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Spirit Realty Capital (NYSE: CBC) is a REIT that invests primarily in single-tenant, operationally critical real estate assets throughout the United States. These properties are leased on a long-term triple net basis to tenants in a wide range of sectors. the revenues from these leases are predictable and often increase with the CPI. As of December 31, 2021, approximately 90% of the company’s ABR was subject to rent increases.

For the last quarter ending March 31, 2022, SRC reported funds from operations (FFO) of $0.88, which missed estimates by $0.01. While the guidance for adjusted funds from operations (AFFO) remained unchanged in the range of $3.52 to $3.58, the company increased its forecast for acquisitions at +$1.5 billion and divestitures at a range of +$200 to $300 million.

Over the past five days, the SRC is down almost 4%, having already lost 13% last month alone. Additionally, the current annual dividend of $2.55 per share yields over 6.5%, which is up significantly from the 5.3% yield in 2021. At the current price, the shares are trading at 11 .4x AFFO forward, which is discounted to historical valuations and the industry median of 16.6x.

Anchored by a strong balance sheet with ample liquidity and a diverse tenant base that fully occupies the company’s available space, SRC is a quality REIT that is being mispriced due to broader market anxiety. For income-focused portfolios that need a boost, SRC is a REIT with significant upside potential.

Diverse tenant base with full occupancy

As of March 31, 2022, the CBC held more than 2,000 properties in 35 industries. These buildings had 334 tenants and a collective occupancy rate of 99.8%.

As part of the company’s strategy, SRC strives to maintain a portfolio that derives no more than 5% of its ABR from a single tenant. Currently, this goal is being met, with their largest tenant, Lifetime Fitness, accounting for just 3.5% of total ABR as of their last filing period date. Other notable tenants in the top 20 include BJ’s (BJ), The Home Depot (HD) and Dollar Tree (DLTR).

SRC Q1FY22 Investor Presentation - Top 20 Tenants

SRC Q1FY22 Investor Presentation – Top 20 Tenants

SRC’s diversity of tenants is complemented by long-term lease maturities, which provide an element of predictability to the company’s cash flows. At a weighted average lease term (WALT) of 10.4 yearsSRC’s average is lower than the average of STORE Capital Corporation, which has a WALT of 13.4 years, but higher than the 9.0 years reported for Realty Income (O) and comparable to both WP Carey Inc. (WPC ) and National Retail Properties, Inc. (NNN), which have slightly higher averages.

In addition to tenant diversification, SRC is also diversified across multiple sectors, with a near 50/50 split between retail and non-retail. While overall services account for around 45% of the total TBA, the retail and manufacturing sectors each account for the largest share of the individual TBA at 11.5% and 7.7%, respectively. This offsets some of the risks of being overexposed to retail-related businesses, particularly during times of significant disruption, such as the ongoing COVID-19 pandemic.

SRC Q1FY22 Investor Presentation - Sector exposure

SRC Q1FY22 Investor Presentation – Sector exposure

Efficient deployment of capital

Since 2017, SRC has completed disposals of +$3.9 billion and added +$4.3 billion in assets. Over the years, SRC has identified many mispriced opportunities in the market, which has resulted in a sharp increase in asset values ​​over time.

In the last quarter, for example, SRC added three main events as a tenant. The company now represents almost 2% of ABR. The addition is important because Main Event was recently acquired by Dave & Buster (PLAY). The absorption of Main Event by a publicly traded company is seen as a major credit enhancement that should result in further cap rate compression.

Through strategic acquisitions, such as Main Event, SRC was able to increase its public exposure from 36.7% in 2017 to 53.3% in 2022. Additionally, just over 20% of these companies have investment grade ratings , a critical factor in accessing Capital.

SRC Q1FY22 Investor Presentation - Public Sector Exposure

SRC Q1FY22 Investor Presentation – Public Sector Exposure

Along with greater public exposure, SRC has also gradually diversified away from retail-focused tenants and towards the asset quality and stronger tenant base of industrial and manufacturing assets. In Q1FY22, for example, 37% of SRC’s acquisition volume was attributable to industrials. With these acquisitions, their exposure is now almost 20%, or 120 basis points more than in the previous quarter.

To take advantage of growing demand for certain asset classes, SRC has increased its divestment guidance from +$100m to a range of +$200m to +$300m. Management expects these divestments to contribute to the growth of AFFOs, while reducing exposure to concentrations of underperforming assets, such as retail and offices.

Recognition of market opportunities and management’s ability to successfully capitalize on them has positioned the company strongly in a competitive environment challenged by challenging macroeconomic operating conditions.

Solid balance sheet

For the most recent filing period, the CBC had total assets of +$7.8 billion and total liabilities of just +$3.5 billion. Taking into account unused line capacity, cash and outstanding term equity, SRC had total liquidity of +$850 million and leverage of 5.2x, with a fixed charge coverage ratio of 5.8x.

Form 10-Q - Partial Balance Sheet

Form 10-Q – Partial Balance Sheet

At just under 40% of total assets, SRC’s debt is manageable and allows the company to invest in acquisitions and provide ongoing payments to shareholders. At around 75% of the AFFO, the SRC’s dividend is well covered with minimal downside risk.

In the absence of large short-term maturities, sufficient funds and strong fixed coverage, the SRC’s conservative balance sheet earns it an investment grade rating from all three rating agencies. This has provided a competitive advantage to the CBC in previous periods and should continue to be an advantage in the future.

Risks

As of March 31, 2022, the CBC had a significant geographic concentration in the Southwest and Southeast. Additionally, 13.1% of the ABR was attributable to Texas, the only state to account for more than 10% of the ABR. Due to the high level of exposure, the SRC would be adversely affected if these regions or the State of Texas were to experience a disproportionate level of layoffs or downsizing, industry downturns, corporate relocations and other negative externalities compared to other regions of the country. .

In addition to geographic concentration, SRC also has significant exposure to the discretionary retail and restaurant sectors, with both sectors accounting for over 10% of ABR. Since these industries are sensitive to national and local economic conditions, a deterioration in factors such as consumer spending, confidence and employment, among others, could lead to material weakness in these industries. To the extent that these unfavorable conditions persist, they are likely to have a negative impact on market rents for these types of spaces.

A central point of the SRC’s strategy is to invest in triple net single tenant leased properties. While this structure has advantages, there are specific and significant risks associated with tenant default. Since there is only one tenant, the SRC’s exposure to financial default is high. If a default were to occur, the SRC would not only lose income on the property, but the value of that property would likely decline as well. This could lead to further problems when re-letting or selling the property.

The loss of sole tenants could also result in significant capital expenditures to renovate the building before it can be re-leased to a new tenant. Due to the single-tenant nature of the Company’s leases, many properties have been designed or physically modified specifically for the needs of individual tenants. If the space were required for a different tenant in a different industry, the costs incurred during the renovation would be significant and could reduce the amount of cash flow available for other purposes, such as acquisitions or shareholder payments.

Conclusion

SRC is a quality REIT that achieved an AFFO CAGR of 6.4% from 2019 to 2022. This is better than several related peers, including Realty Income, Store Capital Corporation and WP Carey, which have recorded growth rates of 5.5%, 3.2%, and 1.5%, respectively. Despite the superior growth rate, the AFFO multiple of the CBC was only 12.9x as of March 31, 2022. This is lower than all related peers.

SRC benefited from a fully diversified portfolio that boasts near full occupancy with long-term maturities. Additionally, over the years the company has reduced its exposure to underperforming asset classes, such as retail and office, and increased its holdings of higher quality assets in industrial sectors. and distribution.

Additionally, management continues to capitalize on opportunities that will result in further value appreciation and cap rate compression, the most recent being the addition of Main Event, which is now the company’s 7th tenant per year. ABR.

Even with the significant level of acquisition activity, SRC is still able to maintain a strong balance sheet that includes cash of +$850 million and manageable debt that represents just under 40% of total non-maturity assets. important in the short term.

The SRC is down almost 20% since the start of the year and more than 10% last month. Currently, the shares are trading at their lows and just 11.4 times the lower limit of AFFO futures. At a multiple of 13x, the shares would be worth at least $45. At an industry median of 16.6x, the upside is even bigger at almost 50%. With gains harder to come by in 2022, an investment in SRC could be just what a long-term portfolio needs to lift the spirits.