Realty Income (O) Pre-Earnings Analysis: A Retail REIT Stock to Watch?

Retail REIT Realty Income Corporation (O) will release its operating results for the third quarter (ended September 30, 2023) post-market closure on November 6. The REIT’s funds from operations (FFO) and revenue are expected to increase significantly over the prior-year quarter.

In this piece, I have discussed why the stock could be best avoided now despite an expected year-over-year financial improvement.

Retail sales continue to be resilient despite the uncertain macroeconomic environment. Retail sales rose 0.7% in September, more than twice what economists had expected. The rise in retail sales closely follows the revised 0.8% rise in August. Moreover, retail sales are expected to grow further, with the holiday season expected to get underway this month.

O’s FFO and revenue for the third quarter are expected to increase 5.7% and 15.7% year-over-year to $1.02 and $955.78 million, respectively. Given the resilience of retail sales during the third quarter, the strong demand for retail properties is expected to have boosted its revenues.

The company owns more than 13,000 properties across different industries, which helps to lower the risks of overexposure to a particular space. This is also likely to have aided the growth in its earnings during the third quarter. In the last reported quarter, the REIT failed to surpass the consensus estimate by 0.2%. However, its revenue beat the analyst estimates by 8.8%.

On October 10, 2023, O announced the acquisition of Spirit Realty Capital for $9.3 billion. No leverage is being taken for the transaction, and it is expected to deliver over 2.5% accretion to O’s annualized Adjusted Funds from Operations (AFFO) per share. Moreover, no new external capital will be required to finance the transaction.

The merger will lead to an enterprise value of approximately $63 billion for the combined company, helping enhance O’s size, scale, and diversity.

On August 25, 2023, O and Blackstone Real Estate Income Trust, Inc. (BREIT) jointly announced that Realty Income had signed a definitive agreement to invest approximately $950 million to acquire common and preferred equity interests from BREIT in a new joint venture that owns a 95% interest in real estate assets of The Bellagio Las Vegas.

Its forward annual dividend of $3.07 yields 6.04% on the current share price. Its four-year average yield is 4.48%. Its dividend payouts have increased at a CAGR of 4.1% over the past three years and 3.7% over the past five years.

The REIT has gained 4% over the past month but declined 24.8% over the past nine months to close the last trading session at $50.85.

Here’s what could influence O’s performance in the upcoming months:

Mixed Fundamentals

O’s total revenue for the second quarter ended June 30, 2023, increased 25.8% year-over-year to $1.02 billion. Its adjusted funds from operations (AFFO) available to common stockholders (FFO) rose 15.1% over the prior-year quarter to $671.74 million. In addition, its AFFO came in at $1, representing an increase of 3.1% year-over-year. Also, its annualized Pro Forma adjusted EBITDAre increased 22.4% year-over-year to $3.65 billion.

On the other hand, its net income available to common stockholders declined 12.5% year-over-year to $195.42 million. Its net income available to common stockholders came in at $0.29, representing a decline of 21.6% year-over-year.

Favorable Analyst Estimates

Analysts expect O’s fiscal 2023 and 2024 revenue to increase 15.1% and 14.4% year-over-year to $3.80 billion and $4.35 billion. Its fiscal 2023 and 2024 FFO are expected to increase 1.8% and 3% year-over-year to $4.11 and $4.24, respectively.

Mixed Profitability

In terms of the forward AFFO Payout Ratio, O’s 76.54% is 3.7% higher than the 73.83% industry average. Likewise, its 83.94% trailing-12-month AFFO/Total Revenue is 92.9% higher than the industry average of 43.51%. Furthermore, the stock’s 40.11% trailing-12-month EBIT margin is 88.8% higher than the industry average of 21.24%.

O’s 0.07x trailing-12-month asset turnover ratio is 43% lower than the 0.13x industry average. Likewise, its 7.79% trailing-12-month AFFO yield is 1.3% lower than the 7.89% industry average. Furthermore, its 3.02% trailing-12-month Return on Common Equity is 5.7% lower than the industry average of 3.20%.

Stretched Valuation

In terms of trailing-12-month EV/EBITDA, O’s 17.22x is 7.6% higher than the 16.01x industry average. Likewise, its 12.37x forward P/FFO is 5.6% higher than the 11.71x industry average. Its 39.42x forward non-GAAP P/E is 28.9% higher than the 30.59x industry average.

POWR Ratings Reflect Bleak Prospects

O has an overall D rating, equating to a Sell in our POWR Ratings system. The POWR Ratings are calculated by considering 118 distinct factors, with each factor weighted to an optimal degree.

Our proprietary rating system also evaluates each stock based on eight distinct categories. O has a D grade for Value, in sync with its stretched valuation. Its mixed profitability justifies its C grade for Quality.

O is ranked #23 out of 30 stocks in the REITs- Retail industry. Click here to access O’s Growth, Momentum, Stability, and Sentiment ratings.

Bottom Line

Despite the uncertain macroeconomic environment, the strong demand for retail properties is expected to have boosted its top and bottom line.

However, the high-interest rate environment is expected to increase the company’s interest expenses. High mortgage rates are also likely to dampen its near-term prospects.

Additionally, the recent rise in treasury yields makes them more attractive than REITs like O. Moreover, O trades at an expensive valuation. Considering these factors, the stock could be best avoided now.

Stocks to Consider Instead of Realty Income Corporation (O)

The odds of O outperforming in the weeks and months ahead are significantly compromised. However, there are many industry peers with impressive POWR Ratings. So, consider these REITs with a B (Buy) rating from the REITs - Retail industry instead:

Saul Centers, Inc. (BFS)

Simon Property Group, Inc. (SPG)

What To Do Next?

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O shares were trading at $50.61 per share on Monday morning, down $0.24 (-0.47%). Year-to-date, O has declined -16.64%, versus a 15.25% rise in the benchmark S&P 500 index during the same period.

Since he was in grade school, Dipanjan was interested in the stock market. This led to him obtaining a master’s degree in Finance and Accounting. Currently, as an investment analyst and financial journalist, Dipanjan has a strong interest in reading and analyzing emerging trends in financial markets.

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