2Q12 Earnings Season Update: Associated Estates Realty

Jul.26.12 | About: Associated Estates (AEC)

So far in 2012 we have seen some strange market reactions to Associated Estates Realty (AEC). Its internal performance, (detailed below) was across the board superb, yet over the first half of the year the market price dropped from $15.95 at the close of 2011 to its recent price of $14.75. The market's response being so opposite to the actual company's performance seems almost inexplicable, but fortunately for investors, it leaves us with an excellent buy.

The full 2Q earnings report is available here, but let us review some of the highlights.

· 2Q12 FFO of $13.74mm increased markedly from $11.19mm the year prior. This was driven by increased rental rates along with continued physical occupancy of 97%. Consequently the FFO payout ratio was improved from 63% to 56.3% over the same time period and this includes the dividend increase.

· Debt was decreased to $602.7mm from $664.8mm at the start of the year, and the value of its undepreciated assets by book value increased to $1.382B from $1.345B over the same period. These changes together create a material improvement in debt to undepreciated book value of assets of 43.6% down from 49.4%

· The average age of AEC's recent acquisitions is 9 and its dispositions averaged around 25 years. This demonstrates its commitment to maintaining strong buildings in prime locations.

Based on stellar performance coinciding with a large drop in market price, it is clear that AEC is discounted relative to its own history, but it is also massively discounted relative to its peers.

Company (ticker)

Recent market price

Price/est. FFO

Total returns last 12 months

Associated Estates

$14.75

12.1

-13.9

Sector avg.

n/a

18.8

3.5

Click to enlarge

In reference to the price of AEC, CEO Jeff Friedman stated in the 2Q conference call that there is "a major disconnect in stock price, value per share, and the FFO multiple." Of course as CEO there is some inherent bias, but the facts certainly agree with him. In fact Associated Estate's NAV/share is estimated at $20.26 as compared to its recent price of $14.75.

Usually with positive articles I include the contrarian viewpoint, but really there is quite little to say for it here. Some would argue the recent offering created share dilution, but the FFO comparisons are significantly increased on a per-share basis with $0.32/share for 2Q11 as compared to $0.27/share the year prior. The dispositions and acquisitions were also effective enough to increase common equity dramatically on a per-share basis from $6.65 at the end of 2011 to $8.35 at the end of 2Q. Consequently, even with the additional shares the value of each share seems to have increased.

Other complaints could be that AEC's fixed rate debt could be considered slightly high at a weighted average of 5.3% but this is largely made up for with excellent rates on its variable rate debt for an overall cost of debt around 4.1%. Additionally, some of their fixed rate debt comes due in 2013 which may provide opportunity to refinance at a superior rate. If there are significant negative points that I am missing here, please comment, because otherwise this stock is clearly underpriced and represents an excellent buy opportunity, the best in the apartment sector.

Disclosure: 2nd Market Capital and its affiliated accounts are long AEC. 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.

Disclosure: I am long AEC.