Federal Realty: Undervalued Dividend King With a High Yield

Even the best-run companies can encounter obstacles that have a negative impact on the business. In some cases, these companies have to consider cutting the dividend in order to preserve capital for whatever ails the business. But the Dividend Kings, stocks with at least 50 consecutive years, are those companies that have faced difficulties and still raised the dividend. There is a reason that there are just 30 Dividend Kings in the market. These names are the best-of-the-best in terms of dividend longevity. One of our favorite Dividend Kings is Federal Realty Investment Trust . Federal Realty Investment Trust had a very difficult year in 2020, as the coronavirus pandemic caused retail store closures across the United States. But the trust is recovering alongside the economy, and in the meantime has a high dividend yield above 5%. Business Overview Founded in 1962, Federal Realty is one of the largest real estate investment trusts in the U.S. The trust focuses its business in the densely populated coastal markets as this offers a higher number of potential customers. This business model has served the trust well as Federal Realty generates nearly $933 million in annual revenue and trades with a market capitalization of $6.3 billion. Federal Realty reported third-quarter earnings results on Nov. 5. Revenue declined 11.1% to $207.4 million, though this was slightly better than analysts had anticipated. Funds from operations (FFO) declined almost 30% to $1.12 per share and was a penny better than expected. Federal Realty has compounded its FFO at a rate of 5% per year over the last decade even as the share count has grown by 2% annually over this period of time. We believe that the prospects for growth will actually lead to a higher growth rate following a recovery from the pandemic. Growth Potential Federal Realty operates a strong business model. The focus on densely populated suburbs gives it a large pool of customers with discretionary income. And while operations were severely impacted by the ongoing Covid-19 pandemic, the trust still had several positives in its most recent report. The trust's occupancy rate for the comparable portfolio fell 170 basis points to 92%. Considering the bankruptcies that have occurred as a result of Covid-19, we considered this a solid performance and note that the occupancy rate isn't that far off of what it was in the previous year. Federal Realty also received 85% of revenues owed during the quarter, including 85% of rent owed in October. This is an improvement from the second quarter when the trust collected just 68% of rent due. As of the end of the third quarter, all 104 properties were in operation with 97% of annualized retail base rents open for business. Overall, conditions seem to be improving over time, a promising sign for 2021. The trust has proved very adept at finding tenants for its properties. Federal Realty signed 101 leases during the quarter for 481,105 square feet of retail space, falling in line with pre-Covid leasing activity. This shows that its properties remain in high demand from tenants even with the uncertainty surrounding the pandemic. Federal Realty also has a very strong balance sheet, with A ratings from the major credit agencies. The trust also recently sold three non-core assets for a combined proceed of $170 million. These funds were then used to repay $250 million of 2.55% senior unsecured notes. Federal Realty also redeemed $250 million of 3% senior unsecured notes due in 2022. The trust now has no public debt maturing until June 2023. The trust has $1.3 billion of current assets, including $863 million of cash and cash equivalents on its balance sheet. A solid cash position combined with no debt repayment needed for almost two-and-a-half years has Federal Realty well positioned to withstand any further impacts from the pandemic or any other unforeseen issues. Due to the strength of the trust's business, we believe that business will normalize following a recovery from the pandemic. We believe that Federal Realty will grow FFO at a rate of 5.9% per year through 2025. Analysts expect that Federal Realty will generate FFO of $4.54 per share in 2020. Dividend Safety Federal Realty's dividend continues to grow. The trust last raised its dividend by approximately 1% for the Oct. 15, 2020 payment. This is much lower than the stock's compound annual growth rate of 4.7% over the last decade, but appears appropriate given the difficult business environment today. Federal Realty has now raised its dividend for 53 years in a row, one of the longest growth streaks in the market. The dividend should be safe moving forward. Shareholders received $4.22 of dividends per share in 2020, which equates to a projected payout ratio of 93%, based on projected FFO for the full year. REITs frequently have elevated payout ratios, but Federal Realty usually has a ratio much lower than its peers. For context, the average payout ratio is just 68% since 2010. The higher-than-usual payout ratio is another reason why the trust's more recent raise was on the low side. We would expect this payout ratio to return to a more normal range following a recovery from the pandemic. While recent dividend growth might be less than ideal, the yield is very attractive. Using the annualized dividend of $4.24 and the current share price of around $84, Federal Realty has a current yield of 5%. The average yield over the last decade is just 3%. The stock has a current yield much higher than the 10-year average. Total Expected Returns In addition to FFO growth and dividends, shareholders' total returns will also be impacted by changes in valuation. While analysts expect FFO to decline this year, we believe that Federal Realty has normalized FFO power of $6.00 per share. We feel that this total better accounts for the true business performance while also allowing for some impairment from the pandemic on results. Using this figure and the current share price, Federal Realty trades for a price-to-FFO ratio of 14. We have a five-year target price-to-FFO ratio of 15. If the stock were to reach our target by 2026, then valuation would be a 0.7% tailwind to total annual returns during this time. Therefore, total returns would consist of the following: 9% earnings growth 5% dividend yield 7% multiple expansion We expect that Federal Realty will offer shareholders a total annual return of 11.6% through 2026. This is a strong rate of return for income investors. Final Thoughts Federal Realty isn't without its struggles at the moment. The pandemic has negatively impacted business results, though the trust did show some resiliency in its most recent quarter. All of its properties and nearly all of its retail tenants are open for business. The trust also saw an improvement in its rent collection quarter over quarter and had pre-Covid-19 levels of leasing activity. This strength is an excellent example of why Federal Realty has managed to grow its dividend for more than five decades. The stock also offers a dividend yield rarely seen over the last decade, which income investors should find extremely attractive. Federal Realty's total return projections, in conjunction with its business model, growth prospects, and dividend history makes the stock attractive for investors.

Federal Realty: Undervalued Dividend King With a High Yield

There is a reason that there are just 30 Dividend Kings in the market.

Columnist Conversation

This Weekend on Real Money

Where Does the Nasdaq Go From Here?

Has the Short-Term Top Come for the XLF/Banks?

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.