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What You Need To Know Before Investing In Viva Energy REIT (ASX:VVR)

Simply Wall St

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Viva Energy REIT is a AU$2.0b small-cap, real estate investment trust (REIT) based in Docklands, Australia. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how VVR’s business operates and also how we should analyse its stock. In this commentary, I'll take you through some of the things I look at when assessing VVR.

View our latest analysis for Viva Energy REIT

Funds from Operations (FFO) is a higher quality measure of VVR's earnings compared to net income. This term is very common in the REIT investing world as it provides a cleaner look at its cash flow from daily operations by excluding impact of one-off activities or non-cash items such as depreciation. For VVR, its FFO of AU$92m makes up 58% of its gross profit, which means the majority of its earnings are high-quality and recurring.

ASX:VVR Historical Debt, July 22nd 2019

VVR's financial stability can be gauged by seeing how much its FFO generated each year can cover its total amount of debt. The higher the coverage, the less risky VVR is, broadly speaking, to have debt on its books. The metric I'll be using, FFO-to-debt, also estimates the time it will take for the company to repay its debt with its FFO. With a ratio of 11%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take VVR 9 years to pay off using just operating income, which is a long time, and risk increases with time. But realistically, companies have many levers to pull in order to pay back their debt, beyond operating income alone.

I also look at VVR's interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it's better to use FFO divided by net interest. With an interest coverage ratio of 2.92x, VVR is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.

In terms of valuing VVR, FFO can also be used as a form of relative valuation. Instead of the P/E ratio, P/FFO is used instead, which is very common for REIT stocks. In VVR’s case its P/FFO is 21.94x, compared to the long-term industry average of 16.5x, meaning that it is overvalued.

Next Steps:

Viva Energy REIT can bring diversification into your portfolio due to its unique REIT characteristics. Before you make a decision on the stock today, keep in mind I've only covered one metric in this article, the FFO, which is by no means comprehensive. I'd strongly recommend continuing your research on the following areas I believe are key fundamentals for VVR:

  1. Future Outlook: What are well-informed industry analysts predicting for VVR’s future growth? Take a look at our free research report of analyst consensus for VVR’s outlook.
  2. Valuation: What is VVR worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether VVR is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.