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General Electric: Finally, It's Over
April 23, 2018 6:11 pm|Comments (0)


Image Source

So far, the word “unpredictable” seems to be one of the most-used descriptive choices when characterizing the events of 2018. And, broadly speaking, this appears to be an accurate term. Just a few months ago, if you were to suggest that the NASDAQ would be seeing “flash crash” activity while General Electric (NYSE:GE) was forming a long-term bottom in a multi-year decline, you might have been laughed out of the room. But this appears to be where we are, given the market’s positive reaction to GE’s April 20th announcements and the generalized lack of certainty in almost every aspect of this current financial environment. We have been saying that the stock declines below $ 13 per share would be the worst of it for holders of GE and we maintain this view in light of the company’s recent strategic moves. We are long GE with a bullish stance on the stock as a long-term hold for portfolio strategies.

Chart: CNN Money

Many analysts have argued that there are fundamental earnings problems within the company itself. But, since this is the most “mega” of the “mega-conglomerates” it is critical to assess the trends over at least three years before drawing any drastic conclusions. The earnings performance at GE has been erratic since 2015. But the revenue side of the equation has been much more stable over the same period.

This implies that GE’s problems are internal (fixable) rather than external (not fixable). This is good news, as long as the company is able to reduce operations and focus on the businesses. Currently, jet engines, power plants, and healthcare machines are GE’s biggest money-makers – and we would prefer to see more of the company’s attention (and resources) focused on streamlining these segments.

Earnings Trend Chart: Yahoo Finance

On the other side of the ledger, the power, oil, and gas markets are still presenting major challenges for General Electric, with revenue in those segments showing significant weakness in Q1. Operating losses in the power unit were lower by 38%, but the company has said that improvements have been made in service operation and cost execution for the segment. Operating losses in oil and gas fell by 30%. Other negatives were seen in the GE Capital unit, as it continues with its weaker trends.

For the first quarter, net losses came in at 14 cents per share (roughly in-line with last year’s performance for the period). On a continuing basis, net incomes came in at 4 cents per share (a solid increase from the in the 1 cent per share seen a year ago). On an adjusted basis, the company posted earnings of 16 cents per share (well above analyst estimates calling for 11 cents per share). Total revenues for the quarter gained by 7% (to $ 28.66 billion against expectations of $ 27.45 billion). In the accompanying statement, Flannery highlighted the fact that margins, industrial earnings, and free cash flows are all gaining on an annualized basis – and this is all good news for dividend investors.

What really matters here is the strategic direction, and the willingness within those in management to cut the fat and become a more modern company. There are still very real questions with respect to whether or not Flannery & Co. will be able to address those needs. But we do know that many of the correct moves have already been made. This includes the decisions to sell NBC, Universal Studios, and its real estate portfolio.

These were areas where the company could not reasonably hope to compete, and sacrifices needed to be made in order to preserve as much of the dividend as possible. Another example of a strategic move in the “right” direction was deal to sell GE’s appliance division for $ 5.6 billion. GE is still in recovery-mode, and this is the short-term outlook that should define the long-term outlook for quite some time.

GE Chart Analysis: Dividend-Investments.com

The key point here is that the word “recovery” implies gradual strengthening. In market terms, that equates to positive price movement, and we view GE as a long-term hold with an attractive yield offering for investors. GE cut industrial structural costs by $ 805 million, and they expect to beat prior goals to reduce costs by $ 2 billion for all of 2018. This is strong evidence of progress, and it has not yet been reflected in share prices.

Shorter-term, we have seen some upside and this is an indication that the market is liking what it sees (so far, at least). Since aviation, healthcare, and transportation divisions all experienced double-digit profit growth, these moves should be viewed as valid. Prior resistance under $ 14 should now be expected to act as price support and we believe that a long-term bottom has likely formed at $ 12.80.

What is your position on GE? We look forward to reading your comments. Stay tuned to Dividend Investors and receive our next alerts by clicking the “Follow” button at the top of the page.

Disclosure: I am/we are long GE.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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PlayStation Gold Wireless Headset Review (2018): Finally Golden
April 6, 2018 6:08 pm|Comments (0)

Have you ever tried using Sony’s pitiful little mono headset that comes with every PlayStation 4? It’s a chintzy freebie at best, and a no-good, annoying, keeps-coming-unclipped-from-your-collar, hanging hellion the rest of the time.

Sony’s 2014 Gold Wireless Headset also angered gamers due to a fragile, crack-prone headband. With this track record, you’d be forgiven for ignoring Sony’s new 2018 Gold Wireless Headset. I was pretty skeptical myself, but aside from a few issues, it’s been one of the best wireless headsets I’ve used on the PS4. I even recommended in our list of best PS4 accessories.

Black is the New Gold

Like the first PlayStation Gold Headset, the color is a bit of a misnomer. You won’t find any gold on them. Like a Model T, this headset is completely black, from earcup to headband, with part of it wrapped in a soft leather-like material. The headband and ear cushions have some extra padding on them, because of unique design of the headband and how it connects with the earcups.

Most headsets are full of hinges and hangers so they can turn and adjust every which way, but not the Gold. Underneath all that faux leather, its entire headband is a single curved horseshoe piece of metal (or possibly an extremely durable plastic) that you pull apart to fit your head.

The earcups don’t flex forward and back a whole lot (just a wiggle), but they can slide up and down the band itself, which makes for a surprisingly comfortable fit. Sony says these are designed to fit around the PlayStation VR headset. Those with wider heads, glasses, or larger ears may want to look elsewhere, though. This design gets less comfortable the bigger your head is, and the padding is thin enough that it will lightly pinch a pair of frames.

It’s not great for those of us with moderate-sized domes, either. I had to slide the earcups up some, which covered up the L and R labels, making it hard to figure out how to put these on. And because there is no boom mic, I had to spend a few extra seconds figuring out which end is the front and back. Sony is far from the first headset maker with this problem. A little rotation in the earcups would also make resting the headset on your shoulders and neck far more comfortable in-between matches.

Lost in the Gloss

The only area on the PlayStation Gold that isn’t brushed or leathery are the glossy vinyl-like edges of the earcups, where all the buttons and controls are located. It’s never a smart idea to gloss up the one area that’s constantly under attack by finger grease, but alas that’s exactly what Sony did here.

The controls themselves are okay, but could be easier to feel and find. Everything is on the left earcup, which seems to be the norm for most headsets. The mute button is on the lower back side, above it is a volume rocker and above that is a toggle for 7.1 virtual surround sound, which simulates surround. I don’t love this feature for most games because it sounds unnatural, but it’s present and accounted for.

On the front is another toggle, but this one adjusts your chat mix (how loud your friends sound compared to the game). Below it is a switch that turns off the headset or puts it in the standard or extra bassy setting. The extra bass adds to the immersion if you’re playing anything with explosions or bullet fire, and if you download the Sony Headset Companion app on your PS4, you can replace that bass boost with game-specific effects, or fully tweak the bass, treble, and mids to your delight.

It took some time to discover, but holding down the mute button also turns on two levels of mic monitoring, which Sony calls sidetones. This lets you hear your own voice as you talk. It helps me talk at a more reasonable volume instead of shouting just to make sure others are hearing what I’m saying. Try it out!

Missing Mic, Cool Connection

The lack of a physical mic is a bummer. None of my friends complained about the quality of my audio, but it wasn’t nearly as good as many headsets. Sony does attempt to isolate the sound of your voice, but it would do a much better job if it had a microphone that could be positioned near your mouth like most of its competitors.

Normally, I’d complain that it’s hard to know if you’re muted or not, but thanks to the high level of integration this headset has with the PS4 (it’s made by Sony, after all), a prompt pops onscreen in the upper left to tell you the battery life, mute status, and whether virtual surround is on any time you adjust a setting. I wish more headsets had this feature.

The battery indicator in that onscreen popup is especially helpful. The Gold gets a decent 7-ish hours of wireless play time thanks to its 570mAh battery, but that’s nowhere near the 15 hours Turtle Beach’s Stealth 600 (8/10 WIRED Recommends) can reach. Unlike that headset, this one comes with an optional 3.5mm audio cable, so even if you run out of battery, you can still plug it in to your controller and keep playing. With the cord plugged in you can use the headset with any compatible system or player. It charges with an included micro USB cable.

Wireless play has been stable and I’ve had no connection problems. It uses a USB dongle to transmit a 2.4GHz wireless signal, which I found to be very stable. The only cutouts I’ve had are when I leave and walk to another room.

Going for the Gold

This is one of the clearest wireless headsets I’ve used, and the bass is quite boomy. I found myself watching Netflix and listening to music with them on from time to time, even with a pile of other headsets to choose from. I still play Fortnite a lot, and the sounds of my footsteps pattering through the woods, avoiding conflict at all costs because I’m a terrible shot, are quite crisp.

The PlayStation Gold Headset can’t quite match up to expensive heavyweights like the hi-fi Arctis Pro line or comfortable Sony PlayStation Platinum, but it doesn’t have to. At around $ 100 it’s one of the best wireless headsets for PS4, and if you hook up that optional wire, it can connect to a whole lot more. It took Sony four years to get this headset just right, but we’re glad it decided to try again.

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After 6 Months Of Delays, Tesla Is Finally On Track With Model 3 Production
April 5, 2018 6:06 pm|Comments (0)

Tesla’s (TSLA) Q1 production update had me singing and dancing with joy. I encourage you to read the whole thing. Or if you prefer, watch this video from HyperChange covering the update:

The top three updates are on Model 3 production, Tesla’s cash flow, and Model 3 quality.

Model 3 production is at a burst rate of 2,000/week

After six months of delays, Model 3 production is finally on track:

In the past seven days, Tesla produced 2,020 Model 3 vehicles. In the next seven days, we expect to produce 2,000 Model S and X vehicles and 2,000 Model 3 vehicles.

If this rate can indeed be sustained into April and even increased, then Tesla is just shy of its goal to produce 2,500 Model 3s/week by the end of March. Bloomberg’s independent model has production about a month behind that target. For Tesla, a month late is basically on time! Moreover, in light of this update, Tesla might only be a few weeks behind.

As always, it bears reminding that this is an arbitrary, self-imposed goal largely designed around motivating employees. It’s not required for any financial, competitive, or technological purpose. A line in the sand just has to be drawn somewhere.

Model 3. Photo by Carl Quinn.

Tesla says it doesn’t need to raise cash this year

Recent alarm about Tesla’s solvency seems to be misplaced:

Tesla continues to target a production rate of approximately 5,000 units per week in about three months, laying the groundwork for Q3 to have the long-sought ideal combination of high volume, good gross margin and strong positive operating cash flow. As a result, Tesla does not require an equity or debt raise this year, apart from standard credit lines.

Boom! That’s what I love to hear! Barring further delays, Tesla is about six months out from achieving massive positive cash flow from Model 3 sales. If targets are met, Model 3 will generate quarterly revenue on the order of $ 3.25 billion and quarterly gross profit on the order of $ 810 million. (That’s assuming a $ 50,000 ASP and 25% gross margin about a quarter after a 5,000/week production rate is achieved.) Previously, Tesla has guided that it will post sustained operating profits starting by the end of 2018, with a possibility of net profit before 2019 as well.

Based on my own review of the numbers, I think that Tesla’s cash “crunch” is being exaggerated. There are aspects of Tesla’s finances that are opaque to outsiders (such as the composition of accounts payable), however, so it is encouraging to get confirmation from Tesla on this. Here’s the basic math: As of the end of Q4 2017, Tesla had a cash balance of $ 3.37 billion. In Q4, it burned $ 277 million. At that rate of cash burn, it wouldn’t run out of cash until the beginning of 2021.

Several one-time factors contributed to cash burn for Q4 being so low, such as customer deposits for the Tesla Semi and next-gen Roadster. However, there were repeatable factors as well, perhaps most notably slowing discretionary capex. Tesla can slow expansionary spending to be in line with growth in revenue and gross profit. This makes particular sense when it comes to the sales, service, and charging infrastructure for the Model 3 fleet. We’ll have more hard data in about a month when Tesla releases its Q1 earnings.

The key here is the threshold beyond which Model 3 production goes from a net cash incinerator to a net cash generator. If all goes according to plan, by the end of this year, Tesla will likely have the ability to have positive free cash flow. However, that doesn’t seem to be the plan.

From the sounds of it, Tesla wants to finance capex for Model Y, Semi, Roadster, Solar Roof, Powerwall, Powerpack, and future products with debt and perhaps even equity, plus other sources of cash like customer deposits and securitizing leases. Note that Tesla says raising cash this year isn’t “required.” That doesn’t rule out raising discretionary cash to fund faster expansion.

Tesla has a total of $ 330 million in debt coming due in 2018. Given Tesla’s end of Q4 cash balance of $ 3.37 billion and ramping Model 3 production, $ 330 million is a manageable amount to repay. Heck, Tesla could probably wipe that debt away by collecting Model Y deposits. Because Elon Musk is a rock star.

Some convertible bonds to the tune of $ 920 million are set to mature in March 2019. The conversion price is $ 359.87. I can’t predict the ebb and flow of the markets, but it seems well within the realm of possibility that Tesla’s share price will exceed that $ 360 a year from now. If not, with approximately $ 810 million in quarterly gross profit from the Model 3, repayment will be no problem.

Tesla Semi. Photo by Korbitr.

Tesla’s internal data shows high Model 3 owner satisfaction

Finally, Tesla again shared internal survey data of Model 3 owners:

The quality of Model 3 coming out of production is at the highest level we have seen across all our products. This is reflected in the overwhelming delight experienced by our customers with their Model 3s. Our initial customer satisfaction score for Model 3 quality is above 93%, which is the highest score in Tesla’s history.

Although this is somewhat encouraging, Tesla is of course incentivized to present the Model 3 in the best possible light. Before I consider this matter settled, I want to see data from an independent source like Consumer Reports. Consumer Reports has yet to publish survey data on the Model 3. So, for now, we wait.

What is not particularly informative are anecdotes about Model 3 quality. If you, like me, believe in the Enlightenment values of science and logically rigorous thought, then you’ll agree that anecdotes plucked from large samples seldom reveal the truth and often mislead. Statistics reveal the truth. It is surprising and disconcerting to me that so much investment and media analysis — particularly of Tesla — seems to exist in a pre-scientific, pre-Enlightenment mode of thinking in which fact and conjecture are haphazardly mixed, cherry-picked anecdotes are held up as representative, and rumour and hearsay are credulously accepted. So much of what you’ll read and hear about Tesla is either essentially made up or grossly exaggerated because there is little to no application of Enlightenment criteria of truth.

The way I think about companies is to try to approximate as best I can the scientific method. Any way I can remove my own subjective bias is a relief. Hard data is always a breath of fresh air. So is any other empirical test that can serve to falsify an idea. Without scientific discipline, we will inevitably fool ourselves, and wander around in the darkness.

So, I don’t consider a photo of a Model 3 with egregious panel gaps to be informative. A photo of a Model 3 with seamless panels is equally uninformative. Ignore anecdotes. Find statistics. For now, we simply don’t know the level of quality of the Model 3.

Conclusion

Panic and doomsaying about Tesla may never stop entirely. However, it has taken another step toward demonstrating that it has a sustainable business model capable of long-term growth and profits. A year from now, we will probably be having a very different conversation about this company. I look forward to it.

Disclosure: I am/we are long TSLA.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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It's Finally Time To Buy This Dividend King
January 25, 2018 6:02 pm|Comments (0)

Source: imgflip

2017 saw the largest number of US retail store closings in history, which the media has dubbed the “retail apocalypse”. However, in reality, rumors of traditional retail’s demise are greatly exaggerated.

Source: Hoya Capital Real Estate

In fact, traditional retail sales have been growing around 2% a year since 2005, right alongside the overall US economy. Better yet? In 2017, a strengthening economy meant that brick & mortar retail growth actually accelerated. This is why, despite over 10,000 total store closings, the number of US retail stores actually increased by over 4,000.

Source: Hoya Capital Real Estate

In addition, shopping center REITs as a whole have continued to post slow but steady same-store net operating income or NOI growth throughout this so called “apocalypse”.

Source: Hoya Capital Real Estate

The bottom line is that shopping center REITs, like all real estate, are made up of both high, medium, and low quality names. This means that there continue to be Grade A industry leaders with world class management, strong balance sheets, and strong growth prospects.

Let’s take a look at Federal Realty Investment Trust (FRT), which is not just the gold standard in its industry, but arguably one of the best REITs you can own period.

More importantly, thanks to the recent sell-off in REITs, Federal Realty is now trading at some of the most attractive valuations in years. That means that this is likely a great time to add the only REIT dividend king to your diversified high-yield dividend portfolio.

The Undisputed King Of Shopping Center REITs

Source: FRT Investor Presentation

Federal Realty Investment Trust may not be a massive REIT, but since its founding in 1962 (making it one of the oldest REITs in the world), it has proven an exceptional ability to make investors rich. It’s done so thanks to its exemplary management team, led by CEO Donald Wood, who took over the top spot in 2002 after serving for four years as COO and CFO.

Specifically, FRT has focused on quality over quantity, being highly selective about only purchasing or developing shopping centers in the nation’s premier property markets. Today, it owns 104 centers making up 24.1 million feet of leasable square footage leased to over 2,800 tenants.

Source: FRT Investor Presentation

Federal Realty’s centers are located in very high density and very affluent areas, which is why it enjoys the industry’s best average rent per square foot by far.

Source: FRT Investor Presentation

The REIT is also highly diversified by both industry subcategory, as well as tenants, with no customer making up more than 2.9% of annual rent.

Source: FRT Investor Presentation, Earning Supplement

Federal Realty’s focus on top-tier shopping centers located in prime locations also means it has consistently enjoyed the industry’s top lease spreads. This means that FRT is able to obtain higher rents anytime it signs a new lease, whether with a new tenant (if an old one has failed or left) or when renegotiating expiring leases.

Source: FRT Investor Presentation

In the most recent quarter, Federal Realty’s lease spread came in at a very healthy 14%, with 400,000 square feet of space leased at an average rental rate of $ 38.24 per square foot.

This helped it to achieve same-store YOY operating income growth of 2.6%, 4.4% when including redeveloped properties. And speaking of redeveloped properties, this is the key to the REIT’s strong growth prospects going forward.

That’s because in recent years FRT has been investing into non retail properties, such as offices, hotels, and apartments (it owns over 2,052 rental units).

Source: FRT Investor Presentation

In the coming years, management says it wants 20% of rent to come from non retail properties. Not only will this provide greater diversification but because the hotels, offices, and apartments are located on top or near its shopping centers, they help to further drive higher traffic that benefits its tenants. That, in turn, means continued strong leasing spreads.

But wait it gets better. Federal Realty’s plans to invest more heavily into non retail means it has a much larger growth market to target in the future, about $ 4 billion over the next 15 years. The cash yields on these investments are usually about 7% to 8% which is much higher than traditional shopping centers (6.3% cash yield historically).

This brings us to another major competitive advantage, FRT’s industry-leading low cost of capital. This ensures strong AFFO yield spreads (cash yield minus cost of capital) on all its investments.

Approximate AFFO Weighted Average Cost Of Capital 2.9%
Historical AFFO Cash Yield On Invested Capital 6.3%
Approximate AFFO Yield Spread 3.4%


Sources: management guidance, FastGraphs, Morningstar

The low cost of capital is thanks largely to two things. First, the REIT has been very conservative with debt, which is why it has one of the highest investment grade credit ratings in all of REITdom (more on this later).

Second, Federal Realty’s track record of successfully adapting to challenging and constantly shifting industry conditions is literally the best in the business. That’s both in terms of growing its funds from operation or FFO (operating cash flow) per share far faster than lower quality rivals, as well as being the only dividend king REIT in the world.

Source: FRT Investor Presentation

Basically, Federal Realty Investment Trust is the bluest of REIT blue chips and the ultimate sleep well at night (SWAN) stock. The disciplined and very shareholder friendly corporate culture has proven to be incredibly resilient which is why the REIT rightfully trades at a substantial premium to its lower quality rivals (more on this in a moment).

However, that premium helps to ensure low costs of equity which allows management to, in concert with retained cash flow and modest amounts of low cost debt, ensure it has ample low cost liquidity with which to grow.

In fact, today FRT’s liquidity (remaining borrowing power + cash) stands at $ 781 million, which is enough to fund about three years worth of its planned investments.

Combined with its existing redevelopment pipeline, as well as its ongoing opportunistic acquisitions, Federal Realty is likely to remain one of the fastest growing shopping center REITs in America.

Shopping Center REIT FFO Growth Projections

Source: Brad Thomas

Or to put another way, Federal Realty is perfectly positioned to take advantage of America’s accelerating economy and rising consumer spending which bodes well for its long-term dividend growth prospects.

Dividend Profile: Excellent Income Growth And Risk-Adjusted Return Potential

REIT Yield 2017 FFO Payout Ratio 10 Year Projected Dividend Growth 10 Year Potential Annual Total Return 5 Year Beta Risk Adjusted Potential Total Returns
Federal Realty Investment Trust 3.2% 67% 5% to 7% 8.2% to 10.2% 0.337 24.3% to 30.3%
S&P 500 1.7% 50% 6.2% 7.9% 1.0 7.9%


Sources: management guidance, GuruFocus, FastGraphs, yCharts, CSImarketing, multpl.com

Ultimately, REIT investing is all about the dividend. That means that investors need to pay particular attention to the dividend profile which is composed of three parts: yield, dividend safety, and long-term growth prospects.

As one might expect from a dividend king, Federal Realty offers a very safe payout courtesy of one of the industry’s lowest FFO payout ratios. But of course, there’s more to dividend safety than just a low payout ratio. One also needs to make sure that a REIT isn’t drowning in debt.

REIT Forward Net Debt/EBITDA EBITDA/Interest Fixed Charge Coverage Ratio Debt/Capital S&P Credit Rating
Federal Realty Investment Trust 5.4 5.5 4.1 56% A-
Industry Average 5.8 3.4 NA 62% NA


Sources: FRT Investor presentation, earnings supplement, Morningstar, CSImarketing, FastGraphs

Fortunately, Federal Realty always takes a long-term approach to business, which means a highly conservative balance sheet. That includes below average leverage ratio, a very strong fixed charge coverage ratio, and an interest coverage ratio that’s much greater than its peers. The REIT also has the lowest amount of variable rate debt (1%) in the industry.

That leads to one of the strongest investment grade credit ratings of any REIT in America, which is what helps to ensure: very low cost of capital, a high cash yield spread on new investments, and strong long-term growth.

Better yet? Like most REITs, Federal Realty is a low volatility stock. In fact, over the past five years, it’s been 66.3% less volatile than the S&P 500. This makes it an excellent choice for low risk investors, such as retirees.

All told, Federal Realty’s long-term dividend growth potential of 5% to 7% means that it should be capable of about 9.2% annual total returns. That may not seem very exciting, but you need to keep two things in mind. First, given the overheated valuations of the S&P 500 today, FRT should be able to beat the market over the next decade. And given its status as one of the highest quality REITs in the world, as well as its low volatility, this means it offers far superior risk-adjusted total return potential.

In addition, this Grade A industry leader, which is rarely on sale, is now trading at the most appealing valuation in about four years.

Valuation: Still Not Cheap But Worth Buying At Fair Value

Chart
FRT Total Return Price data by YCharts

REITs have had a rough year, basically returning nothing while the red hot S&P 500 has gone parabolic. Federal Realty meanwhile has done far worse. However, while some might see that as a sign to stay away, I view it as a potentially good buying opportunity.

REIT P/AFFO Historical P/AFFO Yield Historical Yield
Federal Realty Investment Trust 21.1 19.2 3.2% 3.0%
Industry Median 11.0 NA 5.3% NA


Sources: Hoya Capital Real Estate, FastGraphs, GuruFocus

Now it’s important to keep in mind that on a price/FFO basis, FRT is nowhere near “cheap”. After all, it is still trading at a huge premium to its peers, as well as higher than its historical norm.

However, as a dividend focused investor, I generally like to compare a stock’s yield to its historical norm, and here things look a lot better. Specifically, Federal Realty’s yield is now slightly above its 13-year median and compared to its five-year average yield, it looks like a potentially good buying opportunity.

Source: Simply Safe Dividends

Of course, backwards looking valuation metrics can only tell us so much. After all, profits and dividends come from the future. This is why I like to use a long-term discounted dividend model to estimate a stock’s fair value based on the net present value of its future payouts.

Forward Dividend 10 Year Projected Dividend Growth Terminal Growth Rate Fair Value Estimate Dividend Growth Baked Into Current Share Price Discount To Fair Value
$ 4.00 5% (conservative case) 3% $ 106.74 4.5% -17%
6% (likely case) 4% $ 123.11 -1%
7% (bullish case) 5% $ 146.69 15%


Sources: FastGraphs, GuruFocus

I use a 9.1% discount rate because since 1871 this is what a low cost S&P 500 ETF would have generated, net of expenses. Thus I consider this the opportunity cost of money.

However, because any discounted cash flow model requires estimating the smoothed out future growth rates, there is a large amount of inherent uncertainty associated with this approach. This is why I use a variety of what I consider to be realistic growth models, preferably based on long-term management guidance. In this case, FRT expects to grow FFO/share at 5% to 7.25% a year over the long-term.

When we run the figures, we find that indeed Federal Realty doesn’t appear undervalued. Based on my best estimate of its most likely growth scenario. In fact, I estimate that the stock is pretty much at fair value right now.

However, under the Warren Buffett principle of “better to buy a wonderful company at a fair price than a fair company at a wonderful price”, purchasing FRT is still potentially a good idea. That is assuming you understand the risks associated with the stock, especially the realities of its interest rate sensitivity.

Risks To Consider

There are three risks I think are worth considering before buying Federal Realty Investment Trust.

First, while the REIT does have excellent diversification of its rent in terms of tenants, it is worth noting that some of its largest customers are indeed struggling.

For example, The Gap (GPS), and Ascena Retail Group (ASNA) have been struggling in recent years not just with declining sales in weak stores but with an overall decline in their brands. Similarly, LA Fitness, while e-Commerce proof, is facing increased competition from smaller boutique gyms.

Now keep in mind that none of these tenants represent a substantial amount of rent, so FRT’s dividend safety isn’t likely to be put at risk even if they were to fail entirely. However, in the event of continued decline, it could take some time for management to find new tenants to replace them which could result in short-term FFO/share growth weakness that could hurt the short-term dividend growth rate and share price.

Another potential risk to keep in mind is that Federal Realty isn’t a large enough REIT to fully fund its various growth endeavors. For example, its redevelopment pipeline largely represents joint ventures and partnerships with other developers that means that there is a risk that some of its projects might end up being delayed or even canceled if some of its partners fall upon hard financial times.

Finally, we can’t forget that diversifying into non retail properties can be a double-edged sword. That’s because FRT has the most experience in traditional retail, and developing office, hotel, and apartment real estate is not exactly in management’s wheelhouse.

And since real estate development is a highly complex and localized endeavor, there is no guarantee that FRT will be able to finish its projects on time or on budget. That might mean it fails to hit its 7% to 8% cash yield targets on its redevelopment pipeline which could result in FFO/share growth missing its long-term targets.

What about interest rates? That’s certainly one of the biggest things that REIT investors worry about which is understandable given that REITs can, at times, be highly interest rate sensitive.

Source: Hoya Capital Real Estate

Usually, there is an inverse relationship between a REIT’s beta to the S&P 500 (volatility relative to the market) and beta to a REITs’ yield compared to 10-year Treasury yields.

This is because a REIT’s beta (to the stock market) generally is lower the longer the leases are. This makes intuitive sense since the longer the leases the more stable the cash flow that funds the dividends.

However, longer leases also mean slightly higher inflation risk. That’s because, while rental escalators generally have inflation baked into their formulas, the exact formula is fixed until a new lease is signed or an existing one renegotiated.

The good news is that FRT’s 8.2-year weighted average remaining lease duration is not that large, which explains why its beta to yield is slightly below the industry average.

Source: Hoya Capital Real Estate

Keep in mind that beta to yield (interest rate sensitivity) is cyclical. This means that short-term price sensitive investors, such as those that retiring soon and plan to use the 4% rule, need to understand that there is a real risk of potentially losing money in any REIT if long-term rates spike and you are forced to sell at the bottom.

But don’t let that scare you away from REITs entirely because historically, commercial real estate has been an excellent long-term income and wealth compounder.

That’s because REIT interest rate sensitivity is both cyclical and mean reverting. That means that over the past 45 years, the actual correlation between REIT total returns and 10-Year yields (proxy for long-term rates) is effectively zero (actually slightly positive).

Sources: NAREIT, St. Louis Fed

Note that the R Squared of 0.02, which indicates that since 1972, 10-Year Treasury yields have explained just 2% of REIT total returns. Basically, this means that, over a long enough period of time, REIT investors should not worry about rates at all. That’s because they are largely irrelevant to long-term total returns.

For example, since 1972, equity REITs have increased in value 85% of the time only suffering 7 down years in the past 45 years.

This includes times where interest rates hit all-time highs (10-year Treasury Yield 16% in September 1981). In fact, here’s how equity REITs did as a sector between 1972 and 1990. This was during the fastest period of interest rates in US history as well as a period of steadily declining Treasury yields.

Year 10-Year Yield (Start Of The Year) Equity REIT Total Return
1972 6.09% 8.0%
1973 6.54% -15.5%
1974 7.0% -21.4%
1975 7.53% 19.3%
1976 7.80% 47.6%
1977 7.4% 22.4%
1978 7.94% 10.3%
1979 8.95% 35.9%
1980 11.13% 24.4%
1981 12.68% 6.0%
1982 14.14% 21.6%
1983 10.8% 30.6%
1984 11.67% 20.9%
1985 11.17% 19.1%
1986 9.08% 19.2%
1987 7.18% -3.6%
1988 8.26% 13.5%
1989 9.01% 8.8%
1990 8.43% -15.4%


Source: NAREIT, St. Louis Federal Reserve

In fact, since 1972, equity REITs have handily beaten the S&P 500, on both an absolute and inflation-adjusted basis.

Asset Type 45 Year Annual Total Return 45 Year Inflation Adjusted Annual Total Return Growth Of $ 10,000 In Inflation Adjusted Dollars
Equity REITs 12.8% 6.4% $ 409,583
S&P 500 10.6% 8.6% $ 163,070


Sources: NAREIT, Moneychimp.com

How is that possible? Because the current narrative that “REITs are bond alternatives” is incorrect. Bonds are fixed coupon assets, whose value is purely derived from: remaining duration, the coupon payment, and current interest rates (usually inflation expectation driven).

Equity REITs, on the other hand, are growing organizations whose management adapts over time to varying industry and economic challenges to keep its property base, cash flow, and dividends growing.

But what about costs of capital? If rates are high, then debt is expensive, and so REITs can’t grow profitably, right? Actually not true, because if rates are very high then cap rates are low and so cash yields on new acquisitions are also higher.

In addition, REITs match their debt duration to their lease duration, thus minimizing cash flow (and profit) sensitivity to interest rates.

Source: FRT Investor Presentation

For example, 99% of Federal Realty’s debt is fixed, and over the past three years, it’s managed to both refinance at lower rates. More importantly, the REIT has refinanced for longer bond duration than its weighted average remaining lease duration of 8.2 years.

Or to put it another way, FRT makes sure that the spread between cash yield on invested capital and its cost of capital is fixed. This ensures that its profitability on new investments is constant, no matter what rates are doing.

What happens after the bonds mature though and interest rates are much higher? Well, that’s where people fail to appreciate the beauty of REITs; specifically that REITs are good inflation hedges.

This is because interest rates are usually high when the economy is strong and thus, inflation is usually higher. REITs are able to thus offset rising inflation via higher rents.

Basically, when FRT’s bonds do mature if interest rates are significantly higher than they were when the bond was sold, the new rental rate it can obtain on the property it purchased with the debt will rise as well. Thus, the cash yield spread on invested capital remains highly stable over time.

This explains both how REITs in general, and Federal Realty in particular, have been able to so consistently compound investor wealth over time; in all manner of economic and interest rate conditions.

Source: NAREIT, Index = 100 in 1972

Bottom Line: Federal Realty Investment Trust Is The Ultimate SWAN REIT And Potentially Worth Buying Today

Please don’t get me wrong, I’m not saying the Federal Realty Investment Trust is necessarily a screaming bargain right now. Nor am I predicting that this is the bottom for this REIT or any other. After all, no one can predict short-term stock prices and it’s certainly possible that FRT and REITs, in general, might have a bad year if interest rates rise sharply.

However, knowing that interest rates are NOT a threat to REITs in the long-term, what I ultimately care about is buying the top quality and time-tested names in a growing industry. That means dividend stocks with: strong balance sheets, growing cash flows and dividends, and a proven ability to adapt over time to grow in any economic, interest rate and political environment.

Federal Realty Investment Trust is unquestionably a Grade A SWAN stock that offers all of these features. And with the price now at fair value (something that’s rare for a stock of its caliber in an overheated market), I have no qualms about recommending it to anyone looking for a highly safe and steadily growing income stream.

In fact, should FRT remain at current prices (or fall) in the coming weeks, I plan to add it to my own high-yield retirement portfolio.

———————————————————————————–

Studies show that most investors have underperformed the stock market by about 80% over the past 20 years due to a large number of mistakes, including market timing, improper portfolio structure, and poor stock selection.

Investor In the Family And Seeking Alpha are proud to bring you the 2018 Do It Yourself Investing Summit from Jan. 22nd to Jan. 26th. This summit brings together 21 of Seeking Alpha’s top investing minds (including yours truly) to highlight numerous priceless: investing principles, as well as ideas and tips about the market, economy and individual stocks for 2018.

I hope you’ll join us for this can’t-miss event and gain access to this treasure trove of knowledge that can ultimately save you a lot of: time, money, and can help you to achieve your financial dreams.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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