Realty Income stock forms bullish patterns as a big risk emerges

Realy Income (NYSE: O) stock price has continued underperforming the market this year. It has barely moved even as the S&P 500 and Nasdaq 100 indices have risen by double digits. 

On the positive side, it has done slightly better than the Vanguard Real Estate ETF (VNQ), Schwab US REIT (SCHH), and the Real Estate Select Sector ETF (XLRE). 

Realty Income is a believed dividend fund

Most income investors love Realty Income, a company that has increased its dividends for 26 consecutive years. It is a dividend aristocrat that yields 5.5%. This yield means that a $100,000 invested in the fund will bring in $5,500 annually or $458 monthly all factors constant. Its yield is higher than other REITs.

The company is also beloved by most Wall Street analysts with companies like UBS, Scotiabank, and Mizuho having a buy rating. The average estimate for its revenue is that its revenue will rise to $5 billion this year and $5.39 billion in 2025.

Realty Income is now going through an important phase as it continues to integrate Spirit Realty, which it bought for $9.3 billion last year. Before that, the company acquired VEREIT as it continued to boost its market share. 

Top challenges remain

Realty Income stock, however, has underperformed the market in the past few years. For example, its total shareholder return in the past five years was 8.5% while the Vanguard Real Estate ETF (VNQ) has returned 21%. 

While Realty Income pays a monthly ETF, it has underperformed other generic assets like Invesco QQQ and the S&P 500. 

The most recent challenge facing the company is that interest rates have risen sharply in the past few years. In the US, the benchmark rate has risen to a two-decade high of between 5.25% and 5.50%. The same has happened in other countries where Realty Income operates. 

Fortunately, analysts believe that the Federal Reserve will start cutting interest rates as soon as in September. Such cuts will benefit highly-leveraged REITs like Realty Income that are facing a wall of maturities in the coming years. 

However, even with these cuts, rates are expected to remain at an elevated level for a long time. 

Key tenants have problems

We have covered REITs with weak tenants before. A good example of this is Medical Properties Trust, which has come under pressure following the collapse of Steward, its biggest tenant. It is also having challenges with Prospect, another tenant. 

Some of Realty Income’s biggest tenants have come under intense pressure in the past few years. 

Walgreens, its biggest tenant, is slowly imploding, with its stock being down by over 55% this year. It has dropped by over 78% in the past five years. To solve its woes, the company has embarked on a turnaround strategy that will see it shutter more stores. It will close over 2,100 stores by 2027 on top of the 2,000 it has closed in the last decade. 

Dollar General, another big tenant, is also in trouble as its stock fell by almost 13% this year. The company, which owns thousands of stores in the US, is expected to shut hundreds of stores this year. Dollar General is a 3.4% client for Realty Income.

Meanwhile, Dollar Tree, which also owns Family Dollar, intends to shutter over 1,000 stores as the industry goes through major headwinds. 7-Eleven, the convenient store chain, is closing 250 stores this year. CVS, another big tenant, is also cutting stores as its business goes through a big slowdown. Therefore, these closures will likely have an impact on their landlords, including Realty Income. 

However, on a positive side, Realty Income is a highly diversified company with hundreds of other quality brands. Some of the top names in its portfolio are companies like Wynn Resorts, FedEx, Asda, Saibsbury’s, and MGM. This means that it can weather the storm for now. 

Realty Income stock price analysis

O stock price | chart by TradingView

In my last article on Realty Income stock, I wrote that, while it is a good company for income investors, it was not a good investment. Besides, it has a long track record of underperforming the S&P 500 and Nasdaq 100 indices. I still maintain that view.

On the daily chart, we see that the Realty Income share price has bounced back from the year-to-date low of $50 to the current $57. It has also flipped the important resistance point at $55.17, its highest point in May. 

Most importantly, Realty Income has formed a bullish pennant chart pattern, which is characterized by a tall flag pole and a triangle pattern. It has also formed a golden cross pattern.

Therefore, the stock could soon form a bullish breakout in the coming weeks. A key catalyst for the stock will be its upcoming earnings in August.