While most real estate investment trusts (REITs) were hurt by pandemic-related disruptions last year through reduced occupancy and cash collection rates, STORE Capital (STOR) has been one of the quickest to rebound. This is in large part due to its diversified -- and high-quality -- tenant base. And its advantages showed in a superb second-quarter report earlier this month.
Let's take a look at how STORE Capital positioned itself to recover from COVID-19 in short order, and how STORE Capital is setting itself up to return to growth as the economic reopening plays out across the U.S.
Resiliency in challenging times
STORE Capital is arguably one of the highest-quality REITs, which is backed up by its fundamentals both prior to the pandemic and in the midst of it. It appears as though in the span of a year, the company's fundamentals have bounced back, as virtually all of its tenants are fully reopened.
One of STORE's key strengths is its diversification. No single industry accounted for more than 8.5% of its annualized base rents (ABR) during last year's second quarter, when the retail industry was coping with pandemic-related closures. Even as movie theaters (4% of ABR in Q2 2020) and health clubs (5.3% of ABR) struggled at the height of the pandemic, STORE Capital's cash collection rate bottomed out at 73% in Q2 2020.
And now with COVID disruptions largely behind most of its tenants, CFO Cathy Long noted in STORE Capital's second-quarter 2021 earnings call that the company's "July cash collections rate increased to 98%, essentially in line with pre-COVID levels."
This success wasn't by accident -- some 72% of its ABR in this year's second quarter was rated investment-grade, down a little from 74% at the same time last year. The investment-grade tenants overwhelmingly were able to meet their rent obligations despite COVID headwinds, due to access to capital and their strong business models. This is especially impressive because STORE Capital works under a net-lease model, which means its customers are responsible for their property-related expenses.
And while STORE Capital's occupancy rate has never been under any significant pressure during the COVID-19 pandemic, it has nevertheless mostly recovered from its slight dip. STORE Capital's occupancy rate improved year over year from its COVID low of 99.5% in Q2 2020, when many of its tenants were closed in some capacity, to 99.6% in Q2 2021. It's important to note that this is essentially in line with its historical occupancy rate in the 99% range and just below its pre-COVID Q2 2019 figure of 99.7%.
STORE Capital's adjusted funds from operations (AFFO, the REIT equivalent of earnings) increased 13.6% year over year, from $0.44 per share in Q2 2020 to $0.50 per share in Q2 2021. This is significant because it means the company has returned to its pre-pandemic levels. Looking at this year, STORE Capital's updated forecast of $1.94 to $1.97 in AFFO per share comes in well above the $1.83 it reported in 2020. More importantly, this guidance is almost in line with the $1.99 in AFFO per share produced in the pre-pandemic year of 2019.
The pipeline supports future growth
While STORE Capital appears to have essentially improved to pre-pandemic operating fundamentals, it's critical for investors to focus on where a company is going as much as on where it has been. Fortunately, STORE Capital's investment pipeline contains plenty of opportunities to acquire quality properties while also maintaining its selectivity in securing investment-grade tenants and diversifying its tenant base to sustainably grow AFFO per share.
STORE Capital's investment pipeline grew $100 million from $12.4 billion in this year's first quarter to $12.5 billion in the second (considerably higher than its $9.4 billion in real estate investments). This increase was the result of $2.6 billion in new potential deals being added to the pipeline against $2.5 billion in deals that were taken out (including $341 million in deals that STORE closed).
An encouraging takeaway from STORE Capital's earnings call was that the company believes its pipeline will continue to expand "due to low interest rates, monetary stimulus and pent-up demand," according to President and CEO Mary Fedewa.
Taking advantage of a strong balance sheet
The final Q2 takeaway is that the low-interest rate environment and STORE Capital's investment-grade balance sheet will allow the company to acquire properties at favorable spreads to drive AFFO/share growth.
According to Long's opening remarks during STORE Capital's Q2 2021 earnings call, the company completed its issuance of $515 million in seven and 12-year notes at a blended or average interest rate of just 2.8% in June. For context, this is just 80 basis points (or 0.80 percentage points) above the current 30-year treasury rate of 2%, which is a testament to the confidence that investors have in STORE Capital's balance sheet.
This is especially attractive when considering that during the second quarter, STORE Capital's $341 million in acquisitions were done so at an average cap rate of 7.8% -- 500 basis points above its interest rate for its notes issued in June.
One final thing worth mentioning is that STORE Capital's ratio of debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) was just 3.3 in Q2. This is considerably lower than the investment-grade peer average of approximately 5, which means the company can comfortably meet its liabilities.
Worth the consideration of dividend growth investors
Not only has STORE Capital rebounded from COVID challenges, but the company's massive pipeline and balance sheet to finance future acquisitions should lead to mid-single-digit growth in annual AFFO per share in the years ahead.
STORE Capital's 4% dividend yield is a tad below its median historical yield of 4.3%, but with a dividend increase likely to be announced next month, that is fairly negligible in the grand scheme of things. And at Tuesday's closing price, the stock trades at about 18 times this year's projected AFFO per share, which is very reasonable for such a high-quality business.