Thesis

Broadstone Net Lease went public in late September of this year. The company’s diversified portfolio insulates it from covid risks. Its stable properties have been protected by essential tenants, keeping rental collections above 90% for Q2. With a superior portfolio, ample acquisition opportunities post-IPO, and a discounted valuation, Broadstone is positioned to benefit from the K-shaped net lease recovery.

Diversified Portfolio

Broadstone has a highly diversified portfolio consisting of industrial, healthcare, office, restaurant, and retail properties. A majority of BNL’s portfolio consists of industrial (44%), healthcare (20%), and office (10%), all of which are subject to very little negative impact from covid. Each of these three sectors had over 95% Q2 rental collection rates.

Source- 10-Q

These three sectors also provide protection against the growth in e-commerce, a potential long-term threat to the viability and necessity of net lease properties.

Industrial Portfolio

  • Set to benefit from the increasing penetration of e-commerce, as e-commerce is less efficient than brick and mortar in utilizing industrial space. At the end of 2019, e-commerce consisted of just 15% of total retail sales. This number jumped to 25% by May 2020 due to the increased adoption of e-commerce.

Healthcare Portfolio

  • Medical properties have been largely insulated from e-commerce penetration. The country’s aging population will continue to drive demand for such properties.

Office Portfolio

  • While high rise office properties located in urban cores are high risk long-term due to high rental costs and growing adoption of work from home, BNL’s portfolio is concentrated in single tenant properties in non-core markets. Such properties have seen increased tenant and investor demand as the urban to suburban shift may be in early stages, and many companies are seeking suburban, satellite outposts and offices to relocate or expand to.

Lack of Experiential Real Estate

Experiential real estate was viewed as one of the safest and high reward net lease properties. However, social distancing has significantly reduced the demand for gym/fitness, theater, and entertainment-focused tenants.

While cap rates have compressed for essential-use properties that have experienced little change in demand, experiential net lease properties have been rendered unsalable. BNL has very little exposure to nonessential tenants or tenants whose businesses rely on social gathering.

Net lease peers Realty Income, National Retail Properties, and Store Capital have portfolio with approximately 15% concentration in the experiential sector. In contrast, BNL has no exposure to this sector.

One area of concern for BNL is its exposure to retail and restaurant tenants, which make up roughly 25% of the portfolio. Restaurants achieved rental collection rates at 88.4% for Q2, while retail was at 70%. Casual dining and quick service restaurant cap rates ticked up in the most recent quarter by around 30 basis points. Quick service demand has outpaced casual dining, though both still remain below pre-covid levels.

Source

With regards to retail, BNL’s top tenant is Art Van Furniture, which recently declared bankruptcy. They make up 2.5% of BNL’s annual base rent, so it is a noteworthy, but relatively insignificant headwind facing the company. Additionally, as shown in the previous graph, e-commerce remains a massive threat to physical retail. Covid has accelerated this trend. However, BNL is roughly 4x as invested in industrial as it is retail, making the secular trend a long-term gain for the company.

Long-Term Leases

In addition to having stable tenants with high rental collection rates, BNL’s lease structures are very attractive. BNL has long-term leases, with an average remaining lease term of 11.3 years.

92.1% of its tenants report specified financial information on a periodic basis. Such allows management to evaluate the property-level performance of the vast majority of its tenants.

Lastly, BNL’s leases have built in rental escalators averaging over 2% to protect against inflation. Long-term leases, combined with incremental rent escalations, are attractive elements to investors who value stability in cash flow.

Properties with longer-lease durations will sell for lower cap rates and are in much higher demand, all else equal, particularly in such unstable and uncertain times.

Cap Rate- Treasury Spread

Given their stable cash flow generated from long-term leases, net lease properties are typically thought of as bond proxy investments. Consequently, the 10-year treasury yield is frequently watched and compared to the yields generated by net lease properties.

Source

With the average net lease cap rate at 6.3% and the 10-year treasury yield at .77%, the spread remains over 550 basis points, a record high. Broadstone values its portfolio at a 6.72% cap rate, indicating a slightly higher spread. The 10-year Treasury is certainly a safe haven, the massive spread with net lease cap rates creates a highly attractive investment opportunity.

Earnings and NAV

Broadstone trades at a lower earnings valuation to its peer net lease reits. BNL’s valuation is most comparable to WP Carey, which also is a very diversified net lease REIT. Given that both company’s portfolios have been resilient throughout the recession, the market is unjustly discounting them for their diversified nature.

Company P/AFFO (annualized)
BNL 14.35
WPC 14.85
NNN 15.05
STOR 15.16
EPRT 17.29
O 18.17
ADC 21.04

Source- Company press releases

Future earnings growth could be fueled by upcoming acquisitions from the IPO. proceeds. Thus, current valuation represents an attractive entry point. BNL also has a slightly higher debt load than its peers, with a debt/ebitda ratio of over 7. Many of its peers have a ratio around 5-6. This should come down as management uses some IPO proceeds to deleverage.

Broadstone also trades at a discount to its NAV, as demonstrated by the model below. Annualizing Q2 NOI and assuming a 6.72% cap rate earns the company a NAV of $19.41, about 15% above its current stock price.

Source- Author calculations

Concerns- IPO Timing and Price

Prior to going public, BNL released that it had a Net asset value around $82 per share. They then announced a 4-to1 stock split, bringing the NAV per share down to just over $20. BNL went public at $17 per share, around 15% below the value of the pre-ipo price.

Several commenters on recent Seeking Alpha posts and press releases have commented on the concern that initial investors got short-ended by the much lower ipo price. Net lease REIT valuations are still well-below pre-covid levels, reflecting BNL’s lower valuation.

Stock price appreciation should be in store should conditions normalize over the next few months. Mean reversion potential exists, making up for the lower IPO price. BNL’s IPO proceeds can be used to pursue accretive investment acquisitions, driving higher earnings and stock price.

K-Shaped Recovery- Conclusion

Many indicators point to the on-going economic recovery to be “K-shaped” not only in terms of overall economic trends, but also in the net lease space. Broadstone’s portfolio is defined to benefit from this trend. With long-term leases in predominately the industrial, healthcare, and office sectors, Broadstone owns essential-use properties and has fairly limited exposure to sectors hampered by low rental collections and much higher cap rates. Experiential real estate will likely experience much higher cap rates when the dust settles, as activity remains well below pre-covid levels and bankruptcies loom. Strong and stable sectors that BNL has exposure to have held up well and will recover quicker.

While the market typically discounts diversified REITs, like BNL and WPC, this is unjustified in the current environment. Diversified net lease REITs are less exposed to vulnerable sectors, like restaurants, entertainment, retail, and theaters. Cap rates for essential-use properties have remained steady, and they are deserving of a higher multiple. With plenty of cash on hand for future acquisitions to drive earnings growth and an expected dividend yield of 6% at current prices, BNL is a top tier net lease REIT.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BNL over 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.

Source Article