Agree Realty: A Perfect Tenant Replacement Stock

Introduction

Those who've read my articles or follow me can probably tell by now that I'm a huge fan of Agree Realty (NYSE:ADC). I've written about them a few times here on Seeking Alpha. One day my girlfriend and I were sitting at home and I asked her "If you could own just one stock, what stock would it be?" I had already figured what her answer was going to be and after thinking about it for a few seconds, she said "Microsoft" (MSFT). I then decided to ask a few of my friends the same question. I got a few different answers and some common ones too. One said Amazon (AMZN). One said Disney (DIS). And three said Apple (AAPL). All four of these companies are great long-term investments in my opinion. But none of them fit into my current investment strategy because either they currently don't pay a dividend or the dividend yield is too low. I prefer to focus only on dividend paying stocks yielding between 4% to 7% preferably. Then one of my friends asked, "Who would you pick?" I replied ADC, easily. He then asked, "What's that?" And I didn't expect him to know as he is not an avid investor like myself. So let's get into why I think ADC is the perfect tenant replacement stock.

Rising Home Costs

Most of us working class citizens that work hard for our money expect our checks to hit our bank account every week or so. For me, I get paid bi-weekly. For most retirees, monthly. Lots of dividend paying companies pay investors on a quarterly basis. Some pay more frequently, usually monthly. If I were a betting man, I would bet that investors would rather get paid 12 times a year versus 4. Well with ADC, you can expect to get paid 12 times a year. I've always looked at my stocks how I look at other things in life. I've always been drawn to things or people who were consistent, efficient, and resourceful. Like me. And ADC is just that. To the untrained eye nothing stands out about this stock. Nothing flashy or fancy. It's not the next big investment trend like EV, crypto, or A.I. It just trucks along and gets the job done.

I often talk about REITs at work with my military co-workers and they always seem to brush off the idea of REITs. The only investments they seem familiar with are investing in physical properties. Buy a property, live in it, get new orders, and move a tenant in to pay your mortgage. And while that all sounds nice and dandy, they never seem to think about property management costs, bad tenants, repairs, etc. I currently live in San Diego, California. San Diego is a beautiful place close to the water that's known for its beaches and night life. It attracts a lot of young college kids. Everyone wants to enjoy the beautiful weather, but I often see people struggle due to the cost of living. One of my co-workers in particular loves to brag that she has rental properties and often brushes off the idea of REITs. Always the positives, but never the negatives.

In May 2023, the median listing home price in San Diego was $1 million, up 6.4% year-over-year. In the U.S. the median sales price for a new home is roughly $416k and has jumped 12% between April and May of this year according to Forbes.

I asked my co-worker the price of her purchases. She purchased her first home in 2018. She used the VA and acquired a loan for $320k. Her mortgage is $1600 and her tenant currently pays her $2400. She locked in a good rate at 2.25%. She acquired her 2nd property (where she currently resides) in 2020 using the VA again, this time for $540k at the same rate of 2.25%. That current mortgage payment is $3k a month. I didn't delve into her business of how much money she's spent on management fees, closing costs, repairs etc. but one can see where I'm coming from. And then there's also the tenant headache. I'm not saying investing in physical properties is bad; I'm just saying that REITs are a great alternative investment with less headache and better quality tenants. And even if you decide to manage your own properties, you end up paying with something more important than money, your time! And investors often forget about this. So let's say hypothetically you had a million dollars you inherited that you wanted to invest. Instead of buying a property in San Diego for $1 million, you could invest that same money into ADC. The current price of around $65 would give you approximately 15k shares of the stock. This equates to roughly $975k. At the current dividend of $.0243, this would net you $3,645 in monthly income. No tenants to deal with, no repairs, just a dividend hitting your account every month!

According to their website, ADC has a 6.1% compound annualized dividend growth rate over the last ten years. Below is what investors would get in 10 years if they decided to invest their inheritance into ADC and the stock continued its annual dividend growth rate at a 5.0% price return. Considering all dividends were reinvested, this would equate to an annual dividend income of $117k. When broken down monthly the total amount would be $9,750.

Why ADC?

ADC owns 1908 properties located in all 48 continental states. These properties are leased to industry leading, omni-channel retail tenants. What I like about their omni-channel focus is that this allows the company to engage with customers through more than just the brick-and-mortar business model that a lot of companies are used to. Since the pandemic, more and more customers have adopted the online shopping experience. I have friends who haven't been to a mall in years. Some don't even go to grocery stores anymore. Now you can do all your shopping with the click of a button.

As times change, companies have to be prepared to do the same if they want to continue having a thriving business. Many are saying we are entering the world of "phygital." Physical and digital at the same time, where there is not a physical or digital world, but rather a connected one. Adopting this allows ADC to further their reach, visibility, and impact with customers.

Current Financials

The company currently pays a monthly dividend of $0.2430 and a recently reported FFO of $0.98, beating analysts' estimates by $0.01. The monthly payer has also met or beat analysts' estimates the last 4 quarters. ADC has been growing its dividend for 10 years and raised the dividend recently back in April by 1.2%. Its payout ratio sits well-below the REIT sector at a comfortable 74% and has a FWD payout ratio of 73%. Last year ADC raised the dividend twice in the months of April and October, the first time by 3.1% and the second by 3%. With its conservative management and the uncertainty of the economy, my guess is a 2.9% to 3.0% dividend increase this upcoming October. The company also raised its acquisition guidance to $1.2 billion from $1 billion during its Q1 earnings. Additionally, the company invested over $314 million in 95 high-quality retail net lease properties during the 1st quarter. They also acquired 66 additional tire and auto service, home improvement, grocery, dollar store, and farm and rural supply stores got a weighted average cap rate of 6.7%. I think this shows the experience of the management team and the financial strength of the company.

Tenant Concentration

Something else I like about ADC besides their monthly dividend is their focus on investment-grade tenants. ADC leases to some of the most well-known tenants such as Costco (COST), Walmart (WMT), and Starbucks (SBUX). I consider these behemoths to be highly resistant to economic downturns and uncertainties. Each has a market cap over $100 billion.

Besides their investment rated tenants, ADC also focuses on what I think are recession-proof companies like grocery, home improvement, tire & auto service, convenience, and dollar stores. And with inflation being stubborn and the potential for further rate hikes, this could further strain consumer finances, forcing them to look elsewhere to be cost-efficient such as shopping more at dollar stores.

Ground Lease Strategy

Something else that differs ADC from its peers is its ground lease portfolio. At the end of Q1, ADC had 208 ground leases with an 11 year weighted-average lease term. 87% of those tenants are also investment-grade. These ground leases account for more than 12% annualized base rent. Additionally, because of their high-credit tenancy, the REIT was recently upgraded by Mizuho securities from neutral to buy. Analysts attest this to the company's fortress balance sheet and well-laddered debt all the way through 2033. The company has little to no-debt maturing in 2023, 2024, and 2026, making them prepared for the current macro environment.

Insiders are buying and so should you

Below are some recent transactions of shares sold and bought in the last 12 months. There have been no shares sold of the REIT in the last 12 months according to Simply Wall St. In the recent quarter, over 38k shares have been bought. With the stock trading closer to its 52-week low of $63.34, I think now is a great time to accumulate shares in the stock.

Undervalued and Overlooked

Analysts have an average price target of almost $76 and rate ADC a buy. I agree that the stock is a buy right now. Accumulating now will give investors a fair margin of safety and the potential for an upside of almost 17%. The stock is currently yielding 4.4%, 18% above its 5-year average. My opinion ADC is undervalued and often overlooked. It doesn't get the same respect as Realty Income (O) although it beats O in 5 and 10 year dividend growth, price and total return VS the S&P. Investors should be aware of the potential for further price drops in ADC if a recession does indeed happen. If this does happen perhaps investors could see the price near or around $60. This would give investors an even better opportunity as the stock has not seen a price below $60 since January 2019.

Recession Fears?

Many are predicting a recession as early as this Month July. And lots of investors are on the sidelines with cash because of fears from the last big recession in 2008-2009. And while recessions do typically affect many stock prices, timing the market is not answer. I've had a few followers ask me what I was going to do if stock prices took a dive. And my answer was to hold strong and ride out the storm. Because I believe in acquiring quality stocks and I believe ADC is just that. Here is a look at the VNQ Index during the last recession.

From February 2007 to March 2009, the Index fund saw a drop of more than 70%. But as many can see it quickly recovered. During that same time frame, ADC saw its price drop roughly around the same going from $33 to $11. To be fair though, ADC was not the quality REIT back then that it is today. At the time the company had a market cap of less than $200 million and today has a market cap over $6 billion. The stock was slower to recover but eventually touched double digit share prices a few short months later.

Summary

With the threat of a recession in the near future, many investors are waiting with cash on the sidelines for the right opportunity to get into the stock market. Trying to time the market almost never ends well. With ADC's track record and management team, investors get paid a safe and growing monthly dividend. Additionally, with their high concentration of investment-grade tenants, ground lease portfolio, balance sheet, and current price, investors get the potential for almost 17% upside in the near future with the stock's current average price target.