When Retail Opportunity Investments Corp (ROIC, Financial) first went public in late 2007 at around $9 per share, I was one of the first investors. The story was simple and compelling: Stuart Tanz, a famed real estate investor with a long history of success, was tagged with growing a niche real estate business with reliable tenants and a recession-proof revenue base.
For years, the story played out as expected. Through 2016 — with just under a decade of performance under its belt — shareholders tripled their initial investment when including dividends. The future looked bright, until it didn't. Since those 2016 highs, the stock has halved in value and now trades at historically low valuation multiples, pushing the dividend yield up to 5%. While I sold my shares a bit below the all-time high, the pullback has reignited my interest.
I still like this business model
Despite the strong share pullback, ROIC's business model remains as attractive as the first day it traded publicly. Its strategy is simple: buy properties in growing markets that are anchored with grocery store tenants. Grocery stores rarely go out of business, providing landlords with long-term and reliable cash flows. The adjacent lots, meanwhile, enjoy a steady stream of traffic given that many people frequent their local grocery store several times per week. Indeed, this simple strategy has provided ROIC with market-leading occupancy and renewal rates.
Today, ROIC is the largest grocery-anchored REIT focused exclusively onthe west coast, an area of the country that is experiencing higher population growth rates on average. Around 97% of its portfolio is anchored by either a grocery store or drugstore, by far the leading rate of any publicly-traded REIT. In total, it owns 92 shopping centers and enjoys a 98.2% occupancy rate. A testament to its strategy, that occupancy has never dipped below 96% over the past decade, even including the pandemic years.
The list below, provided by the company, fully explains the company's strategy and success. In my view, all of these supposed advantages have proven true, as evidenced by the underlying statistics. Yes, cash flow streams have been reliable. Yes, occupancy rates have led the industry. And yes, the company's financial situation is nothing to worry about, even with rising rates. There is, however, something management is excited to share with investors, a problem that is behind shares falling 50% over the past few years despite a rising overall market.
There's one catch with this stock
Three charts fully summarize what has stalled ROIC stock in recent years. All three, shown below, paint the same picture: growth is stalling. The asset base is no longer growing. Cash flow growth has flatlined, and depending on the metric, may actually be shrinking. From 2011 to 2016, operating cash flow went from $17 million to $115 million. That's a 5x increase over five years. Over the next five years, however, operating cash flow grew by just 15%. That's still positive, but nowhere near what investors had grown to expect.
Jumping into the balance sheet, the source behind flatlining growth is clear: the company is no longer deploying capital at scale. Debt levels have been scaled back considerably since 2017, and while for many businesses that would be an indicator of success, it is usually a sign of negativity for real estate stocks which rely on leverage to maintain its portfolio. Falling debt levels for a REIT usually signals a shrinking balance sheet overall.
Lower growth has understandably resulted in a shrinking valuation multiple. On a price-to-book basis — one of the most relevant multiples for assessing real estate businesses — ROIC's valuation has fallen nearly in-line with its share price. As mentioned, the business itself has experienced a rapid decrease in growth, but it's not necessarily falling apart just yet. So, the share price decline has really been about a resetting of expectations, swapping a multiple based on growth with a multiple based on steady-state production.
Is now the right time to buy?
When he founded Retail Opportunity Investments Corp, Stuart Tanz already had a storied resume. He was formerly the head of Pan Pacific Retail Properties, which he grew from a $400 million IPO in 1994 to a $4 billion business which he sold in 2006 just before the real estate bubble popped. His strategy with ROIC was perfect on paper, and worked for years. The issue, however, is that the company's blue-chip business model can't be extrapolated forever.
Consider what the company believes are the characteristics of ideal property acquisitions:
All of the above sounds great, right? The issue is that when applying all of these attributes to potential acquisitions, the potential pipeline shrinks pretty quickly. And after a long string of acquisitions, ROIC has arguably already gobbled up the best targets. To continue growth, it would need to feed further down the value chain, sacrificing some of its core principles. Plus, with interest rates continuing to rise, these subprime acquisitions would cost more than ever. These factors combined have pressured growth rates tremendously.
On the most recent quarterly conference call, CEO Stuart Tanz summarized the state of today's market.
“In terms of growing our portfolio, it's safe to say that 2023 has been a frustrating year as the market has been largely idle and slow to adjust to the higher interest rate environment, as I mentioned. Along with the market also adjusting to the ongoing challenges that certain commercial property sectors and certain prominent markets across the country are currently faced with.”
Here's the good news: the market has already digested this phase change, lowering the valuation multiple to decade-lows. Shares are now closing in on a basement-level valuation, with tangible book value just 20% below current values, giving new investors a reliable floor. The 5% dividend yield, meanwhile, should have no issue remaining in place given the company's steady cash flow portfolio. The company should have no issue treading water before returning to a slow-growth model when the growth picture improves.
Again, here's Stuart Tanz from the latest conference call:
“Fortunately, the long-term fundamentals of the grocery anchor sector remain sound, especially as it relates to our specific portfolio and our highly protected markets. As we look towards to 2024, the current expectation in the market is that acquisition activity could potentially accelerate. At property level, low interest rate debt begins to mature in earnest next year and private owners could have limited viable refinancing options. In anticipation, we've been strategically tracking a number of potential off-market opportunities across our core markets, working to establish and maintain an ongoing constructive dialogue with private owners. Over our team's nearly 30-year history of specializing in the grocery anchor sector on the West Coast, this strategy has proven instrumental time and again in our ability to gain access to acquired exceptional properties that rarely ever hit the market.”
Once a growth stock, Retail Opportunity Investments Corp has become a stagnant business, though one with single-digit long-term growth opportunities and a blue-chip portfolio of cash flow producing properties that will fuel a reliable 5% dividend. Now trading not too far above tangible book value (theoretically the company's liquidation value), shares look appropriate for patient investors looking for steady income rather than rapid growth.
