Why Whitestone REIT And Its 8% Yield Is Overvalued

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About: Whitestone REIT (WSR), Includes: KIM
by: John Windelborn
Summary

FFO on a per share basis has been declining since 2015.

Payout ratio now sits at 98% with no dividend raises since inception.

Occupancy rate of 89% is low compared to peers.

Debt-to-EBITDA of 8.5x is absurd for a company with declining FFO per share.

Whitestone REIT (WSR) is a $560 million market cap shopping center real estate investment trust that concentrates on properties in high-growth and income metropolitan areas. Their business model is essentially the same as Kimco Realty (KIM) for those seeking a more well-known peer comparison. The 8% monthly-paid dividend is attractive, but I see a number of issues with the underlying business that make me hesitant to jump on the bandwagon.

Image from finviz.com

With shares of Whitestone REIT at recent highs I thought that shares were worth a look to see if the price action was warranted or not. Like many stocks, WSR has recovered nicely from the end of year woes. The company will report Q4 earnings on February 27th and will hopefully give investors something to cheer about.

This next slide is front and center of their last investor presentation, and boy is it misleading:

Image from investor presentation 2/4/19

All those giant green upward arrows have to mean that things are going well, right? Revenue, NOI, FFO, dividends, they all seem to increased at a good clip over the years. The problem is that so has the share count.

Net asset value per share has taken a hit over the past year and FFO per share has been declining since 2015.

Image from investor presentation 2/4/19

If FFO per share has been in decline, then the dividend might have coverage issues. Indeed, the declining funds from operation per share has caused the payout ratio to climb to 98% for the most recently reported quarter despite the fact that the dividend per share has never been raised since the stock went public in 2010.

Image created by author

A payout ratio near 100% would make me skittish enough to consider not investing in a company, but for a company with declining metrics it makes me wonder about the viability of the dividend going forwards.

Additional Risks

Management is very proud of their geographic concentration of their portfolio and likes to point out the growth/migration and average household income patterns of the surrounding areas. I view this over-reliance on Arizona and Texas as a risk, not a boon.

Image from investor presentation 2/4/19

With 99% of their portfolio in Arizona or Texas, all of their proverbial eggs are in two baskets. Positioning yourself for organic growth is one thing, but most companies like to diversify their risk a bit more. Consider Kimco’s geographic footprint:

Image from Kimco’s Q3 investor presentation

KIM is still focusing on high-growth locations but is limiting a single city/area to no more than 14% of the portfolio. KIM’s average base rent per square foot is $16.08 according to their Q3 investor presentation, and occupancy sits at 95.8%, which is good, but not amazing.

WSR on the other hand, likes to tout their $18.97 per square foot average base rent, but has to hide in the footnotes that this excludes certain legacy assets. Actual base rent is summed up with the following picture from their last 10-Q:

Image from WSR Q3 10-Q

As you can see, actual base rent is much lower than $18.97, and I find this type of obfuscation both frustrating and telling of the type of governance at work here. Weighted average leasing terms of less than 5 years adds risk to their operations, as most companies are able to achieve lease terms of around 10 years. Additionally, WSR has an occupancy ratio of 89% which is not very good when compared to peers. As mentioned before, KIM’s occupancy is 95.8% and Realty Income (O) has a 98.8% occupancy.

In terms of debt, Whitestone has a debt-to-equity ratio of 1.99 which is more than twice as high as KIM’s 0.91. While most of WSR’s debt is a reasonable mid-4%, debt-to-EBITDA of 8.5x (KIM at 6.0x) is simply too high for me to be comfortable.

Summary

Back when Whitestone REIT was yielding 10+% and had a payout ratio in the 80% range, I would have been tempted to go long. However, with a barely-covered 8% yield on cost today, I find shares much too expensive and would expect the share price to decline in the subsequent months. If FFO per share continues to erode we might even see a dividend cut in the future, which would be embarrassing given the fact that there has been zero dividend growth since inception. With high amounts of risk and a low chance for peer-beating returns, we cannot recommend investing in Whitestone REIT at these prices.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.