WP Carey Stock: Why I’m Not Buying This 5% Dividend Yield (WPC)
WP Carey (WPC) is a net leasehold real estate investment trust that, despite performing strong during the pandemic, is still trading below pre-pandemic levels. The 5.2% dividend yield may look attractive, especially given the strong business model and quality metrics of the portfolio. I explain why investors should be concerned about high disposition activity, as it has proven to be a drag on growth rates. Finally, I explain why I am not buying WPC today given the better investment opportunities elsewhere.
WPC share price
WPC has rebounded steadily from pandemic lows as its net rental model has proven to be more than resilient.
I can see stocks returning to pre-pandemic levels, if not higher, but does that make the stock a buy?
WP Carey business model
WPC is a net leasehold REIT, which means that it owns real estate with triple net leases. A triple net lease (“NNN”) is a lease in which the tenant is responsible for property taxes, insurance and maintenance costs. This structure allows profit margins above the average compared to other formats of real estate leases. WPC has a large portfolio diversified across property types and tenant sectors.
Above, we can see that WPC has almost 50% of its assets in industrial and warehouse properties. Some investors argued that this exposure deserved a rating upgrade. However, I see it differently, as the premium multiples seen in the industrial real estate and warehouse sectors are mainly justified due to the large rental spreads realized upon expiration of leases. WPC did not see the same type of benefit, which led me to evaluate these properties like any other net leasehold property.
WPC has maintained strong growth in comparable store rents, even during the pandemic.
In fact, rent collection hovered around 99% even in the depths of the pandemic, which was a highlight for the net lease industry. WPC’s 29% exposure to investment grade tenants contributed to this number, although I note that even peers with comparable investment grade exposure did not report the same excellent rent collection metrics. Yet there is a clear gap between the perceived quality of the portfolio and the actual growth in cash flow. WPC has set 2021 adjusted operating funds (stands for AFFO, equivalent to real estate income) of $ 5.02 per share, up 6% from 2020 but stable from 2019. This difference may vary. ‘explain by the high amount of disposal activity.
In the first 9 months of 2021, WPC reported divestment activity of $ 129 million against investing activity of $ 1.2 billion. WPC has a history of having a high number of layouts, as I noted in a previous post on the company:
In 2020, WPC sold $ 381 million in assets against $ 826 million in acquisitions. This is a staggering 46% divestment / acquisition ratio. In contrast, Realty Income (O) had a 10% ratio in 2020. At times, capital recycling seems to be paying off, as WPC was able to divest occupied properties at a 6% cap rate in Q4 2020. Yet , sometimes the rate of cap provisions is higher, as in 2019, where it was 7.8% for the whole year.
While some investors optimistically believe that WPC recycles assets opportunistically, I note that the net rental industry in which WPC operates generally does not allow for large unrealized gains on real estate assets. Optimal trade flow is for minimal disposal activity and just to collect rent year after year – this can be seen in the fact that WPC has not been able to increase cash flow per share at a rate comparable to that of other well-known peers in net rental.
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 this irresistible, especially given the 23 year history of dividend growth.
However, the stock doesn’t look so appealing when you consider the risk-reward proposition, especially when compared to alternatives in the market. While the long history of dividend growth is enjoyable, it unfortunately has no inherent impact on future results. WPC has increased its dividend at a rate of approximately 1% over the past few years, which is not sufficient to justify the current valuation. Even if we assume that growth accelerates to the 2% to 3% range, the stock price would correspond to a return of no more than 8% in the absence of multiple expansion. Maybe we think the return is too high? I could see WPC trading up to a dividend yield of 4.5%, suggesting potential for capital appreciation of around 13%. With the dividend yield, investors are looking at potential returns of up to 21% in a very bullish scenario.
While WPC is reasonably operated with a high quality business model, this is one case where you can pay too much for security. This is especially noticeable given that growth stocks have been crushed across the board, creating attractive investment alternatives all around. Below we can see an overview of some of the growth stocks that I cover – there are more buy notes in my growth stock coverage than at any time lately.
(Best of Breed Universe Watchlist)
Many of these names are trading at multiples below their fair value with projected growth rates above 30%. In other words, many of these stocks have projected annual returns of around 30% with an additional 30% boost through multiple expansion – offering a much more attractive potential reward than that presented to the WPC. The WPC appears buyable here, although investors should think carefully about whether money is best invested here at this time.