Global Net Lease: Avoid Potential Income Trap With 8.5%+ Yielding Preferred Shares (GNL)

Global Net Lease, Inc. (NYSE:GNL) is a real estate investment trust that net leases commercial properties. Net leases are contracts where the tenant is responsible for a combination of property taxes, insurance, and maintenance. These types of arrangements can be beneficial to landlords as it reduces their capital expenses and makes their free cash flow more predictable. After a recent reduction in the dividend, Global Net Lease currently has a 14% yielding dividend, but I believe the dividend is still on shaky ground and investors should instead consider one of its four preferred shares, yielding above 8.5%, as an income alternative.

Global Net Lease First Quarter Financial Results

Global Net Lease’s first quarter earnings compared to a year ago were impacted by their acquisition of the Necessity Retail REIT. With the jump in both revenue and expenses, operating income nearly doubled to $59 million. What’s concerning is that interest expenses more than tripled to nearly $83 million. Unlike the old company, the new combined company’s interest expense easily consumed the operating income.

Global Net Lease’s balance sheet mainly comprises of real estate assets and debt. The company owns $1.4 billion worth of land as part of its net real estate portfolio of $7.4 billion. The company’s debt amounts to approximately $5 billion and is comprised of mortgage notes, a revolving credit facility, and two privately placed senior notes. Shareholder equity slid $100 million in the first quarter to just over $2.5 billion.

Global Net Lease’s cash flow statement provides the most insight regarding the company’s recent dividend reduction decisions. While operating cash flow grew $30 million to $92 million compared to the old company a year ago, the dividend obligation grew by $40 million to nearly $82 million. Additionally, Global Net Lease pays $11 million in quarterly preferred share dividends. The company is clearly generating the free cash flow ($84 million) necessary to support the preferred dividends, but at the Q1 dividend levels, there was no cash flow left to support debt reduction, which I believe played a role in the subsequent dividend cut.

Liquidity and Debt Maturities – A Concern for GNL

Global Net Lease is currently carrying $131 million in cash and has less than $200 million in capacity on its $1.95 billion revolving credit facility. The approximately $300 million in liquidity is not assuring considering that the company is facing $1 billion in mortgage debt maturities in the next seven quarters. These mortgages are maturing at below market rates, meaning refinancing will drive up interest expense, lower operating cash flows, and further impair the company’s ability to pay dividends.

Management Has a Plan

Since the acquisition, Global Net Lease’s management has been consistent in its communication of how it will handle leverage and upcoming debt maturities. The company is hanging its hat on a combination of asset sales and CMBS financing. Global Net Lease appears poised to meet its asset sale targets of around $500 million in 2024 and with $237 million in CMBS financing completed after the quarter, it appears to have its immediate financing needs to be addressed. As for the remaining debt due in late 2025, the company is holding out in the hopes that the interest rate environment will become more favorable.

The Common Share Dividend Problem

Even with a reduction to $1.10 per share of common dividends, Global Net Lease is committing itself to over $250 million per year in common share dividends (based on existing 230 million shares). By utilizing back of the envelope calculations, Global Net Lease is on pace to generate $320 million in free cash flow in 2024, with $253 million going to common dividends and $44 million to preferred dividends. The remaining $23 million, over the course of the year, is hardly enough to deleverage a balance sheet that has $5 billion in debt.

Management commented that the quarter reflected a commitment to reducing leverage, but very little debt was paid off. By halving its dividend from the current levels, Global Net Lease can grow its liquidity by nearly $150 million per year by using excess cash flow to pay down its revolving credit facility. The boost in liquidity can create a buffer should troubles arise with refinancing debt. While many in the real estate space don’t follow the cash flow statement, I believe it is the best indicator of a company’s ability to follow through on commitments related to capital expenditures, dividends, and debt reduction.

The Attractiveness of the Preferred Shares

Global Net Lease currently has four different preferred share issues with a tight 21 basis range in dividend yield (8.73 to 8.94%). The preferred share dividends require a small cash flow obligation compared to the common shares, and they are senior, meaning the common share dividends would need to be eliminated before the preferred share dividends can be impaired.

Two of the preferred share issuances are callable (GNL.PR.A) (GNL.PC) and two are callable in the next two years. I don’t see any of these shares being called soon, as their dividends are below market for what it would take to refinance the capital stack today. Due to market fluctuations, it is very possible that daily changes may move the yields around. Currently, I prefer the Series D shares (GNL.PR.D) because they pay the highest income, but some investors may like the Series B shares (GNL.PR.B) because they require the least cash at $19.70 per share.

Conclusion

Global Net Lease has not started the process of meaningfully deleveraging yet. With two dividend reductions in less than a year and a sizeable amount of debt to refinance, I believe an investment in common shares is too risky considering the dividend risk. The preferred shares still provide a great income above 8.5% and can’t be impaired until the common dividend is eliminated. For now, I’m investing in the Series B preferred shares.