Few things in this world are sweeter than buying a stock and watching it soar. Realty Income (NYSE:O) investors are familiar with that feeling. The stock has generated a compound annual return of 26% since February 2009.
I know what you're thinking: The stock has fallen 8% in the last month, did I miss the good times? I can't predict the future, but I think there are three good reasons Realty Income's stock will turnaround and climb in 2015.
3. A beat on acquisition guidance
Realty Income has made at least $1 billion in acquisitions every year since 2011, nearly tripling the size of the company. According to Realty Income CEO John Case, we should expect this trend should continue:
Given the healthy volume of acquisitions opportunities we are currently seeing, we are raising our acquisitions guidance for 2015 from $500 million-$800 million to $700 million-$1 billion.
In 2014, Realty Income saw $24 billion in sourced transactions -- deals put together by brokers and bankers -- yet captured only $1.4 billion. That's just 5.8% of the deals it saw. Considering the high volume of activity it's seeing, and the small percentage of those deals the company would need to close, it's possible the company could outperform acquisition guidance.
In fact, Realty Income outperformed 2014 guidance by $200 million, so this isn't without precedent, and it would probably boost the company's stock price.
2. Continuing low interest rates
Among the many reasons Realty Income has performed well over the past several years is the ultra-accommodative monetary policy. The Federal Reserve has kept short-term interest rates near zero since 2009, while holding and reinvesting trillions in bonds to push long-term rates down. As was the Fed's hope, this approach has reignited the economy.
For Realty Income, it has kept borrowing costs low and made acquisitions even more attractive. In 2007, Realty Income was generating a 10% return on its properties before expenses, and that's compared with a 9% return in 2014, again, before expenses. But look at how interest rates have changed.
Whether Realty Income uses short-term or long-term financing, its borrowing costs are cheaper than they were in 2007. For instance, in 2007, Realty Income issued 12-year debt at an interest rate of 6.8%, and that is compared 4.1% for debt with the same maturity in September 2014. So the spread, or the difference between funding costs and returns, is more attractive today.
However, the time for the Fed to increase rates is quickly approaching. In fact, it could happen as soon as the middle of 2015. An increase would add to Realty Income's cost of funds and probably slow down its rapid acquisition rate.
With that said, the Fed has been supporting the economy with low rates for over six years now, so I expect the rise in rates to be slow and methodical. That approach would allow Realty Income to continue to borrow at favorable rates for at least 2015 and encourage continued growth, which could help raise its stock price.
Also, the Fed is considering a rate increase only because it believes the economy looks strong enough to support itself. This is a great sign for Realty Income, because a strong and growing economy is good for its tenants, and it spurs activity, which creates new opportunities.
1. Global expansion
During Realty Income's fourth quarter call, management was asked about international opportunities:
"[T]here was a large portfolio that we saw that had some international assets [...] but it was a very small piece of the pie."-Sumit Roy, Chief Investment Officer.
Realty Income currently owns over 4,300 properties in 49 states and Puerto Rico, and while the company is in no rush to grow their footprint overseas, it doesn't seem out of the question that they would.
Expansion would certainly come with new challenges, but I believe Realty Income's discipline and business model of acquiring well-located real estate and leasing it to businesses selling non-discretionary goods, often at a lower price point, will work anywhere.
Warren Buffett has said, "[T]he mother lode of opportunities runs through America," and as a $10 billion market cap company, there is still plenty of opportunity for Realty Income in the U.S. However, if Realty Income does add some international assets, I believe it would generate excitement around increased diversification and potential growth that could push the company's stock price higher.
One last prediction
Realty Income has a long and proven track record of success, and while my predictions may not come to fruition, I believe Realty Income is a great business, and will continue to be a great business for a long time, which is why I think Realty Income is a strong buy today.