EUR 850.00 For Business Accounts Only

Morningstar | High Releasing Spreads and Large Acquisition Volumes Highlight Third Quarter for Realty Income

Realty Income saw some marginal operational improvements but the bottom line was consistent with our expectations, leading us to maintain our $60 fair value estimate and no-moat rating. Physical occupancy improved 10 basis points sequentially and 50 basis points year over year to 98.8%. Releasing spreads in the third quarter were 7.9%, up from both the first half of 2018 and all of 2017. However, contractual rent growth was only 1.0%, below our estimate of 1.25% growth, which kept revenue growth in line with our expectations. As a result, the company reported adjusted funds from operations of $0.81 that met our estimate for the quarter. The company raised the lower end of AFFO guidance for 2018 to bring up the midpoint of guidance by a penny to $3.195, though our full-year estimate is still just above the high end of management's narrowed guidance range. We think that our number is still reasonable given the volume of acquisitions Realty Income made in the third quarter. The company executed on $603.1 million of new acquisitions in the quarter, the largest acquisition volume the company has achieved since the fourth quarter of 2016, at an average cap rate of 6.3%, in line with the cap rates that it has been able to achieve over the past few years. The company also got upgraded by S&P Global Ratings to A- with a stable outlook, which should lower debt spreads. Management commented that it could exceed its $1.75 billion acquisition target for 2018, which could drive the bottom line closer to our estimate. If Realty Income can continue to source acquisitions at a significant spread above its current cost of capital, the company should be able to create value for shareholders.

Realty Income is replacing CEO John Case with current president and former COO Sumit Roy. Management stated on the call that the decision was mutual between the parties for Case to step down, but we are curious why the change occurred so abruptly without any advance notice provided to shareholders. Case will take $28 million in severance upon his departure, which will impact G&A in 2018 but shouldn't impact the company's AFFO. Given new CEO Sumit Roy's experience with the company and the rest of management remaining in place we do not plan to change the company's exemplary stewardship rating.