Realty Income Corporation Annual Valuation – 2014 $O

220px-Realty_Income_LogoREITs often attract a great deal of investors because of their strong cash flows and dividends, and those investors often overlook other parts of the business, choosing to analyze the company under a different set of criteria than companies in other sectors.  This can create a problem in that it becomes difficult to compare a REIT to an industrial, which is fine if you use the typical top-down approach to stock selection; however, a top-down approach invites speculation in the fact that you are theorizing which sector will perform well going forward.  Benjamin Graham taught that we should avoid speculation as much as possible, which is why it is critical to develop a system for analyzing companies that will allow them to be compared across industries.  This is best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another investment opportunity.  By using the ModernGraham method one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries.  What follows is a specific look at how Realty Income Corporation (O) fares in the ModernGraham valuation model.

Company Profile (obtained from Google Finance): Realty Income Corporation (Realty Income) is an equity real estate investment trust (REIT). The Company is engaged in acquiring and owning freestanding retail and other properties that generate rental revenue under long-term lease agreements (primarily 10 to 20 years). The Company has in-house acquisition, leasing, legal, credit research, real estate research, portfolio management and capital markets. At December 31, 2011, it owned a diversified portfolio of 2,634 properties with an occupancy rate of 96.7%, or 2,547 properties leased and only 87 properties available for lease. It leased properties to 136 different retail and other commercial enterprises doing business in 38 separate industries. It properties are located in 49 states, with over 27.3 million square feet of leasable space, and with an average leasable space per property of approximately 10,400 square feet. In January 2013, it acquired American Realty Capital Trust.


Defensive Investor – must pass at least 6 of the following 7 tests: Score = 4/7

  1. Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
  2. Sufficiently Strong Financial Condition – current ratio greater than 2 - FAIL
  3. Earnings Stability – positive earnings per share for at least 10 straight years - PASS
  4. Dividend Record – has paid a dividend for at least 10 straight years - PASS
  5. Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period – FAIL
  6. Moderate PEmg ratio – PEmg is less than 20 - FAIL
  7. Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 - PASS

Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 3/5

  1. Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 - FAIL
  2. Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – FAIL
  3. Earnings Stability – positive earnings per share for at least 5 years - PASS
  4. Dividend Record – currently pays a dividend – PASS
  5. Earnings growth – EPSmg greater than 5 years ago – PASS

Valuation Summary

Key Data:

Recent Price $49.17
MG Value $33.55
MG Opinion Overvalued
Value Based on 3% Growth $22.12
Value Based on 0% Growth $12.97
Market Implied Growth Rate 11.87%
Net Current Asset Value (NCAV) -$23.91
PEmg 32.24
Current Ratio 0.53
PB Ratio 1.96

Balance Sheet – September 2014

Current Assets $64,800,000
Current Liabilities $121,600,000
Total Debt $4,762,200,000
Total Assets $10,939,800,000
Intangible Assets $1,075,400,000
Total Liabilities $5,378,100,000
Outstanding Shares 222,200,000

Earnings Per Share

2014 (estimate) $2.59
2013 $1.06
2012 $0.86
2011 $1.05
2010 $1.01
2009 $1.03
2008 $1.06
2007 $1.16
2006 $1.11
2005 $1.12
2004 $1.15

Earnings Per Share – ModernGraham

2014 (estimate) $1.53
2013 $1.00
2012 $0.98
2011 $1.04
2010 $1.05
2009 $1.08

Dividend History

Conclusion:

Realty Income Corp is not suitable for either the Defensive Investor or the Enterprising Investor.  The Defensive Investor is concerned with the low current ratio, the the lack of sufficient earnings growth over the last ten years, and the high PEmg ratio.  The Enterprising Investor is concerned with the high level of debt relative to the current assets.  As a result, value investors following the ModernGraham approach should explore other opportunities at this time.  From a valuation side of things, the company appears to be overvalued after growing its EPSmg (normalized earnings) from $1.05 in 2010 to an estimated $1.53 in 2014.  This demonstrated level of growth does not support the market’s implied estimate of 11.87% earnings growth over the next 7-10 years.  As a result, the ModernGraham valuation model returns an estimate of intrinsic value that is below the market price.

Be sure to check out previous ModernGraham valuations of Realty Income Corp (O) for greater perspective!

The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects.  What do you think?  What value would you put on Realty Income Corp (O)?  Where do you see the company going in the future?  Is there a company you like better?  Leave a comment on our Facebook page or mention @ModernGraham on Twitter to discuss.

Disclaimer:  The author did not hold a position in Realty Income Corp (O) or any other company mentioned in the article at the time of publication and had no intention of changing that position within the next 72 hours.  Logo taken from wikipedia; this article is not affiliated with the company in any manner.


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