Deep Value Hidden In The Shares Of Global Self Storage

|
About: Global Self Storage (SELF), Includes: CUBE, EXR, LSI, NSA, PSA
by: David Brown, CFA
Summary

In Q3, Global Self Storage outperformed the industry by several dimensions of analysis.

Moreover, Q3 operational results represent just the next data point in what is becoming an extended sequential history of superior quarterly outcomes.

Further in-depth investigation reveals the attributes of significant value and growth that are presently not being recognized by the market.

Persistently Outperforming the Industry

The information of the below table was taken directly from the most recent Corporate Presentation (November 26th) of Global Self Storage (NASDAQ:SELF) and is accessible here. Therein are contained SELF's Q3 same-store operational results, alongside those of Public Storage (NYSE:PSA), Extra Space Storage (NYSE:EXR), Cube Smart (NYSE:CUBE), Life Storage (NYSE:LSI), and National Storage Affiliates (NYSE:NSA).

During Q3, SELF's same-store revenue growth was 1.7 x the industry average and its NOI growth was 2.44x the industry average, while it maintained end-of-quarter occupancy at 1.3% above the industry average.

Indeed, outperforming the industry quarter after quarter is becoming quite routine for the company. For example, see the articles: "Global Self Storage Logs Exceptional Growth During Q2" (August 17, 2018) and "Splendid Growth Rates Reported by Global Self Storage" (August 22, 2017). Each of these presents similar tables that depict industry-leading operational performance. By doing some simple research, the interested reader can further derive industry preeminent comparative outcomes for each and every recent interim quarter. On that basis alone, the market must be impressed with both the company's underlying strategy, as well as management's competence in implementing that strategy.

High Yield Valuation Metrics

Let's take a look at the present yields for all the publicly traded self-storage REITs based upon closing prices as of November 30th, 2018:

From the above information, the dividend yield for SELF is 1.6968x the average for the self-storage industry. To put this into perspective, at an annualized compounding rate of 4%, it would take 13.48 years for the non-SELF industry portfolio to render the same cash flow as would be realized immediately by an investor in SELF on November 30th. At a 3% annualized growth rate, 17.88 years would be required!

If the industry yield is applied to the current distribution, then SELF's market price should be $6.74. However, the rational income investor might logically ask whether the prevailing market price discount is justified in light of distribution risk.

To address this concern, please see the company's third-quarter earnings report. SELF reports adjusted funds from operations (AFFO) of $660,625 with fully diluted shares numbering 7,626,286. Interpreted, this implies AFFO per share of $0.0866 and a coverage ratio of 1.33x the quarterly dividend of $0.065! Moreover, the robust inherent growth rates that SELF is recurrently experiencing add further confidence to the future momentum and direction of the dividend coverage ratio.

In contrast, the interested reader might take a look at the third-quarter report for National Storage Affiliates (NSA). NSA reports Core FFO at $0.36 and has just declared a quarterly dividend of $0.30. This represents a coverage ratio of 1.2x, somewhat less than that of SELF.

The below table presents the coverage ratios for the industry, based upon the respective third-quarter reports: PSA, EXR, CUBE, LSI.

While standing almost precisely at the industry average, SELF has been experiencing growth rates unattainable by the remaining field. Moreover, as we will discuss later, the company's balance sheet ratios are superior.

Two more observations may be relevant for an income-oriented investor who is considering SELF. First, it appears fully committed to delivering the dividend. See the statement from the company's web site. "The Company's current distribution policy is to provide stockholders with a relatively stable cash flow". It is also worth noting on the same page that the 0.26 annual payments for 2016 and 2017 were entirely classified as "return of capital". As such, the investor would escape both Federal and State income taxation.

Price/FFO Valuation

Next, let's reorganize the above information to gain an alternative assessment, as shown in the table below.

I must concede that I am bewildered by what the market could possibly be thinking here, especially in light of SELF's proven consistently superior performance as demonstrated above (and other factors that we will present later).

Applying the appropriate industry multiple would value the shares at $6.20!

Price/NAV Valuation

In January, I submitted four articles: "How Do Embedded Cap Rates Affect the Values Of Your Self-Storage REIT Holdings?" - Part I, Part II, Part III, and Part IV. Since that time, three major changes have occurred:

  1. The market price of SELF has declined from $4.54 to $3.97.
  2. Simultaneously, it has experienced phenomenal industry-leading growth rates in Revenue, NOI and AFFO.
  3. The appropriate market capitalization rate for self-storage REIT type properties has declined from the previously assumed 5.96%, as the spread to Treasuries has contracted somewhat.

While I will not perform the laborious tasks of recomputing all the NAVs (as I did in the articles above), I will attempt to show that the very same conclusions prevail. In that pursuit, taking an informal survey of relevant and public information, it is reasonable to conclude a representative prevailing market cap rate of around 5.75% as an aggregate proxy for such REIT properties. In the articles, I did explain the criteria used in the selection of the cap rate and the inherent limitations of its accuracy as a single-point estimator across a broad spectrum of individual properties. However, I also did expend the energy to provide the results of simulating a dispersion of rates about the assumed mean. Moreover, during the process of modeling, it was observed that some variance in the estimated rate proxy will not alter the conclusions in any material way.

Referring to SELF's 10-Q for Q3, for the nine months ending on September 30th, revenue was at $6,039,768 and Property Operating Expenses came in at $2,459,160. This results in nine-month NOI of $3,580,608.

Fully annualized NOI was at $4,774,144. At a cap rate of 5.75%, the implied aggregate market value for all the 11 operating SELF stores becomes $83,028,591. From non-property assets remaining, we deduct $694,121 of goodwill and the $900,000 that is due to self-storage and real estate development company Tuxis, which is also an affiliate of SELF. This renders an additional $3,197,168 of tangible assets, for a total of $86,225,759. Subtracting out the $21,296,762 of total liabilities leaves a liquidating value of $64,928,997.

With 7,692,624 shares outstanding, the NAV comes to $8.44 per share. The analysis done in January had NAV at $7.94. However, two things happened in the interim. First, SELF experienced appreciable organic growth in NOI, and, secondly, the cap rate is assumed to have fallen by 21 basis points.

Although I will not go into detail here, below are the same calculations for CUBE.

In reviewing the derivations presented in the associated four articles referenced above, it is seen that the computed NAV values quite closely approximate the prevailing market prices for nearly all the REITs. All, i.e., with the quite striking and anomalous exception of Global Self Storage: at an incredible 53% discount to NAV!

Premier Balance Sheet

Extracting data from the respective 10-Q reports, linked above, provides the following insights as of September 30th, 2018:

*Please note that this computation gives effect to the $900,000 due to Tuxis. This leaves Global Self Storage with unrestricted cash and marketable securities of $2,525,802. Also, note that restricted cash has been removed from all entries.

Clearly, SELF is more liquid and less leveraged than any other self-storage REIT. There are two more significant observations to be made:

  1. The economic value of the company's Total Capital, as computed above, is $86,225,759. The Total Liabilities of $21,296,762 render a restated economic ratio of only 24.7% for Total Liabilities/Total Capital.
  2. The unusual amount of cash available for SELF will be referenced later as immediate funding for a key growth expansion.

Future Growth Prospects: Smaller is Better

The first, and most important, observation is that to provide a decent return for shareholders (at the present market price and distribution rate), the company does not need to grow at all! As was pointed out above, its annual distribution of $0.26 (along with the industry standard coverage ratio of 1.33x) provides a stable current yield of 6.55% at today's deeply depressed price of $3.97 and is 1.6968x the average current yield for the self-storage industry, taken in absence of SELF. In fact, none of the other REITs even come close. The next highest is NSA at 4.29%. Most surprising is that even at a 4% annual compounding rate, more than a full decade would be required for an investor in the non-SELF industry to realize the same nominal cash flow that he would have immediately if he simply made the equivalent investment into Global Self Storage!

Secondly, inhibiting prospective NOI and FFO (and consequential dividend) growth is the current compression of cap rate spreads. It is just not that easy to locate suitable properties with decent cap rates. Hence, both patience and extreme selectivity are needed. In this respect, SELF now has a unique growth advantage going forward. Please refer to the very first table in this article and take note of the range of magnitudes in size for the six REITs. More specifically, with only 11 current properties, the acquisition of a single, well-chosen purchase represents a 9.1% expansion for SELF. However, EXR (with 1606 existing properties), for example, would need to acquire an additional 146 just to match the implied proportioned revenue growth rate that SELF would experience in a single incremental stroke, all else being equal. Certainly, EXR would not be capable of applying the equivalent refined discernment to each and every single property acquired.

In this context, I'd like to quote from the SELF Q3 presentation linked above. CEO Mark Winmill comments: "...We will also be looking to supplement this growth with disciplined and accretive property acquisitions at a time and price that makes most sense". This prudent directive fits in perfectly well with the climate. With the FFO in hand to sustain the huge dividend, the company can simply concentrate upon driving organic profitability through its sophisticated and value-creating revenue and rate management program while it awaits the optimal acquisition targets.

A few articles ago, I commented about a phone conversation with CEO Winmill. I recounted that I was impressed with the degree of intimate acquaintance that he, as CEO, held regarding details of operation down to the property level. A blogger retorted that he would not be surprised, since the company owns only 11 properties. I guess that this is, sort of, the advantage of small size. After all, with high-level insiders holding 6.9% of the shares, it is comforting (for us common and ordinary shareholders) that they have day-to-day, hands-on contact with the grassroots of value creation (the employees) at the property level. As the blogger correctly surmised, this could not be possible for any of the larger self-storage REITs.

The Prospective Millbrook Expansion

Global Self Storage has developed an unparalleled track record of enhancing revenue, NOI and AFFO with calculated expansions of existing properties. Most recent was the lucrative Merrillville expansion of 13,300 sq. ft., which was completed in January 2018. Remarkably, all three buildings were leased up in less than nine months! Before that was the equally rewarding expansion at the Bolingbrook store. Company management must be commended for its judgement of the local market demand, prescience of the ultimate economic outcomes and effective lease-up execution.

Presently, the addition of 16,500 sq. ft. (100% climate-controlled) is in the planning stage for the Millbrook facility. Let's take what information we have and look through the glass darkly at what the impact of this contemplated augmentation might have for AFFO once it is finished and achieves stabilization. First, observe the web marketing page for the Millbrook Store on the Global Self Storage web site. There are three offerings, as shown below:

Since it is not possible to know exactly what the plans are for the 16,500 additional sq. ft., let us assume the lowest computed monthly revenue per sq. ft. when leased is $3.81. Also, assume that the occupancy for these additional units stabilizes at the current level for Millbrook, 96%, as reported in the Q3 10-Q. This translates into a monthly gross rent of $60,350. Next, from the Q3 10-Q, we have aggregate NOI at 61.83% of revenue. Hence, the impact to FFO would be $37,314 per month, or $111,943 per quarter. With 7,626,286 shares outstanding, the quarterly FFO would increase by $0.0147 per share, or 16.97% of the Q3 FFO of $0.0866!

Certainly, this analysis is quite crude and based upon inputs containing considerable variance in certainty. However, the direction of motion is clear. While we do not have yet any estimates for the incremental cost of this expansion, we are aware that SELF holds in excess of $2.5 million of cash and cash equivalents to fund the project.

Summary: Reasons to Buy Shares in Global Self Storage

  1. Quarter after quarter, it outperforms the industry in terms of same-store growth of revenue and NOI, as well as aggregate growth in AFFO.
  2. SELF's well-covered distribution yield of 6.55% is far above the industry average of 3.86%. Based upon the industry yield, the company should trade at a market price of $6.74, or 69.8% above current price of $3.97. (SELF is trading at a 41% discount to its intrinsic value based upon this metric.)
  3. Its Price/Q3 FFO is 45.84x, versus 71.36x for the industry. Using the industry multiple, SELF should be valued at $6.20, or 56.2% above its current price of $3.97. (The company is trading at a 36% discount to its intrinsic value based upon this metric.)
  4. Applying a market cap rate of 5.75% to the underlying property cash flows of SELF produces an NAV of $8.44. Applying the same cap rate to the other REITs renders an NAV relatively close to their respective prevailing market prices. Based upon this valuation, SELF should trade at 112.6% above its current market price. (It is currently trading at a 53% discount to its intrinsic value based upon this metric.)
  5. Fundamental ratio analysis suggests that the company has the strongest balance sheet of all the self-storage REITs.
  6. Within the context of the present compressed market cap environment, the much smaller scale of SELF will permit greater selectivity in proportionately growing its portfolio through acquisitions than can be realized by the larger REITs which will experience considerably more inertia.
  7. On the drawing board is the Millbrook expansion, which arguably could by itself ultimately result in a 17% accretion of FFO and can easily be funded using available cash.

Disclosure: I am/we are long SELF. 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.