Netstreit is trying to sell shares at $21 per share in a new IPO. In my opinion, the shares are undervalued at this mark. The company reports recurrent revenue, and no significant amount of debt. Also, it would trade at 10x-12x EBITDA. Other REITs are trading at 12.79x-23.06x EBITDA. So, I see a significant amount of upside potential in the stock price. In my opinion, the company does not represent a significant risk, and most investors will most likely have a look at their numbers.
Business
Netstreit Corp. is a REIT, focused on acquiring and managing a portfolio of retail commercial real estate. As noted in the prospectus, the company looks for specific tenants looking to create a portfolio resilient through all economic cycles.
Netstreit does not only work with well-known and well-established tenants, but it also selects defensive retail customers selling necessity goods and essential services.
“The majority of our portfolio is comprised of properties leased to tenants operating in these defensive retail industries, with 88.5% of our ABR stemming from necessity, discount and/or service-oriented industries.” Source: Prospectus
Investors need to study the company’s portfolio very closely. I did my due diligence, and I liked what I found. The company operates with good quality tenants. Besides, none of them represents a significant part of Netstreit’s sales.
“Weighted Average Lease Term (WALT) of 11.2 years and consists of approximately 64.0% and 6.5% of investment grade tenants and high-quality unrated tenants, respectively, by Accredited Buyer’s Representative (ABR). None of our tenants represent more than 12.7% of our portfolio by ABR, and our top 10 largest tenants represent in aggregate 56.8% of our ABR.” Source: Prospectus
Investors can have a look at the list of customers given below. These are large organizations. It is not likely that they stop paying their contractual obligations with Netstreit, which the investment community will like.
- 7-Eleven
- Walmart (WMT)
- CVS (CVS)
- Ollie’s Bargain Outlet (OLLI)
- Lowe’s (LOW)
- Advance Auto Parts (AAP)
- Dollar General (DG)
- Walgreens (WBA)
- Home Depot (HD)
- Kohl’s (KSS)
Acquisition Of New Properties And Portfolio Configuration
The company decides to acquire a property by assessing not only financials and the valuation, but also by looking for a rent coverage of at least 2x. As a result, the likelihood of not getting paid appears very low:
The company also has several other rules, which I did appreciate. Firstly, the company is very strict on the percentage of Accredited Buyer’s Representative (ABR). Besides, it also tries to sign contracts with a weighted average lease term of more than 10 years. We are talking about a significant amount of recurrent revenue here, which financial advisors will most likely appretiate:
- Derive no more than (i) 5% of its Accredited Buyer’s Representative (ABR) from any single tenant or property, (ii) 15% of its ABR from any single retail sector, (iii) 15% of its ABR from any single state and (iv) 50% of its ABR from its top 10 tenants.
- Have more than 60% of its tenants with an investment grade credit rating.
- Have a WALT of greater than 10 years. Source: Prospectus
Recurrent Revenue With Positive EBITDA Generation
The company executed a business combination right before the IPO. As a result, investors may have some trouble while looking for the most relevant figures in the income statement. In my view, we need to look at the pro forma income statement for the year ended December 31, 2019. Sales for the year were equal to $39 million, and the company did not report positive net income.
In the six months ended June 30, 2020, rental sales were equal to $19 million with total expenses equal to $21 million and negative net income. Keep in mind that the company reported a gain on sale of real estate assets, which investors may see as an extraordinary item. Without taking into account the sale of assets, the net income is equal to less than -$2.4 million.
With these figures, I would expect the company to report sales of $30-$40 million in 2020. Notice that the company’s tenants operate in defensive retail industries. Hence, I don’t expect sales to be impacted that much by COVID-19. If we assume that it is correct, my sales expectations are, in my view, quite conservative.
“The majority of our portfolio is comprised of properties leased to tenants operating in defensive retail industries, with 88.5% of our ABR stemming from necessity, discount and/or service-oriented industries. Conversely, we have not invested, and do not intend to invest, in experience-based businesses, such as entertainment, movie theaters, and health and fitness, as these types of assets are not traditionally considered essential and are more susceptible to recessionary pressures, as evidenced by widespread closures across these categories during the novel coronavirus (“COVID-19”) pandemic”. Source: Prospectus
In the six months ended June 30, 2020, Netstreit reported EBITDA of $11.5 million. For the year ended December 31, 2019, EBITDA was equal to $23 million. If we assume again that COVID-19 will not damage the company’s future EBITDA that much, 2020 forward EBITDA of $22 million appears conservative.
Good Financial Shape
In my opinion, the company’s balance sheet looks attractive. With pro forma cash of $251 million, I would expect Netstreit to have liquidity to acquire new properties. The asset/liability ratio also looks beneficial; it is equal to 3.9x with loans totaling $173 million. I don’t think that the market will be afraid of the financial debt because the current amount of cash is significant.
Netstreit is financing its operations through debt, so let’s review the interest rates to be paid. The company expects to pay interest rates between 1.25% and 2.3%. I would not expect financial advisors to be afraid of these interest rates. It also shows that bankers don’t see a significant amount of risk in the company’s business model. Take into account that the larger the risk for bankers, the larger the interest rate they offer.
“For so long as the Credit Facility is secured, the interest rates under the Credit Facility are based on the Company’s consolidated total leverage ratio, and are determined by (A) in the case of Term Loans either (i) LIBOR, plus a margin ranging from 1.25% to 2.25%, based on the Company’s consolidated total leverage ratio, or (ii) a Base Rate (as defined in the Credit Facility), plus a margin ranging from 0.25% to 1.25%, based on the Company’s consolidated total leverage ratio and (B) in the case of Revolving Loans either (i) LIBOR, plus a margin ranging from 1.35% to 2.30%, based on the Company’s consolidated total leverage ratio, or (ii) a Base Rate (as defined in the Credit Facility), plus a margin ranging from 0.35% to 1.30%, based on the Company’s consolidated total leverage ratio”. Source: Prospectus
The Company Will Not Receive Anything From The Sale Of Shares
While I appreciate the company’s financial performance, I dislike that Netstreit will not receive any cash from the sale of equity:
“We will not receive any proceeds from the sale of shares of our common stock by the selling stockholders. However, we have agreed to pay all expenses relating to the registration of the shares of common stock, other than any brokers’ or underwriters’ discounts and commissions.” Source: Prospectus
Tilden Park, Davidson Kempner and other financial players own a significant amount of equity. They are selling shares, but they will own big stakes after the IPO. In my opinion, minority shareholders will most likely study these financial firms. At the end of the day, the Board of Directors will be controlled by these firms:
The Shares Are Very Cheap At $21 Per Share
After the IPO, the company expects to have 15.788 million shares outstanding. If the shares are sold at $21.00, the market capitalization will be equal to $331 million. With debt of $173 million and cash of $251 million, the total valuation of the company will most likely be close to $253 million. If we assume forward EBITDA of $22 million, the company would be trading at 10x-12x EBITDA.
As the prospectus reads, the company competes with REITs and other types of institutional funds:
“We face competition for acquisitions of real property from investors, including traded and non-traded public REITs, private equity investors and institutional investment funds, some of which have greater financial resources than we do, a greater ability to borrow funds to acquire properties and the ability to accept more risk.” Source: Prospectus
According to Statista, in 2020, REITs traded on average at 12.79x-23.06x EBITDA. Other sources also offer similar trading range. Netstreit does not have a significant amount of debt, so I don’t see why the company would trade at 10x-12x EBITDA. The EBITDA margin is close to 14%-16%, which is, as compared to REITs, not small. In my view, the shares will most likely trade at more than $21 per share. A ratio of 23x 2020 EBITDA would mean a share price of $37, which, I believe, would be an expensive valuation. Given these figures, I see more upside in the share price than downside.
Risks
Though the company has a solid portfolio, it may be damaged in certain ways by the COVID-19 pandemic. If tenants cannot pay the rent, the company’s sales will most likely suffer:
“The COVID-19 pandemic has had, and another pandemic in the future could have, repercussions across regional and global economies and financial markets and could also have material adverse effects on some of our tenants’ ability to pay rent and on our ability to successfully operate and our financial condition, results of operations and cash flows.” Source: Prospectus
There are several large stakeholders, which own a significant amount of shares. If we buy shares in the IPO, we will be minority shareholders. We will have a lot of trouble in imposing decisions, which may be good for both the company and us. Netstreit makes the following remark in this regard:
“The ability of our stockholders to control our policies and effect a change of control of our company is limited by certain provisions of our charter and bylaws and by Maryland law.” Source: Prospectus
Conclusion
In my opinion, Netstreit will not trade at $21 per share. I will be buying shares if it trades at this mark or below. In my opinion, the normal valuation would be something between $21 and $37. Without significant financial debt, good customers, and a significant amount of recurrent revenue, I don’t see why the company would not trade at that range. There are certain risks, but I don’t believe that the company is too risky for conservative individuals. Everybody will most likely have a look at the company’s business model.
Disclosure: We don’t hold Netstreit shares.
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