When it comes to dividend growth stocks, Realty Income Corp. is one of the best. Over its history, the company has consistently paid monthly dividends to shareholders, increasing them every year since it went public.
But in 2014, dividend increases will be modest. Here's why.
1. Its payout ratio meets the minimum requirements
Realty Income increased its dividend nearly 20% in February 2013 thanks to its acquisition of American Realty Capital Trust. That acquisition was very beneficial for shareholders, but Realty Income may have overshot on its dividend bump.
The company earned $0.60 per share in adjusted funds from operations in the latest quarter. Using last quarter's adjusted funds from operations as the base case for 2014, Realty Income would have a 91% payout ratio given its quarterly dividends of roughly $0.55 per quarter.
Historically, the company has kept its dividend very close to the minimum 90% payout ratio.
2. Big dividend increases require acquisitions
On the last conference call, Realty Income CEO John P. Case explained the company's real advantage in growing its dividend: acquisitions.
Here's a quick quote:
We are running in at about a 165 basis points spread relative to our weighted average cost of capital currently and over the life of the Company that's been about 145 basis points.
What Case is saying here is that Realty Income has been able to purchase properties with a yield 1.65% higher than its cost of capital. Historically, properties yielded 1.45% more than its cost of capital.
The point here is that the underlying growth in rental prices is a very small driver for the dividend. Sure, increasing rents over time do help the bottom line. But Realty Income's growing dividend is supported primarily by its ability to raise funds at X and invest the money at X plus 1.45%.
To see what I mean, you need only look at other triple-net retail REITs like National Retail Properties, which has not had the same record of beefy, annual dividend increases. What's the difference between the two REITs? Not much. Realty Income is just a better acquirer.
Failing any major acquisitions in 2014, Realty Income will find it difficult to deliver a very large dividend increase to shareholders. Certainly, organic growth can't match the company's massive early-2013 dividend increase of nearly 20%.
At a market cap of $8 billion, Realty Income is the second-largest triple-net REIT. As it gets bigger, it's harder to find acquisitions that can drive dividend growth. It's worth noting that the dividend increase in 2013 was an outlier. It was the biggest dividend increase in Realty Income's history as a publicly traded REIT.
That's not to say Realty Income isn't a great dividend growth stock. It is. But investors who expect that 2014 will look anything like 2013 should temper their expectations. Prior to the 2013 increase, Realty Income's dividend grew at a 4.1% compounded growth rate. Pending no major acquisition next year, 4% would be a very optimistic target. I have no doubt Realty Income will increase its dividend since it's vital to its reputation as a dividend growth stock, but investors shouldn't expect a repeat of 2013 in 2014.
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The article Realty Income Corp. Probably Won't Increase Its Dividend Much in 2014 originally appeared on Fool.com.Fool contributor Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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