Public Storage: Expect a Pullback in Price (PSA)

| About: Public Storage (PSA)

A long-term reader asked about Public Storage Inc. (NYSE:PSA), citing in particular that its prospects may be a proxy for overall GDP growth, and adding that as people get older they acquire more stuff which they find difficult to get rid of. That highlights a possible demographics effect for PSA's prospects. The stock has been on a 3-year steady uptrend, with a recent ca. 12% pull-back.

I have always found investing based on broad demographic changes to be difficult, as shorter term exogenous factors, as well as the usual business management factors, can derail the effectiveness of the overall shift. We'll just acknowledge that demographics probably are in PSA's favor, and see if we can make a case for them based on shorter term criteria as well.

There are a couple of things we would anecdotally add to the story, before launching in to the company: First, it is easier today to efficiently get rid of stuff via eBay (NASDAQ:EBAY) or Craigslist, but that isn't as true of large items like furniture. But the disincentive to divest isn't always motivated by economics, as opposed to psychology. Storing, as opposed to selling, allows for putting off those psychologically jarring decisions to a later date. Second, there has been some anecdotal discussion of a shift from "large homes" (4000 sq. ft.) to "smaller homes" (2500 sq. ft.). By historic standards, both of those are huge, and both provide ample storage space. But a cluttered 4000 ft. home will not fit in a 2500 sq. ft. space, so retiring or downsizing baby-boomers may help the storage market. On the other hand, a lot of that excess stuff can go to the kids as they get set up, or can be moved to the vacation home. Both of those trends are likely slow moving ones.

The Company

From their latest quarterly report [.pdf] ending 31 March 2006, they have had Y/Y quarterly top line growth of 11% ($278.7M/$250.9M), or $28M. Of that, $2.2M, or ca. 8% ($5.075M-$2.893M) could be directly attributed to increased interest rates. That says 90% or so of their business is not interest rate dependant in a direct fashion. However, to the extent that a rise in interest rates slows the upscaling of homes, an interest rate increase may indirectly be good for their business. Similarly, to the extent that an interest rate rise stimulates downsizing of homes, it would also work to indirectly augment their business.

Y/Y quarterly expenses increased 7% ($161.4M/$150.7M), or $11M, showing that revenue is growing a wee bit faster than expenses, for an overall Y/Y quarterly net income growth of 18% ($114.2M/$96.4M), or $17.8M, and a quarterly EPS of $0.48.

That all looks fine, but it's a bit boring.

If we look at their latest annual report (for 2005, pdf), and compare their numbers for year end 2003 - just prior to the current run-up in the stock - to the year end 2005 numbers we see that revenue has increased 19% ($1,061M/$894M), expenses have increased 7% ($604M/$565M), and net income has increased 35% ($456M/$337M), or absolute increases of $167M, $39M, and $119M, respectively (they have a few other line-items that account for those number not adding up). EPS have increased 54% ($1.97/$1.28).

The Stock

At a 2003 year-end price of about $30/share, they had a trailing P/E of ca. 23 ($30/$1.28). For year end 2005, at a price of about $70, they have a trailing P/E of ca. 36 ($70/$1.97). A 2003 P/E applied to their 2005 earnings would give them a share price of $45 ($1.97x23). So, it seems that most of their share price increase has been due to a market multiple expansion, rather than fundamentals. That is perfectly reasonable if justified by their growth prospects, but we think they have gotten ahead of themselves. With Y/Y earnings growth in the 20% range or so, a market multiple of 23 seems about right. The current value of 36, we're guessing, is due to the demographic story without running the numbers. They are a solid business, but we think their stock price deserves a pullback.

PSA 3-yr chart:

PSA 3-yr chart