Warren Buffett's Berkshire Hathaway (BRK.A 0.41%) owns a significant position in STORE Capital (STOR). He purchased the stock initially in 2017 and added to his position during the COVID-19 pandemic. He did make some sales earlier this year, but he remains a holder of the stock. What is it that the Oracle of Omaha sees in STORE Capital?
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STORE Capital uses an unusual lease structure
STORE is a real estate investment trust (REIT) that invests primarily in single-tenant properties. The company's name is an acronym for Single Tenant Operational Real Estate. The company develops and leases properties to tenants under a triple-net lease arrangement whereby the tenant is responsible for the majority of the expenses, including rent, taxes, insurance, and maintenance. These leases generally last a decade or more and contain automatic rent increases. This means that STORE needs to do a good job on vetting potential tenants.
Tenant analysis is critical to STORE Capital's business model
Since the tenant absorbs almost all of the operating costs for the property, the triple net lease approximates the cost of buying a property and then financing it. Instead of making an interest payment, the tenant makes a lease payment. Companies like STORE Capital can often borrow money at a better rate than the typical tenant. From the tenant's perspective, going the triple-net lease route makes the company's assets more efficient. Equity in a building is an illiquid asset that can't really be used for much.
STORE Capital targets middle-market and large companies for its leases. The median STORE tenant has annual revenues of approximately $62 million, and the typical tenant is either in the services business (restaurants, fitness), retail (big box, dollar stores) or manufacturing. STORE goes through a unit-level and creditworthiness analysis of all potential tenants. The unit-level analysis is critical, as companies that get into trouble tend to look to retain the profitable stores and vacate the unprofitable ones. The unit-level analysis ensures the properties will be profitable from the start.
STORE Capital reported increases in funds from operations and hiked its dividend twice during the pandemic
Unlike most REITs, STORE Capital was able to report increases in adjusted funds from operations (AFFO) in 2020 and 2021. This is despite pandemic-related store closures, especially for services tenants like fitness centers and theaters. The company also hiked its dividend in 2020 and 2021, when many of its competitors were cutting theirs. The company is guiding for 2022 AFFO per share to come in between $2.25 and $2.27, which is an increase of about 10% compared to 2021.
At current levels, this puts STORE Capital at a multiple of 12.5 times guided AFFO per share, which is pretty reasonable for a top-performing triple-net lease REIT. The dividend yield is quite attractive as well at 5.7%. Triple-net lease REITs tend to be quality dividend-paying stocks and are generally pretty conservative, which makes them good candidates for income investors.
