U-Store-It Trust Dividend Likely to Be Cut

After reviewing the IIIQ 2007 earnings report and reading the conference call transcript for U-Store-It Trust (YSI), we came to one clear conclusion: the dividend is likely to be cut. U-Store-It is the third largest public self storage company in the United States, and in the midst of an operational turnaround. A new CEO and senior management team, brought in from Storage USA, has been busy re-thinking the business as the stock price has dropped more than 50% from its 52 week high. (All three self-storage public companies have dropped in value, but YSI has been leading the pack by a wide margin).

Anyway, the new CEO Dean Jernigan has been implementing a wide range of initiatives. He's brought in new senior managers, and added 4 facility service managers responsible for upgrading all the company's warehouses. YSI has been spending heavily on repainting all 160 storage centers (100 done, 60 to go), undertaking repairs and improvements wherever necessary. Maintenance capex is up, as are regular maintenance costs which are expensed through the P&L. This physical upgrade is necessary to increase occupancy and rates, and to remain competitive, and is months from completion. Even after the upgrades are completed, we'd expect to see U-Store-It spend more heavily than was previously the case. Moreover, Jernigan has authorized an aggressive discounting program to bring in new tenants, and waiving of administrative fees, and additional marketing and promotion to get the word out.

Already, the Company is seeing occupancy rates increase at a time when most competitors are flat or down. Average same store occupancy was up 1.3% over the same period last year, and realized rents per square foot are up slightly. Overall revenues are up modestly thanks to new acquisitions. However, the bottom line has taken a hit from Jernigan's turnaround program. Same store operating income is down 1.2%, and overall Operating Income is down 6%, and interest expense up 14%. The key metric that everyone looks at is the diluted FFO per share (after one-time charges) , which is down from 23 cents to 22 cents (all comparisons against the same period last year).

Here's the problem: the dividend has been running at 29 cents a quarter since the IPO. Plus, U-Store-It is spending over 4 cents a quarter (per share) on Maintenance Capital Expenditures. That suggests the Company is paying out 9 cents a share each quarter more than it is making in FFO, or over $5mn. In the short term matters are only going to get worse. We are entering the slower period for self storage rentals. Occupancy rates were already down at the end of September from the average over the 3 months and have dropped since. The heavy (and necessary) capex and maintenance spending is scheduled to continue for months to come, and Jernigan still has one senior hire to add to the management team. The Company is relatively highly leveraged, and cannot afford to use its revolver to fund this negative cash flow for long. In any case, management seems more interested in a stock buy-back program and asset sales than maintaining the dividend. Jernigan gave nothing away on the conference call, but indicated that after the December 2007 budgeting process for the upcoming year, the Board would decide what to do. We expect a sharp cut in the dividend to follow to 20 cents a share or below. At 20 cents(a nearly 1/3 cut in the dividend) the Company would save real money, and might reach cash-break-even in 2008 as some of the under-performing acquired assets with an occupancy 10% below the average are leased up.

The market seems to have come to the same conclusion, with a big drop in the stock price. At $10.5 as of Friday November 2, 2007, YSI's pro-forma dividend yield would be 7.6% (assuming a 20 cent quarterly dividend). However, that's still not rich enough for our blood. We'd like to see a 10% yield to compensate us for the long term view required on this company, and the higher than average leverage and other uncertainties. We'll be a buyer at around $7.6 a share, which implies the stock would have to drop another 28%.

Disclosure: none