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During the second quarter, when the share prices started to rebound after the initial COVID-19 pandemic and panic, I had to make choices. I was too frugal to pay $12 per share of Monmouth Real Estate (MNR) as the price had dipped below $9 during the initial panic, but I was wrong as my frugality caused me to miss an excellent entry point and the share price continued to trade above $14 all summer long. Around the same time, I initially didn’t want to pay $24.4 for the preferred share(MNR.PC) and I ended up buying the preferreds at par ($25). Monmouth’s share price has come off a bit and I wanted to figure out if I should just pay the $13.30/share it’s currently trading at. After all, quality has its price and given the 99%+ occupancy rate and 99%+ rent collection rate of this single tenant REIT focusing on industrial properties, perhaps I’ll just have to bite the bullet and pay a higher price than I had in mind.
The Q2 results were pretty decent
Monmouth Real Estate’s financial year ends in September, to I was looking forward to seeing the Q3 results which provided an overview of the first full quarter wherein the COVID-19 pandemic had a major impact on the daily life all over the world. Fortunately Monmouth’s performance wasn’t hurt at all by the pandemic thanks to the high occupancy rate (99.4%) while the rent collection rate averaged in excess of 99% throughout the past few months:
Source: press release
Thanks to Monmouth’s strong portfolio and robust tenants, the REIT barely received any requests for rent deferrals and the cumulative amount of deferred rent so far is less than half a million dollar, of which 3/4 th is expected to be paid before the end of the year.
A strong performance indeed, and this is noticeable in the FFO and AFFO result of the company. The FFO came in at $19.7M in the second quarter of the calendar year (and almost $60M during the first nine months of the year) while the Adjusted Funds Flow From Operations reached a very respectable $19.5M or 20 cents per share. This means the quarterly dividend of 17 cents per share has a coverage ratio of 117% (or vice versa, a payout ratio of just over 85%). A safe payout ratio, that’s for sure.
Source: press release
Meanwhile, the current annualized dividend of $0.68/share results in a dividend yield of 5.12% based on Thursday’s closing price of $13.28/share. 5.12% clearly isn’t the highest yield on the market, but again, quality has its price: even if the FFO would inexplicably decrease by 10%, the dividend would still be safe.
A quick look at the balance sheet
So Monmouth Real Estate ticks the dividend sustainability box: the 5% yield is attractive and more than fully covered. My next step was to figure out if the balance sheet contains any red flags.
The total balance sheet size is $1.93B which contains a net book value of $1.74B of real estate (which already takes an accumulated depreciation of $284M into account). Interestingly, the balance sheet contains less than half that amount in liabilities ($908M) while the preferred shares (see later) represented almost $434M of the equity value.
Source: SEC filings
As you can see in the image above, having in excess of $1.02B in equity on a balance sheet total of less than $2B is very decent, but the equity attributable to the common shareholders is just around $589M. Divided over 98 million shares, the book value per share of Monmouth REIT is roughly $6. Which means MNR is currently trading at more than twice its book value.
That sounds expensive, but as you may have already guessed by now, there’s more than meets the eye here. Remember the book value of the assets is less than $1.75B and this may mean the fair value of the properties is higher than the book value. In which case the difference between the fair value and book value would be entirely attributable to the common equity holders as some sort of hidden value on the balance sheet.
As Monmouth traditionally leases its assets on a net lease basis, we can pretty easily extrapolate the rental revenue:
Source: SEC filings
With an annualized rental revenue of $140M, the properties are currently valued at $1.74B indicating the net rental yield on the assets is approximately 8%. Given the high quality of the tenants (FedEx (FDX) represents in excess of half of the rental income) and the current low-yield environment, a valuation of the properties at an 8% rental yield feels cheap. Applying a required rental yield of 6% would put the fair value of the properties at just over $2.3B for a $550M increase or an additional $6/share. This means the fair value per common share is about twice as high as the book value making $13.28/share very reasonable.
However, this also means the preferred shares are quite safe despite the fact they represent almost half of the equity value. The 17.36 million preferred shares are obviously senior to the common shares and given the fair value of the assets is higher than the book value, I feel the preferreds offer an excellent risk/reward opportunity. I will judge them based on A) asset backing and B) the dividend coverage ratio.
The asset backing calculation is pretty straightforward. Let’s even assume I’m 10% off and the properties have a fair value of $2.1B instead of $2.3B. Adding the cash ($12M) and the securities portfolio (almost $120M) and forgetting about all the other current assets while deducting all the liabilities on the balance sheet ($907M), the fair value of the remaining equity portion would be $1.33B. I’m not saying that’s what the company would be worth in a fire sale, but assuming an orderly winddown of the portfolio is possible, this appears to be a reasonable value).
There are only 17.35M preferred shares outstanding, at a par value of $25. However, the fair value of the assets after repaying all liabilities represents $76 per preferred share (I’m ignoring the common shares for a minute as they rank junior to the preferred shares so any residual value after repaying the debt and other liabilities would first be used to repay the preferred shareholders).
So, yes, Monmouth’s preferred shares are backed by roughly $76/share in net assets, more than three times the par value of $25/share.
Secondly, I wanted to check the sustainability of the preferred dividend. Looking at the first nine months of the year, Monmouth generated an operating cash flow of almost $75M and after deducting the $4.7M in capital improvements and adding back the net investment in the working capital position, the net operating cash flow is approximately $73M. The preferred dividends are costing the company $0.3828125 per quarter so roughly $6.65M per quarter.
Source: SEC filings
So of the $73M in cash inflow in the first nine months of the year, less than $20M was needed to cover the preferred dividends which, once again, rank senior to the common shares as these 6.125% dividends are cumulative as well. With a coverage ratio of almost 400%, the preferred dividends are very safe.
I currently still don’t have a position in the common shares of Monmouth and would still be interested in picking up stock on a weak day. However, I am very impressed with the risk/ reward ratio of the 6.125% preferred shares as the net assets after repaying all liabilities will be more than sufficient to cover the repayment of the preferred shares while the preferred dividends use less than 30% of the incoming cash flow (despite accounting for about 40% of the equity).
I think the Monmouth preferred shares remain a strong buy on any weakness. I may add the common shares as well, but only on dips as I’m mainly interested in the safe preferred dividends, collecting the 6%+ preferred yield.
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Disclosure: I am/we are long MNR.PC. 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.