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W. P. Carey: Why I'm Not Buying This 5% Dividend Yield

Jan 8, 2022
Bear Market

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W. P. Carey (WPC) is a net lease real estate investment trust which in spite of performing strongly during the pandemic, still trades below pre-pandemic levels. The 5.2% dividend yield may appear attractive, especially considering the strong business model and portfolio quality metrics. I discuss why investors should care about the elevated disposition activity as it has proven to be a drag on growth rates. Finally, I discuss why I am not buying WPC today given the better investment opportunities elsewhere.

WPC Stock Price

WPC has steadily rebounded from pandemic lows as its net lease model proved more than resilient.

Chart

I can see the stock trading back to pre-pandemic levels if not higher, but does that make the stock a buy?

W. P. Carey Business Model

WPC is a net lease REIT, meaning that it owns real estate with triple net leases. A triple net lease (‘NNN’) is one in which the tenant is responsible for real estate taxes, insurance, and maintenance costs. This structure allows for above average profit margins relative to other real estate lease formats. WPC has a large portfolio diversified across property type and tenant industries.

(Investor Presentation)

Above, we can see that WPC has nearly 50% of its assets in industrial warehouse properties. Some investors have made the case that this exposure is worthy of a re-rating upgrade. However, I see things differently, as the premium multiples seen in the industrial and warehouse real estate sectors are primarily justified due to the large leasing spreads realized upon lease expiration. WPC has not seen the same kind of benefit, leading me to value these properties just like any other net lease property.

WPC sustained strong same store rent growth even during the pandemic.

(Investor Presentation)

In fact, rent collection hovered in the 99% range even at the depths of the pandemic, which was a high watermark for the net lease sector. WPC’s 29% exposure to investment grade tenants contributed to that number, though I note that even peers with comparable investment grade exposure did not report the same excellent rent collection metrics. Yet there is a clear discrepancy between perceived portfolio quality and actual cash flow growth. WPC has guided for 2021 to see adjusted funds from operations (stands for AFFO, equivalent to real estate earnings) of $5.02 per share - up 6% from 2020 but flat from 2019. This discrepancy can be explained by the elevated amount of disposition activity.

Through the first 9 months of 2021, WPC reported disposition activity of $129 million versus investment activity of $1.2 billion. WPC has a history of having an elevated amount of dispositions, as I noted in a prior article on the company:

In 2020, WPC sold $381 million in assets versus $826 million in acquisitions. That is a staggering 46% disposition to acquisition ratio. In contrast, Realty Income (O) had a 10% ratio in 2020. Sometimes the capital recycling seems to pay off, as WPC was able to dispose of occupied properties at a 6% cap rate in the 4th quarter of 2020. Yet sometimes the disposition cap rate is higher, such as in 2019, when it was 7.8% for the full year.

While some investors take the optimistic view that WPC is opportunistically recycling assets, I note that the net lease sector which WPC operates in does not typically allow for material unrealized gains on real estate assets. The optimal business flow is for minimal disposition activity and to just collect rent year after year - this shows in the fact that WPC has been unable to grow cash flow per share at a comparable rate with other well known net lease peers.

Is WPC Stock A Buy, Sell, or Hold?

At recent prices, WPC is trading at an attractive 5.2% dividend yield. The reader may find that irresistible especially considering the long 23 years of dividend growth history.

(Investor Presentation)

However, the stock does not look so attractive when considering the risk-reward proposition, especially compared to alternatives in the market. While the long dividend growth history is nice, it unfortunately does not have any inherent bearing on future results. WPC has grown its dividend at around a 1% rate in the past several years, which is not enough to justify the current valuation. Even if we assume that growth accelerates to the 2% to 3% range, the stock would be priced for at most 8% returns absent multiple expansion. Perhaps we think that the yield is too high? I could see WPC trading up to a 4.5% dividend yield, suggesting around 13% in capital appreciation potential. Together with the dividend yield, investors are looking at up to 21% potential returns in a very bullish scenario.

While WPC is reasonably leveraged with a high quality business model, this is a case where one may be paying too much for safety. This is particularly notable considering that growth stocks have been crushed across the board, creating attractive investment alternatives all around. Below we can see a snapshot of some of the growth stocks I cover - there are more buy ratings in my growth stock coverage than at any point in recent times.

(Best of Breed Universe Watchlist)

Many of these names are trading at multiples below fair value with projected growth rates north of 30%. In other words, many of these stocks have projected annual returns of around 30% with additional upside of another 30% from multiple expansion - providing for a far more attractive potential reward than that presented at WPC. WPC looks buyable here, though investors should think carefully if money is best invested here at this time.

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