W.P. Carey (WPC): A High-Yield REIT With 18 Consecutive Years of Dividend Increases

With the stock market hitting record highs day after day, many value focused investors are understandably nervous about investing new money at this time.

 

Fortunately, there are still a few industries where high-yield dividend investors can turn to for generous, secure, and growing dividends.

 

One of these is Real Estate Investment Trusts, or REITs; the easiest way for dividend investors to gain exposure to real estate. Many REITs have sold off in recent months as rising interest rates have made them relatively less attractive investments.

 

W.P. Carey (WPC) converted to REIT status in 2012 and has seen its stock price decline 18% since early August. However, the company proven itself a master at growing long-term investor income and wealth over time.

 

 

In addition to its high 6.6% yield, the company is a dividend achiever that has paid uninterrupted dividends since 1998 and increased its dividend annually for 18 consecutive years.

 

With the recent pullback in its share price, let’s take a closer look at W.P. Carey for consideration in our Conservative Retirees portfolio.

 

Business Description

Founded in 1973, W.P. Carey is one of the oldest REITs in the world and a pioneer in the sale/leaseback model of triple net REITs.

 

Essentially W.P. Carey raises capital from investors and then purchases freestanding real estate from companies, who then sign long-term (i.e. 20 to 25 years) rental agreements to pay rent to W.P Carey for the use of those properties.

 

Companies are willing to do this because they are able to monetize the value of their real estate in a tax-efficient manner by getting upfront capital, and they can deduct 100% of rent from their income statements, boosting earnings.

 

Another appeal of the business model is that these are triple net leases, meaning the tenant is responsible for maintenance, taxes, and insurance. In other words W.P. Carey only has to buy the properties and then sit back and collect rent.

 

This creates a low overhead business model in which the REIT generates high adjusted funds from operations, or AFFO (REIT equivalent of free cash flow and what funds the dividend), which must be paid out to investors for tax reasons in the form of generous, secure, and growing dividends.

 

But what specifically makes W.P. Carey a standout in the world of sale/leaseback triple net leases?

 

For one thing, most triple net REITs, such as blue-chip giants Realty Income (O) or National Retail Properties (NNN), are primarily focused just in the U.S. and specialize in retail properties.

 

However, as you can see below, W.P. Carey offers investors far more global diversification, with just over one third of its properties located overseas.

 

More importantly, its 910 properties are spread out over far more REIT sectors, including hot growth markets such as warehouses, which are experiencing strong growth due to the rise of e-commerce and the growing need for more fulfillment centers.

 

Source: W.P Carey Annual Report

 

This greater regional and industry diversification means that W.P Carey enjoys very stable and predictable cash flow, which makes it a sleep well at night, or SWAN stock.

 

Finally, the third major difference between W.P Carey and its peers is that in addition to owning a global portfolio of rental properties, it operates a highly successful investment management division.

 

In fact, since inception, the REIT’s investment management division has generated 11%, net of fees, compound annual returns for its investors.

 

Such strong performance explains why W.P Carey has $12.2 billion in assets under management, up 16% compared to Q3 of 2015.

 

The company’s non-traded REIT management division not just provides the REIT with future potential growth opportunities, but also fast-growing and lucrative management fee revenues (up 35% year-over-year) that made up 20% of the REIT’s total revenue in the most recent quarter and 8% of AFFO over the last year.

 

Business Analysis

The key to any long-term investment is quality management. W.P Carey has built its business around a long-term focus of acquiring quality properties around the globe at opportunistic prices and slowly but surely growing its cash flows in a disciplined manner.

 

It’s important to remember that because W.P Carey operates as a hybrid of a traditional equity REIT as well as a private equity fund, its growth in revenue, cash flow, and dividends can be lumpy.

 

 

That’s because management likes to recycle capital, which means selling properties that have become overvalued when they generate good internal rates of returns and then reinvesting that cash into other, more attractively priced assets.

 

For example, thus far in 2016 W.P Carey has sold off $618.1 million in properties, at an average cap rate of 7%. In total, the REIT was able to achieve internal rates of return of over 20% annually on the sales of its properties this year.

 

More important than W.P Carey’s individual quarterly or annual results is the fact that management is constantly working to manage its property portfolio with an eye on tenant quality, credit risk, and cash flow stability.

 

For example, in the past year W.P Carey has managed to not just raise its occupancy to one of the highest levels in the industry (99.1%), but also to extend the weighted average lease term from 8.9 years to 9.4.

 

Better yet, the amount of lease expirations in 2017 and 2018 has fallen from 10.6% of annual base rent to just 3.4%, meaning that the REIT’s cash flow is becoming even more stable and reliable over time.

 

All of which means higher dividend security for income investors, far more than the current high-yield might otherwise indicate.

 

Key Risks

While W.P Carey is a high-quality REIT, nonetheless it has a few key risks for investors to keep in mind.

 

The first risk is that W.P Carey, because of its hybrid REIT/private equity structure, has a slightly above average leveraged balance sheet, especially relative to pure retail triple net REITs such as Realty Income and National Retail Properties.

 

REIT	Debt / EBITDA	EBITDA / Interest	Debt / Capital	S&P Credit Rating
W.P Carey	6.42	3.72	52%	BBB
Realty Income	5.40	4.21	43%	BBB+
National Retail Properties	4.86	4.59	37%	BBB+
Industry Average	6.36	NA	64%	NA

Sources: Simply Safe Dividends, Morningstar, FastGraphs

 

 

Of course REITs in general, due to their business model (in which at least 90% of earnings must be paid out as dividends), have high debt loads, and W.P Carey’s debt is far from dangerous levels, as seen by the company’s investment grade credit rating.

 

However, in a rising interest rate environment, rolling over that debt is likely to put increasing pressure on its interest coverage ratio and could slow the rate of future dividend growth.

 

Speaking of rising interest rates, investors need to keep in mind that as rates rise (they are up about 0.7% since November 8th), there could be additional growth headwinds for REITs.

 

Not necessarily because of rising debt capital costs (management has proven it can grow consistently even during much higher rate environments), but because REITs need to frequently raise equity growth capital from investors. W.P. Carey’s diluted shares outstanding have more than doubled since it converted to a REIT in 2012, for example.

 

 

The problem is that over the past eight years, many yield-starved investors have turned to REITs as bond alternatives. However, thanks to the U.S. economy finally showing signs of stronger growth, as well as the expected Trump stimulus (infrastructure spending and tax cuts), inflation expectations, and thus long-term Treasury yields, could rise by several percent in the coming years.

 

Which means that many of the investors that bought into REITs such as W.P Carey in recent years (and provided lots of cheap equity growth capital) might end up rotating their capital back into risk-free assets such as 10- and 30-year U.S. Treasuries; especially if the yields on these securities rises to 4%, 5%, or even 6% in the coming years.

 

W.P. Carey traditionally trades at a 2% to 3% risk premium over U.S. Treasuries, which means that in a rising interest rate environment investors may demand much higher yields from the stock than they do now.

 

That in turn could keep the share price depressed for several years, and mean higher costs of capital that make finding sufficiently profitable investment opportunities harder to come by.

 

Finally, we can’t forget that the same geographic diversification that can be a long-term asset can also be a short-term detriment. That’s both due to potential negative currency effects (higher US interest rates mean a stronger dollar and slower cash flow growth from overseas), as well as the potential negative economic effects of things like Brexit.

 

However, W.P Carey hedges some of its currency risk, which means minimal short to medium-term risk to its dividend growth prospects.

 

Dividend Safety Analysis: W.P. Carey

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

W.P. Carey has a Dividend Safety Score of 64, indicating that the dividend is highly secure. In fact, with a year-to-date AFFO payout ratio (the best measure of a REIT’s dividend security) of just 73.4%, W.P Carey’s dividend is among the most secure in the triple net lease sub sector.

 

For example, Realty Income, which is considered the ultimate SWAN stock in the REIT industry, has a year-to-date AFFO payout ratio of 83.5%.

 

You can also see that W.P. Carey’s other key metrics have been growing throughout the year, suggesting that its dividend remains quite secure.

 

Metric	YTD 2016	YTD 2015	YoY Change
Revenue	$713 million	$673 million	5.9%
AFFO/Share	$3.89	$3.72	4.6%
Dividend	$2.94	$2.86	2.8%
AFFO Payout Ratio	73.4%	76.9%	-4.6%

 

Even when times weren’t so good, W.P. Carey reliably continued paying dividends. The company’s revenue fell by just 4%, 9%, and 3% in fiscal years 2007, 2008, and 2009, respectively.

 

W.P. Carey’s long-term leases, valuable property locations, and diversification by tenant type and geography helped it better weather the financial crisis than many of its REIT peers. Management also raised the dividend during the last recession, and WPC’s stock outperformed the S&P 500 by 13% in 2008.

 

Despite the company’s healthy payout ratio and relatively strong performance during the financial crisis, W.P. Carey’s balance sheet reduces its Dividend Safety Score.

 

A company will always make its debt and interest payments before paying dividends, which are more discretionary in nature. As seen below, W.P. Carey’s long-term debt to capital ratio has doubled over the last decade, reducing some of the company’s financial flexibility.

 

 

However, the company continues to maintain an investment grade credit rating and easily remains in compliance with its bond covenants:

 

 

Overall, W.P. Carey appears to have one of the safer dividends for a company that yields over 6.5%. The company’s reasonable payout ratio, cycle-tested business, tenant diversification, and proven commitment to its dividend over time all support its above-average Dividend Safety Score.

 

However, given the company’s relatively new REIT status and, therefore, higher payout ratios and leverage than it had prior to the last recession, I think it could be more difficult for the company to maintain its dividend during the next recession. There isn’t anything to worry about today, but that’s something to keep in mind.

 

Rising interest rates and/or an unexpected plunge in the company’s share price, which raises its cost of issuing equity, are risks that REIT investors also must deal with, but W.P. Carey looks to be in reasonably good shape today.

 

 

Dividend Growth Analysis

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

W.P. Carey has a Dividend Growth Score of 35, indicating that W.P Carey shareholders shouldn’t expect the most recent years’ strong payout growth to continue.

 

That’s not to say that W.P. Carey isn’t a solid and consistent dividend grower because it is. In fact, the company is a member in the Dividend Achievers Index, signaling that it has increased its dividend for at least 10 consecutive years.

 

However, as you can see, in recent years management has become far more conservative with the dividend’s growth.

 

W.P. Carey’s dividend has increased every year since the company went public in 1998, but the pace of dividend growth has dropped by more than half from 7.9% per year over the last decade to just 3.8% last year. W.P. Carey’s dividend was last increased by 1% in December.

 

 

That’s likely due to the REIT wisely anticipating an eventual increase in interest rates, and so most of the marginal AFFO is going to strengthen the balance sheet so that management can continue to grow the business into the future in an era of more costly debt.

 

While shareholders may have to accept relatively slow dividend growth in the next few years, that doesn’t necessarily mean that W.P. Carey isn’t a good long-term high-yield, dividend growth investment.

 

After all, management has a lot of growth runway in the form of those $12.2 billion in REIT assets under management. That’s because W.P. Carey has a history of occasionally purchasing large tranches of non-listed REITs it manages, which is why its growth comes in fits and spurts.

 

The REIT assets W.P. Carey is currently managing represent a potential 144% growth runway based on the company’s total assets today ($8.5 billion). It doesn’t seem unreasonable to assume that this REIT should be able to, over the long-term (next 10 years), continue growing its dividend at a rate of 4% to 5% a year.

 

While that may not sound like much, it’s hard to find stocks with a combination of high yield and fast dividend growth (WPC shares yield 6.6%).

 

Valuation

When it comes to valuing REITs, the standard P/E ratio is a poor metric to use. That’s because GAAP EPS requires subtraction of depreciation and amortization for a REIT’s properties. However, in actuality properly maintained property appreciates over time.

 

The two most important metrics to look at are price/AFFO and dividend yield. As you can see, W.P Carey is trading at substantial discounts to its historic norms in both metrics.

 

P / AFFO	Historic P / AFFO	Yield	13-Year Median Yield
11.7	13.6	6.6%	5.9%

Sources: Fast Graphs, Gurufocus

 

Over the past decade W.P. Carey’s yield has ranged from 3.44% to 10.93% (during the financial crisis), with a median value of 5.9%.

 

Which means the current yield represents some value relative to the stock’s history. That’s especially true given how secure the payout is and the good long-term growth and total return prospects the company possesses.

 

Of course you want to keep in mind that with short- to medium-term dividend growth likely to be slower in the coming years, and interest rates rising, W.P. Carey’s share price may have further to drop.

 

That means that if you have a short time horizon of five years or less and will need to sell shares to cover expenses (such as retirees), you want to keep in mind that W.P Carey’s yield might rise to 7% or 8% in the coming years.

 

That would likely represent a potential share price low of $52.50 to $60, potentially indicating that shares could realistically drop another 10%+ from here, depending on a number of uncontrollable factors.

 

Conclusion

With a great, time-tested management team, strong global and pan sector property diversification, and cash flow secured by rental agreements as long as a quarter century, W.P. Carey represents a high-yield quality REIT that appeals to many income investors.

 

While REITs as a whole could continue selling off if the rise in interest rates accelerates over the next year, W.P Carey’s valuation doesn’t appear unreasonable for long-term dividend growth investors.