Retail Opportunity Investments: Taking Advantage Of The Weakness (NASDAQ:ROIC)

Dear subscribers,

Some of you want alternatives for some of the more popular REITs when you’re overexposed to things like Realty Income (O), Agree (ADC), or VICI (VICI). There are great opportunities out there – but you also have to be willing to accept a lower overall rate of return due to lower yield (at least usually).

In this article, I’ll provide you with an update around 2 months after my first article on Retail Opportunity Investments Corp. (NASDAQ:ROIC), a West Coast-focused REIT that has experienced a significant drop in its stock price despite its strong fundamentals.

The company operates real estate assets worth billions at high occupancy rates of over 98% and is mostly focused on grocery-anchored opportunities and shopping centers. The company has significant advantages, including experienced management, potential for growth, and a good valuation-related upside. Since my last article, the company like the REIT sector has dropped in valuation – and quite significantly.

I’m still positive about this company – and now it’s time for an update here!

Retail Opportunity Investment Corp – Still an opportunity in retail

So – BBB credit, low debt, a 5%+ yield at the current valuation, and a solid $1B+ market cap, are the specifics of this relatively undercovered market player. This is despite the fact that the company’s operational specifics have made it the largest grocery-anchored shopping center REIT with a west-coast focus. This last part might not endear it to everyone in the current market, but I have more tolerance with regard to this compared to others.

The company lease rate, or occupancy, despite the weakness in REITs overall, has only reduced the occupancy by 30 bps. The company’s 92 shopping centers are still 98.2% occupied, and its 10.5M square footage leased to 2,038 tenants as of September of 2023, still performing well. Its investment-grade credit ratings are not under negative reviews by any credit agency, and the company has the IG rating from the trifecta – Moody’s, S&P Global, and Fitch.

With the exception of the company’s geographical exposure, the strategy screams being risk-averse here. The company has over 25 years of experience focusing on the West Coast, being grocery-anchored and essentially executing exactly the same strategy for that time. This has brought them knowledge not only about grocery-anchored shopping centers but specifically West-coast shopping center operations. The company has acquired $6B worth of them, and sold $4B worth of them, with the C-suite working together for over 20 years, with 2 successful public REITs under their belt. The precursor to ROIC was Pan-Pacific Retail properties, around 10 years’ worth of public history which grew from $400M to $4B in portfolio value.

Here is the updated portfolio as of September 2023.

The company’s main tenant, by far, is Albertsons/Safeway, which comes in at 5.7% of ABR – the second-largest is Kroger (KR) at 3.4%, and everything else is below 2%. Therefore, the company’s exposures are extremely conservative, and diversified.

In 3Q23, the company managed to generate a same-center NOI growth of 8%. This is above the average for the company, while new leases are showing a rent growth (on a same-space basis) of 36%, with a 7% increase for new overall leases.

So why is the company down so much?

Because, as I see it, the risk-free rate and current macro. Unfortunately, ROIC has a history of trading at a relatively significant premium. If we look at AFFO, these premiums can at times go up to 23-24x, which is very high, but at one time not that long ago was justified for what the company offered.

Not any longer.

The company’s current valuation has gone down to 15x P/AFFO, and at times below that 15x level. Like many other REITs, the increases in interest rates, labor and inflation have, despite the company’s hard work to make sure that earnings remain up, resulted in a negative YoY AFFO result for 2022, and is only expected to grow slightly at around 5% in 2023E, before moderating and even declining slightly in 2025E.

In short, the reason I believe ROIC is being more heavily discounted here is the same reason/s for other REITs being discounted – not because of any fundamental deterioration of safety, but for increased costs translating into reduced rates of returns, and better or equal-level investment at better risk profiles being available.

The safety of the company can be expressed in metrics – the company’s unencumbered (by debt) gross leasable area, or GLA, is 97%. Less than 5% of the company’s debt is mortgage debt. The company has a net debt/annualized EBITDA of less than 6.5x and an interest coverage on the basis of EBITDA of 3x.

This is down slightly, from 3.4x at the end of last year, to 3.0x at the latest quarter. However, total debt is only 43% of total assets. Less than 4% of the company’s debt is at floating rates.

So while results are less, or not as good as historical levels and the future certainly seems to hold more pressure, this is not a bad company or bad results. It’s an 8.2% 3Q23 increase in same-store NOI, and a recently-confirmed dividend of $0.15 per quarter, coming to over 5% yield, which is close to a multi-year high for this business.

The advantages I see for ROIC in this environment are several. First, maturities. It’s not the best in the sector, but it’s also not at anything close to a worrying level given the company’s overall trends. The company’s yield is also now 50 bps higher since when I last wrote about the business.

Any worries or concerns here to be aware of?

The company has pharmacy exposure, for one. I’m not a big fan of pharmacy exposure, given what has been happening to the sector in the last few years. Furthermore, the exposure here is Rite Aid, which might be the worst aside from Walgreens (WBA). Given the ongoing bankruptcy process, the question is how the company will use this space. I’m not massively worried about the company finding tenants here – there’s a queue looking to rent from ROIC (Source: 3Q23 Earnings call), but the question becomes at what leasing rates can you rent out the sort of space that we’re talking about here. Also, as a further reduction in risk, only one location has been rejected by Rite-aid, with significant interest in the space.

The company currently targets, according to comments, a cap rate of 6.5% to 7.5% given the current cost of capital, with the ability to drive rents either through operating efficiencies or solving vacancies, with an 18-month rent improvement of 150 bps. This would put the company in an 8-9% cap rate, financed as follows for the forward period.

Financing is done through a combination of OP units, and we do have an OP in the transaction that I believe will come to fruition now. If not in the first quarter, in the second quarter of next year, certainly at a stock price that will be higher than where our stock is currently trading. But it’s a combination of that transaction, OP units, a combination of selling some more assets and our ATM. That’s how we’re going to help finance the upcoming opportunities, as we look into the end of this year and into next year.

(Source: ROIC 3Q23 Earnings call)

The company will come with official 2024E guidance during the year-end call in a few months. At that point, we’ll know more – for now, the company is in a better valuation-related position, which might make it a good alternative for investors looking for alternatives.

Let’s see what the upside is here.

ROIC – There’s a good ROR from ROIC.

As I said, the typical valuation for this REIT comes to a fairly high premium. Looking at the 15-year AFFO multiple, we’re seeing 23x. The current is at 15x. A 5-year average is around 20x, and the upside to that 20x is around 20%, with a total 50% RoR until 2025E.

The main problem with investing in ROIC is simply the fact that there are objectively better businesses available at either better valuations, better yields, better upside, or a combination of all of these things. It’s not a bad opportunity – not in the least – but we’re simply in an environment where despite no longer being at a crash-level valuation for many REITs, there are still excellent investments out there.

This leaves the company with a niche appeal and for those looking to diversify their portfolio – which ROIC can certainly do for your portfolio.

I still have a small position in the business – I have not yet expanded this position, though I may do so next week, as the FX trends have started to normalize once again, making USD/CAD investments more and more attractive.

When I invest I am primarily focused on the underlying asset quality and company quality of what I buy. Valuation then decides whether the company/these assets can be bought or not. But this valuation is then put into the context of the broader market – and that’s where other opportunities are somewhat better than ROIC.

However, here is the upside to a forward 20-21x P/AFFO, meaning we have at least the 15% annual upside that we’re looking for when investing in any company.

ROIC has a current S&P Global target range starting at $12 and going up to $17. I would put a fair target value at around $15, (which is $1 lower than previously due to the somewhat lower growth estimate and the more difficult macro). This still puts us in the double digits in terms of average. S&P Global average is around $13.6.

At iREIT on Alpha, we give the company a PT of $18/share. So between $15-$18/share, I believe this company has a decent upside and may give you outperformance.

Still, I believe other REITs are worth looking at more than ROIC here – so be careful when you invest.

Here’s my updated thesis for the company.

Thesis

• ROIC, or Retail Opportunity Investments Corp, is a REIT out of the West Coast with an investment-grade credit, over 5% yield, and a portfolio that’s attractively exposed above all to grocery anchors. The company’s solid performance speaks in favor of investing in this business as it navigates the challenging macro we find ourselves in.

• While I would not call this company the first investment anyone should make, ROIC offers meaningful diversification for those already invested in other companies, or those wanting higher West Coast exposure with a doubled-digit potential combined upside from yield and reversal.

• This company does not miss or fail its estimates or forecasts. Combined with the solid track record of management, I rate ROIC a “BUY” here, and would give the company a target of at least $15/share.

Remember, I’m all about:

1. Buying undervalued – even if that undervaluation is slight, and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.

2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.

3. If the company doesn’t go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.

4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them (italicized).

• This company is overall qualitative.

• This company is fundamentally safe/conservative & well-run.

• This company pays a well-covered dividend.

• This company is currently cheap.

• This company has a realistic upside based on earnings growth or multiple expansion/reversion.

This REIT currently fulfills all of my demands when it comes to a company I’m looking to invest money into.