Will Dollar Tree's Struggles Shake Up Realty Income's Stock?

Realty Income (NYSE: O) is a popular dividend stock for income investors. It's one of the largest real estate investment trusts (REITs), with 15,540 properties worldwide and more than 1,500 different clients across 90 industries. Since its initial public offering (IPO) in 1994, it's kept its occupancy rate above 96%. It's also more balanced than many retail REITs because it primarily serves recession-resistant businesses, like discount retailers, convenience stores, drug stores, and casinos.

As a REIT, Realty Income needs to pay out at least 90% of taxable income as dividends to maintain a favorable tax rate. It pays monthly dividends, has hiked its payout 127 times since its public debut, and still pays a high forward yield of 5%. Investors who reinvested those dividends netted a total return of 5,500% over the past 30 years.

Image source: Getty Images.

With interest rates set to decline in the near future, Realty Income and other REITs are heating up again as investors pivot from CDs and Treasury bills toward higher-yielding dividend stocks. Lower rates will also make it cheaper for REITs to buy new properties. That's why Realty Income's stock rallied more than 20% over the past three months.

Yet, some of Realty Income's top tenants have been struggling in recent years. One of those weak links is Dollar Tree (NASDAQ: DLTR) , which recently saw its stock sink to its lowest levels in nearly nine years after a dismal earnings report. Could Dollar Tree's problems derail Realty Income's growth and drag down its stock?

What happened to Dollar Tree?

Dollar Tree was once considered a recession-resistant retailer because it sold most of its products for a dollar (and some for less than $1). But in 2015, it acquired Family Dollar, which sold pricier products and directly competed against superstores like Walmart (NYSE: WMT) . Over the following decade, Family Dollar's sluggish growth offset Dollar Tree's healthier expansion.

Dollar Tree reacted by closing hundreds of Family Dollar stores, integrating Dollar Tree sections into some Family Dollar stores, and converting other locations into Family Dollar/Dollar Tree combo stores. But as it tried to execute that capital-intensive turnaround, rising tariffs on Chinese goods, soaring inflation, and theft all reduced its gross and operating margins.

That pressure forced Dollar Tree to raise its namesake banner's base price twice -- from $1 to $1.25, then $1.25 to $1.50 -- over the past three years. It also adopted a multi-price strategy and lifted the price ceiling on all Dollar Tree products to $5 in 2023 and $7 earlier this year. Unfortunately, those desperate moves further eroded its defenses against Walmart and other discount retailers -- and its same-store sales growth slowed to a crawl over the past year.

Data source: Dollar Tree.

For the full year, Dollar Tree expects its net sales to rise just 0%-1% as its adjusted earnings per share (EPS) declines 5%-12%. It's also aiming to close nearly 1,000 Family Dollar stores over the next few years.

What does that mean for Realty Income?

Dollar Tree leases 1,389 of its 16,388 locations from Realty Income. Those locations account for 3.1% of Realty's annualized rent, making it the REIT's third-largest tenant after Dollar General (NYSE: DG) (3.4%) and Walgreens (NASDAQ: WBA) (3.3%).

However, Realty Income doesn't own all the properties that Dollar Tree plans to shutter. Those store closures will also occur in phases as their leases expire, so Realty Income should still have plenty of time to find new tenants for those abandoned locations. So, even in a worst-case scenario, Dollar Tree's decline should impact only a percentage of its 3.1% in annual rent for Realty Income instead of abruptly reducing it to zero.

We should also recall that Dollar General, which faces some of the same macro headwinds as Dollar Tree, still plans to open 730 new stores this year as its same-store sales growth accelerates. That expansion could offset Dollar Tree's decline.

In other words, Realty Income's investors shouldn't fret too much over the struggles of its individual tenants. There are certainly other notable losers in its portfolio -- including Walgreens, Red Lobster, and AMC Entertainment -- but there are also long-term winners, like Walmart, 7-Eleven , and FedEx . So, as long as Realty Income's winners grow at a healthier pace than its losers and it continues to secure new tenants to replace its departing ones, its core business should remain healthy.

Simply put, there's no reason to believe that Dollar Tree's ongoing problems will disrupt Realty Income's monthly dividends or meaningfully reduce its occupancy rates. Instead, Realty Income's stock still looks like a bargain at 16 times last year's adjusted funds from operations per share and will likely attract even more investors as interest rates decline.

Should you invest $1,000 in Realty Income right now?

Before you buy stock in Realty Income, consider this:

The Motley Fool Stock Advisor analyst team just identified what they believe are the 10 best stocks for investors to buy now… and Realty Income wasn’t one of them. The 10 stocks that made the cut could produce monster returns in the coming years.

Consider when Nvidia made this list on April 15, 2005... if you invested $1,000 at the time of our recommendation, you’d have $729,857 !*

Stock Advisor provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month. The Stock Advisor service has more than quadrupled the return of S&P 500 since 2002*.

See the 10 stocks »

*Stock Advisor returns as of September 9, 2024

Leo Sun has positions in Realty Income. The Motley Fool has positions in and recommends FedEx, Realty Income, and Walmart. The Motley Fool has a disclosure policy .