High yield is viewed as a badge of dishonor in today’s market. Once an investment sells off to lift the yield into double digits, an accelerator effect frequently kicks in, and selling intensifies.
[ad#Google Adsense 336×280-IA]The effect can be traced to the trials and tribulations in the U.S. energy sector, particularly among the upstream master limited partnerships (MLPs).
Other high-yield equity investments have sold off due to guilt by association.
Business sector be damned; high yield equals high risk these days, so investors perceive.
The real estate investment trust (REIT) sector is one high-yield sector suffering guilt by association.
Yields run high, but that doesn’t mean risk runs high. Contrary to many energy MLPs, where risk actually does run high, risk actually runs low with many REITs.
Government Properties Income Trust (NYSE: GOV) is one such REIT. Its shares yield 12.5%, yet the risk behind that REIT dividend yield actually runs low. Many investors believe otherwise, because many investors focus on the wrong metric.
Last week, GOV reported a $0.03 per share loss for the fourth quarter. For the full year, GOV reported a $2.97 per share loss. All that red ink would appear to be an ominous sign for a company that pays a $1.72 per share dividend.
Perception is the problem. Because GOV is a REIT, earnings shouldn’t be the focus. Cash flow is the focus. REITs have high depreciation and amortization expenses. These non-cash expenses materially lower reported earnings. In fact, depreciation and amortization are GOV’s largest expense, accounting for 38% of reported expenses last year.
These expenses, though, don’t impair GOV’s ability to pay its dividend. Therefore, focus on cash flow, which means focusing on funds from operations (FFO). This is the key metric of dividend support for a REIT. If FFO exceeds the stated dividend payout, chances are good the dividend will be sustained.
On that front, chances are good that GOV will sustain its dividend. In the fourth quarter, GOV reported $43.6 million, or $0.61 per share, of FFO. For the full year, GOV reported $2.39 per share in FFO, compared to $2.29 per share in 2014. FFO easily covers the dividend. What’s more, it has been that way since GOV came public and began paying a dividend in 2009.
More important, GOV has the tenant base to continue to generate FFO to support the dividend. The federal government is GOV’s largest tenant. When combined with 12 state governments, municipal tenants and the United Nations, government in total accounts for 92.8% of GOV’s rental income.
That said, GOV has suffered from a few “legacy” issues. For one, management made a lousy, and self-serving, deal for GOV a couple of years ago when it issued 25.8 billion GOV shares to buy a 28% interest in Select Income REIT (NYSE: SIR), a REIT that owns industrial properties. Select has been mostly a losing proposition for GOV.
Fortunately, GOV has a sufficiently strong tenant base to overcome the occasional self-serving deal. Besides, it appears management has learned its lesson.
I basically agree with David Blackman, GOV president and chief operating officer, who opines, “Yes, we currently think the stock is undervalued. We think it generates a very compelling dividend yield. We think that dividend has the potential of growing over time. And we certainly believe that the share price will increase over time as well.”
Given the cash flow and financial wherewithal behind GOV’s 12.5% yield, I’m given to agree with Blackman.
— Steve Mauzy
Source: Wyatt Investment Research