VICI Properties: First line of defense against market volatility (NYSE: VICI)

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Investment thesis

VICI properties (NYSE:VICI) stocks remained resilient in the face of the market sell-off. The previous article outlined why investors should expect capital gains boosting its dividend by 5%. Since then, shares have risen 5.2%, bringing total return to 6.6%, from an 8% decline. in the wider market.

Several factors are supporting the company’s valuation, including renewed interest in properties as an alternative asset class as institutional investors realize the importance of properties as an instrument of diversification. This idea has proven itself during market liquidation.

Investors could benefit from the addition of high-yielding dividend stocks such as VICI as a source of stable income, backed by long-term triple net leases. Nevertheless, it should be noted that although this dividend is a defensive source of income, it is not immune to a recession.

Revenue Trends

During the pandemic, VICI collected 100% of rents from its tenants. This does not say so much about its occupants as about the importance of the service it renders. Paying rent is a priority for any business. Its two biggest clients, Caesars Entertainment (CZR) and MGM Resorts, have a history of bankruptcy.

Yet, as public companies, its tenants have access to the capital market, creating a safety net or cushion if they fall foul. There are other lines of defense put in place to protect VICI. It is common industry practice to collect rent in advance and several months’ deposit for any unpaid rent.

The concept of a gambling REIT is new, and today there are only two such trusts among the 1,100 REITs registered with the IRS and 225 registered with the SEC. As the outlook for a recession increases, it is difficult for us to assess the dynamics of a recession in the gaming REIT sector, especially given the concentration of income, which makes it difficult to dissipate a tenant, which gives it bargaining power. I imagine a scenario where CZR or MGM asks for a rent deferral on certain properties during a recession. VICI’s management will find it difficult to say no to a client representing more than 40% of its turnover.

Yesterday, VICI closed the MGM Growth Properties (MGP), which has slightly increased tenant diversity, but its two largest tenants still account for a significant share of revenue, as shown below.

VICI properties

VICI properties

VICI has one of the most iconic properties in the world, located in some of the most desirable commercial areas with the highest square foot sales rates in the world. It’s safe to say that when the going gets tough, VICI will find help from states and municipalities interested in playing around with taxpayers’ money to find new tenants. This dynamic offsets the risks inherent in the lack of alternative uses for gaming properties. In my view, VICI shareholders will benefit immensely if management diversifies outside of the gaming industry.

Financial situation

From what I understand, VICI financed the acquisition of MGP with $11 billion in debt and approximately 200 million new shares, bringing the total value of the acquisition to $17 billion. The deal significantly changes VICI’s financial position, tripling debt and increasing the number of outstanding shares by 26%. Investors should expect a $1 billion increase in revenue, which represents a 66% jump from TTM’s sales of $1.5 billion before the acquisition.

What comes to mind is the effect of rising interest rates on the business. Most of VICI’s term debt is fixed rate notes, which protect it from rising interest rates until maturity. Below is VICI’s pro forma debt schedule after the MPG tender.

VICI Properties, Morningstar

VICI Properties, Morningstar

VICI doesn’t have to worry about rising interest rates until 2024, when it will have to refinance the $1.05 billion debt it inherited from MPG. At that time, he will most likely face a higher cost of borrowing than he did. MGP issued these notes a few years ago. This dynamic is reflected in the depreciation in the prices of VICI’s notes it held before the acquisition, pushing effective yields higher as the Fed tightens monetary policy. For example, the price of its 4.25% notes due in 2026 fell from $104 to $95, bringing the effective yield to 5.5%.

The Company’s leases contain CPI indexations. However, the benefits are limited by rental contracts setting limits on these indexations. For example, in some lease contracts, the total increase in rent cannot exceed 3%, compared to the current level of inflation, equal to 8.5%. At the same time, the company also has a minimum rent growth, set at 2%.

Overall, I believe VICI is in a solid financial position. The company recently got its credit rating upgrade from Moody’s to Ba1, one notch below investment grade. Diversification beyond gambling ownership will help reduce the risk inherent in the cyclicality of the industry.

Summary

I think the current market sell-off validates institutional investors’ move towards real estate as an alternative asset class to diversify portfolios and reduce risk. Companies such as Blackstone (Bx) expanded their portfolio to meet demand from institutional investors for real estate as a tool for diversification. These dynamics have reflected VICI’s resilience in recent weeks.

Despite the debt reduction, VICI’s financial position remains strong. A substantial increase in income accompanies the rise in debt. The added benefits of diversification contributed to Moody’s decision to upgrade the company’s ratings.

VICI owns some of the most iconic real estate in the world. Its real estate portfolio offers investors a hedge against inflation, increasing its dividend yield by 5%.

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