When it comes to dividend growth potential, there aren't many investment situations that are better positioned than Extra Space Storage (NYSE:EXR). The stock can be volatile from time to time and growth oriented investors could find it opportune to buy it now when it (along with many other REITs) is out of favor in the market. In this article I will (1) provide commentary about the self-storage industry's fundamental position in the economy, (2) an assessment of EXR's fundamental investment merits, and (3) an appraisal of the stock's current technical investment appeal.
I will then conclude that EXR looks like a "no brainer" investment opportunity at this time for investors seeking an above-average dividend return and significant growth potential for coming years. I bought some shares on Thursday (1-9-2014) at $42.60 to initiate a position in the stock.
The Fundamental Investment Merits of the Self-Storage Industry
Self-storage is the fastest growing sector within the commercial real estate industry. It is considered by many observers to be recession resistant. And, it operates within a favorable economic environment because of the following reasons: (a) customer demand is growing due to demographic factors, (b) occupancy is at a historically high level due to a paucity of new supply, (c) new supply will likely remain low because of protracted start-up costs on new facilities, (d) operators of stabilized properties have pricing power, and (e) discounting is generally limited to the signing of new leases.
Additional perspective about the industry's operations is provided by data released in November 2013 by the Self-Storage Trade Association. Such is summarized as follows:
(1) The industry is highly fragmented, having only five publicly traded companies with a national reach, some 4,500 large and mid-sized firms that own and/or operate more than one facility, and about 30,000 one owner-operator facilities.
(2) The top-five self-storage companies include four REITs. By order of size they are Public Storage (NYSE:PSA), Extra Space Storage, Sovereign Self Storage (NYSE:SSS), and CubeSmart (NYSE:CUBE). The fifth major company is U-Haul International, a non-REIT. Collectively, they own, operate, and/or manage some 5,800 self-storage facilities. They account for about 12% of the country's storage facilities. And, they have competitive advantages over the smaller entities because of their large advertising budgets and sophisticated revenue management models that determine what rent should be quoted to each customer based upon multiple inputs.
(3) It takes about three years for a new facility to reach a stabilized level of occupancy and that serves as a barrier to entry for new entrants into any given market. Very few new facilities were built in the last five years because financing was unavailable for all but the strongest operators.
(4) The geographical distribution of U.S. facilities is as follows: 32% urban, 52% suburban and 16% rural.
(5) About 84% of all U.S. counties (that's 2,634 out of 3,141) have at least one "primary" self-storage facility.
(6) Occupancy rates for self-storage in Q3 2013 were 87.4%, up from 83.6% at the beginning of the year.
(7) About 9% of all American households currently rent a self-storage unit.
(8) About 13% of all self-storage renters rent for less than 3 months, 18% for 3 to 6 months, 18% for 7 to 12 months, 22% for 1 or 2 years, and 30% for more than 2 years. The short-term rental agreements make it easier for operators to increase rates to what the traffic will bear in each market.
(9) There are more than 110 privately-held firms that own and operate 10 or more self-storage facilities, about 2,450 firms that own and operate two to nine facilities, and some 30,800 firms that own and operate just one facility. Combined, they provide significant opportunities for the large firms to grow their businesses via the acquisition route. Most of the acquisitions made by the major players involve privately held regional and small local owner/operators who represent about 90% of the self-storage universe. A few years ago the acquisitions often involved distressed properties. That has changed and now stabilized properties are being acquired.
And (10) it took the industry more than 25 years to build its first billion square feet of rentable space. And, it added the second billion square feet in just 8 years (1998-2005).
This overview shows that growth opportunities abound for the major players. Favorable demographic factors benefit all participants. But the industry is highly fragmented and the major players are advantaged and they are well positioned to expand via the acquisition route.
The Fundamental Investment Merits of EXR
Since its IPO in 2004, EXR grew its footprint by seven fold, mainly through the acquisition of stabilized facilities owned by others. The map below shows the geographical diversification of the company's 910 storage facilities at the end of 2012: 448 were wholly owned and 462 were managed for others.
Management has been disciplined in its approach to acquiring properties. In the first three quarters of 2013 it purchased 30 assets for $290 million. In Q4, the acquisition pace quickened and it acquired a portfolio of 17 assets located in Virginia for about $200 million and had additional properties under contract for about $58 million. For the full year ending December 31, 2013, EXR acquired a total of 78 properties for $586 million. It also added more than 70 branded assets to its management program. In a year end statement, the CEO (Spencer Kirk) stated, "Extra Space Storage is a growth-oriented company and the addition of these assets to our portfolio will continue to allow us to provide strong returns to our shareholders."
In Q3, occupancy increased to a record high level and finished at 90.6%, up 1.7% over last year's level. Rental rates increased by about 3% and discounts to new customers were below the year-ago level. As a result same store revenue growth was 7.8% for the quarter. Expenses trended towards normalized levels as increases were due largely to growth in payroll, insurance, repairs, and maintenance expenses. Net operating income for the quarter increased 9.7% and the company is on track to have its best year ever.
FFO in Q3 was $0.46 per share, which includes a non-recurring expense of $0.08 from extinguishment of debt. Also included in FFO was a one-time benefit of $0.02 from recent debt modifications. Adjusting for these one-time events FFO was $0.52 per share. FFO as adjusted was $0.57 per share; or $0.55 per share when adjusted for the one-time benefit from the debt modification. Management increased its full year 2013 FFO guidance to $1.96 (give or take a penny) per share. This estimate includes non-cash interest expense, acquisition related costs, and one-time charges. When adjusted for those items, FFO would have been about $2.10 per share for the full year. In 2012, FFO was $1.59 per share.
Some 14 analysts submit estimates to First Call and their consensus FFO estimates for 2013 and 2014 are $1.98 and $2.33 per share, respectively. This year's gain from 2012's FFO of $1.59 would be 24.5%. The indicated YoY gain for 2014 is 17.6%. I think the estimate of $2.33 is easily doable.
The quarterly dividend rate was increased to 40 cents per share in Q2 from 25 cents in Q1 and has since remained at 40 cents. At $42.63, the indicated dividend yield is 3.8%. EXR's dividend growth record in recent years has been outstanding: in 2010 the dividend distribution was $0.40 per share. It then increased to $0.56 in 2011, $0.85 in 2012, and $1.45 in 2013. Another significant increase in the dividend distribution is highly probable in 2014.
The Performance of Storage REITs in the Market
The chart that follows was constructed from data readily available on Yahoo Finance.
During the past year the S&P Equal Weight Index (RSP) trended upward (the blue line) as it worked its way higher to reach historic highs. The (green lined) iShares Real Estate Index (NYSEARCA:IYR) performed almost as well as the RSP during the first half of the year but, after peaking in May, it grossly underperformed it and just about every other major industry group in the market. It finished the year with a loss and is now trading near its low for 2013.
The four publicly traded storage REITs took turns outperforming the RSP and then underperforming it. The REITs referred to are CubeSmart, Public Storage, Sovereign Self Storage and, of course, Extra Space Storage. At the present time each of them is priced about where it was six months ago despite the fact that each of them posted good interim operating results for 2013 that were in line with secular growth trends. Each of them is above its price level at the beginning of 2013 but EXR and CUBE have done significantly better than PSA and SSS. The 10 to 20 analysts who submit estimates to First Call for each of them show increases in FFO for both 2013 and 2014. All four of them increased their dividend payments from rates extant earlier in 2013 and/or from 2012 levels.
The express purposes of the chart and table are to show (1) the short-term volatility of the storage REITs vis-a-vis the market, (2) acknowledge that the lackluster market performances of the stocks were incongruous with the recording of good operating results and/or dividend increases, and (3) call attention to the fact that the analysts continue to be optimistic about their operating performances in 2014.
The Technical Investment Merits of EXR
The chart below was constructed from data in my workbook.
(1) The bold black line on top is price and the bold pink line below it is relative strength. (2) The three dotted lines (black, blue, and red) are moving averages. There is a set of those for price and a similar set for relative strength. They are used to define trends and detect trend reversals. (3) The 5 sets of dotted-gray parallel lines and the 10 sets of gray parallel lines (the two overlap half of the time) that frame price and relative strength action are 22-day and 11-day trading ranges, respectively. Their progression shows how the trading ranges shifted during the 110 days charted. And (4) the four wavy-blue hashed lines that straddle the price line are Bollinger Bands. They are used to detect overbought or oversold situations.
Any of the items listed as (2) or (4) is independent of the others and each could be used as a valid technical indicator for making buy or sell decisions. But in order of importance, the moving averages are of primary importance while the trading ranges and the Bollinger Bands are of secondary and tertiary importance, respectively.
EXR's trading range for 2013 was $36.39 to $49.29. It began the year at $36.50 and finished at $42.13. So, despite the volatility and the poor performance of the REITs in general, EXR managed to record a gain of 15% for the year.
It is mathematically impossible for a stock to trend higher until it breaks through its downward trending moving averages and its trading range starts to shift upward. The chart shows that on four occasions, EXR found support at about $40.50, so that price can be considered to be a hard technical bottom for EXR. More importantly, the price line has now broken above its downward trending moving averages and the trading range has shifted upward. The relative strength line has not yet followed suit. It will have to do that if EXR is going to outperform the market, which is what I am guessing it will do. With a 20% gain in FFO indicated for 2014 and another significant increase in the dividend probable, the fundamental catalysts are present for that to happen. It was because of these considerations that I chose to start a position in EXR at this time.
I have not been ordained to preach, so I am not going to pound the table and tell you (the reader) that you must do as I do. I just wrote the article on a company I think has considerable investment appeal and told you what I am doing with the stock. It is up to you to discount what I wrote as you see fit and make your own decision according to your personal investment criteria.