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Digital Realty Trust(DLR-N)

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These Red-Hot Dividend Stocks Still Look Like Great Buys

Motley Fool - Sat Aug 19, 7:03AM CDT

The S&P 500 has rallied about 15% this year and is even further above its bear market bottom of last fall. Meanwhile, many stocks have been even hotter over the past year.

Despite their rally, several hot stocks still look like attractive buys right now. Digital Realty(NYSE: DLR), Tanger Factory Outlet Centers (NYSE: SKT), and Rithm Capital (NYSE: RITM) stand out to a few contributors as compelling investment opportunities, even though they're up sharply. One big draw is the attractive dividends.

Finally making progress

Matt DiLallo (Digital Realty): Shares of Digital Realty have surged more than 20% this year, outperforming the more than 15% rally in the S&P 500. The data center REIT's progress on its 2023 capital plan is a big catalyst. That has eased some of the pressure on its balance sheet and the concerns that it might need to cut its 4%-yielding dividend.

Digital Realty set a target of bringing in $1.5 billion to $2.5 billion of cash proceeds from asset sales and joint venture transactions this year. That would enable it to recycle cash into its expansion program (it planned to invest $2.3 billion into capital projects) while limiting the pressure on its balance sheet by only issuing $1 billion to $1.5 billion of new debt.

It was slow going at first. By early June, the REIT only sold one non-core data center for $150 million. Because of that, it had to sell $1.1 billion of stock to fund its investment activity. However, it has signed two major joint ventures over the past month. It will receive $1.3 billion in proceeds by selling an 80% interest in a portfolio of data centers in northern Virginia to a private equity fund. It also sold a 65% interest in two data centers in Chicago to another fund for $743 million.

Digital Realty now expects to complete $2.2 billion to $3 billion of transactions this year and only issue $740 million of debt. As a result, its leverage ratio will fall from 6.8 times to a more comfortable 6.3 times. That progress put its dividend in a much firmer financial position.

Digital Realty's improving financial profile will enhance its ability to capitalize on the growth it sees ahead. CEO Andy Power noted on the second-quarter conference call that data centers will be crucial in supporting digital transformation and artificial intelligence. That will drive the need for more facilities in the future, which could power accelerated growth for the REIT.

That upside opportunity makes Digital Realty an attractive REIT to buy even after its rally, especially for those also seeking a compelling income stream.

This REIT occupies a retail sweet spot and could keep on rallying

Marc Rapport(Tanger Factory Outlet Centers): Tanger Factory Outlet Centers operates a niche in a sweet spot for sour times when it comes to retailers and their landlords.

This real estate investment trust (REIT) operates a portfolio of 37 open-air upscale outlet centers in 20 U.S. states and Canada, giving more than 600 retailers more than 2,700 locations to sell off merchandise without knocking down prices at their regular locations.

People like that combination of brand and price, and the stock has proven appealing to investors of late, too. Even in a strong year for the greater market, this retail REIT has outperformed. This chart shows how Tanger stock has done against the benchmark Vanguard S&P 500 ETF in total return so far this year.

Chart showing Tanger's total return beating the Vanguard S&P 500 ETF's in 2023.

SKT Total Return Level data by YCharts

Tanger stock had dipped to as low as $13.26 in the past year, but has rallied to about $25 while reporting growing occupancy rates and rents. After suspending its dividend during the pandemic shutdowns in early 2020 and bringing it back at half the prior rate in early 2021, the REIT has bumped the payout for two consecutive years.

The stock is now yielding about 4% and has passed analysts' consensus target price of $22.75. They still rate it a moderate buy, and with its modest payout ratio of about 51% based on cash flow, there appears room for continued growth for Tanger's dividend and share price.

Despite the headwinds in the mortgage sector, Rithm has outperformed the S&P 500

Brent Nyitray (Rithm Capital): Rithm Capital is a mortgage REIT with three major lines of business: Mortgage origination, mortgage servicing, and mortgage-backed security investing. These businesses are complementary and outperform in different interest rate environments. Despite the well-documented headwinds in the mortgage sector from rising interest rates, Rithm Capital has outperformed the S&P 500 year to date.

Rithm invests in mortgage-backed securities, like most mortgage REITs. Mortgage-backed securities are packages of home mortgages bundled together to make them more liquid. These securities have underperformed Treasuries this year, largely due to increased interest rate volatility. Once the Federal Reserve ends its tightening policy, volatility should decrease, which will support mortgage-backed security pricing.

Rithm also invests in mortgage servicing rights, which have performed admirably over the past year due to rising interest rates. Mortgage servicing rights are an unusual asset that increases in value when rates rise. Mortgage servicers earn a fee for handling the administrative tasks on behalf of the mortgage-backed security investor. The right to perform this service is worth money, and it is capitalized on the balance sheet as an asset.

Finally, Rithm has a mortgage origination business. Mortgage origination has struggled for the past 18 months due to rising rates. However, Rithm recently filed a confidential S-1 filing with the Securities and Exchange Commission (SEC) that involves the mortgage company. Whether Rithm will sell the mortgage operations or spin them off remains to be seen. But Rithm believes that this will unlock value that the stock market has ignored.

Rithm trades at a 19% discount to book value, and has a dividend yield of 10%.

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Brent Nyitray, CFA has no position in any of the stocks mentioned. Marc Rapport has positions in Digital Realty Trust. Matthew DiLallo has positions in Digital Realty Trust. The Motley Fool has positions in and recommends Digital Realty Trust and Vanguard S&P 500 ETF. The Motley Fool recommends Tanger Factory Outlet Centers. The Motley Fool has a disclosure policy.

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