Shares of Realty Income Corporation (NYSE:O) dropped 2% after the company reported first-quarter earnings after the bell on Wednesday. And I don’t expect the O stock price to bounce back any time soon. This is purely a dividend stock.
Realty Income is part of the S&P 500 and a member the elite S&P High Yield Dividend Aristocrats group because it has paid out — and increased — its dividend in each of the last 20 years. It’s an impressive track record.
On the earnings front, Realty Income posted net earnings of 27 cents per share, above the 24 cents Wall Street was expecting. Revenue was $246.7 million, also topping analysts’ estimates of $238.5 million.
Management posted full-year adjusted funds from operations (AFFO) of 68 cents per share, a penny over estimates, and forecasted full-year AFFO between $2.66 and $2.71.
From the quarterly numbers posted, it appears to be business as usual for Realty Income — but that may be the problem. Year-to-date, O stock is down 1.5% while the S&P 500 is up 1.8%. Realty Income has paid four dividend payments and now posted two earnings reports, both of which on the surface appear to be strong.
But the biggest issue with O stock is share dilution. In 2010, Realty Income’s balance sheet stated the company had 110 million outstanding shares. By the end of last year, that number had grown to 225 million.
Yes, the share count doubled in four years. That is bad — and it will continue to get worse as times goes on.
First, due to the Real Estate Investment Trust rules, all REITs must pay out 90% of their earnings to maintain their generous tax structure (hence why REITs typically have high dividends). That only leaves a REIT with 10% of its earnings to grow the business.
That’s usually not enough, so the company typically takes on debt in any acquisition. And when it has trouble paying off the debt — again, it only keeps 10% of its earnings — it has to issue new shares to pay down debt.
For instance, in April 2014 Realty Income issued 13.8 million shares of common stock to raise $528 million, all which was used to pay off debt incurred from its acquisition of a credit facility. And this week when reporting its quarterly earnings, Realty Income disclosed that it issued 5.5 million additional shares, raising $276 million, to pay off more debt from that purchase.
Despite all this share dilution, the company still carries a debt of $5.4 billion.
Realty Income also has a program, since 2011, that allows shareholders to receive additional common stock instead of a cash dividend payment.
Lots of investors like receiving more stock as opposed to cash because they don’t need the money until retirement. But, Realty Income’s program allows it to issue new shares instead of giving the dividend payment. In the first quarter, 2 million new shares of O stock were issued, and the company pocketed $102 million in dividend payments.
So what does all this really mean? It means while Realty Income is a great monthly dividend-paying company with a proven track record, the O stock price will not likely be moving higher any time soon due to the constant share dilution.
Furthermore, the share dilution will eventually hit a level that will put the dividend payment, and especially its growth, in jeopardy.
Investors need to pay close attention to debt and share dilution over the next few quarters and shouldn’t expect much growth from the O stock price during that time.
As of this writing, Matt Thalman did not hold a position in any of the aforementioned securities. Follow him on Twitter at @mthalman5513.