It's Not Rocket Science, STAG Is Hitting All Cylinders
- I am seeing more and more articles written on high-yielding REITs that offer no promise of dividend growth.
- It’s almost as if the readers are being mesmerized by the double-digit returns with no warning that growth is not sustainable.
- Today, I am going to provide a textbook example of one of my top Durable Income Portfolio picks using the dividend barometer methodology.
Recently, I was speaking with a friend of mine about the volatility in the retail REIT sector, and he was explaining that he decided to sell shares in Tanger Factory Outlet Centers (SKT). As I explained to him, and also in an article yesterday:
“Only you can decide if the glass is half-empty or half-full. Investors must have an obligation to themselves to thoroughly analyze the underlying business and its prospects before purchasing a stock.”
One of the best ways for me to select the winners is to study dividend performance. When I see a company like Tanger increasing its dividend on a consistent basis, it provides a signal that earnings can be relied upon and that management is committed to growing the dividend.
Given the selloff in the REIT sector, I am seeing more and more articles written on high-yielding REITs that offer no promise of dividend growth. It’s almost as if the readers are being mesmerized by the double-digit returns with no warning that growth is not sustainable. As Josh Peters, author of The Ultimate Dividend Playbook, explains:
“A dividend payment is the ultimate sign of corporate strength... I take dividend increases as the loudest and clearest message that management can send.”
Dividend growth is not the only way to find the best REITs to own, but a dividend record can offer valuable clues, just as valuable as earnings reports and much more valuable than market timing.
In fact, one of the reasons that my Durable Income Portfolio has generated strong returns since inception (May 2013) is because I have weighted the picks based on the strength of the underlying dividend. I have found that dividend growth is one of the absolute best barometers for total return performance, as it simply blows away the performance of the “sucker yield” pickers.
Today, I am going to provide a textbook example of one of my top Durable Income Portfolio picks using the dividend barometer methodology. It’s not rocket science, STAG is hitting all cylinders.
Not Your Typical Industrial REIT
My first article on STAG Industrial (NYSE:STAG) was published on November 2011, just a few months after the company had closed on its IPO (in April 2011). I explained that “STAG is buying assets ‘on the cheap’ and the market rent metrics are further evidence of a sustainably attractive income and growth. Asset selectivity is very good and the prospectus for continued pipeline fulfillment looks promising.” As you can see below, the pipeline has filled up very nicely over the last 6+ years:
It’s not just the asset growth that has been impressive, but also the dividend growth. STAG pays monthly dividends, and as you can see below, the company has increased its dividend every year since going public in 2011.
STAG stands for Single Tenant Acquisition Group, and this REIT seeks to acquire individual, single-tenant industrial properties that are priced according to the binary nature of their cash flows. The acquisition of these properties and the addition of the binary risk cash flows they generate to a diversified portfolio mitigates the risk and enhances the stability of cash flow derived from the portfolio.
By precisely targeting single-tenant industrial properties, adhering to a relative value investment model and developing operational expertise in its target markets, STAG has consistently delivered a combination of both income and growth to its shareholders. As you can see below, shares are up 100% since April 2011:
By adhering to the above-referenced dividend safety strategy, STAG investors like me have been well-served. There has certainly been price volatility along the way, but the predictability of dividend performance provided me with the necessary confidence to grow my nest egg, recognizing that the short-term fluctuations would average out.
Since going public, the REIT has grown from 105 buildings to 360 buildings in 37 states, with approximately 70.8 million rentable square feet.
STAG owns standalone (or free-standing) buildings, and the company's average building size is around 215,000 square feet. That's important because it ranks 2nd in terms of the largest industrial REITs based on average building size. In STAG’s 2017 Annual Report, the company’s CEO, Ben Butcher, explained:
“We believe the opportunity to identify and acquire mispriced assets in the Primary and Secondary markets is very large and that it will be in our shareholder’s best interest to have our portfolio’s distribution trend toward the Primary/Secondary distribution of the overall industrial market.
We believe that this can be accomplished while still maintaining acceptable annual FFO/share growth. Our probabilistic approach can identify relative value across all markets and market conditions. We will maintain our overall pricing and return discipline to deliver this accretive portfolio growth.”
STAG defines secondary markets as "net rentable square footage ranging between approximately 25 million and 200 million square feet, and located outside the 29 largest industrial metropolitan areas".
Because of its Class B (secondary markets) industrial investment rationale, the company enjoys low capital expenditures and lower tenant improvement costs (relative to other property types).
Also, its Class B tenants tend to stay longer, since moving costs and business interruption costs are expensive relative to relocating a "critical function" facility. The company also has a diversified portfolio, as illustrated below (top markets):
STAG refers to its well-diversified model as a "virtual industrial park". It makes sense, since the REIT's portfolio of properties represents many of the different categories that you would see while driving through a large industrial park.
It has outsized automotive exposure (12.9%), and this material concentration should be advantageous given pro-growth policies. The U.S. has already seen a number of automotive announcements, and this continued growth should benefit STAG's business model.
The company's automotive exposure spreads across 14 states (East, South, Midwest, West), and it has OEM relationships with Ford (NYSE:F), Chrysler (CGC), General Motors (NYSE:GM), BMW (OTCPK:BMWYY), Toyota Motor (NYSE:TM), Hyundai (OTCPK:HYMLF), etc. and auto plant relationships in nine plants (Jeep Cherokee, Ford 150, Cadillac, Camaro, etc.).
To mitigate secondary market risks, STAG has built an impressive portfolio that provides well-balanced tenant diversification. As illustrated above (far left chart), its largest tenant represents just 2.5% of ABR, and the top 10 tenants represent just 13.7% overall.
Improving the Cost of Capital
STAG’s balance sheet continues to be very strong, as evidenced by a BBB rating, which was affirmed by Fitch in March. The company has not issued common equity this year, and leverage was 5.1x on a net debt-to-run rate EBITDA basis at quarter end.
Including subsequent acquisitions and dispositions, STAG’s leverage remains at 5.1x and the fixed charge coverage ratio was 4.2x. The REIT’s liquidity is $312 million.
In March, STAG drew $75 million of the previously undrawn $150 million term loan, and this term loan is fully swapped with an all-in interest rate of 3.15%.
In April, the company closed a $175 million private placement transaction with a weighted average interest rate of 4.2%. The transaction consists of two tranches, $75 million of 7-year notes with a coupon of 4.1% and $100 million of 10-year notes with a coupon of 4.27%.
STAG continues to identify accretive opportunities, closing on $79 million of acquisitions (in Q1-18) at a 6.7% stabilized cash cap rate. Note: Two of the deals were in my hometown of Greenville, SC.
The REIT also closed on $50 million of dispositions, resulting in a gain of $23 million and an unlevered IRR of 13.5%. Note: One of the dispositions generated $32 million of proceeds and was sold at a 6.2% cap rate. (STAG acquired this building in 2010 at a 9.2% cap rate.)
STAG intends to maintain balance sheet flexibility and keep leverage comfortably below the upper end of the target range of 5x-6x. Its acquisition guidance ($500-700 million) remains unchanged.
Retention, Retention, Retention
As you know, the most important attribute for real estate is location, location, location... but when it comes to investing in STAG, it is retention, retention, retention.
In Q1-18, STAG’s retention was 83% on the 5.6 million square feet expiring in the quarter. For context, the 4.6 million square feet renewed in Q1-18 was greater than the amount of space renewed for any given calendar year during the company history.
The REIT operates a comprehensive operating platform capable of addressing every physical aspect and tenant scenario related to industrial real estate ownership. The latest retention results validate that STAG is consistently outperforming. In-house construction and engineering professionals oversee value-add capital projects, including expansions, roof replacements, general site and tenant-specific work, and that helps with the retention results.
More Favorable Earnings Results
STAG’s same-store cash NOI decreased by 80 basis points in Q1-18, which was better than previously forecasted due to the higher-than-expected retention of releasing spreads.
Accordingly, the company raised its same store guidance to positive 25-75 basis points from its previous guidance of flat to positive 50 basis points. It is also increasing the expected retention guidance for the year to between 75% and 80%.
IN Q1-18, STAG’s core FFO was $0.43, an increase of 4.9% as compared to Q1-17. As you can see below, the REIT has maintained a very reliable earnings (FFO/share) record and is forecasted to grow FFO/share by 7% in 2018.
It’s Not Rocket Science
As I said at the outset, I rely heavily on dividend performance when selecting REITs because earnings are a proxy for cash flow. While I find STAG to be an attractive REIT, I find the company’s dividend safety even more impressive. As noted above, the FFO/share growth is solid, but now consider the company’s payout ratio:
What this tells me is that STAG has become a much safer REIT since my first article over six years ago. The company has become much more diversified by revenue (its largest tenant is just 2.5% of ABR), geography (37 states), and category. In addition, the balance sheet is stronger (investment grade), with strong liquidity (~$350 million), and the dividend is much safer (78% payout ratio). Since January 1, 2012, shares have returned an average of 17.8% per year.
Now take a look at STAG’s dividend yield compared with that of its peers:
As you can see, STAG is trading at an attractive yield (remember, the dividend is paid monthly). Now compare the P/FFO multiple:
Keep in mind, STAG is unique in that it fishes for properties in secondary markets, but over the years, the company has been able to mitigate that risk by scaling (diversifying) and maintaining an attractive cost of capital. I am impressed that it has continued to reduce its payout ratio, while also growing the dividend. Now let’s compare STAG’s forecasted FFO/share growth with that of the peers:
A few days ago Prologis (PLD) agreed to an $8.4 billion purchase of DCT Industrial Trust (DCT) in a stock-for-stock transaction, and STAG’s CEO, Ben Butcher, replied on the earnings call:
“I was a little surprised on a public transaction occurring in these days of such aggregated private capital. But having said that, when in the past, our experience has been aggregating portfolios of smaller variety, five to ten assets. We've seen, in our history of doing that and some of them, 100 to 150 basis points of cap rate compression between the individual asset pricing and the portfolio pricing. We have suggested in the past that there's another leg in that transaction, as you move from that small portfolio to an enterprise, i.e., assets that are being operated by an operating entity, there should be another 100 or more basis points of cap rate compression.
We would look at the DCT transaction, we're not surprised that the DCT was the target of acquisition attempts. It's a well-run company with nice assets, a very clean story, but the 4.1 or 4.2 cap rate to us represents that next leg up in terms of, it's an enterprise with operating characteristics and there is since development expertise.
It's worth noting however that PLD already had that evolved expertise. So presumably, that wasn't much of the equation, perhaps, the development opportunity, but not the expertise.
We're very confident of our ability to produce growth going forward through our execution of relevant value purchase, but as similar to what we think some of our peers like DCT can produce by developing assets. So we're very encouraged by the mark that occurred with the DCT purchase and we think it's consistent with the opportunities that exist within the industrial market.”
While DCT’s assets are not entirely comparable to those of STAG, it is worth noting that STAG has built an enviable portfolio by focusing on blocking and tackling. Clearly, there is a premium attached to a portfolio of high-quality properties, and STAG has proven that it can build scale and maintain attractive cost of capital - two of the most important pillars in REIT investing.
In summary, I am maintaining a Buy on STAG shares, and the latest earnings results validate the recommendation. I believe that STAG’s multiple should begin to move closer to the peer average as the company continues to maintain capital market discipline and do selective acquisitions.
Tax reform also serves as a catalyst, as many of STAG’s tenants should benefit and that should drive leasing and retention efforts. As Josh Peters reminds us, “dividends are more than information; they provide insight that any investor can use to make successful investments”.
Note: Brad Thomas is a Wall Street writer, and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors, if they are overlooked.
Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking. If you have not followed him, please take five seconds and click his name above (top of the page).
Source: F.A.S.T. Graphs and STAG Supplemental (Q1-18).
Other REITs mentioned: Monmouth Real Estate Investment Corp. (MNR), Terreno Realty Corp. (TRNO), EastGroup Properties, Inc. (EGP), PS Business Parks (PSB), First Industrial Realty Trust (FR), Gramercy Property Trust (GPT), DCT, W.P. Carey (WPC), Duke Realty Corp. (DRE), and PLD.
This article was written by
Brad Thomas is the CEO of Wide Moat Research ("WMR"), a subscription-based publisher of financial information, serving over 100,000 investors around the world. WMR has a team of experienced multi-disciplined analysts covering all dividend categories, including REITs, MLPs, BDCs, and traditional C-Corps.
The WMR brands include: (1) iREIT on Alpha (Seeking Alpha), and (2) The Dividend Kings (Seeking Alpha), and (3) Wide Moat Research. He is also the editor of The Forbes Real Estate Investor.
Thomas has also been featured in Barron's, Forbes Magazine, Kiplinger’s, US News & World Report, Money, NPR, Institutional Investor, GlobeStreet, CNN, Newsmax, and Fox.
He is the #1 contributing analyst on Seeking Alpha in 2014, 2015, 2016, 2017, 2018, 2019, 2020, 2021, and 2022 (based on page views) and has over 108,000 followers (on Seeking Alpha). Thomas is also the author of The Intelligent REIT Investor Guide (Wiley) and is writing a new book, REITs For Dummies.Thomas received a Bachelor of Science degree in Business/Economics from Presbyterian College and he is married with 5 wonderful kids. He has over 30 years of real estate investing experience and is one of the most prolific writers on Seeking Alpha. To learn more about Brad visit HERE.
Analyst’s Disclosure: I am/we are long ACC, AVB, BHR, BRX, BXMT, CCI, CHCT, CIO, CLDT, CONE, CORR, CTRE, CUBE, DEA, DLR, DOC, EPR, EXR, FRT, GEO, GMRE, GPT, HASI, HT, HTA, INN, IRET, IRM, JCAP, KIM, KRG, LADR, LAND, LMRK, LTC, MNR, NNN, NXRT, O, OFC, OHI, OUT, PEB, PEI, PK, PSB, QTS, REG, RHP, ROIC, SBRA, SKT, SPG, STAG, STOR, TCO, TRTX, UBA, UMH, UNIT, VER, VNQ, VTR, WPC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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