REIT Pair Trade: Morgan Stanley Upgrades Store Capital, Downgrades Realty Income

Morgan Stanley offered a real estate investment trust pair trade Monday in the form of Realty Income Corp. O and STORE Capital Corp. STOR. 

The Analyst

Morgan Stanley analyst Vikram Malhotra upgraded Store Capital from Equal-Weight to Overweight with a $31 price target.

The analyst downgraded Realty Income from Overweight to Equal-weight with a $57 price target.

The Thesis

Completely avoiding long-term REITs is unwise considering their growth and late cycle potential, Malhotra said in the note. (See the analyst's track record here.) 

Despite the outperformance in triple nets like Realty Income and Store Capital, the analyst advocates exposure to the sector. “Within triple nets, we believe relative growth prospects, balance sheet and tenant health will be key differentiators.”

Store Capital has the following fundamental advantages over Realty Income, Malhotra said: 

• Store Capital’s high investment spreads. “This is important given external growth accounts for a large proportion of earnings growth.”
• The company’s more flexible funding options, such as a lower payout ratio and master funding conduit.
• A more diversified tenant base.

Store Capital’s low payout rate gives the trust a greater opportunity to grow dividends, the analyst said.

“STOR's valuation has benefited from its strong management team and consistent message. We believe the current 10-percent valuation gap to NNN is likely to change during the next 12 months.”

Realty Income’s exposure to potential risk industries will likely cause near-term headwinds along with uncertainty on future rates, Malhotra said.

"[A] long track record, including 25-plus years of dividend growth, has given the company a unique retail-heavy shareholder base that can continue to provide additional support to shares.”

Price Action

Realty Income shares were down 0.4 percent at $56.66 at the time of publication Monday, while Store Capital shares were down 0.14 percent at $27.75. 

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