On Seeking Alpha last year, I explained that “there’s no shortage of media headlines instructing investors where to find high-yield investment opportunities.” Many people read articles on this website daily hoping to find the next 'home run' stock that will deliver everlasting high dividend yields.
However, we all know investments don’t pay 10% plus in this environment unless there’s risk. I don’t care how smart you are, it’s critical that when you’re taking a more aggressive approach, you should double-down on the knowledge of the prospective company.
As I explained, “a high dividend can signal that a company is in distress - and investors who buy solely on the dividend may experience losses when the dividend’s cut and the stock price declines in response”. Ultimately, the stock market is forward-looking and usually detects underlying problems – which of course are what made the stock “appear” attractive in the first place.
More importantly, high dividend yield is often temporary, as the same catalyst that beat down the stock price would most likely lead to a reduction in the dividend.
At other times, the company may elect to keep the dividend and reward dedicated shareholders (i.e. WPG), but savvy analysts and investors should be smart enough to look into the financial statements and question whether or not the dividend can be maintained. That’s precisely why we spend countless hours researching management’s track record of paying dividends.
I’m perfectly content watching the high rollers play on these dangerous tables, while I 'sleep well at night' with a balanced approach with intermediate-term time horizons of five to 10 years.
Now I’ll be honest, you'll rarely see me fishing in the more speculative channels of high-yielding stocks, there’s a reason I don’t cover/research residential mortgage REITs. However, I must finish out my “Do You Feel Lucky” series, in which I have examined the “REITs that yield 7% plus” and the “one’s that yield 8% plus”. Now it’s time to conclude the sequence with the eye-popping double-digit dynamos.
Yet, before we get started, I must caution you that 'double-digit' yields are hazardous because of the beaten down price, Mr. Market is signaling that the dividend payout may not be sustainable and a decrease is more likely. Frank J. Williams (If You Must Speculate, Learn The Rules) wrote,
“People of the dupe type are hypnotized by the glare of gold. They stare so long at glistening fortune that their minds are brought under subjection to one of nature’s strongest passions – greed. They will listen to any tip, however wild and ridiculous, and impulsively act on any suggestion.”
Beware of the Sucker Yields
I’m sure you’ve heard me refer to these higher-risk REITs as sucker yields. I’ll provide you the definition as explained on Investopedia:
“When a company is paying a dividend beyond its earning power it is essentially eroding capital. Suppose an investor purchase shares in a company that is paying a dividend yield of 10%. The company has a track record of cutting dividends and its balance sheet has considerable leverage…
When a stock is paying an extraordinarily high dividend yield combined with an unsustainable business model, there will almost always be loss of principal.” Finding the right REIT at the right price – with a margin for safety against unknown market risk – is the ultimate goal."
While screening for double-digit dividend paying REITs we went to our Intelligent REIT Lab and discovered 10 companies that are yielding at least 10%, here’s the list:
We have SELLs on a number of the REITs (listed above) including Colony Credit (CLNC), Apollo Commercial (ARI), New Senior (SNR), Senior Housing (SNH), and Government Properties (GOV). In addition, we have a STRONG SELL on CBL Properties (CBL) and Washington Prime (WPG).
Regardless of how cheap CBL becomes, we have no interest in purchasing shares. I drive by my area CBL Mall everyday, and I am counting the days that more stores to shutter, and I believe that in this stage in the cycle, CBL is just downright dangerous.
Washington Prime is also scary and now yields 19.2%, this signals a dividend cut is on the way. While other analysts and investors have cheered the recycling efforts of the company, I am intently focused on the safety of the dividend (or lack of safety). In December I explained,“…we believe that the writing is on the wall: that Washington Prime will be forced to cut its dividend in 2019.”
3 Spec Buy REITs
We have 3 speculative buy ratings associated with the above-referenced double-digit list and they include Landmark Infrastructure (LMRK), PREIT (PEI), and Uniti Group (UNIT).
As you can see, PREIT (-42.9%) and Landmark(-28.0%) have under-performed in 2018, while UNIT squeezed out +1.1%. For comparison, here’s how these 3 REITs performed versus CBL and WPG (over 2 years).
As you can see, UNIT is the only company that generated positive returns in 2018 and the others suffered massive price erosion ranging from -26% to a whopping -61.7%. What I’m trying to tell you is that you are not playing on the SWAN table, you have definitely landed on the high-roller table.
Now let’s recap our SPEC BUY picks:
PREIT is a mall REIT that was forced to reinvent itself by becoming a "new REIT" focused on these key objectives: balance sheet improvement, operational excellence, elevating portfolio quality and positioning the company for growth. The company’s primary investment focus is on retail shopping malls located in the eastern half of the United States, primarily in the mid-Atlantic region.
The portfolio consists of interests in 28 retail properties, of which 25 are operating retail properties and three are development or redevelopment properties. The 25 operating retail properties have a total of 20.0 million square feet and include 21 shopping malls and four other retail properties.
The company has done an “excellent” job with managing through the BonTon and Sears store closures. However, the company has 14 J.C. Penney locations (in the consolidated property portfolio) and if that company were to announce another round of store closures, it could become problematic for the PEI payout ratio. Currently PEI’s payout ratio is 55% (based on FFO), however, AFFI is much tighter (95%), and analysts forecast -8% growth in 2019. Given the company’s elevated JCP exposure, we consider the shares speculative.
UNIT is an Infrastructure REIT that spun off from troubled regional telecom Windstream (WIN) in 2015 as Communications Sales & Leasing. The company initially owned 80% of Windstream's fiber lines, which are essential to its daily operations. In 2017, it changed its name to Uniti Group.
When it was spun off, Uniti was 100% dependent on just one customer, Windstream, with which it had a 15-year master lease that ensured high margin, recurring and recession-resistant cash flow. But since Windstream is a struggling regional telecom, management made sure that that revenue was safe in case of a Windstream Bankruptcy. Since Windstream is 100% reliant on a distressed telecom does not a safe dividend stock make, which is why Uniti has spent $1.8 billion over the past three years diversifying itself via acquisitions.
Uniti's wide moat and cash rich assets have incredible scalability that represents massive organic growth potential. But in order to achieve that growth potential, first the company needs to achieve its diversification goals, which are critical to ending its liquidity trap and lowering its cost of capital. Fortunately, that plan remains on track and has a good chance of succeeding.
Analysts currently expect long-term AFFO/share growth of just 3% (4% in 2019), which is not spectacular. But as long as the company is able to avoid taking on any more debt, and diversify away from Windstream by a substantial amount, then the REIT is likely to preserve its 13.9% yielding dividend. With a yield that high, you'll get market-crushing total returns in dividends alone, and no future payout growth is required. Uniti’s payout ratio (based on AFFO) is 93%.
Finally, the last double-digit dividend dynamo is Landmark Infrastructure. Keep in mind that Landmark is a small-cap MLP, that made changes to broaden its investor base by creating a REIT subsidiary that substantially eliminates unrelated business taxable income, otherwise known as UBTI. The company simplified its state income tax filings for unit holders, and with this change, the company did not eliminate the Partnership structure since that will continue to give the company operating flexibility.
At a high level, Landmark provides investors with an attractive opportunity to own real property interests that underlie tenants with operationally essential infrastructure assets. The company serves three masters: wireless communication, outdoor advertising, and renewable power generation industries.
Landmark is externally-managed but the company is not waiting around for the internalization process, it said it has already “taken additional steps to position the partnership for such an internalization, including first of all, shifting the investment strategy to a direct acquisition development model versus the previous dropdown portfolio acquisition model, driving more accretion with higher cap rate acquisitions and development.”
Also, Landmark said it was “reducing financial leverage levels to provide more operational flexibility and more closely resembled the balance sheets of REIT peers.” Most importantly, Landmark is now “providing performance metrics that are common to REIT, including FFO and AFFO per unit, and lastly, maintaining the existing quarterly distribution of $.3675 per quarter in order to retain operating cash flow in the near-term to fund higher organic growth including acquisition and development activities.”
Based on the Q3-18 data, Landmark’s AFFO payout ratio is 108%. While this is obviously elevated (higher risk), we believe the payout ratio will decline as the company buys and develops new properties at higher cap rates, that should drive AFFO per share. I’m glad to see Landmark reporting REIT metrics because they will make it easier for REIT analysts going forward. As noted, we maintain a speculative buy.
In closing, I want to remind you that this last edition of the “Do You Feel Lucky” series is the highest risk edition. Investors should maintain caution while investing in higher risk securities and that means always utilize adequate diversification and conduct due diligence before buying. As Frank Williams warned,
“The most successful speculators are the fairly substantial businessmen whose daily work is to keep in touch with business and credit conditions. These executives usually are sound and level-headed and often are familiar with the industries they are buying into”.