Retail Opportunity Investments Corp.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

Retail Opportunity Investments Corp. (ROIC) is a REIT that specializes in acquiring, owning, and managing necessity-based retail properties, primarily shopping centers anchored by grocery stores, located in the Western United States.

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.

ROIC is a real estate investment trust (REIT) focused on acquiring, owning and managing necessity-based retail properties across the Western United States.

Business Overview

  • Revenue Distribution: ROIC’s revenue is generated primarily from rental income from tenants in their properties. A significant portion of their tenants are grocery-anchored retailers. Lease structures are designed to provide a predictable cash flow stream, with the potential for rent increases over time. Their business model does not have any real value-added services or product manufacturing. They are purely a landlord with limited ability to innovate.
  • Industry Trends: There’s increasing competition with e-commerce companies that is affecting the retail landscape with many tenants moving to online models or decreasing their footprint. There are also increases in online ordering and delivery of groceries that are reducing foot traffic in brick and mortar locations. The economy plays a big role in the success of brick and mortar retailers.

  • While online growth is a challenge, ROIC’s properties are considered necessity-based, so many of the tenants are “internet-resistant” businesses such as grocery stores, services, and local businesses.

  • Margins: The company has low operating margins, about 25-30% of its total revenue. The main expenses are related to building management, loan payments, administration, and property taxes. For the year ended December 31, 2022, the Company’s operating expense was $115.625 million.
  • Competitive Landscape: The market for necessity-based real estate is not without competition. Many large REITs are also acquiring similar properties. However, ROIC distinguishes itself with a focus on specific types of retail and geographical presence in the western states that have high economic growth. Their properties are mostly grocery-anchored shopping centers, making them relatively resistant to shifts in consumer spending.
  • Differentiation: ROIC’s geographical focus and specialization in grocery-anchored retail are the key aspects that make them different from the competition. Having properties in fast-growing western states can be beneficial over the long term.
  • Other Relevant Facts: Real estate valuations are heavily influenced by inflation, interest rates, real estate bubble dynamics, and many other factors. Therefore, there are significant risks related to their business, as many different parameters can affect the value of their real estate assets.

Financials Analysis

  • Recent Performance: ROIC’s recent financial reports show consistent increases in revenue over the past several years with an increase in net income. For instance, for the 6 months ending June 30, 2023 the company had a net income of 21.685 million.
  • Revenue Growth: The business has shown steady growth over time as they have acquired more properties and tenants have increased their sales. For instance, the same-store net operating income has grown 2.8% year over year since March 31st, 2023.
  • Profitability: As mentioned earlier, the operating margins are in the 25%-30% range, as they are mostly a landlord, their business involves a great amount of leverage. However, they are extremely profitable on a per-square-footage basis, therefore generating decent returns on investment. ROIC has a history of paying consistent and increasing dividends.
  • Leverage: ROIC does have some significant leverage, with a debt to market value at about 30 percent. However, considering the stability of the business, this is not an unreasonable amount, and also their ability to pay all dividends fully in cash is a positive sign for the company. The company’s net interest expense for three months ended September 30, 2023 was $35.642 million, while for the previous three months it was $34.886 million.
  • Cash Flow: The company has strong and predictable cash flow, primarily derived from the rental agreements they have in place with tenants. In addition, the company has the right to re-lease the properties at higher rates and generate more revenue. All their properties can be used as collateral for raising even more money. The operating cash flow of ROIC was $111.57 million in the three months ended September 30, 2023, showing strong cash flow generation capabilities.
  • Overall Assessment: The company is consistently showing increases in revenue and profitability. Their balance sheet is stable and they are actively re-leasing existing properties. All their metrics point to a business that is growing steadily and is capable of withstanding economic turmoil.

Moat Analysis

  • Moat Rating: 2 / 5
    • Justification: ROIC’s moat is quite narrow. The company lacks durable competitive advantages. Although their focus in grocery-anchored shopping centers offers some stability, their business can be easily replicated. The switching costs for tenants is low, and any competitor can buy a similar location. Their locations are usually not unique. They do, however, benefit from local knowledge of markets, and a network of local tenant relationships which does give them a slight edge over newcomers. They do earn excess profits in the long term because of their focus on grocery-anchored properties, but this can be competed away and many competitors have the same strategy. Their focus is solely on real estate investments and not improving operating efficiencies or providing innovative services. Therefore, their returns on investment can easily be competed away by new entrants and their business lacks an ability to significantly beat competitors or increase their margins. The only area where they can have an advantage is in local relationships with suppliers, which is not an extremely hard moat to defend. The company has high margins only because they have high leverage, and their profits can be negatively impacted due to interest rate hikes and economic slowdowns.
  • Risks to the Moat:
    • E-commerce Impact: The rise of e-commerce could cause tenants to shut shop or reduce their demand for physical locations. While necessity-based retail is less susceptible, it is not entirely immune.
    • Economic Downturn: If the economy goes down, tenants will struggle to pay rent which could lead to reduced income for the company. As most leases are fixed, companies also face the risk of the economy not growing as expected, which reduces opportunities for rent increases.
    • Interest Rates: As they have significant debt, the company’s future profits are heavily linked with interest rate fluctuation, and rising interest rates could hurt the bottom line and reduce dividends for shareholders.

The high leverage of the company makes their profits especially sensitive to interest rate hikes.

  • Business Resilience: The company has a low-risk real estate strategy, as most of their tenants are reliable grocery stores and small businesses. As well as the geographical selection focused on regions that are seeing a high growth in population. These two factors make them more resilient to external pressure. They have proven to be consistently profitable, and their financial situation is stable enough to handle market volatility. However, this does not mean that the company is immune from the effects of a recession or a drastic decline in economic activity, and they can face significant headwinds in an economic turndown.

Understandability

  • Understandability Rating: 2 / 5
    • Justification: The business model is easy to understand: the company owns and rents real estate properties, and profits by making more money in rental income than their expenses. However, the financial statements are quite complicated because of how the leases are treated, and also other accounting treatments for property investments. The value of real estate is difficult to forecast and needs many assumptions about the growth of the properties. Therefore, although the business model is easy to understand, the investment is quite difficult to analyze and understand.

Balance Sheet Health

  • Balance Sheet Health Rating: 4 / 5
    • Justification: As REITs are highly leveraged businesses, ROIC does carry a moderate level of debt, especially in the current interest rate environment. It is also a levered business that is primarily dependent on leverage for profits. A change in interest rates or a downturn in the business cycle can affect the company’s ability to fulfill its debt obligations. However, they have a history of generating sufficient operating cash flow to service their debts, and so their balance sheet is considered healthy. They also have long-term leases that provide stable income which makes the company less sensitive to financial issues.

Recent Issues and Management’s Take

  • Share Dilution: ROIC recently approved a share dilution that might have an effect on its future share price. While their earnings per share did improve recently, it was primarily as a result of this share dilution.
    • Management’s Response: The company is not issuing shares to the public, but directly to their partners, in order to create long term value.

While it may not create immediate value, the dilution of shares will have a dilutive effect on earnings per share which makes the investment less attractive.

  • High Debt & Interest Rates: The high amounts of debt that they possess means they are highly sensitive to interest rates hikes.
  • Management’s Response: The management expects short term rates to fall and therefore it will improve the debt situation. Moreover, the company has been able to fix interest rates in the long term which will protect them from short term interest rates fluctuations.

While the management’s responses are reassuring, any interest rates changes can affect debt and valuation. The future is still unpredictable and we need to be careful with the changes.

  • Overall: Despite their strong and predictable profits and a resilient business plan, the company is extremely sensitive to changes in the business environment, which makes this a less-than-perfect investment. The share dilution is a concern and the high debt load is also a concern for shareholders. The management has been taking steps to try to minimize these risks, but it still remains to be seen whether they can truly manage it.