When a stock comes with a dividend yield close to 10%, it’s usually a sign that investors are concerned about something. But sometimes, the potential rewards are worth the inherent risks.
NewRiver REIT (LSE:NRR) shares currently come with a 9.71% dividend yield. And while there’s a clear risk on the horizon, there is a lot to like about the company.
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Business structure
NewRiver owns a portfolio of around 40 shopping centres and retail parks. It also manages another 39 similar properties through partnership arrangements.
In terms of some basic REIT fundamentals, the firm looks pretty good. Occupancy levels are around 95% and the firm collected 97% of its rent in the six months leading up to September.
The company also has a relatively diversified tenant base, with its largest tenant accounting for around 4% of total income. And the average lease doesn’t expire for another nine years.
All of that looks pretty good from a reliable passive income perspective. But there is a risk on the horizon, which is why the stock is trading with such a big dividend yield.
Balance sheet
The issue is debt. NewRiver’s loans reach maturity in the next couple of years and refinancing these is likely to result in higher interest expenses than the current 3.5% average cost of debt.
This is a risk investors need to think about, especially if they’re focused on the dividend. The question isn’t really whether this will affect profits, it’s how much it will affect them.
Even with interest rates falling, refinancing is likely to mean lower profits over the next few years. If the firm’s cost of debt rises to 6%, the increase will likely be around £10m annually.
NewRiver’s pre-tax income is around £32m, so a £10m increase is clearly significant. But the company does have some key strengths that can help limit the overall effect.
Capital allocation
NewRiver is in the process of selling off some of its weaker properties to generate cash. And some of this has been used to strengthen the firm’s balance sheet.
Combined with strong occupancy and collection metrics, this should help limit borrowing cost increases. But this isn’t the only thing the company has been using its cash for.
NewRiver has also been buying back its own shares. And with the stock trading at a 30% discount to the firm’s net asset value per share, this looks like a good move.
It’s also a strong sign the company’s management is confident about the balance sheet. In other words, the risk of higher costs is real, but it doesn’t look like an existential threat.
Investment equation
There’s a lot to like about NewRiver REIT from an investment perspective. Retail isn’t the most dynamic growth industry, but the firm has a diversified mix of reliable tenants.
Investors need to take a look at the upcoming debt maturities. But the company is making moves to strengthen its balance sheet, which might go some way towards offsetting this risk.
With a dividend yield close to 10%, passive income investors might well think there’s an opportunity worth considering here. And my view is they’d be right to do so.
