NNN REIT (NYSE:NNN) is one of the first REITs I ever bought when I switched my strategy to strictly investing for income. One thing that stood out to me was their conservatism. The company never blows earnings out of the water, nor is it super popular amongst investors. In comparison to peer Realty Income (O), whom I also hold and enjoy, NNN seems to fly under the radar. And one thing I enjoy about the company is they just continue to perform. Nothing flashy, just a steady eddy blue-chip stock that helps me sleep well. During their close out earnings for 2023 they continued this trend, showing why they’re one of the best in the business.
I last covered NNN REIT back in November along with another favorite in the sector of mine, Agree Realty (ADC) in an article: Solid Earnings Show Why Both SWANs Are Great Buys Right Now. Since then, NNN is trading roughly $1 higher than the share price at that time.
The company had recently reported their Q3 earnings and delivered another solid quarter, beating FFO estimates by $0.01. Because of high interest rates, the stock had fallen to an attractive level around $39 a share presenting investors with a great buying opportunity. Fast-forward 3 months later, and I still think the stock is attractive here.
The REIT’s revenue fell short of analysts’ estimates during Q3, but management still raised FFO guidance during the quarter, showing the company’s resiliency in a challenging environment.
They also continued growing their portfolio with additional properties at an attractive cap rate of 7.4%, impressive considering the current environment. And although the sector seemed to shift positively very briefly, prices have retracted since the last Fed meeting.
Well, for starters, the REIT has a long track record of success. And despite the macro environment, NNN continued to perform exceptionally well, growing their portfolio. And this continued in Q4 to close out the year.
During Q4, they increased their FFO by $0.04 from the last quarter and also beat analysts’ estimates by $0.04. FFO of $0.85 rose quarter-over-quarter from $0.81 and from $0.80 year-over-year.
Revenue of $216.23 million also rose quarter-over-quarter by 5.4% and nearly 9% year-over-year, again showing their resiliency and consistency in the past year while REITs have been out of favor with investors. Furthermore, the strong year allowed for the company to surpass management’s FFO estimates of $3.19 – $3.23 for the full-year with $3.24.
They also deployed nearly $1 billion in capital this year, with $800 million in investments. And even though this is slightly less than the $848 million deployed last year (a record year), I find this especially impressive considering high interest rates, where it has made it difficult for some to make acquisitions at attractive spreads. Furthermore, this is higher than the last 5 years, with the exception of last year.
You can see in the chart below, their portfolio has consistently grown in the past year from 3,449 to 3,532 free-standing properties at the end of Q4. That’s a growth rate of 2.4% which is something I like to see, although this may not be appealing for some investors.
They also sold 19 existing properties for a gain of $7.3 million. The 40 additional properties acquired had an impressive cap rate of 7.6% and an average lease duration of nearly 20 years. These also had a long-term yield of 8.9%. One reason NNN is able to acquire companies at an impressive cap rate despite the challenging environment is the company focuses more on non-investment grade tenants, unlike peers like Realty Income or Agree Realty.
Investment-grade tenants usually have more bargaining power due to their status and well-known brands, so seeking lower-quality tenants has its advantages also. Management touched on cap rates becoming more challenging the last 60 days because of the macro environment and pressure from competitors. When rates do decline, sometime this year in my opinion, cap rates will likely stabilize, making it more enticing for REITs to acquire additional properties at more attractive spreads.
As a REIT investor, one metric I’m sure most consider is the safety of the dividend. Can the company continue acquiring properties to grow the portfolio, leading to FFO & AFFO growth? Do they maintain a consistent payout ratio that gives them ample room to continue growing it for the foreseeable future? These are all things I look for when investing in REITs, and not just the high-yield that some offer.
And even if they do offer a high-yield, is it sustainable for at least 4-5 years? This is something I look at when investing into any company, not just a REIT. As I’ve stated before, my plan is to hold my stocks forever unless the fundamentals change.
For the full-year, NNN’s FFO & AFFO payout ratio equaled 68.8% & 68.4% respectively, conservative for a REIT. Although they are required to pay out a substantial amount of cash flow in the form of dividends by law, I prefer my holdings to retain a good amount to reinvest back into the business. And a lower payout ratio allows that. For the year, the company retained $187 million in free cash flow after dividends and expenses. That’s in comparison to the last 5 years where they retained an average of $135.2 million.
I typically like to see a payout ratio in the 70s, but the 60s is even better. But, some REITs prefer to payout more of their cash in the form of dividends. One example is Easterly Government Properties (DEA). I recently wrote an article touching on the REITs payout ratio (read here), which was above 90% at the time. Soon after, I had the luxury of speaking with their CEO, Darrell Crate, who informed me the company prefers to have a higher payout ratio because of their REIT classification. Again, no knock on DEA, as I used to own shares of the company early in my investing journey.
With a current dividend coverage ratio of 1.50x, this is slightly below popular retail peer and Dividend King, Federal Realty Investment Trust’s (FRT) 1.51x. And Brixmor Property Group’s (BRX) 1.83x. Both NNN and FRT have much longer dividend streaks than Brixmor.
During their latest earnings, management called for what seemed to be soft guidance, with FFO expected to be in a range of $3.25 – $3.31. AFFO is expected to be $3.29 – $3.35. This is in comparison to the $3.19 – $3.23 guidance they set during Q3 earnings. Although this $0.01 higher than this year’s FFO, I suspect management is being conservative to manage expectations.
It’s better to undersell and outperform than to be too overly optimistic and miss expectations. But anything can happen between now and then. One reason for the soft guidance is management projects $80 to $120 million of dispositions and G&A expenses of $46 to $48 million.
I expect guidance to come in near the top or exceed like years before. NNN’s management likes to set a guidance then drift this higher quarter-over-quarter, and I expect 2024 to be no different. If rates decline as expected, the company could post a large beat in the second half of the year.
Strong Balance Sheet
With the strong investment activity in 2023 from NNN, investors may be worried how these were funded. As you may know, REITs use debt to fund some of their acquisitions, it’s just part of their business model. But investing in a fiscally conservative REIT like NNN REIT who likes to retain cash, they have a smaller chance of taking on a huge debt load to continue growing.
Of the $800 million for the full-year, the company funded 37% with free cash flow and disposition proceeds. This is why a lower payout ratio is a very important metric when looking to invest in REITs. Yes, some pay out higher cash flows in the form of dividends, but that’s less cash to use to fund future growth.
At the end of the year, NNN’s net-debt-to EBITDA ratio of 5.5x remained the same from Q2. Their interest and fixed-coverage charge of 4.5x also remains strong, down slightly from 4.6x in the middle of 2023.
And although they have $350 million in debt due this year that they will likely have to refinance at a higher rate, their liquidity profile remains strong with nearly $1 billion available on their $1.1 billion credit facility.
Great Price Currently
Under $40 a share where NNN currently trades at the time of writing, NNN is a great buy in my opinion. Matter of fact, I added to my holding today as the stock dipped below $40. In fact, I like NNN at $40 or below and typically add when shares dip below this price.
At a P/AFFO ratio of 12.2x, the stock is trading below its 5-year average of 14.5x and the sector median of 13.31x. Furthermore, their dividend yield of 5.67% is above their 5-year average of 4.83%. This is also above peers Federal Realty and Brixmor’s 4.30% and 4.66% respectively.
One thing of note, before the start of rate hikes, NNN was trading above $50 a share and if rates are indeed cut, and we avoid a recession, I can see the price moving closer to that range in the foreseeable future. But until rates are cut, I suspect NNN and peers’ prices will remain suppressed.
Using the Dividend Discount Model and a WACC of 7.5%, this gives me a price target of nearly $46 for NNN. This is roughly in between analysts’ average and high price targets for the REIT. I also expect NNN to conduct a penny and a half increase to $0.58 per share. This is $0.01 higher than the $2.28 estimate.
Risk To Thesis
With the recent retraction due to negative sentiment surrounding interest rates, this caused many in the sectors’ prices to fall from the brief rally they experienced. And with a rate cut seemingly out for March, rates will continue to be a headwind for REITs.
Some are now predicting a cut sometime in May, but of course, this is all data dependent and a lot can happen in 3 months. If the FED doesn’t cut rates in March or May, I suspect REITs will fall even further from their current prices.
Besides price suppression, higher for longer rates will also make it more difficult for some to make acquisitions. Some will have to refinance their debt at higher rates, as seen by NNN’s debt maturing this year. All of these combined will continue to weigh on share prices for the foreseeable future. And even for a stock as resilient as NNN REIT, this could also lead to higher vacancies in their portfolio.
Many REITs are now trading at attractive valuations well-below their 5-year averages. Despite their suppressed prices, their financials quarter-over-quarter have remained resilient. Additionally, those with strong balance sheets like NNN, although they will likely have to refinance at higher rates, their strong liquidity profiles allow them to navigate the current macro environment.
Furthermore, NNN continues to perform, acquiring additional properties at attractive cap rates due to their experienced management team and investment-grade balance sheet. Investors looking to buy this REIT get a near 6% dividend yield that is secured with a very low payout ratio. With their long track record of success, strong management team, and dividend yield above their 5-year average, NNN REIT remains an attractive buy with decent upside.