3 Reasons I Changed My Mind And Bought Modiv Industrial Stock (NYSE:MDV)

Modiv Industrial (NYSE:MDV) is a unique, small-cap net lease real estate investment trust (“REIT”) that focuses almost exclusively on manufacturing properties in the United States.

In my three previous articles on MDV, I rated it a “Hold” and advocated buying its high-yielding 7.375% Series A Preferred Stock (MDV.PR.A) instead. After all, at the time I recommended it, MDV.PR.A still sported an 8%+ yield and over 10% upside to par value. Not bad!

However, over the last year or so, a lot has changed.

1. The preferred stock has risen in price to become less appealing.
2. MDV sold a portfolio of non-core properties and rebranded itself as “Modiv Industrial.”
3. MDV has positioned itself to benefit rhetorically and financially from the trend of reshoring.
4. MDV’s simplified and focused story makes it a more appealing buyout prospect or joint venture partner.
5. Although debt is on the high side at a net debt to EBITDA of 6.7x as of Q3 2023, there are no significant maturities until 2027, and the ~$3 million of mortgage principal maturing in 2024 will likely be repaid with cash on hand.
6. The somewhat odd consideration of Generation Income Properties (GIPR) preferred stock was converted into common stock and distributed out to MDV shareholders already, which removes a complication.

I consider these to be big, important developments that made MDV more appealing as a long-term investment. Thus, I decided to buy MDV when the stock price dropped after the GIPR stock distribution ex-dividend date in mid-February. Since then, the stock price has steadily crept back upward while the broader REIT index (VNQ) has trended down.

Based on my estimated run-rate AFFO per share of $1.32, MDV currently trades at a price to AFFO of 11.3x, which gives it about 20% upside to my fair value estimate of 13.5x AFFO.

Meanwhile, the annual dividend of $1.15, paid monthly, should continue to be covered with a payout ratio in the 85-95% territory until the portfolio stabilizes. That makes the 7.7% dividend yield attractive.

But why buy MDV now? The REIT reports Q4 2023 earnings on March 4th. Why not wait for more clarity?

While that is of course an option, it should be noted that MDV’s strongly shareholder-aligned management team always make a vigorous and passionate case for the company, which is what I expect this time as well. Their infectious optimism combined with any news on major value creation efforts via a strategic JV partnership could give the stock price a boost. Thus, I am buying shares in advance of the earnings report.

With that said, let’s cover the three reasons I decided to buy MDV.

1. Doubling Down On The Manufacturing Real Estate Niche

The first year after MDV went public, the REIT’s portfolio was diversified across office, industrial, and retail — much of which were vestiges of previous investment vehicles (such as the former Rich Uncles crowdfunding platform) and management teams.

While single-tenant office properties are unappealing for risk-related reasons and MDV lacked the cost of capital to focus on investment grade retail, the REIT ultimately settled on the more under-the-radar niche of net lease that is manufacturing properties. These are not typically huge factories or steel mills but rather mission-critical light-assembly facilities for their tenants.

MDV carved out a smart investment strategy that targeted sale-leasebacks of manufacturing facilities leased to industrial tenants with long histories of operating at these properties. Also, since most non-investment grade industrial businesses are sponsored by private equity backers, MDV focuses on PE sponsors with good track records and a commitment to long-term value creation for their businesses as well as themselves.

Moreover, MDV hunts for business-tenants that produce goods in essential industries such as infrastructure, auto parts, aerospace & defense, technology hardware, and light metal fabrication.

For example, MDV’s largest tenant, Lindsay Precast, produces concrete and steel molds for highway guardrails, overpasses, commercial construction projects, and utility equipment pads. It has a long history of operating at the locations MDV now owns, and it could even benefit from increased infrastructure spending in the US.

This portfolio is carefully curated. As previously stated, MDV tries to avoid PE-backed businesses in which the PE sponsor is seeking a sale-leaseback primarily for financial engineering purposes, such as a dividend recapitalization that adds no value to the business itself.

Often, these PE sponsors pursue sale-leasebacks to free up capital for expansion purposes, which theoretically should increase the creditworthiness of the tenant.

Of course, by nature of their being little competition for these properties, MDV is able to secure attractive lease terms via these sale-leasebacks. That is how the REIT boasts a ~14-year weighted average remaining lease term as well as ~2.5% weighted average annual rent escalators.

2. The Balance Sheet Is Stronger Than Leverage Metrics Would Imply

MDV’s net debt to EBITDA sits at 6.7x as of Q3 2023, which is definitely on the high side for net lease REITs.

To be fair, EBITDA tends to jump around a good bit each quarter because of the moving pieces involved in MDV’s portfolio recycling and refocusing efforts, so it is difficult to say where MDV’s net leverage ratio will settle out when the portfolio recycling is complete.

That said, even with elevated leverage metrics, the balance sheet is actually quite well positioned. As of Q3 2023, 100% of debt had effectively fixed interest rates, and exceedingly little debt matured until January 2027.

Obviously, the revolver has quite a high interest rate, but as of the end of Q3 2023, MDV had nothing drawn on it. Management will likely use it sparingly or not at all until the Fed cuts interest rates.

The mortgage attached to the OES property, maturing in March 2024, had only a touch over $3 million still owed. This one will likely be paid off with cash on hand at maturity.

Finally, by far the biggest source of debt financing for MDV is its $250 million term loan, which is really two different loans with a weighted average interest rate of 4.53%. The term loan matures in three years, giving plenty of time to renegotiate or extent that debt.

3. Potential For Buyout Or Strategic Joint Venture

Finally, MDV has a potentially significant catalyst ahead as it is on the hunt for a strategic joint venture partner. If it does manage to secure such an agreement, this would free up a large sum of capital with which to expand its portfolio. Also, it would open a new stream of income from asset management fees.

According to the end-of-year business update, MDV has entered “nine separate nondisclosure agreements with a list of potential strategic partners and have provided them access to our due diligence items.”

MDV is seeking a major joint venture partnership “that would be conducive to the long-term increase in our tradeable float and market capitalization.”

For a large REIT like W. P. Carey (WPC), which internalized its managed assets a few years ago, being an asset manager in addition to a direct property owner can be a disadvantage by complicating the balance sheet and splitting management’s attention. But in the case of a tiny REIT like MDV with a weak cost of capital, forming a strategic JV could be just the transformative move it needs to greatly increase its portfolio, share float, and valuation.

MDV trades at an AFFO yield of 8.9% right now, which is as high or (likely) higher than the cash cap rates MDV could obtain on acquisitions. If a major JV partnership managed to raise MDV’s equity valuation to a sufficient degree to make accretive acquisitions via equity issuance possible, it would be a huge win for MDV.

Of course, given MDV management’s strong shareholder alignment, it also would not be surprising to see them accept a premium buyout offer if all other avenues of attempted shareholder value creation have been exhausted.

A buyout may limit long-term appreciation potential and instead simply reward shareholders with a short-term pop. But there would be potential buyers for MDV.

For example, alternative asset manager Blue Owl Capital (OWL) recently expressed interest in exactly MDV’s target property type in their Q4 2023 conference call:

Our more recent real estate funds have invested heavily into the demand created by the on-shoring movement. With geopolitical tensions and supply chain issues continuing to dominate headlines, companies have elevated on-shoring to the top of their priority list. This $1 trillion opportunity represents, in our view, not a moment in time, but a transformational manufacturing renaissance in the U.S.

Would OWL be interested in a buyout of MDV at a premium to MDV’s current valuation? Perhaps. But I suspect that MDV’s management would only accept such a deal if they have exhausted all other options and if the buyout offer came at a nice premium to the current stock price.

Bottom Line

MDV does have some weaknesses, including ones I’ve pointed out in the past. Most notably, its cost of capital is too high to make acquisitions accretive. Once the portfolio recycling is complete, it is difficult to see how the REIT will generate meaningful growth — unless, of course, investors push up the stock price and/or a major JV partnership is secured.

That said, MDV also enjoys some notable strengths:

• Valuable US manufacturing assets
• A focused strategy that theoretically benefits from reshoring
• A highly motivated and shareholder-aligned management team
• The ability to capture attractive lease terms such as long tenures and high annual rent escalations
• A well-structured balance sheet with almost no debt maturities until 2027
• A consistently covered, 7.7%-yielding dividend

To my mind, MDV’s strengths outweighed its weaknesses and risks, which is why I decided to buy shares recently.

If management have good news to share in their Q4 2023 earnings report, then it might prove to be a good idea to buy shares in advance of it.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.