Stock Analysis: Realty Income (O)

Realty Income Corporation (O) engages in the acquisition and ownership of commercial retail real estate properties in the United States. The company leases its retail properties primarily to regional and national retail chain store operators. Realty Income is a real estate investment trust widely known among its investors as the monthly dividend company. The company is a dividend achiever, which has increased its dividend for 16 years in a row by raising its monthly distributions several times per year.

Over the past decade this dividend growth stock has delivered a total return of 15% per annum to its shareholders.

Realty Income owned 2496 retail properties at the end of 2010. The company’s properties which are leased by 122 retail and other consumer businesses in 32 industries are located in 49 states. Most new properties acquired are under long term leases (15-20 years) with tenants from a variety of industries and geographic location. The average remaining lease life was 11.4 years in 2010. Tenants are typically responsible for monthly rent and property operating expenses including property taxes, insurance and maintenance. In addition, occupants are also responsible for future rent increases based on increases in the consumer price index, fixed increases or, to a lesser degree, additional rent calculated as a percentage of the tenants’ gross sales above a specified level. Due to the stability of company's revenue streams and above average yield, the company might be a good pick for investors who are seeking current retirement income.

As a Real Estate Investment trust, the company has to distribute almost all of its net income to shareholders. An important metric for evaluating REITs is Funds from operations (FFO), which stood at $1.83/share in 2010. Realty Income distributed $1.722 /share in 2010. FFO is defined as net income available to common stockholders, plus depreciation and amortization of real estate assets, reduced by gains on sales of investment properties and extraordinary items. The company doesn’t have any debt maturing until 2013 and also has an unused credit facility worth $425 million.

Over the past decade FFO has increased by 3.90% on average.

Over the past decade distributions have increased by 4.90% per annum. A 5% annual gowth in distributions translates into dividends doubling every 14 years. In 2010 the company has raised distributions by 0.90%.

The FFO payout ratio has increased to 94.10% in 2010, which is higher than the range over the past decade. In addition, FFO payout ratio of over 90% is not very sustainable for a real estate investment trust.

The main risk for the company is if occupancy rate decreases. About 3% - 4% of the company’s properties face lease expirations each year, which is why it has to be able to find new tenants. The company could try to sell properties which are not occupied currently however, which might be problematic in the current market for real estate. The portfolio occupancy rate for Realty Income hit a record low of 96.60% in 2010, which was down slightly from 96.80% in 2009. Another negative for the company is the fact that it typically expands its operations through additional sales of its common stock, which dilutes the stakes of existing stockholders.

Realty Income acquired 186 new properties in 2010 for $713.5 million dollars. The average lease term was 15.70 years and the initial weighted average lease rate was 7.90%. The company’s strategy is to acquire existing seasoned properties, which are already profitable and where profits far exceed the rent the retailer pays to Realty Income. This characteristic makes it more likely for the retailer to renew their lease after the 15 -20 year term is up. In addition to that, the company is spending a lot of time, effort and research to uncover new areas of investment which would allow the company to increase FFO and dividends.

Realty Income has also acquired 13 properties so far in 2011 for $18.40 million and also has signed definitive purchase agreements to acquire 33 additional properties for $544 million. The tenants of these properties include Caterpillar, FedEx, International Paper, Walgreen Co, Cinemark, T-Mobile, Coca Cola Enterprises and others.

The company owns and actively manages a diverse mix of properties, which provide a stable and dependable income stream for the company’s shareholders. Realty Income currently yields and has raised distributions and FFO’s for over 16 years in a row. I believe that Realty Income is a good addition to any dividend growth portfolio, since it provides growing income and also provides diversification into commercial real estate.

Full disclosure: Long O

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- Four High Yield REITs for current income

- Dividend Portfolios – concentrate or diversify?

- Are Dividend Investors Stock Pickers?

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