Quick Thesis

• Resilient cash flows from long-term triple-net leases
• Clear path to 10%+ annual returns through dividend + internal/external growth
• Well-diversified portfolio with 99.5% occupancy
• Tenants with strong balance sheets and coverage ratios
• Ability to drive growth through attractive spreads between cost of capital and cap rates

Company Introduction & Full Thesis

STORE Capital(STOR) is an internally managed triple-net lease REIT focused on single tenant operational real estate. The company owns a 99.5% occupied, diversified portfolio of around 3000 properties operated by 579 tenants in 124 different industries. 

Fun fact: STOR is Warren Buffett’s only REIT investment

Equity REIT business model is very easy to understand. The company raises capital through equity offerings and debt, acquires various properties and then leases them out to tenants. The average weighted length of STOR’s lease deals is 17.2 years, which provides great long-term cash flow visibility for us investors.

STOR’s property portfolio is very-well diversified across different tenants and industries, with no single tenant making up more than 2.9% of the rent roll and no industry making up more than 6.9%.

Triple-Net and Master Leases

STOR rents out properties on “Triple-net lease(NNN)” basis. NNN type of lease contract means that the tenant agrees to pay all the expenses of the property (such as insurance, maintenance and property taxes) on top of rent payments to STOR. This is a very good deal for the REIT, as it just collects payments from the tenant and doesn’t have to spend any money on the property for the duration of the lease. 

This type of lease contract makes rental cash flows very predictable as the REIT doesn’t have unexpected costs related to the upkeep and maintenance of the properties. 

In addition to this, 94% of STOR’s portfolio is subject to “master leases“, meaning that if a tenant leases more than one property from STOR, the lease deal is for all the properties and can’t be cancelled for individual properties. 

Cap Rate/Cost of Debt Spread

Where eREIT’s make money, is the spread between the cost of their debt and the acquisition cap rates. 

For example, if a REIT raises debt with a 3% interest rate and acquires a property with a 7% cap rate, the 4% spread is where they make their profits. As we can see on the graph below, STOR is able to keep very wide spread between the 2, regardless of the interest rate environment, which shows how well managed the business is.

Total Return Potential

The value proposition in STOR’s case is very simple.

1. 5.5% yielding dividend
2. 2-2.5% growth from built-in yearly lease escalators
3. 3% growth from re-investing post-dividend aFFO

As we can see, the path to 10%+ returns from current valuation is very well mapped-out.

The company still needs to execute on its acquisitions profitably and be able to access debt well-below cap rates, but I like the risk-reward proposition here. 

Dividend

The dividend currently yields 5.5%, which is the highest yield this stock has offered since the IPO, outside CoVid crash in March 2020.

Dividend payments are covered with a 68% aFFO payout ratio (based on FY22 guidance), which is a very safe level for a triple-net REIT.

Outside the IPO year massive dividend raise, STOR has raised the dividend by around 6% per year.

Going forward I expect dividend raises to be in-line with aFFO growth at around 5% pear year.

Today’s yield + dividend growth potential is attractive at current levels.

Balance Sheet

Net-lease real estate is a debt-heavy business as these REITs largely make profits from the spread between cost of capital and cap rates.

Balance sheet carries $4.7 billion of long-term, fixed-rate debt with an average weighted interest rate of 3.8%.

STORE’s debt/EBITDA is around 5.7x, which is at the low-end of the company’s target range.

As cash flows are very predictable due to the length and nature of the leases, STOR can carry higher leverage without excessive risk.

The company also puts large emphasis on their tenant’s property-level debt coverage ratios, to make sure that tenants are able to comfortably cover their lease payments to STOR. 

99% of locations provide STOR with unit-level financial reporting to help the company assess the tenants financial strength.

STOR uses a ratio called “fixed-charge coverage ratio” to measure that. FCCR shows us how well the tenant is able to cover its fixed costs such as rent, utilities and debt payments.

Currently, the weighted average FCCR of STOR’s tenants is a healthy 3.6x coverage

Valuation

I estimated STOR’s Fair Value based on the average result of 2 valuation methods:

• Historical average aFFO valuation multiple applied to current year’s estimated aFFO 
• 2-stage discounted cash flow model, with 5% estimated aFFO growth over the next decade, discounted back to present day value with a 10% discount rate.

Below are the Fair Value targets based on both methods and the average of the 2.

Historical average aFFO multiple of 16x applied to current year estimated aFFO ($2.26) gives us a Fair Value target of $36.1 per share

Discounted cash flow model with 5% growth over the next decade and 2% after that (based on lease escalators) and a 10% discount rate gives us a Fair Value target of $34.9 per share

The average of the 2 valuation methods comes out to $35.5 per share

Compared to the current share price of $27.9 ,STOR is potentially undervalued.

Risks

Deteriorating macroeconomic conditions would put pressure on STOR’s tenants which would decrease their rent coverage ratios and increase risk of potential deferrals. 

Some industries renting from STOR are also under threat due to increased penetration of e-commerce in their respective industries.

Interest rates going up increases STOR’s future financing costs, putting pressure on the cap rate/cost of debt spread. STOR would need to acquire higher cap rate properties to offset that, but much higher cap rates would mean lower-quality tenants/properties.

If inflation stays elevated for longer time periods, the lease escalators aren’t high enough for the rental cash flow to grow in real terms.

Summary

STOR has a simple business model that is able to generate predictable, robust cash flows over long time periods. Shares are currently offering significant income from a 5.5% dividend yield as well as double-digit total return potential through internal and external growth opportunities.