This Under-Followed REIT Offers Great Growth Potential And a 7.6% Yield

One of the things that stinks about being a growth investor is companies looking to expand don’t usually pay much for a dividend.

This makes sense, since it doesn’t make sense to pay out a large portion of earnings back to shareholders and then borrow to fund growth. These stocks will often pay out small dividends, however, just to expose the company to mutual funds and ETFs that exclusively invest in dividend payers.

Every now and again though, a growth stock comes along that pays a succulent dividend. The company can use debt to finance its empire, leaving most of the profits left to pay shareholders a generous payout each month.

Such a stock exists today on the Toronto Stock Exchange, but with a market cap of just $227 million I wouldn’t be surprised if you’ve never heard of it. The REIT isn’t allocated in many REIT ETFs, and it’s relatively unknown.

The skinny

Automotive Properties REIT (TSX:APR.UN) isn’t your average REIT. The company is the only player in a niche part of the real estate market. It buys auto dealerships and then leases these locations back to dealership operators.

You’d think this is destined to be nothing more than a tiny business, but it has loads of growth potential. Canada’s automotive dealership market is incredibly fragmented. There are some 3,500 dealerships across the country and the leading operator, Dilawri Group, owns a mere 72 of them. In fact, the top 10 dealership groups only own 11% of Canada’s car dealerships. There are a lot of local businesspeople who own a dealership or two who are looking to retire in the next decade.

A big chunk of the cost of acquiring dealerships is paying for the real estate. That’s where Automotive Properties steps in. Say a dealership costs $15 million to acquire. The real estate alone costs $10 million while the rest (shop equipment, inventory, etc.) costs $5 million. If an acquirer can pay $5 million instead of $15 million, it can expand without tying up that much capital.

Automotive Properties is so busy buying dealerships it’s hard to keep up. Since its July 2015 IPO, the company has acquired 34 properties to boost its total portfolio from 26 to 60 properties. Acquisitions in 2019 include a Tesla service depot in Kitchener-Waterloo, two locations in Winnipeg, two properties in Guelph and a Volkswagen dealership in Abbotsford, BC. Total gross leasable space just surpassed 2.2 million square feet. A year ago, gross leasable space was less than 1.5 million square feet.

Yeah, that’s right. Automotive Properties grew the size of its portfolio by more than 50% in a year.

The company has a close relationship with Dilawri, owning approximately half of the dealer group’s properties. Rent collected from Dilawri was 100% of earnings when the trust had its IPO; that percentage is down to about 62% today. This relationship is a net positive because it contributes to much of Automotive Properties’ growth potential. The trust has first right of refusal on any Dilawri property that hits the market.

Drive this dividend all the way to the bank

Automotive Properties has one of the best dividends in the entire market right now. Shares currently yield a robust 7.6%. The company is also included on our list of the best Canadian REITs.

You might think a yield that high is in danger, but that’s the beauty of this stock. Because the bottom line is growing so quickly, the company is bringing its payout ratio down. This means the dividend gets more secure each quarter.

So far in 2019, Automotive Properties has generated $0.493 per share in adjusted funds from operations. During the same period last year, it earned $0.447 per share in adjusted funds from operations. That’s an increase of 10.2% on a year-over-year basis.

This dropped the payout ratio significantly, from 90% to 82%. Yes, there’s always a risk a nasty event or a hard recession could force the dividend to be cut, but it would take a lot for that to happen with this stock. The payout is secure.

 

 

2 thoughts on “This Under-Followed REIT Offers Great Growth Potential And a 7.6% Yield”

  1. Perhaps a a few comments on the companies fundamentals would be appropriate when discussing a potential equity.
    * This stock has remained flat since IPO. Why one would wonder?
    * No dividend hike for 3 years
    * Debt almost equals revenue.

    This company has a PE ration of over x61 and payout ratio of 172%. Don’t you think this should be discussed?

    I would certainly NOT head your advice on this company without digging through the tons of foot notes in the annual report. Caveat Emptor.

    • Hi Mike:

      Thanks for taking the time to comment. To address some of your concerns:

      I think the stock has remained relatively flat since the IPO because investors are concerned about where we’re at in the business cycle. If we’re in the late stages of an economic expansion, it’s not good for the auto sector. But APR.UN owns the real estate, not the dealerships. It’s well positioned to weather such a storm if it hits.

      There has been no dividend hike because the company is trying to keep its debt under control. Besides, it already offers a 7.6% yield. If you reinvest the dividend into more shares you’ll get a 7.6% raise every year. I would do that if I were very concerned about dividend growth.

      Debt/revenue is a poor way to look at a REIT. Most analysts prefer a debt-to-assets ratio. APR.UN’s debt-to-assets ratio is approximately 50%, which is fine. Anything above 53-55% gets me worried. The best REITs have debt/assets ratios in the 40-45% range (like SmartCentres and RioCan), but they usually have plans to get that ratio up to the 50% range by doing development projects or acquiring new properties.

      P/E ratios are an incorrect way to value a REIT. Accounting rules say a REIT must adjust their portfolio’s value every quarter. This gets reflected in earnings but it has no impact on the long-term profitability of a portfolio of property. In other words, earnings fluctuate wildly because of noise. The REIT sector uses funds from operations (FFO) as a proxy for earnings, which is essentially a measure of cash flow from operations. I prefer adjusted funds from operations (which I used in the article) because it approximates free cash flow (cash flow minus capital expenditures). Most analysts in the sector use adjusted funds from operations when figuring out whether a REIT can afford its dividend.

      The REIT has a payout ratio of just over 80% of adjusted funds from operations, which is about average for the sector. I would never use earnings to determine whether a REIT can afford its payout. Adjusted funds from operations is the much more appropriate number.

      In short, you can’t value REITs like you would a normal company. REITs have special rules that really only apply to the sector which make normal valuation methods pretty much useless.

      Hope that helped. Feel free to reply if you have any more questions.

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