as prices continued to fall.
I think it's about time for me to finally follow suit.
What I'm watching
To be brutally clear, STORE Capital is a very high-risk stock right now. There's no telling how bad things might get, and management suspended its 2020 guidance. In addition, they hinted that they might even have to temporarily stop the dividend payments, too.
Neither the guidance cut nor the potential dividend stoppage bother me at all. If fact, I'd welcome a temporary dividend cut to help the company maintain as much liquidity as possible.
My bottom line is this: STORE is a high-quality business that has a bright future ahead, and I'm ready, willing, and able to accept all of the risks that are on the table. I'll be purchasing a few shares for my portfolio as soon as the Fool's trading rules allow me to do so.
STORE's first-quarter conference call is scheduled for May 5. If you're interested in this stock, I highly recommend tuning into to get an updated read from management. If they can successfully weather the storm, I think the stock could be more than capable of providing investors with strong double-digit percentage returns annually from here.
