This week we continue on the thematic of REITS and look at two US based entities one of which, VICI Properties, we feel makes a rather rational investment case for inclusion in portfolios while the other, Digital Realty, is on our watchlist.
VICI Properties (VICI.NYSE)
For those of you familiar with this particular REIT, you may know it as the spinoff from Caesars when that particular company filed for bankruptcy a few years back. Given the unique tax treatment for REITs in the US, the administrators at the time thought it prudent to take the underlying casino assets from Caesars, including iconic assets such as Caesars Palace in Vegas, and put the assets in a REIT structure. Since emerging from bankruptcy in 2017, the trust has made significant headway in not only diversifying the business to now include categories across gaming, hospitality, entertainment and leisure destinations but also strengthening their balance sheet and geographic exposure. The most recent acquisition has been the Venetian (another iconic piece of real estate in Vegas) at a cap rate of 6.5%. The operating segments now comprise both real property and golf courses across Vegas, the Midwest and East coast.
So, why is this company worthy of consideration as an investment proposition? Let's get to the numbers first. Revenue at TTM (Trailing Twelve Months) currently stands at approximately $1.34bn USD, growing from $900m USD in 2018. Price to book stands at an attractive 1.8 while the PE (again, on a trailing basis) stands at 14x. This in itself stands as an attractive proposition in comparison to some of their peers in the market. While the securities did take a hit during the Covid related sell-off last year, the market seems to have woken up to the fundamentals. Firstly, the nature of the rental contracts ensured that the business continued to get paid while the underlying valuation of the properties continued to grow.
As the economy across their major markets, including the Midwest and East coast, continues to recover we should see the business come back into the spotlight. In addition, the nature of her revenue stream, especially gaming, ensures sustainability through market cycles. Take for example, the last major crisis before Covid, the GFC, from peak to trough from ‘07 to ‘09, the gaming industry overall lost 9% in revenues compared to 11% in broader retail and 18% overall in terms of the S&P500. This indicates the durable nature of her revenue streams. Moreover, the Weighted Average Lease Term across the portfolio stands at stellar 34.5.
From a portfolio allocation perspective, what is attractive about this business is the nature of her revenues. What we are referring to here is the fact that there are built in escalations of an average of 1.5% and a further 94% of the contracts indexed to CPI. This proposition is further enhanced by the fact that 91% of the debt is fixed (as opposed to floating) and 69% unsecured, which should see it protected against any surprise changes to Fed policy.
My Expectations: A great reflation trade and bond substitute that should see more interest from the broader market over the next 24-months. The attractiveness is further enhanced in an inflationary environment (as a protection against loss of purchasing power). Significant growth as it is somewhat insulated, in my view, from the “Amazon effect.” By that we mean that people remain attracted to the physical experience of going to the casino (you also can’t physically play golf online). In addition, the moat comes from the capital intensity and high barriers across most of their revenue stream.
Dividend Yield: 4.14% (historic growth of 9.5% p.a.) and, in our view, there is no reason for this not to remain the case as the trust has a payout ratio of 71% even at this yield, a significantly lower proportion in comparison to her competitors Spirit or Realty Income (an average of 80%).
Digital Realty Trust (DLR.NYSE)
Digital Realty is quite possibly one of the biggest businesses you’ve never heard of. A technology business masquerading as a REIT. It owns and operates nearly 300 data centres globally, operating in every continent apart from Antarctica. To put it simply, they invest into carrier-neutral data centres. It works like this, say you’re NAB (who are in fact a customer) trying to move and compete in a digital world with requirements ranging from online banking to internal ERP (Enterprise Resource Management) systems and handling sensitive information. The requirements can be summed up simply:
Digital Realty helped by creating a 5,600 square meter facility based out of Deer Park (this also consolidated their close to 20 smaller existing data centres based out of various commercial properties across the nation). If you have a NAB account or have interacted with the business, all things equal, your information may have just passed through the infrastructure. What is more interesting in my opinion is the long-term nature of the lease and the moat that is built around their revenue stream. Just like most ERP systems, once customers have made the decision to allocate capital, it becomes exceptionally sticky as customers grow more reliant and their requirements increase in complexity. Anyone who has experience with this kind of software/technology knows how exceptionally difficult it becomes to migrate away.
On top of being a traditional REIT, DLR operates a unique value-add model that has two attributes: 1) cash flow; and 2) stickiness of revenue. For the ESG-focused amongst you (which will help it make it more palatable for the institutional flows), the company also has a 100% renewable target. From a strategy perspective, they seem to have taken the old adage “if you can't beat ‘em, join ‘em” to heart, offering multi-platform solutions working with IBM, Oracle and Equinix (who are also customers, which is rather handy). For the Australian investor familiar with a company we used to own in Megaport (MP1.ASX), the business has a partnership there too. In emerging markets, the go-to partner is Brookfield (Latin America) and Mitsubishi in Japan.
Coming to the numbers, revenue on a TTM stands $4.17bn USD and Net Margin stands at 10%. Price to book at 2.66 and P/E at 111.11. The last number is off putting but it has to be considered in conjunction with the Net Margins as well as the growth potential going forward. Looking back to the thesis around inflation, similar to VICI, over 94% of the debt on the balance sheet is fixed and, more than VICI, this remains unsecured.
My Expectations: This remains an expensive proposition (which is why this no longer owned but rather on our watch list) but, to paraphrase the PM of our Global Mobility strategy, data is the oil of the 21st century. I would go further, oil is rather pro-cyclical but data will be the lifeblood of business going into the 21st century (i.e. oil with attributes of consumer staples). From that perspective, DLR still remains on our watchlist with some of the risk mitigated by the stability of revenues, the fixed nature of the debt on the balance sheet (any increases to CPI is effectively a transfer of wealth from debt holders to bond holders) and de-risked given the unsecured nature of said debt.
The risk remains the high P/E and any changes to the headline rate environment should impact the business. But for the long term investors, this is not a yield story but rather a dividend growth story.
Dividend Yield: 2.98% with the expectation of long-term growth within the high single or double digits given the space it operates in.
Disclaimer: VICI is held in the G-REIT segment of TAMIM's Listed Property portfolio. DLR, while not currently held, is being monitored.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.