Why Buffett Bought Store Capital & What We Can Learn From It

July 3, 2017

Why Buffett Bought Store Capital & What We Can Learn From It

  • Analyzing Buffett’s purchase can give us excellent insight into how good investments can be found in any environment.
  • STOR still offers a 7.7% AFFO yield for 2017, a 5% dividend yield, and expected growth of over 5% per year.
  • REITs’ performance is closely related to interest rates, but when you find one where the yield is satisfying and the risk is low for your portfolio, well, then you don’t have to care much about what’s going on in the economy or with interest rates.

Introduction

If you’ve been reading Investiv Daily for a while, you know I’m always using Warren Buffett as an example of investing excellence.

Buffett has been doing the same simple things over and over again for the last 52-years, thus since present management took over at Berkshire Hathaway (NYSE: BRK.A, BRK.B), and has been extremely successful with average yearly gains of 19% compared to the S&P 500’s 9.7% with dividends.

So when Warren Buffett buys a specific stock, it’s important to analyze the purchase in order to learn as much as possible from it.

Buffett’s latest acquisition is a 9.8% stake in Store Capital (NYSE: STOR), so today I’m going to analyze the purchase to see the rationale behind the investment and see whether the knowledge can be applied to other similar opportunities out there, or if perhaps STOR is still a good buy.

Store Capital

Buffett is famous for buying companies with good management, but what’s even more important is that the companies he buys are cheap. STOR was pretty cheap as it was 30% below its August 2016 highs when Buffet took a position. Berkshire bought 18.6 million shares through a subsidiary at a price of $20.25.

Speaking of August 2016, back then I wrote an article about how real estate investment trusts (REITs) should be avoided, so I’ll take this opportunity to see whether they are a better investment now. That article is available here.


Figure 1: STOR’s stock price since IPO in 2014. Source: Yahoo Finance.

Store Capital’s management has a 35-year positive track record, though the company didn’t go public until 2014. STORE is an acronym for Single-Tenant-Operational-Real-Estate, and the company has 1,750 properties leased to 369 customers in total.

A look at fundamentals shows us why STOR is so interesting to Buffett. Its adjusted funds from operations (AFFO), which is the usual metric to value REITs, is $1.76 which gives an AFFO yield of 8.8%. On top of that, STOR is one of the few REITs that doesn’t pay out all of the available cash flows but instead reinvests a third of it. This makes STOR a perpetual growth company and keeps the debt level low.


Figure 2: STOR’s growth model leads to an average of 5% internal growth annually. Source: STOR.

The reinvestment of funds gives STOR average internal growth of 5% per year. Given the 8.8% funds yield at the price Buffett bought and the 5% growth rate, it will only take STOR 2 and a half years to reach a return of over 10% for Buffett. By reinvesting the 5% dividend yield, the return could be even higher thanks to compounding.

What’s also very interesting about STOR is the relatively low debt level, where total liabilities are just 49% of total assets. The company is also well diversified across industries with 67% of customers in service, from restaurants to kindergartens, 18% are in retail, and 15% are in manufacturing. This makes STOR a company that isn’t under any kind of threat from the Amazon (NASDAQ: AMZN) retail offensive.


Figure 3: STOR’s diversified customer base. Source: STOR.

The average remaining lease contract term is 14 years and the occupancy rate is 99.5%, which is high.

Also consider that only 1% of S&P 500 companies offer a combination of earnings growth and a high dividend yield with stable debt levels like STOR.


Figure 4: STOR’s combination of growth and earnings. Source: STOR.

To conclude with STOR, everything I’ve described above makes the company an investment that satisfies the three rules I wrote about last week on how to achieve sustainable returns of 10% per year. That article is available here.

STOR has a dividend yield of 5%, an AFFO yield of 8% at current stock prices, and a growth rate over 5%. Thus pretty soon, the AFFO yield will be above 10% and the dividend will also  always be growing. The relatively low debt makes it a safer investment as the company can easily weather economic turmoil.

Comment On REITs

As I wrote in my August 2016 article, REIT investing is closely related to interest rates.

Higher interest rates increase debt costs which lower available cash, and higher treasury yields make the dividends less attractive. However, if you can find a REIT like STOR, which is close to a 10% cash flow yield, has a relatively safe, diversified portfolio, and low debt levels, you can easily invest in it without being afraid of interest rates changing or what the economy will do because you can focus on the stable and growing dividend.

In August 2016, the AFFO yield for STOR was close to 5% which is a risky yield for REITs. However now, even after Buffett’s purchase, it’s still 7.7%, so it’s a pretty nice return given the potential growth. In the long term, the returns could easily be close to or even above 10% per year.