Agree Realty Corporation

Moat: 3/5

Understandability: 1/5

Balance Sheet Health: 5/5

Agree Realty Corporation is a real estate investment trust (REIT) that focuses on acquiring and developing properties leased to retail tenants, primarily in the United States, boasting a diverse portfolio and long term tenants.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

### Business Overview

Agree Realty Corporation (ADC) is a real estate investment trust (REIT) specializing in the ownership, acquisition, and development of net lease properties. Unlike traditional retail REITs, ADC focuses on single-tenant properties leased to national and regional retailers under long-term net leases. This structure shields ADC from property level operating risks and allows for predictable long-term cash flow. The Company operates by acquiring properties for cash flow and rent growth from high quality clients and also participates in redevelopment projects with an emphasis on creating value and enhancing long-term viability and profitability.

Net-lease properties signify that the tenant pays for most or all of the expenses related to the property (such as taxes, insurance, and maintenance), minimizing operational expenses for ADC.

#### Revenue Distribution

ADC’s revenue is derived almost entirely from rental income on the properties they own. The company has a diversified tenant base, with no single tenant accounting for more than 10 percent of total annualized base rent. This is important as a concentrated tenant base can lead to risks if one or more tenants have financial trouble and default.

Some of Agre Realty’s Top Tenants include: Walmart (4.4%), Dollar General (3.5%), Dollar Tree/Family Dollar (3.8%), Tractor Supply (3.0%), CVS (3.2%), Best Buy (3.4%), and Home Depot (2.9%)

#### Industry Trends

  • Net-Lease Retail Real Estate: The net-lease retail sector has been very stable, even in periods of high uncertainty and economic downturns, since they offer stable cashflows.
  • Shift to Experiential Retail: While e-commerce continues to grow, some experiential retail sectors have remained largely immune to disruption. Grocery, home improvement, and drug stores, which tend to offer needs-based products, are all areas that are performing particularly well. ADC has been focused on adding to their portfolio areas with these type of tenants.
  • Inflation: Inflation could mean rising property valuations and rents. While, in general, rents and other related costs may rise during high inflationary environments, this could lead to higher rents at renewal.
  • Increased Consolidation: Due to various factors, including low interest rates and a desire for scale, consolidation within the retail sector has picked up. A growing industry consolidation means less, better-credit tenants are available, and tenants can gain greater negotiating leverage.

#### Competitive Landscape

The single-tenant net lease REIT space is a very competitive one, with a large number of REIT’s and private companies vying for properties. The scale, financial strength, and operational expertise have become more essential in order to obtain the best-valued assets. Moreover, competition could erode yields for new acquisitions. There are a number of high-quality players including: Realty Income Corporation (O), National Retail Properties (NNN), STORE Capital (STOR), and Essential Properties Realty Trust (EPRT). It is tough to have a distinct advantage over these, due to the competitive landscape.

ADC differentiates itself primarily through its focus on high-credit-quality tenants and strategic investments in diverse retail sectors that are resilient in various economies.

#### What Makes Agree Realty Different?

  • Stronger Management: The management team at ADC is very experienced, with a good track record of capital allocation and real estate management. The company’s leadership has been in place for an extended period of time, which should minimize any unwanted disruptions.
  • Strong Tenants: The tenants are typically industry leaders that have a long operating history and a good credit profile.
  • Disciplined Investment Strategy: ADC focuses on acquiring properties that have a proven history of generating cash flows, which tends to lend to less risk. Moreover, they actively dispose of assets that are becoming less desirable, and therefore are able to constantly keep improving their portfolio.
  • Geographic Diversification: The company’s focus on geographic diversification helps mitigate risk and also create opportunities for better returns.

As of Q3-2023, their portfolio consisted of 1,977 properties across 48 states. Their portfolio consists of primarily retail, and the company focuses mainly on tenants in the essential retail space, such as grocery stores, pharmacies, and home improvement stores.

### Financial Analysis

Let’s delve deeper into the financials of the firm.

#### Key Metrics and Trends

  • Revenue: Consistent revenue growth can be observed over the past 5 years, driven by a steady expansion of the company’s property portfolio and annual rent escalations in tenant leases. Over the last 3 years, their revenue has increased by 10.7 percent (from $352.7m in 2019 to $390.2m in 2022). Moreover, growth in revenues was 17.2% in 2022 from 2021, a substantial jump.
 On the Q3-23 earning call, they highlighted that their adjusted funds from operations (AFFO) rose 11.8 percent.
  • Profitability: ADC consistently maintains a net profit margin of around 30-35 percent over the past 3 years, a clear indication of its high quality tenant base and high occupancy rates. This highlights the profitability of the company. The company also uses net operating income (NOI) to measure profitability. NOI margin for 2022 and 2021 were 82.2% and 81.1% respectively, showing a slight increase.
ADC's ROIC has averaged around 10.2% over the last 3 years.
  • Return on Invested Capital (ROIC): This measure shows how well the company invests its capital. ROIC is the most crucial metric for a REIT such as ADC as it is used to measure the amount of cash and profits are generated per $1 of investment. A higher ROIC generally translates into a larger moat.
As per the company, from 2004 to 2023, their Return on Invested Capital (ROIC) has averaged 10 percent. This suggests that the company creates returns that are in excess of its cost of capital.
  • Capital Allocation: One way management creates value, is through appropriate allocation of capital. The management team at ADC has shown a dedication to acquiring and redeveloping assets that create value. They have spent a little above $1B each year in acquisitions for the past couple of years and sold $171M worth of assets in 2022 that they deemed as low-returning or risky.
  • Occupancy: Maintaining high occupancy levels means consistent rental income, and minimal losses from vacant properties. As of Q3-23, their occupancy stood at 99.6%, showcasing its strong position and minimal risks.

The average remaining lease term of ADC’s portfolio of tenants is around 10.6 years.

  • Balance Sheet: From a balance sheet perspective, the company maintains a solid financial position with an increase in equity in line with the asset growth. A diversified approach to financing has also been implemented by the company, with 60% of their debt being from unsecured sources.
A key factor for companies to have lower borrowing rates is their credit rating, and ADC has recently received upgrades from Moody's, and Fitch as well.

#### Recent Concerns/Controversies

  • Interest Rate Risk: As the interest rate has risen quickly over the past few years, the company is having to pay more interest on its floating rate debt. In order to mitigate this risk, management has used a mixture of fixed-rate and floating-rate debt. However, they expect their debt-to-EBITDA to be at the target range of 5.0 to 5.5 by the end of 2024.
  • Inflation and Construction Costs: Inflation has also increased the cost of acquiring and building properties. This could cause an erosion in return-on-investment, if rents don’t adjust appropriately.
  • Acquisition Spree: As the company seeks to continually expand their portfolio, they have been heavily involved in acquisitions. This poses a potential risk, if they overpay for assets. However, their management has been disciplined with acquisitions to ensure they are value accretive.

### Moat Assessment

ADC has a narrow moat due to its scale and strategic relationships, but it is not as strong as other wide-moat REITs due to limited barriers to entry within the REIT sector itself.

  • Network Effect: The company has some positive network effects as tenants prefer operating out of their properties. However, due to low switching costs, this is a minor factor in their wide moat.
  • Intangible Assets: ADC has established a very strong presence and brand name in its niche. Moreover, it has very high customer satisfaction due to its efficient service and the quality of its tenants. However, this does not constitute as a strong moat by itself since competitors can quickly duplicate this model.
  • Switching Costs: The clients of ADC tend to be sticky as it costs them time and effort to switch locations and build new clientele. So, once clients commit to a location, they stay in for a longer time. The tenant base includes well-known national chains, which further increases this stickiness.
  • Cost Advantages: It has some cost advantage due to its geographic footprint and scale which enables them to create a national presence in a cost-effective manner.

There is considerable risk to the moat due to competitive pressures and the nature of the REIT business, where other players can replicate their model with ease. Moreover, a shift in tenant preferences, or the impact of technological innovations could impair its existing properties.

### Business Understandability: 1 / 5

The business model of ADC is very easy to understand. It is simply collecting rent from its real estate tenants. However, understanding some aspects of the financial model, can be difficult without extensive accounting knowledge.

### Balance Sheet Health: 5 / 5

ADC has a very healthy balance sheet. Their low leverage and high-quality tenants are quite attractive. They’ve also secured funding through a variety of sources to reduce any credit-specific risk.

  • Debt Levels: Leverage metrics remain good, with net-debt to adjusted EBITDA of 5.2x at the end of Q3-2023. Their Debt-to-capital is around 0.4.
  • Liquidity: The company has had good liquidity, as of the end of the Q3, with $36 million in cash and $600 million available under its credit facility, meaning they can continue to pursue acquisitions and development projects with minimal financial risk.

### Conclusion

Overall, ADC is a very high quality REIT with a focus on high-quality, stable tenants. It’s a very easy business to understand, and it has a very solid balance sheet that should provide investors with confidence. However, there is still competitive and industry-related risks that could pose problems down the line. The current economic headwinds may also place short-term pressures, however management has been resilient in the past.