VICI Offers Long-Term Sustainable Growth (NYSE:VICI)

We fundamentally believe that the Las Vegas Strip is the most dynamic experiential strip in America. The most dynamic experiential strip in America. I also believe that this may be the most economically productive single street in America. – Edward Pitoniak, CEO of VICI Properties (NYSE:VICI)

Investment Thesis

VICI is a NNN REIT that primarily owns casino and experiential properties. I believe that VICI is a stock that can accumulate long-term capital appreciation through the continuation of property acquisition and baked in annual lease escalators. Considering their 2022 acquisitions and my expectation for next year’s FFO/Share of $1.87, at a 20x multiple, VICI should be priced at around $37.50/share, returning 8.6% before dividends.

Considering capital appreciation and their 4.50% dividend yield, owning VICI will provide both an equity exposure that has historically offered better stability, and on a 1-, 3-, and 4-year basis has beat the S&P500, as well as a fixed income component that has outperformed the Aggregate Investment Grade Index (AGG). At this time, I give VICI stock a BUY recommendation.

Risks involved in owning VICI include the increasing rates market can have a negative effect on valuations and relative returns as compared to less risky trades such as rolling the 6-month treasuries that yield just under 5% annualized. Other company-related risks include financing new projects at a higher cost as compared to their 4.5% aggregate interest payment on their debt, the inability to increase lease payments to keep up with a higher inflationary market, consumer income and their willingness to spend at regional properties, and the very real possibility of not being able to acquire new properties at an appealing valuation. All risks considered, I believe VICI will make a great addition to a portfolio as an alternative asset that can see some very real long-term capital appreciation.

A Brief History

VICI was born as a result of the bankruptcy of Caesars Entertainment (CZR) in 2017. The spin-off resulted in VICI becoming the landlord for 49 casinos across the US and Canada, over 450 bars, restaurants, clubs, and sportsbooks. Through the $17b acquisition of MGM Growth Properties (MGP), the landlord for MGM Resorts International (MGM), VICI is nearly the sole owner of the entire Vegas Strip. And, as of January 2023, VICI acquired the remaining 49.9% of the partnership units for MGM Grand and Mandalay Bay from the Blackstone “BREIT” JV. The addition of this share of partnership units increased the annual lease rate by $310mm.

I was a big fan of MGP’s operating structure. Their sole purpose was to operate as a property owner. Nothing more, nothing less. All operations, including capital investment was done by their sole operating company, MGM. In fact, there was a required minimum annual investment baked into the master lease agreements with the operating companies to keep all properties in pristine condition.

VICI, on the other hand, takes a slightly more active approach in which they will co-invest in capital investment, having a little more skin in the game than MGP. I will note, however, that VICI had a consistently larger operating margin of 94% (normalized for CECL allowance), as compared to MGP’s margin of 63% at the time of acquisition. I’m expecting the operating margin to be roughly 78% for 2022.

VICI also included annual rent escalators in each of their master leases, of which 47% are not capped. 96% of their lease agreements have a minimum 2% escalator and are CPI-linked (adjusted on year 6 of the lease). As we should all be very aware, this rent protection allows VICI to retain its value in inflationary markets with minimal loss in cash value. One risk to VICI’s rent increases is that 53% of their leases are capped and may not be able to track close to CPI at this elevated rate. Lease escalators are also only adjusted to the higher rate after a grace period of 5 years. That said, their limited overhead and operating costs as well as acquisition growth can accommodate for this.

The acquisition of MGP in early 2022 added an additional $9,268mm in leasable assets for a 2.9% acquisition cap rate. This was a major acquisition in which 33% of VICI’s book now consists of MGP’s properties, adding an additional $882mm in annual cash rent. This added some challenges as well; the acquisition added a substantial amount of debt to VICI’s books; however, net leverage remains within a manageable amount at 6x using pro forma 2021 figures and should be pulled closer to 5x-5.2x with 2022 earnings. Debt is typically paid down using new share issuance, though this hasn’t disrupted the company’s ability to grow their FFO/share and dividend rate.

With a total debt of $13,950mm on the balance sheet as of q3’22, VICI does not have a debt maturity until 2024 in the amount of $1,051mm. As of q3’22, cash on the balance sheet will cover just under half of this and may need to raise capital between now and then. The two options at this point will be to issue new shares or refinance in a higher rates market. Reviewing their last debt issuance from April 2022, rates on their senior notes span between 4.375% for their 2025 notes through 5.625% for their 2052 notes. VICI’s aggregate rate of 4.5% provides an annual interest payment of $627mm, giving VICI an EBT of ~$2b for 2022. I will note that VICI holds an investment grade rating from all the major ratings agencies and shouldn’t run into any financing issues.

A higher financing cost may disincentivize VICI from growing through acquisition or can lead to VICI using more bridge loans and equity to finance their acquisitions. This may also benefit VICI to require a higher acquisition cap rate, depending on the state and solvency of the casino operator at the time of acquisition. I don’t believe we can discount opportunistic acquisitions in a tight economic environment.

Using their current share count and their pro forma financials in their 8-k and the addition of rent revenue from their various acquisitions throughout 2022 plus a 2% escalator on their aggregate leases, we can calculate 2022 FFO/share to come out to ~$1.87, a 5% increase from the previous year’s FFO of $1.77.

VICI’s success ultimately comes down to the success of Caesars Entertainment and MGM Resorts. Each casino operator has been working to expand their mobile gaming platforms and sportsbooks. In fact, MGM’s sportsbook controls 13% of the market share. As of this writing, 36 states have legalized sports gambling in their own respective fashion, whether online or brick & mortar. Caesars is still having trouble getting their operations back to profitability since 2020; however, their loss has gradually narrowed when reviewing their financials on a TTM quarterly basis.

Caesars does have just under $1b in cash that can be leveraged if necessary. MGM appears to have recovered their income at a faster pace and should provide the proper solvency for VICI’s success. Rent payments have yet to be missed since VICI’s inception and should remain consistent going forward.

Catalysts

Positive

• Consistent growth in FFO/share and distribution gives VICI a spot in a balanced portfolio as a proxy for Fixed Income; yields ~4.5% before capital gains
• Vegas is marketing itself as the center for sportsbooks; casino operators see huge revenue potential as states legalize sports betting, allowing for consistent rent payments

Negative

• A higher inflationary market can devalue the lease terms for VICI, making it more challenging to increase rent at the rate of inflation
• Higher interest rates can add a nominal risk to the value of their dividend, making less risky assets more appealing for a portfolio
• A higher rates environment can add pressure to financing new acquisitions, potentially leading to slower future growth
• $1,051 debt maturity in 2024 may require refinancing in a higher interest rate market or diluting the share count to cover debt payment

Valuation

VICI currently trades at a premium of 18.5x 2022 FFO, relatively in line with their average range and a bit above the aggregate Real Estate Sector multiple of 15x, as provided by SeekingAlpha. VICI has historically traded in the range of ~16x-20x FFO and can easily command a $37.50 price tag. VICI has historically outperformed the S&P 500 since inception as well as the MSCI REIT Index and given their lease growth, has the potential to continue to outperform.

Owning VICI, as compared to other NNN REITs comes with the benefit of limited competition and does not run the risk of overbuilding/overcapacity as seen in other areas of real estate like single and multifamily housing. I believe the premium is necessary given this as well as the lower risk of potential downward pressure on rental rates for office and multifamily. Lastly, VICI has the ability to consistently generate cash given that their operations are mostly limited to owning the property and not facility operations on an NNN basis. The assets that lie on top of their properties are also limited to depreciation given the built in minimum CAPEX requirement on all master leases.

Shareholders of VICI have benefited from consistent dividend growth since inception. Historical annual growth rates have been 10.9%, 9.1%, and 8.3% for 2020, 2021, and 2022. Though not many NNN REITs have resorted to cutting their dividend as a result of C19, those in residential run the risk of slower dividend growth if the economy and housing market were to continue to stall. This challenge should not be absorbed by VICI.

Conclusion

To sum it all up, I believe VICI will make a great investment as a long-term buy and hold strategy. Given their long-term rent growth, conservative acquisition strategy, extraordinary margins, and their ability to grow their FFO/share, I believe their premium holds merit. I recommend adding VICI to your portfolio either as an alternative investment or a proxy for fixed income. Dollar-cost averaging is always a good trading strategy, especially in these volatile markets.