STAG Is Really In A Class Of Its Own

Summary

• What we are seeing is that this level of demand is starting to filter down to these smaller markets.
• Because of its Class B (secondary markets) industrial investment rationale, STAG enjoys low capital expenditures and lower tenant improvement costs (relative to other property types).
• The level of warehouse demand is beginning to trickle down to the secondary markets where STAG dominates.
• This idea was first discussed with members of my private investing community, Intelligent REIT Investor. To get an exclusive ‘first look’ at my best ideas, subscribe today >>

According to CBRE, “while primary industrial markets often have higher rents and lower vacancies for warehouse and distribution center space, research published (by CBRE) makes the case for increasing future growth for secondary industrial markets.”

In a report, entitled “Pent-up Demand: Secondary Logistics Markets Poised for Accelerated Growth,” CBRE explained that supply chain modernization has led to a warehouse development boom in primary markets that handle the majority of goods distribution, but adding that now the need for a deeper supply chain presence to cover regional locations is getting ready to accelerate secondary market growth.

“Slower warehouse rent growth in secondary markets may have been a constraint, but now that rents have pushed past pre-recession levels, the opportunity for increased development is here.”

In an interview, David Egan, Americas Head of Industrial & Logistics Research for CBRE, explained that for the first half or even more of the current industrial real estate cycle going back to 2010, much of the user activity was focused on large, or Tier 1, markets, which are places where the majority of infrastructure exists, large populations are concentrated, and where much of the existing industrial stock already was.

“Those markets really led the charge, and as a result they saw the fastest-growing rent and fastest-declining vacancy rates, which was concentrated in those markets,”

With rents rising past pre-recession levels in secondary and tertiary industrial markets, those markets are behaving very well but relative to the overall market are still lacking a little bit. CBRE maintains there is a lot of opportunity in those markets, because there is still available stock to some degree, because there are still rents under control, and e-commerce users bringing access to customers in those markets.

Egan said, “You need to figure out how to get your product from wherever it is sitting to a person in New York, Atlanta, or Kansas City in the same amount of time. A warehouse in Atlanta can get an order to a customer there fast, but that same warehouse cannot service Kansas City as quickly. What we are seeing is that this level of demand is starting to filter down to these smaller markets.”

A few weeks back I wrote an article titled, Why STAG Is A Best-In-Class Sleep Well At Night REIT. Of course, STAG Industrial (NYSE:STAG) is considered an industrial REIT, but the company does not compete directly with the companies that focus exclusively on primary markets. With 352 properties in the portfolio, and a large majority located in secondary markets (51.3%), STAG is really in a class of its own. The company is differentiated by its secondary market focus and this provides an excellent opportunity for investors to capitalize on the powerful demand drivers of this uniquely positioned REIT.

Photo Source

What’s STAG?

STAG Industrial stands for “Single Tenant Acquisition Group”, and that’s why the company 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. Asset selectivity is very good and the prospectus for continued pipeline fulfillment looks promising.

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, STAG has grown from 105 buildings to 370 buildings in 37 states, with approximately 72.5 million in 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.

STAG sees the opportunity to identify and acquire mispriced assets in the Primary and Secondary markets is very large and that it’s in the company’s best interest to have the portfolio’s distribution trend toward the Primary/Secondary distribution of the overall industrial market.

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.

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 (NYSE:FCAU), 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 below, its largest tenant represents just 2.5% of ABR, and the top 10 tenants represent just 13.7% overall.

The Balance Sheet

With debt to EBITDA below 5x at quarter-end, the balance sheet continues to strengthen after an active few months in the capital markets. Common equity was issued, preferred equity was called and redeemed after the quarter, private placement debt was closed and funded, and the revolver was upsized and refinanced.

During the quarter, STAG raised $177 million in gross proceeds through its ATM program at an average share price of $25.92. This resulted in leverage of 4.7x and a fixed charge coverage ratio of 4.4x at quarter-end.

In June, STAG called its Series B preferred equity and fully redeemed the security on July 11. (After this redemption, STAG only has one series of preferred equity outstanding, a $75 million, 6.875% Series C, which is callable in March 2021).

STAG’s $175 million private placement notes closed in April and were funded in June with the proceeds applied to the balance on the revolving credit facility. The transaction consists of two tranches, $75 million of seven-year notes and $100 million of ten-year notes with a weighted average interest rate of 4.2%.

On July 27, STAG drew the remaining $75 million associated with Term Loan D. This facility is now fully outstanding with an all-in swap interest rate of 3.15%. The proceeds were also applied to the outstanding revolver balance.

STAG refinanced its revolving credit facility that now matures in 2023. It was increased from $450 million to $500 million with a reduction in the pricing grid of 10 basis points. Also, STAG originated a new $175 million term loan that matures in 2024. The term loan is fully swapped with a delay draw feature for up to one year with an all-in rate of 4.12%.

Including these debt transactions, STAG’s available liquidity is $739 million and pro forma leverage is 4.9x. These above-referenced capital market transactions enhance an already strong balance sheet, which continues to be well-positioned to support STAG’s attractive opportunity set and impressive growth trajectory.

STAG intends to maintain balance sheet flexibility and keep leverage comfortably below the upper end of the target range of 5x-6x.

The Latest Earnings Results

STAG’s bottom line growth continues to be a focus as the company reported a 10% increase in core FFO per share in Q2-18 over the prior year period. As the company’s CEO explained, “this should not come as a surprise given the momentum of the platform, accelerating acquisitions volume, same-store NOI growth, impressive retention and re-leasing spreads.” As noted, Core FFO was $0.45 for the quarter, an increase of 10% as compared to Q2-17.

The 10% FFO bump is due in large part to a combination of acquisitions achieved from the last 12 months and internal growth metrics.

STAG’s acquisitions volume for the year more than doubled, with over $190 million closed in Q2-18 through July 31st with an average stabilized cap rate of 7.1%. As STAG’s CEO explained:

“The acquisition team was successful across a broad array of markets in which STAG operates marketplace, markets like Houston with a well-established institutional capital presence and markets like Charlotte which benefits from attractive demographic trends including significant population growth but has not yet drawn the same attention from organized institutional capital.”

STAG's relative value approach to acquisitions enables the company to find attractive risk-adjusted returns across many markets. With over $270 million acquired through July, and the historical trend of relatively larger third- and fourth-quarter acquisition activity, STAG opted to raise its acquisition guidance for the year to a range of $600 million to $700 million.

G&A for the second quarter was $8 million and $16.7 million year-to-date. The company has been focused on processes and efficiencies over the past several years with an emphasis on data and how the company uses it.

Given the organizational gains in efficiencies, rationalization of third-party contracts and a share performance to-date, STA lowered full-year G&A guidance to a range of $34 million to $35 million.

STAG has a very scalable model and, over time, the company’s G&A is expected to move to around 10% of NOI from its current levels of 14% to 15%, as the scalability impacts the level of G&A

Retention Was Excellent

STAG’s retention for the quarter was 88% with cash re-leasing spreads of 8%. These results contributed to the trend of improving same-store NOI growth. The 75% to 80% is still a good number for the full year.

STAG’s cash and GAAP re-leasing spreads were 8% and 15%, respectively, on total leasing for the quarter and 8% and 16% year-to-date, respectively. The combination of these metrics produced positive same-store cash NOI growth this quarter. This continues to track STAG’s same-store guidance for the year of between 25 and 75 basis points of growth.

The Best Quarter Yet!

STAG’s latest quarter could be summed up as one of the best (quarters) since the company went public. FFO was up 10%, leverage was reduced to 4.7x, acquisition guidance was boosted, retention was strong, and G&A was down. E-commerce continues to be an incremental demand driver across all markets, and in a recent Forbes article, I explained,

“It’s Boom Time For Logistics Landlords”

Greenville-Spartanburg is STAG's third-largest market by ABR, and my hometown has exhibited population growth exceeding the national average and offers one-day truck access to reach the large affluent populations along the East Coast. This market benefits from an inland in Greer, a diversified distribution and manufacturing demand base and a favorable demand to supply dynamic.

Sure, Prologis (PLD), Terreno Realty (TRNO), and First Industrial Realty Trust (FR) aren’t focused on my hometown, but STAG clearly recognizes the sleepy little southern town that is also home to BMW’s U.S. manufacturing plant and Michelin Tire’s North American headquarters.

Now let’s compare the valuation metrics, starting with dividend yield:

From a dividend perspective, STAG continues to moderate its dividend payout ratio. The company said it wants to drive that dividend payout ratio to 80% of AFFO with less nonrecurring CapEx over the long term. A few more quarters of strong FFO per share growth should certainly help the cause.

Now, let’s examine STAG/s P/FFO multiple, compared with the peers:

Class is almost out: I hope you enjoyed the latest STAG article, and as you can tell, I am especially pleased with STAG’s Q2-18 earnings results, here’s the scorecard:

Photo Source

We are maintaining our BUY rating on STAG, even though the company does not have the superior cost of capital advantage as a few of the peers, we believe the company has been able to successfully mitigate risks by managing its balance sheet. Also, keep in mind that STAG operates domestically and doesn’t have global risk (like PLD with investments in Mexico, Japan, Europe, etc.).

In conclusion, the level of warehouse demand is beginning to trickle down to the secondary markets where STAG dominates. In fact, it’s because of the secondary markets that STAG is really in a class of its own. Maintaining BUY and SWAN status:

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: FAST Graphs and STAG Supplemental and Investor Presentation.

Other REITs: (MNR), (PLD), (PSB), (FR), (DRE), (TRNO), (EGP), (DCT), and (COLD).

Analyst’s Disclosure: I am/we are long ACC, AVB, BHR, BPY, BRX, BXMT, CCI, CHCT, CIO, CLDT, CONE, CORR, CTRE, CXP, CUBE, DEA, DLR, DOC, EPR, EQIX, ESS, EXR, FRT, GEO, GMRE, GPT, HASI, HT, HTA, INN, IRET, IRM, JCAP, KIM, KREF, KRG, LADR, LAND, LMRK, LTC, MNR, NNN, NXRT, O, OFC, OHI, OUT, PEB, PEI, PK, PSB, PTTTS, QTS, REG, RHP, ROIC, SBRA, SKT, SPG, SRC, STAG, STOR, TCO, TRTX, UBA, UMH, UNIT, VER, VICI, VNO, 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.