Realty Income Stock: Recession Fears Overdone (NYSE:O)

Realty Income Corporation (NYSE:O) stock has performed well over the past two months, edging ahead of the S&P 500 (SPX) (SPY). Undergirded by a stable NTM dividend yield of 4.54%, paid monthly, O posted a total return of 4.26%, compared to the SPY’s 1.37% since our previous update.

Realty Income’s rental base is robust and well-diversified as one of the leading triple-net lease retail REITs endowed with strong tenants.

As such, the company confidently posted its “631st consecutive common stock monthly dividend,” with the company boasting a 4.4% dividend per share (DPS) CAGR since 1994.

Hence, O is likely used by REIT investors as a core allocation in their portfolios, given the scale and visibility of its AFFO over time. Moreover, its payout ratio remains prudent, with its AFFO per share estimates for FY22 covering its DPS by more than 1.3x.

However, it’s also vital for investors to note that capital appreciation is a critical underpinning of its long-term total return CAGR.

Accordingly, O posted a 5Y and 10Y total return CAGR of 9.7% and 9.6%, respectively. The 10Y average of the REIT’s NTM dividend yield amounts to about 4.5%. As such, we believe investors need to pay close attention to O’s price action, as much as they focus on the clarity of its AFFO projections bolstering its dividend payouts.

O’s price action was significantly impacted by the upheavals caused by the Dollar Index (DXY) appreciation. As such, market operators forced a steep capitulation in O in October, likely causing investors unduly concerned with its forex exposure to bail out rapidly.

However, the DXY has declined, losing more than 11% from its September highs. As such, the market has likely priced in the normalization of its forex exposure, as seen in the recovery from its October lows.

So, what could help drive the company’s valuation upward, even as Wall Street analysts remain cautious about its prospects in 2023/24?

Analysts have revised Realty Income’s AFFO per share projections downward for FY23. O is estimated to post an AFFO per share growth of 8.4% for FY22. However, the growth cadence is projected to fall to 2.6% in FY23.

Hence, we believe macroeconomic headwinds and market volatility could continue to affect Realty Income to drive AFFO accretion.

Notwithstanding, we believe Realty Income’s recent move to raise funds suggests that the company expects interest rates to moderate in the medium term.

Realty Income priced a combined offering of about $1.1B in early January consisting of senior unsecured notes of $500M (due January 13, 2026) at 5.5% and $600M at 4.85% (due March 15, 2030).

For its notes due January 2026, it’s also “callable at par” on January 13, 2024, implying that the company is considering the potential opportunity in refinancing at lower rates in early 2024.

Coupled with a three-year $500M fixed-to-variable interest rate swap executed against its 2026 notes, we believe the company has confidence that a lower rate environment could follow moving ahead.

As such, we believe it corroborates the rally in the market since the start of 2023, as market operators prime themselves for lower rates by the end of 2023, despite the Fed’s hawkish messaging.

Bearish investors anticipating a drop toward its October lows could be sorely disappointed.

O has been consolidating well at the current levels since early November 2022, as its upward momentum improved in 2023.

With a more constructive macro outlook and still reasonable valuations, investors can consider adding more exposure at its next pullback.

Rating: Hold (Reiterated).