WP Carey (WPC) is a global real estate investment trust (“REIT”) that invests in commercial properties. The company has a long and successful history (over 45 years) of working with different companies to monetize the value of their real estate. And our bullish thesis is based on the following considerations:
- WPC owns a large and diverse portfolio of high quality real estate totaling 146 million square feet. The company has an occupancy rate of over 90% and an annualized base rent of $1.2 billion. Over 99% of leases have built-in escalation. With the current inflation outlook, this will be a good hedge if inflation persists longer and higher.
- She remains active in her real estate investments in 2021 and finds many opportunities to invest. Its year-to-date total reached approximately $1.193 billion in Q3 2021, compared to the guided range of $1.5 billion to $2.0 billion for the full year. Its recent acquisitions further strengthen its quality real estate portfolio with warehouses, office buildings, Casino Guichard-Perrachon shops, etc.
- In terms of valuation, the recent price correction has created an entry opportunity. It generates stable cash flows thanks to its long-term leases which contain significant increases in contractual rents. And you will see that it is attractively priced in terms of multiple FFOs. Independently, its current valuation is also attractive in terms of its property portfolio, as detailed below.
Assessment 1: FFO valuation
Thanks to its quality and diversified real estate portfolios, WPC benefits from a solid and stable organic income. In its latest earnings report, it claims the AFFO 2021 guidance range of between $4.94 and $5.02 per diluted share. This includes real estate AFFOs between $4.82 and $4.90 by dilution, based on a full-year investment volume of between $1.5 billion and $2.0 billion.
Notably, WPC is also well positioned to benefit from inflation. Over 99% of leases have built-in indexation, and the vast majority of leases have CPI-linked rents, which are expected to increase over the coming quarters.
Through real estate investments and long-term partnerships with tenants, WPC has provided stable income for investors. WPC investors have been handsomely rewarded over the past decade through a combination of earnings growth and valuation expansion. In terms of FFO multiples, as the following chart shows, WPC has been valued at an average of 13.4x historically. And shareholders have often been rewarded with rising valuations in the past.
Thanks to its robust and stable earnings, the chart also shows that whenever the price falls near or below 13.4x FFO, it has been a good time to buy. And as you can see, how is such a moment. The stock is valued at around 14.5x FW FFO, quite close to its historical average of 13.4x.
Report 2: the Asset + Income Valuation approach
For REIT stocks like WPC, another very intuitive and effective valuation approach that we use ourselves is based on its assets and earnings. Details are provided in our recent article on STORE Capital, and a brief summary is provided here to facilitate this discussion:
- If you think like a long-term business owner (instead of a stock trader), investing in a REIT is nothing more than buying real estate to collect rent. The investment value therefore consists of two parts: the value of the property itself and the future rent.
- Our valuation method approximates the first part by its book value (“BV”) and the second part by 10x of its dividends. In other words, the investment value (“IV”) of a REIT share must be: IV = BV + 10 x dividend.
- This method offers the advantage of a valuation anchored in the most easily accessible data with the least uncertainty: BV and dividend. When it comes to investing, we always prefer the use of a few reliable data points rather than many less reliable data points.
I hope the above should be very intuitive for you – when investing in REITs, we are willing to pay up to the face value of the business (the BV) and 10 years rent. Just to provide a data point for reference, the weighted average lease term for WPC is 10.6 years.
With the above understanding, the following table shows the results of this method applied to WPC. As can be seen, it has captured the market price very well since 2012. Note that the company was not a REIT business until its conversion in 2012. Therefore, the behavior of stocks prior to 2012 was more a transition and it made sense that he didn’t follow the IV closely. As this chart shows, after the end of the transition, when the market price moves below the IV, it presents good entry opportunities followed by nice total returns – although you have to be able to handle the volatility short term.
Note that I applied a multiplier, M, to book value in this calculation. The idea is that if a given REIT (like WPC) can earn more than average on their property, then every dollar of their property should be worth more than average. The details are again in our recent article on STORE Capital. The M applied for WPC here was 1.36. WPC earned approximately $0.14 of FFO on every dollar of its BV (i.e. its return on equity FFO is 14%). Average REITs earn about 12%, so M = (14%/12%)^2 = 1.36.
As seen, the current IV, based on forward BV and dividend, is around $72.5. And at a price of $75, the stock represents a quality company to sell at an attractive price in today’s broadly expensive market, which is very consistent with the FFO valuation above.
The first chart below shows its valuation and projected return based on FFO (and dividend). As the following figures in the table show, at its current price level, it is very close to a fair value. It’s overvalued by about 9% based on historical FFO multiples, and almost exactly evenly priced based on historical dividend yield.
Looking ahead, for the next 3-5 years, a low mid-digit annual growth rate is expected (close to 6.5%) due to A) its strong portfolio and stable cash generation, B) its current active investments and C) the continued inflation adjustment built into the majority of its leases. And total return over the next 3-5 years is expected to be in the range of 18% (the low-end projection) to around 27% (the high-end projection), which translates to a healthy 4.3 % to 6.2% annual total return.
In terms of asset pricing method, it is relatively straightforward to project a “normal” return scenario also in the next 3-5 years, as summarized in the chart below. This projection is made under the following very conservative assumptions:
- BV grows about 1% per year to reach $40 per share in 3-5 years.
- FFO’s return on equity remains at the historical average of approximately 14%, and as a result, FFO increases to $5.2 per share.
- The dividend would increase to $5.3 per share.
Based on these assumptions, the projected IV 3-5 years out would be around $100, again very close to the projections obtained from the FFO analysis. And at the current price level, the total return should be around 33%, or 7.4% annualized.
It is not necessary to neglect the average annual return to higher single digits. This is a solid return when adjusted for risk – consider A) that most of the return will come from dividends, which are funded by stable rental income locked in for many years, and B) that much of the stock price is backed by real estate properties.
A major risk is interest rate risk. The company has quite a high debt load (like all REIT companies). Its current long-term debt is approximately $6.7 billion. Thus, a 1% increase in its interest rate would result in $67 million in additional interest expense. Its FFO is around $930m in 2021. Therefore, additional interest charges represent around 7% of its FFO, a significant risk.
Although the reality is more complicated and could be better or even worse than this simple estimate here. On the positive side, most of WPC’s debt is fixed rate and well-laddered, as shown below. Thus, the effects of higher interest charges will be gradual and not abrupt to give management time to react and adapt.
But on the negative side, there is always the possibility that interest rates could rise more dramatically than the current Fed dot chart. And WPC must also continue to issue new debt to finance its new investments. For example, in Q3 2021, WPC raised $457.2 million through forward equity sales and also raised $123.2 million in net debt.
Conclusion and final thoughts
The recent price correction has created an entry opportunity for WPC. It is attractively valued both in terms of FFO and real estate assets. And our bullish thesis is supported by the following considerations:
- WPC holds a large and diversified portfolio of high quality real estate. The company has an occupancy rate of over 90% and over 99% of leases have built-in indexation.
- She remains active in her real estate investments in 2021 and finds many opportunities to invest. Its recent acquisitions further strengthen its quality real estate portfolio with warehouses, office buildings, Casino Guichard-Perrachon shops, etc.
- In terms of valuation, the recent price correction has created an entry opportunity. Its attractive valuation is confirmed by two independent valuations. Both approaches show a target price close to $100 in 3-5 years, translating into a mid-single-digit annual return (around 7.4%). It is not necessary to neglect the average annual return to higher single digits. This is a solid return when adjusted for risk – consider A) that most of the return will come from dividends, which are funded by stable rental income locked in for many years, and B) that much of the stock price is backed by real estate properties.