6%+ Yield and 40%+ Upside? I’m In!

Summary

  • Here is a company with over 100 years of experience paying a 6%+ yield.
  • Management aims for a 5-9% annual distribution increase for years to come.
  • At the current price, BEP shows a strong upside potential along with a healthy dividend. What’s not to like?

If you think that you have missed the mini-market correction because the S&P 500 rapidly bounced back, think again; there is plenty of opportunity lying right in front of you. One of them is Brookfield Renewable Partners LP (BEP) or (BEP.UN.TO).

Investment Thesis

I truly believe the future of energy will be found across hydroelectric, solar, and wind power. 80% of BEP’s portfolio is focused on hydroelectric power. The company has power plants across North America, South America, Europe, and Asia. BEP enjoys large scale capital and expertise to manage its projects across the world. Management aims at a 5-9% annual distribution increase for years to come. At the current price, BEP shows a strong upside potential along with a healthy dividend. What’s not to like?

Understanding the Business

The company is a rare pure play in the renewable energy sector. With over 2,000 employees, $27 billion in power assets and $285B in AUM, BEP is also one of the largest players in this industry. Good news; BEP is only down about 12% (as of March 14th) since the beginning of the year and it is almost trading at its early 2017 level.

 

Source: Q3 2017 investor presentation

While the stock is down, the company currently surfs on the renewable energy tailwind. This is not just a trendy moment – renewable energy is at the center of our future economic development.

Revenues

Source: Ycharts

Brookfield Renewable Partners strategy uses both organic and acquisitions to boost its revenue. Their goal is to “acquire a renewable power assets and businesses that below intrinsic value, finance them on an investment grade basis, and optimize cash flow and value utilizing our depths of operating expertise,” says CEO Sachin Shah.

The company currently has around $1.5 billion in cash for future investments. As the M&A market is currently boiling, you can expect management to use its liquidity to fund further projects. Over the years, management has developed a strong expertise in such deal. Therefore, I am confident this money will be used wisely to the great pleasure of shareholders.

Dividend Growth Perspective

On its website, BEP shows its distribution history since 2011. The company has successfully increased its payout since then. The small dent in 2014 was due to a change of date in the dividend payment. Therefore, the February payment (which was supposed to be the March payment) was pro-rated (2/3 of the regular dividend). BEP doesn’t qualify as a dividend achiever, but still shows a great dividend profile.

The Dividend Achievers Index refers to all public companies that have successfully increased their dividend payments for at least ten consecutive years. At the time of writing this article, there were 265 companies that achieved this milestone. You can get the complete list of Dividend Achievers with comprehensive metrics here.

Source: Ycharts

Source: Ycharts

Using the classic payout ratio (and even the cash payout ratio) is not useful to determine BEP’s dividend sustainability. You are better off using the FFO/units. Over the past 5 years, BEP has maintained an 8% FFO/units CAGR while increasing its dividends by 6%.  If you want to know more about how to assess MLP’s, I suggest this guide.

However, since 2016, its generosity pushed the FFO payout ratio to around 98%. In 2017, the FFO/unit was $1.90. Considering the most recent dividend increase (now $1.96 per year per unit) and an FFO growth of 8% ($2.05), the 2018 payout ratio will become 96%.  This is well over management’s target of 70%.

Potential Downsides

As this kind of company is growing mostly through leverage, the debt level is always an issue. BEP currently shows nearly $11 billion in long term debt. As interest rates rise, this will impact BEP future profitability.

The second concern could be put toward future dividend growth. With a FFO payout ratio near 100% and management target around 70%, it will become difficult to maintain a steady dividend hike and reach a lower payout ratio at the same time. However, as long as the FFO grows around 8% per year, you can expect a 5-6% dividend growth.

Valuation

In order to determine BEP’s fair value, I’ve used the dividend discount model. I used a 6% dividend growth rate for the next 10 years. While there is a risk BEP doesn’t match my assumption due to the high payout ratio, I still consider this number as the company showed more commitment to increase its payouts than keep its FFO payout ratio in order.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $1.96
Enter Expected Dividend Growth Rate Years 1-10: 6.00%
Enter Expected Terminal Dividend Growth Rate: 5.00%
Enter Discount Rate: 10.00%
Discount Rate (Horizontal)
Margin of Safety 9.00% 10.00% 11.00%
20% Premium $66.94 $53.40 $44.37
10% Premium $61.36 $48.95 $40.68
Intrinsic Value $55.79 $44.50 $36.98
10% Discount $50.21 $40.05 $33.28
20% Discount $44.63 $35.60 $29.58

Please read the Dividend Discount Model limitations to fully understand my calculations.

If some may think that I was overly optimist, I did the calculation with a 4% dividend growth rate. I kept a 10% discount rate and still find some value at the current price. In both cases, BEP is a buy.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $1.96
Enter Expected Dividend Growth Rate Years 1-10: 4.00%
Enter Expected Terminal Dividend Growth Rate: 4.00%
Enter Discount Rate: 10.00%
Discount Rate (Horizontal)
Margin of Safety 9.00% 10.00% 11.00%
20% Premium $48.92 $40.77 $34.94
10% Premium $44.84 $37.37 $32.03
Intrinsic Value $40.77 $33.97 $29.12
10% Discount $36.69 $30.58 $26.21
20% Discount $32.61 $27.18 $23.30

Final Thought

Renewal energy should be a part of our future. Solid dividend payments should also be part of our future as investors. Therefore, you have the two best reasons  in the world to consider Brookfield Renewable Partners.

Disclaimer: I do not hold BEP in my DividendStocksRock portfolios.

Realty Income – A Diversified REIT with A Sound Dividend Track Record

Summary

  • One of the only 9 U.S. REITs with at least one “A” credit rating
  • A highly diversified REIT in terms of tenants, industries, geographies and property types
  • 24-year track record of regularly increasing the dividend

Investment Thesis

Realty Income Corporation is the largest net lease real estate investment trust (REIT) in the U.S.The REIT is highly diversified and enjoys a regular stream of cash flows from investment grade tenants. Realty Income deserves to stay in a dividend income investor’s portfolio not only because it has paid dividends for almost five decades, but also because it has a steady cash flow stream from diversified properties and quality tenants, maintaining high occupancy levels consistently which never dropped below 96%.

Understanding the Business

Founded in 1969, Realty Income Corporation (O) is a real estate investment trust (REIT) that engages in the asset management of commercial properties in the U.S. It earns regular revenue in the form of rental income from properties in diverse locations and quality tenants.

The Realty Income’s property portfolio can be broadly classified into retail (80% of revenue), industrial (13%), office (5%) and agriculture (2%). The company’s portfolio consists of more than 5,000 properties across 49 states. Realty Income today has around 251 commercial tenants from over 47 different industries.

Source : Realty Income Investor Presentation

Revenues

Source: Ycharts

The REIT owns and purchases freestanding, single-tenant properties in key locations.Location is the key to the success of a REITbusiness and Realty Income’sproperties in key markets and strategic locations is one of the main reasons for its strong revenue growth.The properties have a high occupancy ratio of more than 98% which indicates the success of its portfolio strategy. In addition, Realty Income typically enters into triple net leases (where tenants pay maintenance, taxes, and insurance costs) with initial lease term of 15 years with provision for annual escalations. The REIT also has a sound track record of lease roll overs. It re-leased 181 properties with expiring leases (by the end of Q3’17), out of which 164 were to same tenant (89%).

Its tenants can be grouped into 47 activity segments and 27 other non-reported segments. This provides a good diversification of revenues. More than half of the REIT’s rental revenues come from its top 20 tenants (like Walgreens, FedEx, Dollar General etc.). This insulates the REIT from changing consumer behaviour. Ten out of these tenantsalso have investment grade ratings. All these factors improve cash flow visibility and add to diversification.

Source : Realty Income Investor Presentation

In addition, Realty Income is also expanding its footprint through acquisitions and added 505 new properties worth a whopping $1.86 billion in 2016 alone.

Earnings

Source: Ycharts

Realty Income earns a regular and secure stream of income since its properties are let out under long term leases (remaining lease term of 9.7 years) to a well-diversified customer base from the non-discretionary service industry.

Assets have grown to 5,062 properties from 630 properties in 1994. A solid investment grade balance sheet and strong cash flow generations have enabled the company to raise its AFFO per share by 5% (in 2016) in spite of aggressive acquisitions.

Management expects 2017 AFFO per share of $3.03 – $3.07, representing annual growth of 5.2% – 6.6%.

Dividend Growth Perspective

Source: Ycharts

Realty income is one of only five REITs that is a member of S&P High Yield Dividend Aristocrats index. It is also part of the Dividend Achievers list. Realty Income has grown dividends at a CAGR of 4.6% since its listing in 1994. The REIT has paid monthly dividends for 49 years in a row.Its payout ratio is high at 84% and it last raised its payout by 4% y/y.

The REIT’s highly predictable and diversified sources of cash flow ensure highly stable and growing dividends.

Source : Realty Income Investor Presentation

Potential Downsides

Realty Income holds a large proportion of retail properties in its portfolio. The retail sector is under increased pressure from rising e-commerce threat which has caused many large brick and mortar stores to down shutters.However, Realty Income is quite insulated from this risk as 97% of its total portfolio is protected against retail e-commerce threats and economic downturns.

An increasing interest rate environment is not favourable for REITs. By entering into long-term leases, Realty Income is more sensitive to rising interest rate. However, Realty Income has performed better than most of the other REITs, during a period of steadily rising rates.

Valuation

Source: Ycharts

The stock has slumped 14% so far this year and is trading 22% below its 52 week high.

A conservative balance sheet with investment grade ratings ensures access to low cost of capital. The REIT maintains a higher level of EBITDA margin which has never dropped below 90% since 1998.

I have also used the Dividend Discount Model to determine a fair value for O. Given Realty income’s investment in future acquisitions, its past dividend growth streak and a solid balance sheet, it will continue its payout growth.Realty Income has grown dividends at an average 5% in the past, hence I have assumed a dividend growth rate of 5% in the initial period and reduced it to 4% going forward. As for the discount rate, I never use under 9%. The output shows that the stock is undervalued currently.

 

Input Descriptions for 15-Cell Matrix                                INPUTS

Enter Recent Annual Dividend Payment:                                         $2.63

Enter Expected Dividend Growth Rate Years 1-10:                         5.00%

Enter Expected Terminal Dividend Growth Rate:                            4.00%

Enter Discount Rate:                                                                               9.00%

                               Discount Rate (Horizontal)                                                                       

Margin of Safety             8.00%                   9.00%                   10.00% 

20% Premium                   $88.96                  $70.96                  $58.96

10% Premium                   $81.55                  $65.04                  $54.05

Intrinsic Value                  $74.13                  $59.13                   $49.14

10% Discount                    $66.72                  $53.22                  $44.22

20% Discount                    $59.31                  $47.30                  $39.31

 

Final Thought

Realty Income is focussing its growth from retail and industrial properties. It has a reliable cash flow from multiple sources and investment grade tenants. It invests in properties operating in attractive industries conducive to economic growth.

The REIT has recorded a growth of 16.4% CAGR in annual shareholder returns since its listing, outperforming other equity REITs and indices.It also offers a reliable dividend income stream which makes it attractive for long-term investors and has earned itself the brand of“the monthly dividend company” due to its long record of paying monthly payouts.

 

 

Disclosure: I do not hold O in my DividendStocksRock portfolios.

Additional disclosure: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

CubeSmart – Leveraging Growth in the Self-Storage Industry

Summary

  • One of the top three self-storage REITs with good properties and an expanding portfolio
  • Growing strongly through both organic and inorganic routes
  • Macroeconomic factors like a growing population and rising rents acting as tailwinds

This article has been written by Sneha Shah for The Dividend Guy.

Investment Thesis

One of the main reasons to invest in REITs is their attractive returns  (at least 90% of its income is required to be distributed). REITs, which focus on self-storage properties, are even better as they are less sensitive to economic downturns than other real estate product types.

CubeSmart is amongst the top three national owners and operators of self-storage facilities in the United States. Its portfolio of high quality properties in good locations and a diversified customer base have enabled long term value creation for its shareholders. CubeSmart has been regularly increasing its payout over the last seven years and is just three years away from making it to the Dividend Achievers list. It offers a yield of over 4% and its strong cash flows imply investors have nothing to fear about future payouts as well.

Understanding the Business

Founded in 2004, CubeSmart (CUBE) is a real estate investment trust (REIT) that engages in the ownership, operation, acquisition and development of self storage facilities in the US. It operates a portfolio of 908 stores, more than half of which is owned by CubeSmart, in 23 states and District of Columbia. Its high quality portfolio focuses on supply constrained markets with good demographics.

The REIT earns its revenues principally from rent received from customers under month-to-month leases, which provides good short-term visibility and the ability to upwardly adjust rents in case of inflation.

Source : CubeSmart Investor Presentation

Revenues

Source: Ycharts

The REIT caters to the needs of a wide range of residential and commercial customers. Its properties have an average occupancy rate of 93.3% and are located near densely populated retail centers. Stores in metropolitan cities like Florida, New York, Texas, and California accounted for 17%, 16%, 10% and 8%, respectively, of CubeSmart’s total 2016 revenues.

The self-storage industry in the US is highly fragmented and consists of around 51,000 facilities having 2.6 billion rentable square feet space. About 16% of the total rentable square footage is owned by the top 10 operators collectively, which indicates that CubeSmart has a huge market to grow.

In addition to growing organically, CubeSmart is also focusing on acquisitions and has invested and estimated $50 million in making strategic acquisitions and adding 123 new properties (till November 2017).

Source: CubeSmart Investor Presentation

Earnings

Source: Ycharts

Cube Smart has successfully grown both its revenues and earnings over the last few years. Its funds from operation (FFO) have grown continuously every quarter in 2017, with the last quarter reporting an increase of 10.5% y/y.

The company is looking at maximizing its cash flows by increasing rents, occupancy levels and number of facilities; and by controlling operating expenses. In addition, CubeSmart’s Third Party Management program has allowed to leverage its operating platform, and develop an additional revenue stream.

As a publicly traded REIT with a BBB/Baa2 investment grade balance sheet, CubeSmart also has easy and multiple sources of access to capital.

Management estimates full year 2017 FFO per share, to range in between $1.57 and $1.58, which represents an increase of 9.4% y/y.

Source: CubeSmart Investor Presentation

Dividend Growth Perspective

Source: Ycharts

CubeSmart has an impressive dividend growth track record, increasing payouts by 28% CAGR over the last five years and by 23% in the last year itself. It has also grown its payout for the last seven years in a row and has a current yield of 4.2%. Its payout ratio stands close to 71% which is reasonable for REITs.

Strong cash flow generation and a disciplined investment strategy has allowed for meaningful increases in distributions to shareholders.

Source: Ycharts

Self-storage businesses are expected to perform better in good economies where people end up buying more things but have little space to store.

Potential Downsides

Rising interest rate is the biggest risk for CubeSmart, which reduces the attractiveness of investing in REITs. With US Treasury yields increasing sharply in 2018, CUBE might come under pressure.

An increasing population choosing to start families late and an older generation downsizing their homes could pose potential challenges for CubeSmart. Oversupply concerns and heightened competition are also potential risks.

Natural calamities can also adversely impact operation. CubeSmart estimates $1.4 million in repair costs, net of insurance proceeds, for damages caused by hurricanes Harvey and Irma.

Valuation

CubeSmart is a one of the biggest players in the self-storage market and should continue to grow through industry consolidation. Its market capitalization value is just $4.7 billion compared to $32 billion for Public Storage (PSA), industry’s largest player.

CUBE is currently trading at higher valuation relative to the industry median. It maintains a net debt-to-EBITDA ratio of 4.8x which is lower than industry average of ~6x.

Source: Ycharts

I have also used the Dividend Discount Model to determine a fair value for CUBE. Given CubeSmart’s strong cash flow growth, a conservative balance sheet and past growth I have assumed a dividend growth rate of 6% in the initial period and reduced it to 5% going forward. As for the discount rate, I never use under 9%. The output shows that the stock is currently reasonably valued.

 

Input Descriptions for 15-Cell Matrix                                     INPUTS

Enter Recent Annual Dividend Payment:                                             $1.11

Enter Expected Dividend Growth Rate Years 1-10:                            6.00%

Enter Expected Terminal Dividend Growth Rate:                              5.00%

Enter Discount Rate:                                                                                 9.00%

 

Discount Rate (Horizontal)

Margin of Safety             8.00%                   9.00%                   10.00% 

20% Premium                   $50.71                  $37.91                  $30.24

10% Premium                   $46.48                  $34.75                  $27.72

Intrinsic Value                  $42.26                  $31.59                  $25.20

10% Discount                    $38.03                  $28.43                  $22.68

20% Discount                    $33.81                  $25.27                  $20.16

Please read the Dividend Discount Model limitations to fully understand my calculations.

Final Thought

The self-storage business is a slow changing, relatively stable and predictable business because consumers need a place to store their stuff even during recessions. CubeSmart being an industry leading name with a strong operating performance and a conservative balance sheet should continue to grow steadily in the coming years.  It is in a good position to acquire high-quality assets in select markets and leverage the expertise of its partners to generate attractive returns.

 

 

Disclosure: I do not hold CUBE in my DividendStocksRock portfolios.

Additional disclosure: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.