NNN REIT: A High-Quality REIT To Buy Now On Sale (NYSE:NNN)

Hard truths. Some people avoid them. Some people find liberation in them. I tend to fit in the latter group.

One of the tougher truths of life that applies to personal finances is as follows: As long as there is life, bills tend to follow not far behind.

Upon entering adulthood, this becomes a distressing reality for many. Unless somebody has someone who sets them up with a carefully constructed multi-million-dollar trust fund, they will probably have to work to financially support themselves.

And as long as they are dependent on a paycheck to live, they will never truly be free to pursue their passions. This is what makes it so important to 1) live with no debt to minimal debt 2) live below means 3) save and invest money.

I believe that is the path out from under financial servitude and into financial freedom. Since I write investing articles and I trust that my audience is generally up to speed on those first two steps, I’m going to focus more on that third step.

There are many ways to construct a portfolio that can throw off passive or relatively passive income. Some people chart their paths in real estate and invest money that way. Others are interested in alternative options like royalty investing or peer-to-peer lending.

Now, I’m a dividend growth investor. I also presume most people also are who read my articles here on Seeking Alpha, but this isn’t to say that my way is necessarily the right way.

In my seven years of investing thus far, I have built a dividend growth portfolio that covers approximately a third of my expenses. In those first two years, I was even finishing up my final two years of undergrad and paying tuition in full.

On a separate note, thank God I get along with my parents, and they have been kind enough to let me live with them throughout the years. I haven’t reached the financial promised land yet, but I’m living proof that the dividend growth investing strategy can work.

Accounting for a 0.6% weighting, NNN REIT (NYSE:NNN) (formerly known as National Retail Properties) is one holding within my 100-stock portfolio. When I last covered NNN with a buy rating in October 2020, I was impressed by its 31 consecutive years of dividend growth and the consistency of the business model.

Today, I’ll be revisiting this REIT’s fundamentals and valuation to explain why I’m keeping my buy rating. Briefly, this has to do with the dividend growth streak extending to 34 years. The results for 2023 and positioning for the future give me confidence. Lastly, the current valuation appears compelling.

A Decent 2023 And Balance Sheet Flexibility

NNN’s 2023 was what I would expect from a quality REIT.

The company’s core FFO per share grew by 3.8% over 2022 to $3.26 in 2023. On the surface level, this isn’t exactly inspiring. As is the case with many aspects of life, context is everything, though.

From my perspective, NNN’s results are a testimony to the viability of the business model. The quality and defensive nature of NNN’s 3,500+ retail property portfolio helped to hold occupancy above 99% throughout 2023.

It’s also worth noting that NNN also can grow core FFO per share by 1.5% annually through organic means. This is because, according to CFO Kevin Habicht’s remarks in the Q4 2023 Earnings Call, contractual rent increases average 1.5% annually.

In its 39-year operating history, the company has operated in just about every economic environment possible. Recessions, high inflation, typical inflation, low inflation, deflation, a pandemic. You name it, NNN has probably been through it.

Every time, the company has also adapted to these circumstances. Per FAST Graphs, NNN’s core FFO per share has risen in all but two years since 2004.

The calendar year 2023 was no different. What disruptive factors were going on last year?

As I noted in a recent article on Realty Income (O), 10-year U.S. Treasury notes (US10Y) are key to financing for REITs and executing deals. Like its peers, NNN had to navigate a volatile interest rate climate.

This made it more difficult to execute deals. Yet, the company still closed on $819.7 million in property investments in 2023 at an average initial cap rate of 7.3%, with 18.8 years remaining on these leases.

The REIT also wasn’t closing acquisitions just for the sake of closing acquisitions, either. NNN leveraged its BBB+ credit rating from S&P on a stable outlook to issue $500 million of 5.6% notes due 2033 last August. This was only a roughly 150 basis point premium to 10-year notes at that time. Relative to its 7%+ cap rates, that’s a solid investment spread.

Heading into 2024, NNN had $968 million of availability on its $1.1 billion bank credit line. Earlier this month, that credit line was upped even further to $1.2 billion. When this credit line matures in April 2028 (there is the option to extend it to April 2029), the amended facility could be up to $2 billion. Simply put, NNN has the credit available (and a low enough dividend payout ratio) to keep funding deals for future growth.

The FAST Graphs analyst consensus is that core FFO per share will edge 1.2% higher in 2024 to $3.30. This is expected to grow another 3.3% in 2025 to $3.41 and an additional 2.6% in 2026 to $3.50. To me, bolt-on acquisitions and contractual rent increases seem to make these reasonable earnings inputs (unless otherwise noted or hyperlinked, all details in this subhead were sourced from NNN’s Q4 2023 Earnings Press Release and NNN’s February 2024 Investor Presentation).

Shares Are A Good Value

NNN isn’t just a reliable REIT. It also looks to be discounted in more ways than one.

The stock’s five-year average dividend yield is 4.8%, which would suggest a fair value of $47 a share. Because dividends tend to drive the bulk of total returns for REITs, I think dividend yield theory is a sensible valuation method.

The last five years have seen a variety of interest rate policies from the Federal Reserve. That includes a zero interest rate policy, a more normalized interest rate policy, and the current higher rate policy. Along with stable fundamentals, this is why I think a reversion to the five-year average could begin with eventual rate cuts.

Additionally, NNN also looks cheap via the P/FFO ratio. The current P/FFO ratio of 12.5 is well below the 10-year normal P/FFO ratio of 17.4. Even when factoring out the higher teen multiples when rates were zero or near zero, I think a return to a multiple of 15 is a reasonable projection.

I will be using the $3.30 core FFO per share consensus for 2024 and the $3.41 core FFO consensus for 2025 as earnings inputs. As I explained earlier, I think NNN’s business model can support and sustain this type of growth.

The stock market tends to focus on the next 12 months in pricing stocks. So, weighting for the 67% of 2024 that’s left and 33% of 2025 ahead ($3.34 weighted average core FFO per share x a 15 valuation multiple), I get a weighted fair value of $50 a share.

Averaging out these two fair values, I get a fair value just shy of $49 a share. This would represent a 16% discount to fair value from the current $41 share price (as of April 26, 2024).

Counting On More Slow And Steady Dividend Growth

Even in this environment, NNN’s 5.5% forward dividend yield makes it an appealing option for income. This is moderately above the real estate sector’s forward median yield of 4.8%. That is adequate to earn NNN a B market from Seeking Alpha’s Quant System for forward dividend yield.

NNN’s dividend payout ratio in the high-60% range is also below the 90% that rating agencies prefer from REITs. This arguably positions the dividend for modest future growth as well.

Taking the company’s $3.28 core FFO per share midpoint for 2024 ($3.25 to $3.31), the payout ratio would be 69.8% for the year. That assumes a 2.7% raise in the quarterly dividend per share to be announced this July to $0.58.

Risks To Consider

NNN is a fundamentally fine REIT. Like any investment, however, there are risks to the investment thesis.

For one, NNN is somewhat geographically concentrated. In 2023, the company derived 41% of its annual base rent from just five U.S. states. This included three sunbelt states (Texas, Florida, and Georgia) and two rust belt states (Illinois and Ohio) (page 10 of NNN’s 10-K filing).

If these geographic areas experienced substantial natural disasters, this could interrupt operating results. The company’s properties could also possibly be damaged beyond their commercially insured amounts. This could harm NNN’s fundamentals as well.

Any major regulatory changes to the way that REITs must conduct business in these states could also weigh on the company’s results.

NNN’s top five tenants (7-Eleven, Mister Car Wash, Camping World, Dave & Buster’s, and LA Fitness) also comprised 19% of the annual base rent in 2023. If any of these tenants experienced financial difficulties, there could be at least a temporary impact on the REIT’s performance. This is because affected properties may require renovations to attract and accommodate new tenants.

Summary: NNN Is An Income And Valuation Multiple Upside Story

Given the macroeconomic situation, NNN is a stock that probably won’t go anywhere fast. Until rates do start to ease, I’d expect shares to be stuck in the high-$30s to low-$40s.

But I like that while I’m waiting for the valuation multiple to re-rate higher, I’m getting paid a reliable nearly 6% yield. This is why I’m reiterating my buy rating for NNN stock right now.