Realty Income: Dividend Keeps Growing (NYSE:O) (2024)

Introduction

I had a 'Strong buy' thesis for Realty Income's (NYSE:O) stock in March. The stock returned 1.6% to investors since March 26, including its monthly dividend. There were monthly dividend hikes in June and May, underscoring the reliability of payouts. Management is quite confident in this year's performance as it recently boosted both earnings guidance for 2024 and announced a very aggressive expected increase in investments this year. Realty Income's prudent underwriting approach is still in place, meaning that risks from the company's perspective are quite low. Experts believe that the retail commercial property market is in excellent shape and O is one of the primary benefits of the industry's strength. There is a 19% undervaluation and forward dividend yield is close to 6%, which makes me reiterate my "Strong Buy" rating.

Fundamental analysis

The major reason why I remain bullish about Realty Income is consistency of its dividends. The company raised its monthly dividend again on June 11 to $0.263 per share. There were dividend increases announced in May. The forward dividend yield is approximately 6% as of now. The trend is quite inspiring, and the management looks confident in O's bright near-term future. There was a boost to the lower end of O's FY2024 earnings guidance, and the management also increased its 2024 investment volumes expectations by massive 50%, from $2 billion to around $3 billion.

The management's very prudent approach to selecting new properties to drive growth is one of the company's major strengths. The total amount of sourced potential acquisition targets was $9.3 billion YTD 2024. Out of them, the actual investment volume was $0.6 billion in Q1 2024. The process of selecting new assets is rigorous and no changes are expected to happen with O's prudent underwriting approach. Therefore, we can expect that O's occupancy rates will stay close to 100%.

Despite the broader real estate industry experiencing headwinds due to the tight monetary environment, it looks that O's segment of retail real estate is in good shape. According to Cushman & Wakefield's (CWK), the demand for retail real estate is strong partly due to a robust pipeline of store openings by large retailer. As one of the U.S. largest retail REITs O is poised to benefit from the favorable trends in the segment.

The company has been expanding internationally in the last few years, and Europe is the main destination. Some good news is coming from the other side of the Atlantic Ocean, as the European Central Bank ('ECB') started cutting interest rates earlier this month. There might be two more rate cuts this year, which will be quite beneficial for the European real estate industry. O has been historically strong in absorbing industry tailwinds, and positive developments in Europe are likely good for shareholders.

The fact that the Fed's last rate hike took place eleven months ago, in July 2023, means that currently interest rates are highly likely at peak levels, and they will go downward. But the timing and pace of rate cuts are still two big questions which can make the market nervous. Nevertheless, as O is mostly concentrated on retail real estate it is better to look a bit narrower at macro factors.

Retail industry significantly depends on the financial health of the U.S. consumers. Despite a tight monetary policy, the U.S. unemployment rate is still close to historical minimums at 4%. Real wages demonstrate modest growth, which also contributes to the health of American consumers. Moreover, the U.S. household wealth levels continue breaking records in 2024.

O's fundamental strength is reflected in EPS projections for the next several quarters. FFO is expected to demonstrate consistent modest growth, which is good for dividend investors. With the management's consistently prudent approach and industry tailwinds, I think that the projected EPS growth is reasonable.

Valuation analysis

My previous valuation method for O was the dividend discount model ('DDM'), which needs assumptions to be updated to recalculate the fair value of the stock. The discount rate is 8%, a softer one compared to the previous 8.3% rate. I am more dovish in terms of the discount rate because the Fed plans to start cutting rates by the end of this year. Current dividend is $3.12, an estimate of Wall Street analysts for FY 2025. Growth rate remains the same as in my previous DDM, conservative at 3%. The fair value of the stock is $62.4, higher than the previous $57.7 estimate. Reasons for the upgrade are expected to improve monetary conditions (lower discount rate) and the upgrade to the current year's dividend from $3.06 to $3.12 from consensus. The current share price is 19% lower than the fair value.

Looking at a REIT's Price to FFO ratios also helps in understanding valuation fairness. Forward P/AFFO ratio is 14.5% lower than O's prior five years' average, which aligns with the upside potential determined by the DDM. I find the valuation attractive based on two approaches: the DDM and ratios analysis.

Mitigating factors

The uncertainty around interest rates is a headwind for all REITs including, Realty Income. Higher rates mean higher borrowing costs for the company, which adversely affects the ability of the business to expand faster. Monetary policy is cyclical, and the pivot to a looser interest rates environment is inevitable sooner or later. However, the high level of uncertainty around the timing of the pivot highly likely distracts the management in making strategically important decisions.

When O released its previous quarterly results, the company failed to deliver the EPS at least in line with consensus estimates. Missing consensus estimates is rarely a good sign and undermines investors' trust in the stock. The deep discount for the stock price is also explained by the underperformance in the past quarter's results, and if Realty Income fails to deliver a positive surprise for the next quarter, the discount might deepen.

When big tech stocks continue beating their all-time highs several times this year, the market is likely much more interested in growth stocks. The stellar Q1 performance of the largest growth companies means that the show is likely to go on, which means lower demand for dividend stocks like O.

Conclusion

Realty Income's approach to underwriting at acquisitions remains the same and prudent, meaning that high occupancy rates will persist. Despite high interest rates, the retail commercial property market is healthy, and O is poised to benefit from it. The valuation and forward dividend yield are very attractive, which means that O remains a 'Strong Buy', in my opinion.

Coming from an IT background, I have dived into the U.S. stock market seven years ago by managing portfolio of my family. Starting managing real money has been challenging for the first time, but long hours of mastering fundamental analysis of public companies paid off and now I feel very confident in my investment decisions. My hands-on experience shaped deep understanding of risk, reward and the delicate balance between these two variables. Driven by a desire to share my insights and contribute to the investor community, I embark on this new chapter with Seeking Alpha. My articles will be crafted with clarity and precision, devoid of jargon and fostering accessibility for investors of all experience levels. My background in IT grants me a valuable perspective, particularly when navigating the complexities of technology stocks. Yet, my pursuit of knowledge extends beyond the realm of silicon, encompassing diverse sectors and uncovering promising prospects across the economic landscape. Whether you are a seasoned investor seeking fresh perspectives or a nascent one embarking on your financial voyage, I extend a warm invitation to join me on this intellectual journey. Through collaborative exploration and insightful analysis, let us unlock the secrets of the market and chart a path towards shared financial success.