To the value investor, the mispriced security is the Holy Grail. Optimistically, you want to find shares to buy at a 20% discount to normalized value. Additionally, if the issue is a dividend payer, you want to collect the outsized dividend the discounted shares pay until the point the share price is normalized. Pessimistically, you want to find shares to short at 9x the ultimately collapsed price.
Today I'm describing an issue opportunistically in flux. I will defend the fairness of the current market valuation of First Industrial Realty Trust's (NYSE:FR) common shares. I'll describe the company's troubles heading into and out of the recession. I will laud management's progress in righting the ship, right-sizing the balance sheet, and steering the company to new levels of profitability. Lastly, I'll foretell the rapid transpiration of events that will paint a market pricing J-curve that takes FR from fairly priced to momentarily discounted and back to a higher, fair value.
Experienced investors, institutional and individual alike, develop a process through which they screen prospective investment opportunities. They filter factors such as Price to Book, Market Cap, Price to Earnings, Price to Sales, PEG Ratio. Each metric has varying levels of importance to each investor. A major screening factor for REIT investors, however, is dividend yield. And dividend yield is the inflexion point, the crux, of what we are talking about here.
The calendar isn't material, but as it happens my pre-market Monday morning routine begins with a series of metric screens to determine which REITs are or may have become cheap in their sector. This process is commonly referred to as peer analytics and I'll present a few screens to illustrate some of the metrics under consideration:
Closing Price ($)
|Market Capitalization ($M)||Price/ FactSet FFO Estimate 2013||Price/ FactSet FFO Estimate 2014|
|DCT Industrial Trust Inc.||DCT||6.95||1,870.8||17.0||16.3|
|EastGroup Properties Inc.||EGP||55.09||1,632.6||17.9||17.3|
|First Industrial Realty Trust||FR||14.70||1,446.1||15.1||14.0|
|Monmouth Real Estate||MNR||10.27||423.1||16.7||16.6|
|STAG Industrial Inc.||STAG||19.96||826.5||18.3||15.4|
|Terreno Realty Corp.||TRNO||16.40||220.3||25.2||20.4|
The table above is familiar to all investors who weigh value relative to a measure of price/earnings ratio. In the realm of REITs, price/FFO is the substituted/comparable metric. Price to earnings buyers are almost universally seeking a low P/E opportunity. In terms of price/FFO, the table above describes First Industrial Realty Trust, at 79.4% of current year average P/FFO and 79.5% next year average P/FFO, as the most discounted issue in the industrial REIT sector.
|Company Name||Ticker||Closing Price ($)||Market Capitalization ($M)||Dividend Yield (%)||LTM FFO Payout (%)|
|DCT Industrial Trust Inc.||DCT||6.95||1,870.8||4.03%||66.67%|
|EastGroup Properties Inc.||EGP||55.09||1,632.6||3.85%||68.40%|
|First Industrial Realty Trust||FR||14.70||1,446.1||0.00%||n/a|
|Monmouth Real Estate||MNR||10.27||423.1||5.84%||90.91%|
|STAG Industrial Inc.||STAG||19.96||826.5||5.41%||n/a|
|Terreno Realty Corp.||TRNO||16.40||220.3||2.93%||77.97%|
REITs are generally lumped with utility stocks and corporate bonds as go-to investments for high, predictable and safe dividend yields. The table above contrasts a sector average dividend yield of 4.15% against FR's non-existent dividend. My thesis is that, even though First Industrial's common shareholders have profited handsomely over the last couple of years, a significant portion of REIT investors remove FR from consideration in the absence of a dividend.
|Company Name||Ticker||Closing Price ($)||Market Capitalization ($M)||Price/ Estimated NAV per Share (%)|
|DCT Industrial Trust Inc.||DCT||6.95||1,870.8||109.10%|
|EastGroup Properties Inc.||EGP||55.09||1,632.6||113.30%|
|First Industrial Realty Trust||FR||14.70||1,446.1||101.40%|
|Monmouth Real Estate||MNR||10.27||423.1||101.30%|
|STAG Industrial Inc.||STAG||19.96||826.5||120.00%|
|Terreno Realty Corp.||TRNO||16.40||220.3||89.30%|
Indeed, absent a dividend, FR shares trade at price/Net Asset Value lower than the industrial sector average.
|Company Name||Ticker||Closing Price ($)||Market Capitalization ($M)||Total Return One Year (%)||Total Return Five Year (%)|
|DCT Industrial Trust Inc.||DCT||6.95||1,870.8||30.68%||8.67%|
|EastGroup Properties Inc.||EGP||55.09||1,632.6||25.65%||75.06%|
|First Industrial Realty Trust||FR||14.70||1,446.1||33.64%||-47.37%|
|Monmouth Real Estate||MNR||10.27||423.1||18.95%||90.85%|
|STAG Industrial Inc.||STAG||19.96||826.5||80.89%||n/a|
|Terreno Realty Corp.||TRNO||16.40||220.3||21.33%||n/a|
While FR's total return matched the sector average over the last 12 months, long-term shareholders have really suffered.
The Coming Parity
Burdened with too much leverage in the biggest recession of our lives, FR paid its last dividend on 12/21/08. Absent dividends, it seems investors walked and, for the most part, haven't looked back. If those that sold their stock in 2009 revisited the company today, they would discover a vastly improved First Industrial Realty Trust. Events that may transpire in coming weeks might bring FR into valuation parity with the sector and deliver a vastly improved stock price.
Since assuming the helm as CEO in January 2009, Bruce Duncan has repeatedly outlined, fine-tuned, and reiterated First Industrial Realty Trust management's objectives of stabilizing the portfolio, reducing leverage, selling non-strategic assets, and improving overall portfolio occupancy and quality. Like the post-recessionary economy, FR's progress has been uneven and frustratingly slow, but the company has really made great strides.
A quick perusal of its REITWorld 2012 presentation on November 14th provides bullet points of management's accomplishments.
· Debt to EBITDA Ratio reduced from 9.8x to 6.4x
· Dramatically reduced cost of capital - $106 million secured financing at 4.03% - deployed to retire 6.5 -7.5% debt
· G&A expense reduced by more than 70%
· Sold 6.9 million sq. ft. for $175MM - 35% above carrying book value
· Improving occupancy - 88.5% in 3Q12 up from 81.4% in 1Q10
· Growth - more than $200 million in new development/expansion projects
In every conference call Bruce Duncan identifies becoming a dividend paying REIT as a top priority. He recounts all the progress that's been made, that the company has hit or exceeded all its targets, but that it has to further improve leasing/occupancy before recommending dividend reinstatement to the board of directors.
In its November 26th report, the National Association of Realtors forecast that by 4Q 2013 industrial property vacancy rates would decline to 9.5% from the present 10.1% level. On December 4th SNL Financial reported that First Industrial inked two leases (a 38,491 sq. ft. new lease and an expansion from another existing tenant) in Georgia. On December 11th CoStar Group reported that FR had leased its 65,000 Arlington, Texas building to Bedz King. On December 21st the Business Journal of Milwaukee reported that FR had sold a 44,300 sq. ft. property in Waukesha, WI. I anticipate the 4th Qtr. call will disclose these and additional transactions.
With the December 21st redemption of 2,000,000 shares of its Series J Preferreds and retention of the associated $3.625MM annual preferred dividend expense, First Industrial moved a big step closer to freeing cash flow for redirection to a common dividend. Because the dividend issue has been such a big part of every conference call's Q&A session, I'll speculate and predict that announcement of dividend reinstatement will be part of the 4th quarter earnings release.
The Value of Being Average
Looking back at the tables we can see that, on average, dividend paying REITs in the Industrial sector had a payout ratio of 74% of their last 12 months FFO. If we apply the 74% ratio to the midpoint of First Industrial Realty's most recent guidance ($0.92/share) we could see an annualized dividend of $0.68/share for a yield of 4.6% as measured against its 01/18/13 closing share price of $14.70. A yield slightly above the sector average of 4.15%, but nothing to get really excited about.
The average to which I think FR truly aspires, though, is the sector's price/FFO. Deemed average and trading at the sector average price/ FFO of 19, we'd see FR shares changing hands north of $18 (more than 20% upside). That's a return to get excited about and while we can pull future stock prices out of thin air, I think there is a realistic likelihood that FR will trade up significantly.
In a world where 10 year treasuries pay 1.9%, REITs have become the darling of investors clamoring for yield. But many investors, individual and institutional alike, won't look twice at a REIT that doesn't pay a dividend. Many specialty funds, by the dictates of their investment charter, can't own a non-dividend payer. Until the dividend is reinstated, to these investors FR really doesn't exist. Upon reinstatement, however, hundreds, if not thousands, of new buyers will step up to pay a market average price for new yield.
Disclosure: 2nd Market Capital and it's affiliated accounts are long FR, FR-J, and FR-K. This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer.