STORE Capital stock: 6% dividend compensation for the Corona-Crash

STORE Capital Corporation (STOR) rents mainly to service providers, such as restaurants, fitness clubs and movie theaters, but also to retailers and the manufacturing industry. STORE Capital’s business model consists of the acquisition of properties and their long-term rental. For you as a long-term dividend investor, STORE Capital can be an interesting and lucrative investment if there is a general recovery and STORE Capital is able to continue to lease its properties at attractive prices without significant payment defaults.

STORE Capital stock
Logo
Country	USA
Industry	Retail
Isin	US8621211007
Market cap.	5.8 billion USD
Dividend yield	5.9%
Dividend stability	0.92 (max. 1.0)
Earnings stability	0.95 (max. 1.0)

The business model: How STORE Capital earns money

Store Capital is an equity Real Estate Investment Trust, whose acronym “STOR” stands for “Single Tenant Operational Real Estate”. In contrast to, for example, Realty Income (O), the “Monthly Dividend Company”, STOR finances and leases predominantly to small and medium-sized enterprises (SMEs). Realty Income, on the other hand, leases to large chains such as Walgreens or Dollar General.

STOR is one of the few single-tenant REITs. This means that the property is usually leased to a single tenant who, in addition to the mandatory rent, also pays for the operation of the property and all other maintenance costs such as insurance, taxes and maintenance. Generally, these rental agreements are long-term, which makes cash flows reliable and predictable, as the rent automatically increases over time due to rent escalators often built into these agreements.

Basically, this is one of the simplest business models you can imagine. Companies like STORE Capital finance the purchase of lucrative and attractive properties and then lease them. The delta between financing costs and rental income minus other expenses is booked as profit. As rents increase over time due to the built-in rent escalators and financing costs remain stable thanks to the predominantly fixed-interest loans, income gradually increases over time.

STORE Capital owns over 2,500 properties in the USA with over 490 different tenants in over 110 different industries and boosts an occupancy rate of over 99%. STORE is thus broadly diversified in nearly all states in the USA with geographical concentration in the metropolitan areas on the East and West Coast, Texas, and in the Detroit and Chicago areas.

Geographically dispersed Portfolio with consistently high occupancy rates

STORE Capital’s portfolio is divided into three major segments: Service (65%), Retail (19%) and Manufacturing (16%). The largest share in the service segment is accounted for by restaurants and childcare education, which together account for approximately 20% of rental income of the entire portfolio and comprise more than 800 properties. The retail segment is dominated by furniture stores and markets for agriculture, hunting and fishing which generate approx. 11% of rental income. The manufacturing segment consists mainly of the metal and plastic processing industry as well as tenants from the food industry.

STORE Capital 2019 Annual Report

The Corona crisis led to numerous temporary closures of entire industries, which resulted in heavy rent losses since end of March. Before COVID-19, the most important indicator for assessing a REIT was not revenue or profit, but funds from operations (FFO). Profit is not a meaningful measure, as it is heavily distorted in the case of REITs by high write-downs on real estate assets. However, depreciation on real estate neither reflects an actual loss in value nor does it cost the REIT real money. For this reason the reported profit is not suitable for measuring how much cash a REIT generates bottom-line; after all, the dividend is financed by real money. FFO, on the other hand, is calculated by adding depreciation and amortization to the income and then subtracting all profits from sales. This is therefore also the more meaningful parameter for valuing REITs – more on this later.

In times of COVID-19, FFO continues to play an important role. But even more important at present is rent coverage. STORE Capital provides monthly updates on this and reported rent coverage of 70% in April and 67% in May. In other words, STORE Capital has received on average just over 2/3 of the contracted rent for these two months. Just below ¾ of the rent losses are attributable to the six core industries of restaurants, preschools, furniture stores, fitness studios, cinemas and entertainment.

COVID-19 impacts depends on wehter the affected industries are pandemic resistant or not

In the long term, rent losses of almost a third are fatal and clearly demonstrate the immense economic damage of the pandemic. The still relatively high rent coverage is probably due to the fact that the pandemic has a delayed impact on tenants’ business and thus on their ability to pay rent. The longer shops remain closed or customers are absent, the more likely it is that even previously solvent tenants will find themselves in financial difficulty. For example, “social distancing” measures mean that not the same number of tables are occupied as before the outbreak.

Rent is usually the largest or second-largest item of expenditure and a correspondingly large burden in the struggle for survival.

STORE Capital, on the other hand, has no interest in losing its tenants, who are actually solvent but who have been affected by corona. One possibility is rent discounts. For STORE Capital, receiving a lower rent is of course better than no rent at all. Especially because it is not at all certain that STORE Capital would find new tenants in the current situation. Because of the precarious situation, STORE Capital publishes monthly updates showing the development of monthly rental income and STORE Capital gives a general assessment of the current situation.

Are STORE Capital dividends safe?

The high dividend is usually the main reason for buying a REIT, as they are obliged to distribute at least 90% of their profits. Since its IPO in 2014, STORE Capital has increased its dividend annually in the mid to high single-digit percentage range while maintaining a constant payout ratio of 70%.

Conversely, this means that FFO has also increased at the same rate, which underlines STORE Capital’s excellent business model. Currently, the STORE Capital stock yields approx. 5.7%, which is well above the 4-year average of 4.7% as shown in the Dividend Turbo.

STORE Capital’s historic dividend yield in Dividend Turbo

The current payout ratio of 70% is one of the lowest in the sector, but is expected to increase in the second and especially in the third quarter. As mentioned above, many of the tenants could run into financial difficulties relatively quickly, and if these companies can no longer afford to pay rent, this will ultimately affect STORE Capital and raise the payout ratio to an unhealthy level.

Earnings, FFO and dividend development over time from STORE Capital stock

However, rent losses and a higher payout ratio do not automatically mean that the dividend will be reduced or even cancelled altogether. This depends on management’s assessment of the short and medium-term future and how strong the balance sheet is. STORE Capital has been able to raise funds in the face of the crisis. Compared to the end of 2019, cash and cash equivalents have increased from USD 111 million to a record level of almost USD 650 million, which is more than 2.5 times the annual operating costs. In the last 4 quarters Store Capital distributed dividends worth USD 318 million, less than half of the current cash position. In addition, there is a credit facility of 800 million USD, which STORE Capital can draw if needed.

Development of key balance sheet positions from STORE Capital

It can be seen as a sign of strength that STORE Capital declared an unchanged dividend on 15 June. At the same time, however, it must be taken into account that within the last 10 days the number of new infections in the USA has risen sharply in many states, so that it cannot be ruled out that the outlook will deteriorate further and the dividend will no longer be maintained.

Is the STORE Capital stock fairly valued?

Since its IPO, STORE’s stock has outperformed many other REITs. Within 5 years the stock price had doubled and reached an all-time high of USD 40.96 at the end of 2019. At the time of writing, the stock price is only just around USD 24.

Assuming that the FFO dent by Corona is only temporary and that STORE Capital can grow again in 2021, the stock is currently very favorably valued. The Dynamic Fair Value Calculation determines different fair values for one stock. In case of STORE Capital, fair values based on reported FFO, adjusted FFO, dividend and even operating cash flow make sense. These lie in a close range between USD 29 and 31 and are thus significantly above the current stock price of just below USD 24. The STORE Capital stock therefore appears to be significantly undervalued.

Fair Value Calculation of STORE Capital

These calculations are based on the latest actuals from the last 4 quarters. However, as STORE Capital probably will be facing rent losses and rent reductions, the forecast for the current year and therefore also the fair values for the financial year 2020 decrease slightly to a range between USD 26 and 29 based on the then lower estimates. But even then the stock still appears to be undervalued. Regarding dividends, the stock looks even more undervalued. The exceptionally high dividend yield boosts the Fair Value dividend to USD 34 (blue line).

Should the USA not face a second corona wave and the economy stabilizes in due time, the STORE Capital stock has a short-term upside potential of at least 18 percent until the end of the year, which is visualized by the red dotted line.

Simply Wall St. arrived at a somewhat more optimistic assessment with the help of a two-stage DCF model based on the adjusted funds from operations (AFFO). According to their calculation, the fair value of the stock is approximately $35.5, which would undervalue the STORE Capital stock by 31%.

STORE Capital valuation by Simply Wall St

However, I do not expect the STORE Capital stock to reach this fair value in the near future. The uncertainty regarding duration and impact of the pandemic is very high and the risk of future rent losses is correspondingly high as well, which the market prices into the stock. I see a further risk in the emerging “work from home” mentality. If this becomes established, businesses could have significantly fewer walk-in customers in the future, even in previously desirable and profitable locations.

The STORE Capital stock is a bet on the upswing

STORE’s stock is currently pricing in a high risk given that no one knows exactly whether and how long it will take for rents to return to their previous level or whether lower rents may even have to be accepted in the long term, as the shopping habits of customers have changed permanently due to the crisis. STORE Capital will only be successful in the long term if its tenants are successful as well.

I cannot rule out the possibility that the dividend will be reduced. Everything depends on whether the US economy falls into a deep depression and the classic shopping malls become increasingly orphaned. If you believe in a future for stationary retail, you can buy the STORE Capital stock as a bet on the upswing.