Why Isn't VICI Properties Stock Bouncing Back After Strong Earnings?

VICI Properties (NYSE:VICI) continues to deliver steady growth, but you wouldn't know it from the real estate investment trust's (REIT) stock performance. The casino landlord recently reported higher rental revenue and adjusted funds from operations (AFFO), raised its full-year outlook, and increased its dividend for the ninth consecutive year.

However, its shares remain under pressure. While VICI's results contain plenty of positives, a closer examination reveals why the REIT isn't bouncing back after earnings.

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Strong earnings in the third quarter

VICI Properties reported solid third-quarter results. Its total revenues rose 5.8% to $1.1 billion, while its adjusted funds from operations (AFFO) increased 4.3% to $0.62 per share. That earnings growth supports the REIT's ability to raise its dividend by another 2.2% to $0.46 per share, its ninth straight annual dividend increase. At its recent share price, the experiential property landlord yields 7.5%, giving it one of the highest yields in the S&P 500.

The high-dividend REIT's strong dividend coverage (74% payout ratio) provides it with excess free cash to make new investments and allocate capital to create shareholder value. While VICI didn't announce any new investments in the third quarter, it has closed several deals this year, including the $1.2 billion Golden Entertainment sale-leaseback transaction and $1.5 billion One Beverly Hills construction financing. Additionally, the REIT recently announced a $2 billion share repurchase program.

Overall, these results are exactly what investors would want from an income-producing REIT. However, the earnings report also contained a less reassuring development.

What's really holding the stock back?

VICI Properties' third-quarter earnings aren't the biggest story this quarter. The REIT reported a $458 million increase in expected credit losses, largely due to its lease with Caesars (NASDAQ:CZR). VICI cited a credit-rating downgrade affecting Caesars' senior secured debt, among other factors, as driving the increased expectation of credit losses.

Caesars' financial health is a major concern because it accounts for roughly 38% of VICI's rental revenue. Caesars carries nearly $11.7 billion in debt, and a credit-rating agency recently downgraded its senior secured debt amid concerns about its financial structure following its pending acquisition by Fertitta Entertainment. That downgrade, along with updated assumptions about future lease renewals, prompted VICI to increase its expected credit-loss allowance related to Caesars. While this noncash charge doesn't mean Caesars has stopped paying rent, it highlights the potential risks of VICI's heavy reliance on Caesars.

Valuation: Is the stock worth buying?

Growing credit concerns related to Caesars and rising interest rates have weighed on VICI's stock, which currently sits more than 20% below its 52-week high. The REIT currently expects to generate at least $2.47 per share of AFFO this year, up from its prior forecast. At its recent $24 share price, it trades at less than 10 times AFFO. That's a very reasonable level for a REIT.

It wouldn't take much for VICI Properties to deliver attractive total returns from here. For example, at its current 7.5% dividend yield, the REIT would need to grow its AFFO per share by only 2%-3% annually to deliver a double-digit annualized total return, assuming no change in its valuation multiple. It could deliver much stronger returns if it can maintain its current mid-single-digit AFFO per share growth rate and its valuation multiple expands.

However, there's potentially significant downside risk, particularly from its meaningful exposure to Caesars. If the casino operator runs into financial trouble and needs to renegotiate its lease, that could create a sizable earnings and valuation headwind.

I think the most likely outcome is that Caesars' new owner will sell off some of its operations to reduce debt, with new tenants signing new leases at rents near the current rates. The REIT has lots of experience with these situations. For example, during the third quarter, VICI entered into a new master lease with Highfield Investment Group after it bought Century Casino's Century Mile Racetrack and Century Downs Racetrack. The new 20-year lease has the same initial base rent as the prior lease.

This belief drives my view that VICI Properties is an attractive investment opportunity, especially for income-seeking investors.

A higher-risk, high-yielding income stream

VICI Properties' latest earnings suggest that its underlying business continues to perform well. The REIT is growing its cash flow, increasing its dividend, and maintaining a reasonable payout ratio.

However, concerns about Caesars Entertainment explain why its shares haven't rebounded. While investors shouldn't ignore that risk, the stock's low valuation and 7.5% dividend yield make it an appealing opportunity for more risk-tolerant investors seeking to bet on a high-potential payoff.

Matt DiLallo has positions in Vici Properties. The Motley Fool recommends Vici Properties. The Motley Fool has a disclosure policy.