The other night I was watching Storage Wars (A&E) with my son, which naturally lead to a discussion of the storage industry and the attractiveness of the industry (yes, my children have been subjected to industry and credit discussions for years - and they are not yet in high school). During the course of the discussion it came to me that it might be worthwhile putting together an analysis of the biggest player: Public Storage (NYSE:PSA). (Note: unless otherwise noted all data is derived from company reports and presentations and was compiled by me.)
Public Storage is the world's largest owner and operator of self-storage facilities, serving over one million customers. At September 30, 2011, PSA had direct and indirect equity interests in 2,056 self-storage facilities (with approximately 130.5 million net rentable square feet) located in 38 states in the U.S. operating under the "Public Storage" name. In Europe, they own one facility in London, England and have a 49% interest in Shurgard Europe (the other 51% owned by the New York Common Retirement Fund), which owns 188 self-storage facilities (with approximately 10.1 million net rentable square feet) located in seven Western European countries, all operating under the "Shurgard" name. Public Storage also has direct and indirect equity interests in approximately 23.5 million net rentable square feet of commercial space located in 11 states in the U.S. primarily operated by PS Business Parks, Inc. (NYSE:PSB) under the "PS Business Parks" name.
A little more on PSB: Public Storage has a 42% common equity interest in PSB comprised of ther ownership of 5,801,606 shares of PSB's common stock and 7,305,355 limited partnership units in the operating partnership. The limited partnership units are convertible at PSA's option on a one-for-one basis into PSB common stock. Based upon the closing price at September 30, 2011 (PSB: $49.54), the shares and units owned had a market value of approximately $649.3 million, as compared to the carrying value of $329.5 million.
Public Storage is the 800 pound gorilla in the storage sub-sector of the REIT sector. Their size and tenure in the business give them distinct advantages - namely access to capital, geographic diversification and a premium valuation. Management has a strong track record and the company has a very flexible capital structure - using preferred stock instead pof debt to obtain their "leverage". Operating metrics have been decent, although still somewhat weighed down by Shurgard Europe and PSB. While transactions with related parties make me nervous (the Hughes family - family of the founder), the company states that all transactions are done using third party appraisers and estimates.
I think the equity of PSA (and its peers) is fully valued at these levels and better value can be found in other REIT sectors. As well, I think there are better values available to preferred stock investors away from Public Storage within the REIT sector.
The industry in the United States consists of approximately 45,000 facilities with 2.1 billion rentable square feet, out of which the top ten operators collectively own approximately 14.8% of the aggregate rentable square footage market share.
Self-storage has long been viewed as a stable business because it is an expense borne out of necessity. "We are a solution to a problem or a challenge that has been life-changing for an individual," said Spencer Kirk, chief executive of Extra Space. "It's not glamorous, but it's stable," he said. "It's recession-resistant. and if properly managed, it can produce a great return for an investor." The foreclosure crisis also has boosted demand for storage space as families downsize into smaller rental housing. (WSJ 1/11/12 WSJ Storage)
The self storage industry had another banner year (as measured by equity REIT returns during 2011:
Source: NAREIT (REIT Sector Returns)
As stated earlier, the company has storage facilities located in 38 states operating under the "Public Storage" name. The geographic breakdown of their facilities (same store as of 9/30/11) is as follows:
Portfolio activity (2011): During the nine months ended September 30, 2011, PSA acquired five operating self-storage facilities in Nevada and one each in New York, Florida, California and Maryland (741,000 net rentable square feet) and the leasehold interest in the land of one of our existing self-storage facilities for $61,277,000 of cash and the assumption of mortgage debt with a fair value of $9,679,000. During the same period, the company completed four expansion projects to existing facilities at an aggregate cost of $19,653,000.
Leases for PSA are month to month, which is standard in the industry.
Cash flows for the company have been growing at a moderate rate. FFO has been growing at a CAGR of 6.6% (although FFO to common has been growing at 9.3%) and FAD has been growing at a CAGR of approximately 3% over the last five years. Top line growth has been somewhat anemic at 3.6%.
A snapshot of the company's top line and cash flow (I include trailing twelve month numbers, but did not use them in the CAGR calculation):
Public Storage's capital structure is relatively straightforward, but much different than the majority of REITs (or companies for that matter) as it is comprised primarily of equity and preferred stock (with the exception of a line of credit of $300MM and one outstanding "legacy" note). Here is an overview of the capital structure and my thoughts on each level will follow:
click to enlarge
Equity: The company currently (as of 9/11) has 171 million shares outstanding with a market capitalization of 23.2B. Key equity stats (and those of peers) are as follows:
As is clearly evidenced, PSA is the 800 pound gorilla in the storage space (and the second largest REIT by market cap, behind SPG if I recall) being larger than its three public peers combined. As a result, it is afforded a premium valuation (that and its lower volatility - a sleep well stock if you will). From an income basis, I would rather own PSA than PSB for the 28bps in yield you give up, but Sovran (NYSE:SSS) with a yield of 4% is attractive - although you are buying into a small player with higher volatility. Taking all these factors into consideration, I do not see a compelling reason to own the storage sector at the equity level of the capital structure. I included KIM in order to show what another large REIT has to offer in terms of yield and potential upside. Bottom line: storage looks fully valued, I would look to other REIT sectors to deploy any capital being allocated to REITs.
A quick snapshot of YOY revenue growth as of the last quarter:
Source: CapitalI Q
Preferred Stock: Before I list the outstanding issues of PSA's preferred stock, it is worth a mention as to why they use preferred stock instead of debt (which would be more traditional). PSA uses preferred securities as a form of leverage despite the fact that the dividend rates are higher than conventional debt for the following reasons:
- under the REIT structure, a significant amount of operating cash flow needs to be distributed to shareholders, making it difficult to repay debt with operating cash flow alone,
- perpetual preferred shares have no sinking fund requirement or maturity date and do not require redemption, all of which eliminate future refinancing risks,
- after the end of a non-call period, the company can call higher coupon preferreds at par with the proceeds of new preferred shares at lower rates,
- preferred shares do not contain covenants (as REIT debt does - with one exception within Kimco(NYSE:KIM)), which provides the company with significant financial flexibility, and
- dividends on the preferred shares can be applied to satisfy our REIT distribution requirements.
With that said, lets look at their preferreds - and some peers:
pricing via QuoteMedia.
As is evident from the above table, call protection costs in the PSA preferred complex. This is because Public Storage is an active manager of their preferred stock - ie. they will issue new series when they can lower their rates and call higher coupon issues. This is also evidenced by their capital transactions this month where they issued $400MM of 5.90% series S and called the 6.75% series E and L.
When I was running a preferred portfolio, we used to swap around within the complex based on yield and call protection. Looking at it in that way, I would consider the PSA-O and grab three years of call protection with a current yield of over 6%. That said, given the size of PSA within a preferred stock index, you have to carefully consider your weighting and most preferred stock portfolios will own PSA. Should you not be running against an index, I think their are better opportunities within the REIT sector of the preferred stock market.
Debt: As PSA does not use debt in their capital structure (the one outstanding note is a Shurgard note which does not trade) there are no readily investable debt instruments. Should you want to look for it, however, it is the 5.875% due March 2013.