This week, I introduce STORE Capital (STOR) to the prudent portfolio and am selling Blackstone (BX) and watch list stock Malibu Boats (MBUU).
STORE Capital (STOR) is a REIT (Real Estate Investment Trust) that manages hundreds of restaurants, retailers and other business properties. (STORE stands for Single Tenant Operational Real Estate.)
The investment is well diversified, which adds security in the case of a real estate downturn. The REIT owns 1,660 property locations operated by 360 customers as of the end of 2016 (the 2017 annual report is yet to be filed). As of December 2016, no single tenant contributed more than 2.8% of revenues, while the top 10 tenants comprised only around 16.7% of total revenue.
During 2016, almost 90% of the leases originated by STORE Capital were master lease agreements with an average lease term of 17 years. The company undergoes a thorough evaluation of tenant’s financial statements to make sure the tenant has enough cash flow to pay the lease obligations. Despite its stringent vetting process, STORE Capital’s occupancy rate is more than 99%, which shows the remarkable achievements of its sales team.
In addition to its high quality of investments and superior salesforce, STORE Capital is also inflation-hedged; 75% of its leases and loans have annual escalations adjusted to the Consumer Price Index (CPI) and 23% have fixed escalation. STORE can act as an effective hedge against inflation in the likely scenario of higher inflation. In 2016, the average lease escalation was 1.8%.
As of Q3 2017, the company had $1.78 billion in land and improvements and $3.76 billion in building assets. Rental revenue is expected to be around $400 million in 2017, with a rental yield of 8% of the net property. A lease escalation of 1.8% puts the gross yield at more than 9%, which is remarkable in the industry.
On the liability side, the company has around $2.4 billion of debt, the majority of which (about $1.5 billion) is facilitated through STORE Capital’s master funding conduit. Virtually all the company’s loans are fixed rate, so an interest rate hike is not a big concern. The average current interest rate is about 4%.
The spread between the rental yield of about 8% and the borrowing rate of 4% allows STORE Capital to expand by prudent leveraging.
My forecast for STORE Capital is optimistic because I expect the company to increase its leverage and expand its asset base while maintaining its high occupancy rate. I calculate its intrinsic value to be about $30 per share.
Warren Buffett recently started accumulating shares of STOR according to the 13F filing at a range of about $20 to $25 per share. STOR is down 10% year-to-date, making its current price a good entry point for long-term investors. STOR has a dividend yield of about 5.3%. The company’s next quarterly earnings report is due on February 22. You could wait until then to avoid any volatility or start accumulating the stock now and buy more on dips. BUY.
Blackstone (BX) is a private equity firm with significant real estate exposure. My addition of STORE Capital pushes our allocation to real estate too high. I believe STOR has the greater potential, so I recommend selling BX now.
In 4Q 2017, the company’s net accrued performance fee from real estate was $1.8 billion while the contribution from its private equity division was only $1.1 billion. With the recent promotion of its former head of real estate to the position of COO, I expect the company will increase its focus on its real estate business. Furthermore, the company’s increasing complexity makes it hard to arrive at an appropriate valuation. SELL.
Malibu Boats (MBUU) was on our December issue’s watch list when it was trading at 29.5 per share. Last week, the stock had a quick surge in price after a stellar earnings result and is currently trading at 34.72 per share, up 17%. If you recall from the December issue, I advised MBUU only from a short-time view because of concerns regarding an $80 million tax liability for its pre-IPO private equity owners. The unusual liability will continuously erode Malibu’s future free cash flows even while the company maintains its current growth.
The stock may continue to grow in the short term, but from a fundamental standpoint, it has almost reached its fair value. If you bought MBUU, the current level is a good exit point for a quick short-term gain. SELL.
There were no other major updates on my recommendations this week.
