Brave Eagle Wealth Management’s founder, Robert Ruggirello, CFA, has continued on his quest for REIT exposure and done some excellent work on STORE Capital (STOR), a company that I’ll characterize as a poor man’s version of Realty Income (O).
Realty Income, you’ll recall from the work we published on it, signs triple net-lease agreements with its clients for stand-alone retail locations. Triple net-lease means that the lessee is responsible to maintain the property, so the REIT itself does not have to spend any money on maintenance capital expenditures.
STORE Capital also uses triple net-leases in its contracts, but rather than renting to retail giants (Walgreens, etc.) as does Realty Income, it leases locations to small to medium-sized chains.
The nominal credit quality of STORE’s clients is low, so STORE can charge a handsome lease fee. A financial theorist would say that this was a matter of course: higher risk should correlate with higher return. However, STORE does several things to reduce the risk of loaning to what Moody’s might consider low credit quality firms:
- It requires location-level financial statements for all its leases.
- It rents to locations which are profit centers, not cost centers.
- It bundles all the leases for a given client into one master lease. If a single location fails out of five locations, the full amount of the five leases must be paid by the remaining locations.
By looking at each location’s profit and loss statement, STORE acts in the role of a local bank, in a sense, and can judge the true credit quality of the locations to which it is leasing. With better information, STORE can be relatively more assured that its rents will be paid.
Even though STORE is a relatively new firm, its founder has been in the real estate business for 30 years. He knows that retail locations that are generating profits will remain open even if the firm goes into bankruptcy. Furthermore, the operating leases STORE provides have higher priority than senior debt in a liquidation event, so if things go pear-shaped, STORE has another level of risk control.
The company is partially owned by Warren Buffett’s Berkshire Hathaway. Uncle Warren bought STORE for $20.25 / share in a private offering. Compared to that, the present price of around $26.00 / share does not look too good, but Robert makes a good case that the shares are trading at the low end of the company’s valuation range and is worth a look.
I will likely add this as a bond replacement investment.
- Framework Valuation Model for STORE Capital
- STORE Capital 2017 Annual Report: With Robert and Erik’s notes.
- STORE Capital 2017 CEO Shareholder Letter
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