With the Federal Reserve strongly hinting at raising fed-funds rates multiple times this year, investors' fears of a possible recession have risen accordingly. In the first quarter of this year, Gross Domestic Product (GDP) fell at a 6.5% annualized rate. According to the Atlanta Fed's GDPNow Index, second-quarter GDP growth is predicted to come in below 1%. If we have negative GDP growth in the second quarter, some analysts consider that a significant (but unofficial) indication that the U.S. is in a recession.
During recessions, stocks with defensive characteristics tend to outperform. STORE Capital (STOR) is a real estate investment trust (REIT) with highly defensive characteristics that has an attractive yield as well. Here's why it should thrive in a recessionary environment.
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The secret to Single Tenant Operational Real Estate success
STORE is an acronym that stands for Single Tenant Operational Real Estate. The company develops stand-alone properties and leases them out to tenants under long-term leases that require the tenant to absorb most of the costs, including taxes, maintenance, and insurance. These leases are generally called "triple-net" leases, and they are different than the typical gross lease, in which the tenant pays rent and the owner handles maintenance, insurance, and taxes.
Tenants are generally choosing between owning the property outright or leasing. Leasing is an attractive proposition to a company that wants flexibility. Long-term triple-net leases usually contain less restrictive covenants than bank loans, and are easier to unwind if the tenant chooses to leave. STORE generally buys the property from the tenant and then leases it back, which is called a "sale-and-leaseback" transaction. Often STORE Capital has the ability to borrow at a lower rate than the original tenant, which is partially how it provides a value proposition to its tenants.
A largely defensive tenant base
STORE Capital's tenant base is concentrated in businesses that are largely insensitive to the state of the economy. Restaurants (fast food and full service) are the biggest category at 12% of revenue, followed by early childhood education centers, automotive repair, and health clubs. It also leases space to manufacturers and retailers, especially farm and ranch stores. These businesses will generally outperform cyclical stocks during a recession. People will still go to the gym, get gasoline, buy groceries, and need their oil changed. Mall REITs, which house many fashion stores, will be more at risk.
STORE outperformed most REITs during the pandemic
Unlike most REITs, STORE Capital was able to navigate the COVID-19 pandemic without cutting its dividend. Indeed, the company's funds from operations (FFO) increased in 2020 and 2021. FFO is generally used for REITs because depreciation and amortization is a major charge that is deducted from net income under generally accepted accounting principles (GAAP). That said, depreciation and amortization are non-cash charges, which means the company doesn't actually write a check, so the cash earnings are higher than net income would suggest.
Most of STORE Capital's debt is fixed-rate, therefore the current rise in interest rates will have only a muted effect on the company's earnings going forward. At current levels, the stock has a dividend yield of 5.8%, which is pretty attractive. The company has increased its dividend every year since 2015. If STORE Capital was able to navigate the COVID-19 pandemic and increase FFO and dividends, it should be able to weather any upcoming recession.
