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Monday, December 1, 2008

* Stock Analysis: Realty Income Corp (O)

This article originally appeared on The DIV-Net November 24, 2008.

Linked here is a PDF copy of my detailed analysis of Realty Income Corp (O). Below are some highlights from the above linked analysis:

Company Description: Realty Income Corporation engages in the acquisition and ownership of commercial retail real estate properties in United States.

Fair Value: I consider four calculations of fair value, see page 2 of the linked PDF for a detailed description:
  1. Avg. High Yield Price
  2. 20-Year DCF Price
  3. Avg. P/E Price
  4. Graham Number
O is trading at a discount to 1.) and 3.) above. If I exclude the high and low valuations and average the remaining two, O is trading at a 14.4% discount. O earned a Star in this section since it is trading at a fair value.

Dividend Analytical Data: In this section I consider five factors, see page 2 of the linked PDF for a detailed description:
  1. Rolling 4-yr Div. > 15%
  2. Dividend Growth Rate
  3. Years of Div. Growth
  4. 1-Yr. > 5-Yr Growth
  5. Payout 15% of avg.
O earned one Star in this section for 3.) above. O has paid a cash dividend to shareholders every year since 1994 and has increased its dividend payments for 5 consecutive years. However, O's dividend has trended upward for the last 12 years and was awarded a Star on this basis. Last year's dividend payout was 152%, up from 138% in 2006. Since the increase was in excess of 15 points, a Star is deducted, leaving a net of zero Stars in this section. As a REIT, O is required by law to pay out 90% of its taxable income.

Dividend Income vs. MMA: Why would you assume the equity risk and invest in a dividend stock if you could earn a better return in a much less risky money market account (MMA)? This section compares the earning ability of this stock with a high yield MMA. Two items are considered in this section, see page 2 of the linked PDF for a detailed description:
  1. NPV MMA Diff.
  2. Years to >MMA
O earned both of the available Stars in this section. The NPV MMA Diff. of the $47,698 is in excess of the $7,500 minimum I look for in a stock that has increased dividends as long as O has. O's current yield of 10.43% exceeds the 4.61% estimated 20-year average MMA rate.

Other: O is a member of the Broad Dividend Achievers™ Index. Same-property revenue and net operating income will likely be positive across the industry over the next 12 months. Most retail properties have long-term leases normally between 5-20 years. These leases include automatic rent adjustments that should help insulate REIT's from a softening economy. Risks include lower consumer spending and retail sales in the near term. The weak economy could lead to more store closings and retailer bankruptcies.

Conclusion: O earned one Star in the Fair Value section, did not earn any Stars in the Dividend Analytical Data section and earned two Stars in the Dividend Income vs. MMA section for a net total of three Stars. This quantitatively ranks O as a 3 Star-Hold.

Using my D4L-PreScreen.xls model, I determined the share price could increase to $31.36 for O's NPV MMA Differential to be around the $7,500 that I like to see. At that price the stock would yield 5.30%.

Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the $7,500 NPV MMA Differential I'm looking for, the calculated rate is -3.5%. This dividend growth rate is significantly below the 5.2% used in this analysis.

O bills itself as The Monthly Dividend Company since it is one of the few companies that pays a dividend 12 times a year. Its dividends aren't increased on an obvious schedule. Instead, they gradually drift up every few months at odd increments. The last increase was in October 2008 when the dividend increased to $0.1411/share from $0.1405/share.

Management takes great pride in their company's dividend history and generally focuses a lot of attention on dividends each year in the annual report. Given this heightened importance, I believe that a dividend cut from this company would only come as a last resort. O is in my higher risk category. I would be comfortable adding to my position in O at prices below $19.20.

Disclaimer: Material presented here is for informational purposes only. The above quantitative stock analysis, including the Star rating, is mechanically calculated and is based on historical information. The analysis assumes the stock will perform in the future as it has in the past. This is generally never true. Before buying or selling any stock you should do your own research and reach your own conclusion. See my Disclaimer for more information.

Full Disclosure: At the time of this writing, I was long in O (4.4% of my Income Portfolio).

What are your thoughts on O?



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