Seeking Alpha • Aug 18
Necessity Retail REIT: 10% Yield, 40% Upside, Deep In Debt
Net Lease REITs are the third-best performing REIT sector so far this year.
Necessity Retail has not kept pace with Net Lease REITs, but its 4.99% total return has widely outpaced the VNQ thus far.
This 10% yielder has 40% upside, according to Wall Street analysts.
Management went on an epic buying spree in the first half, financing it with debt and share issuance.
This article examines growth, balance sheet, dividend, and valuation metrics for this small-cap REIT.
Net Lease REITs are the third-best performing REIT sector so far this year. According to Hoya Capital Income Builder, Net Lease REITs as a whole have returned a gain of +1.13% YTD, while the Equity REIT average shows a loss of (-12.32)%.
Hoya Capital Income Builder
Necessity Retail's (RTL) 4.99% total return has outpaced the Net Lease REIT sector as well as the VNQ thus far.
RTL Total Return Level data by YCharts
What is the secret of this company's success, and is it likely to continue?
Meet the company
Necessity Retail
Founded in 2013 and headquartered in New York, Necessity Retail is a small-cap Net Lease REIT, with a market cap of $1.07 billion. The company owns 1,057 properties in 48 U.S. states, with just 90.9% occupancy, earning $389 million per year in SLR (straight-line rent), on leases with a remaining average term of 7.2 years. RTL is externally managed by AR Global, which also manages mousetrap REIT Global Net Lease (GNL).
RTL divides its portfolio into 4 segments:
Single-Tenant portfolio (48% of SLR), rented long term to primarily stable investment grade tenants, this segment includes 941 properties, comprising 12.3 million square feet, with occupancy of 95.7% (much higher than the total portfolio average), 9.9-year average remaining lease term, 81% leased to retail and 17% leased to industrial tenants.
Power Center portfolio (28% of SLR) anchored by national brand retailers.
Anchored Center portfolio (13% of SLR) featuring multiple big box stores.
Grocery Center portfolio (11% of SLR), anchored by grocery stores and highly resistant to economic downturns due to necessity-driven and in-person nature of grocery shopping.
RTL website
The Power, Anchored, and Grocery-centered segments, also known as the "open-air portfolio," combine for 113 properties across just 29 states, with 17.0 million square feet, and occupancy of just 87.6%. Only 41% of the tenant are investment grade, and average remaining lease term much shorter, at 4.6 years. However, these three segments still account for 52% of SLR when combined. Management aims to raise occupancy by about 5%, to the low-to-mid 90's.
The overall tenant base is appropriately diversified, with the top customer (Trust Bank) accounting for just 3.9% of SLR, and the top 10 together contributing just under 30%. Tenants include many well-recognized national brands.
RTL website
RTL is highly diverse geographically. Although 57% of SLR comes from the Sunbelt, the balance is spread all across the country, especially in dense suburbs with "community-centric lifestyles." The heaviest concentration is in Georgia, which accounts for only 10% of SLR.
RTL website
Tenants are also highly diverse by industry. Out of 44 industries represented in the tenant base, gas/convenience stores lead the way at just 8% of SLR, followed by discount and specialty retailers, at 7% each.
RTL website
The company's acquisition strategy focuses on:
Credit-worthy tenants with robust unit-level financial metrics and competitive advantages in sustainable industries, and
Locations that serve as a central neighborhood destination for nearby residents,
In secondary U.S. markets with strong growth profiles and demographics.
For their single-tenant segment, they seek service-oriented retail properties. For the open-air segment, they look for necessity-based and downturn-resistant retail.
Management went on a buying spree in H1, adding 79 multi-tenant properties to the open-air segment, and 12 single-tenant properties. The open-air center acquisitions cost a staggering $1.3 billion, growing the company's total square footage by about 10 million, an increase of 45%.
Quarterly results
Here are the Q2 highlights, according to the company's 10-Q for Q2 2022:
Revenue from tenants was up 43.3% YoY (year-over-year), at $116.9 million.
Operating expenses exploded by 144% YoY, to $153.5 million. Property operating expense more than doubled to $27.5 million, G&A expense more than doubled to $8.4 million, and the company showed a huge leap in "impairment of real estate investments," from $91 thousand to $59 million. This impairment charge reflected the company's decision to remove from their books a property in Minnesota that they intend to sell.
Once interest expenses are added in, the company lost $50.5 million in Q2, compared to a loss of "only" $1.5 million in Q2 2021.
Net loss per share was (-$0.43), compared to (-$0.07) in Q2 2021.
RTL increased share count by 19.6% over the past 12 months.
Net cash from operations was $104.6 million, up 60% YoY.
Total capex $1.8 million, down from $4.4 million YoY.
Same-store NOI of $16.5 million, down 13.5% YoY.
Newly-acquired stores posted $21.1 million in NOI.
FFO of $35.7 million, up 42.6% YoY, thanks to acquisitions.
FFO per share $0.27, up 17.4% YoY.
Completed acquisition of $1.3 billion worth of open-air shopping centers.
For the first half of 2022, these are the highlights:
Revenue from tenants of $211.9 million, up 31.8% YoY.
Net operating income of $44.2 million, up 28.5% YoY
Net loss of (-$4.65) million, compared to (-$5.24) million in H1 2021, after factoring in interest expense.
Net loss per share of (-$0.13), compared to (-$0.16) in H1 2021.
Share count increased by 19.1% YoY.
Total assets of $4.7 billion, up sharply from $3.8 billion YoY.
Total capex $5.2 million, down from $6.8 million YoY.
Base rent revenues in 2023 will be $353 million, tapering off each year to just $223 million by 2027.
Company 10-Q for Q2 2022
Rent collections for RTY were hit hard during the 2020 pandemic, but have recovered to 99% as of Q2.
Growth metrics
Here are the 3-year growth figures for FFO (funds from operations), TCFO (total cash from operations), and market cap.
Metric 2019 2020 2021 2022* 3-year CAGR
FFO (millions) $98.6 $97.0 $97.3 $137.2 --
FFO Growth % -- (-1.6) 0.0 41.0 11.6%
FFO per share $0.93 $0.90 $0.83 $1.03 --
FFO per share growth % -- (-3.2) (-7.8) 24.1 3.5%
TCFO (millions) $105.6 $92.7 $145.3 $210.0 --
TCFO Growth % -- (-12.2) 57.7 44.5 25.75%
*Projected, based on H1 2022 results
Source: TD Ameritrade, CompaniesMarketCap.com, and author calculations
The picture above tells a clear story. Of course, like all retail, RTY was hit by COVID, but because of the essential nature of its stores, the setback to FFO was relatively mild, and the 41% surge this year results in double-digit 3-year growth. But FFO/share is another matter, lagging FFO every year, and growing by only 3.5% as an annual average. This means the company is issuing new shares faster than it is growing revenue.
Meanwhile, cash flow took a hit in 2020, but has roared back in each of the last two years at phenomenal rates.
Meanwhile, here is how the stock price has done over the past 3 twelve-month periods, compared to the REIT average as represented by the Vanguard Real Estate ETF (VNQ).
Metric 2019 2020 2021 2022 3-yr CAGR
RTY share price Aug. 15 $12.24 $7.45 $8.57 $8.02 --
RTY share price Gain % -- (-39.1) 15.0 (-6.4) (-13.14)%
VNQ share price $90.25 $81.15 $106.76 $102.26 --
VNQ share price Gain % -- (-10.1) 31.6 (-4.2) 4.25%
Source: MarketWatch.com and author calculations
RTY's share price has underperformed the VNQ in each of the past 3 years. Investors have seen an average annual loss of (-13.14)%, compared to the VNQ's plodding 4.25% gain. RTY's superior dividend yield does not cover that 17.4% gap. It has been a mousetrap of significant proportions.
Balance sheet metrics
Here are the key balance sheet metrics, and this is where RTY presents the greatest cause for concern for investors.
Company Liquidity Ratio Debt Ratio Debt/EBITDA Bond Rating
RTL 1.58 55% 17.4 BB
Source: Hoya Capital Income Builder, TD Ameritrade, and author calculations
The company's Liquidity Ratio of 1.58 is down considerably from the 1.81 mark they held at the close of 2021. The company's total debt for mortgage notes, senior notes, and credit facility loans comes to $2.75 billion as of June 30. The weighted average interest rate is 3.8%. RTL's weighted average debt maturity is 4.6 years, and 83% of its total debt is fixed rate.
The company has cash and equivalents of $87 million through Q2, down from $237 million in H1 2021, despite a $390 million jump in cash from financing in H1 2022. Cash from investments netted (-$686 million) in H1, nearly 10 times the outflow in H1 2021. Total liquidity, including undrawn available credit, stood at just $108 million on June 30.