🏠Business Overview

🎯Key Metrics

Total: 1/17

• +2 ✅ Projected Operating Margin: 45.47%
• +0 ⚠️ Projected 5-Year Revenue CAGR: 4.70%
• +0 ⚠️ Last 5-Year ROIC: 2.52%
• -2 ❌❌ Estimated Cost of Capital: 7.18% (higher than ROIC)
• -1 ❌ Last 5-Year Shares Outstanding CAGR: 12.11%
• +1 ✅ Projected 5-Year EPS CAGR: 11.68%
• +0 ⚠️ Projected 5-Year Dividend CAGR: 3.46%
• +1 ✅ Moody’s Rating: A3
• -2 ❌❌ Morningstar Moat: None
• +2 ✅✅ Morningstar Uncertainty: Low

📈 Realty Income is a reliable dividend payer. It’s true that its growing its dividend at a rate a little below or a the economy growth rate ~3%, but its low uncertainty makes this company a safe bet for every dividend investor.

📉 The fact that the volatility and risk on the west, where its revenues are exposed, have been increasing may put pressure on the stream of revenues.

Let’s move on to the valuation, to see if it’s a good opportunity at the current prices.

📝Business Valuation

To calculate the intrinsic value of the company I’ll use multiple methods:

• DDM (Stable Growth) – the fair value is estimated by projecting the dividend payments across the following years and discounting them to the present value using the estimated Cost of Capital. Given the growth rate below economy I’ll be using a stable growth rate;
• Historical Dividend Yield – we assume mean reversion to the historical Dividend Yield values;
• Historical P/FFO – we assume mean reversion to the historical P/FFO values;
• Discounted Cash Flows (DCF) – Intrinsic value is estimated by projecting its free cash flows over the next 10 years and discounting them to present value using the estimated cost of capital.

Please note that given that investor see this company mainly as a consistent and reliable dividend payer I’ll be putting more weight into the dividend methods and then use the historical P/FFO (Price to Funds From Operations – generally used as a relative valuation for R.E.I.T.s) and DCF methods as a sanity check.

Cost of Capital

I’ve used the latest annual financial statement of the company, the 10-Year US bonds as the risk free rate and revenue geographic exposure to come up with its cost of capital, cost of debt and cost of equity. Also, given the fact that Moody’s provided a rating for the company I used it as the debt rating.

Cost of Capital: 7.18%.

This value will be used later as a discount rate in the valuation methods.

Please feel free to come up with your own values by using the tool I’ve used: Cost of Capital – The Fair Value Journal. It is and will ever be completely free 🙂

DDM – Stable Growth (Weight: 50%)

Now we look at a Dividend Discount Model (DDM). This will allow us to value the company, using its dividend payments and the overall growth of it. In this type of DDM we’ll set the dividend to grow at a stable growth rate that will be maintained “forever”. Normally I use a stable growth rate for companies growing their dividends below the economy growth rate / risk free rate.

As you can see below I set the dividend growth at 3.46% (analysts expectations). Also note the use of the Cost of Equity, calculated previously when we also calculated the Cost of Capital.

Why use Cost of Equity and not Cost of Capital as the discount rate for DDM? Its because dividends are paid to equity holders after debt obligations. Since DDM values equity-only cash flows, we use an equity-only discount rate (the Cost of Equity).

The DDM gives us an estimated fair value of 85.71 dollars for Realty Income.

Something that we can also do now is to play around with Monte Carlo simulations. What this will allow us to do is to simulate multiple DDM valuations with pre-defined ranges for each of the inputs. Each simulation will randomize the inputs between these pre-defined values. For this I also used analysts estimates.

Using the DDM method, it seems the company is undervalued because its current price of 66 dollars is below P10. From this we can extrapolate that there’s 90% probability for the stock to be undervalued.

As always, take this single output with a grain of salt and let’s check the other valuation methods.

Historical Dividend Yield (Weight: 30%)

The current Dividend Yield ratio is a little above its 10 Year average. This means that the company is a little undervalued by this metric. Assuming a mean reversion to its historical average of 4.59% we can assume a fair value of 69.61 dollars.

Historical P/FFO (Weight: 15%)

The current P/FFO (Price / Funds From Operations) ratio is a little below its 10 Year average. This means that the company is a little undervalued by this metric. Assuming a mean reversion to its historical average of 19.09 we can assume a fair value of 71.32 dollars.

Discounted Cash Flows (Weight: 5%)

I’ve used the latest annual financial statement of the company, the analyst estimates for both revenue and margins and the cost of capital calculated previously.

Some notes on the inputs above:

• Terminal Revenue Growth – I’m using the risk-free rate (10-Yr bonds of the US), because long term the company should not grow more than the rate of the economy. I’m using the risk-free rate as a proxy to it, so the terminal growth becomes it.
• Terminal Cost of Capital – I’m assuming that the cost of capital begins at its current estimated value and gradually converge to the industry average.
• Initial and Terminal Tax Rate – I’m assuming here a tax rate near its current values ~7% and gradually converging to industry values.

All the other inputs were taken from the financial statement or from analyst projections.

The DCF gives us an estimated fair value of 34.81 dollars for Realty Income.

Then again, let’s use the Monte Carlo simulations.

As you can see from the above Realty Income seems to be overvalued given that its current price of 66 dollars is well above P90. However, please note that a DCF is not the best method to value a R.E.I.T. and can undervalue the company. Take this more like a sanity check.

Please be free, as before, to fill in your own values. Make the valuation your own and do yourself a DCF valuation using your own assumptions: DCF – The Fair Value Journal

✍️Summary

Now that we did all the heavy work, let’s take the above and come up with the company weighted average fair value.

I basically take each valuation method used and given my confidence on the company apply a 20% or 10% discount (when to buy) and addition (when to sell) or use the Monte Carlo P10, P20, P80 and P90 values:

Feel free to choose your own values and your own margin of safety, but for me I would start buying Realty Income shares below the 66.94 dollars mark, given its stability, dividend reliability and overall low uncertainty.

Please remember that the fair value estimate has a 100% probability of being wrong and it will never be a precise number, even if it has decimals next to it 😮

Overall it seems Realty Income is a little undervalued at the current prices.

Fair Value: 73.46 dollars