AvalonBay's 3-Brand Strategy

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About: AvalonBay Communities, Inc. (AVB)
by: Dividend Sleuth
Summary

AvalonBay develops and manages apartment communities designed for mostly young professional singles and families.

The company focuses on key U.S. urban and suburban markets in twelve states and the District of Columbia.

AvalonBay operates over 85,000 apartments through three distinct brands, each with a specific submarket.

This is the fourth in a series of articles about real estate investment trusts with Standard & Poor's credit ratings of A or A-.

AvalonBay offers investors a focused diversity

AvalonBay Communities, Inc. (AVB) develops and manages apartment communities primarily in New England, the New York/New Jersey metro area, the Mid-Atlantic, the Pacific Northwest, and Northern and Southern California. These communities are designed for mostly young professional singles and families. The company is moving into two new markets: Denver and Southeast Florida.

AVB focuses on leading metropolitan areas in regions that the REIT believes "are characterized by growing employment in high wage sectors of the economy, lower housing affordability and a diverse and vibrant quality of life."

As of March 31, 2019, AVB owned or held an interest in 291 apartment communities containing 85,383 apartments in 12 states and the District of Columbia, offering garden, mid-rise and high-rise communities for three distinct demographic submarkets.

Three brands for three submarkets

AvalonBay's coast-to-coast U.S. geographic footprint includes 15 of the nation's strongest urban markets. AVB believes it is well-positioned to grow with the economy, particularly among urban and suburban professional adults.

The company offers three brands to serve specific submarkets:

  1. Avalon is a luxurious, spacious brand for professional singles and couples looking for "effortless enjoyment" near shops, restaurants and entertainment, with club rooms, fitness centers and on-site management.
  2. AVA is for active, urban millennial young adults, designed "to impress with an understated cool," with WiFi, U-verse, smartphone charging stations, a fitness center, common areas for socializing and bike storage to "stay fit and hassle-free." AVA appeals to mostly young singles in "high energy, transit-served" urban areas.
  3. Eaves, often pet-friendly and more suburban, is for the value-conscious, including families wanting "a few extra amenities, a friendly staff and a secure, comfortable place to live. These typically are garden apartment communities.

AVB Portfolio Mix (Slide 40 from June 2019 Investor Update on AVB website)

Looking for an apartment REIT?

Three apartment REITs have A- S&P credit ratings: AvalonBay, Equity Residential (EQR) and Camden Property Trust (CPT). These REITs share a common goal to reach urban high income millennial and generation Z apartment seekers.

Each of these REITs has distinctive features. Equity Residential is the most narrowly focused, in fewer cities with more exclusive properties. Camden tilts toward the sun belt, with properties near, but not in, the most exclusive neighborhoods. AvalonBay includes both urban and suburban, with a significant garden apartment component.

AvalonBay addresses this demographic group through its broad national footprint and three distinctive brands designed for specific sub-markets. AVB is the eighth largest publicly-traded REIT. It is the largest apartment REIT by market capitalization at $28.324 billion, neck-and-neck with Equity Residential's $28.131 billion.

Of the three A- rated REITs, AvalonBay offers the greatest diversity with its three brands. AVB's recent expansion into the Denver and Southeast Florida markets broadens the company's footprint and national brand recognition.

The demographic group sought by these REITs tends to have an interest in environmental sustainability. AvalonBay addresses sustainability in its Corporate Responsibility Report.

AvalonBay's financial performance

AvalonBay's conservative balance sheet is reflected in its A- credit rating from S&P. At year-end 2018, net debt was 4.6x core EBITDA.

The company's experienced management has grown AvalonBay through new construction and accretive acquisitions. The company's "match funding" strategy connects new developments with long-term capital, locking in the spread between capital costs and projected returns. At 12/31/2018, unencumbered assets provided 91% of net operating income.

From the Q1 2019 press release:

"Net Income ... for the three months ended March 31, 2019 was $170,366,000. This resulted in an increase in Earnings per Share ... of 19.4% to $1.23 from $1.03 for the prior year period.

"Funds from Operations ... per share for the three months ended March 31, 2019 increased 6.5% to $2.31 from $2.17 for the prior year period."

During the Q1 2019 earnings call, Chief Executive Officer Tim Naughton said:

"It was a solid quarter. ... every region posted 3%­ plus same-­store revenue growth for the first time in over 6 years."

In the Q1 earnings call, Chief Operating Officer Sean Breslin said:

"... we believe the current pace of job and wage growth ... supports rent growth in the 2.5% to 3% range for our portfolio."

AvalonBay expects apartment demand to remain strong, driven by a healthy labor environment, favorable demographics and continued delays in family formation (e.g., marriage, children). Management projects same-store revenue growth of 3.0%. AVB plans to launch $950 million in new apartment community construction in 2019.

The F.A.S.T. Graph below shows steady growth of funds from operations, or FFO (the dark green area), from $4.00 in 2010 to $9.00 in 2018, interrupted by one slight dip in 2013. FFO growth has averaged 10.11%. There has been a general uptrend in operating earnings per share, listed in the second table following the graph, though EPS growth has been less steady than FFO growth.

AVB FAST Graph FFO

AVG FAST Graph Operating Earnings Table (FFO graph and operating earnings table from F.A.S.T. Graphs)

The AvalonBay dividend

AvalonBay has increased its dividend for eight consecutive years, beginning in 2012. The 5-year dividend growth rate has been 6.9%. The most recent increase was 3.4%, when the quarterly dividend was raised from $1.47 to $1.52, for an annual dividend of $6.08. At a closing price of $207.87 on July 5, 2019, the yield was 2.92%.

Simply Safe Dividends gives AvalonBay a very safe dividend safety score of 98 out of a possible 100, with 50 being average.

From 2014-2018, AVB's high yield averaged 3.58%, from 3.2% (2015) to 4.1% (2014).

What is an appropriate valuation for AvalonBay?

AVB'S 52-week price range has been $167.01 to $211.75. The current price of $207.87 is just 1.83% below the 52-week high and 9.76% above the $189.38 mid-point of the 52-week range. The low was reached on December 26, 2018, and the high was reached on June 18, 2019.

The Stock Selection Guide is a tool developed in the early 1950s by the (then) National Association of Investment Clubs (now BetterInvesting.org). It helps an investor determine a possible price range for the next 5 years, using selected data from the past 10 years, augmented by one's judgment about factors that may enhance or impede growth.

AVB Stock Selection Guide p 1

AVB Stock Selection Guide p 2

(Author’s calculations using Better Investing’s Stock Selection Guide)

Estimated high price. F.A.S.T. Graphs projects earnings per share growth of 6% in 2020 and 4% in 2021. Better Investing reported analyst estimates of 6.4% annually. I chose an estimated EPS growth of 6.4%, which would give a possible high EPS of $9.61. For a possible high price/earnings ratio for the next 5 years, I chose the past 5-year average high P/E ratio of 30.5. I multiplied $9.61 by 30.5 to arrive at a possible high price of $293.20. (Remember that for most REITs, FFO is a better indicator than EPS of a REIT's strength. REIT P/E ratios tend to be higher than P/E ratios for companies in other sectors.)

Estimated low price. The Stock Selection Guide offers ways to calculate a possible low price, ranging from $149.60 to $171.30. I chose $150.00 as a possible low price for the next 5 years.

Price range. A possible 5-year price range of $150.00 to $293.20 represents a price swing of $143.20. The lower 25% is a "buy" range, the upper 25% is a "sell" range and the middle 50% is a "hold" range.

Buy and sell ranges. The "buy" range is $150.00 to $185.80 (the lower ¼ of the range). The "sell" range is $257.30 to $293.20 (the upper ¼ of the range).

At a current price of $207.87, AvalonBay is in the hold range. I do not have a position in AVB, and I would consider initiating a one-third position at a 3.5% yield, which would be $173.71. I've set an alert at Custom Stock Alerts for that price. This is within the 52-week price range, but it would be a 16.4% drop from the present price.

The SSG calculations suggest a top "buy" price of $185.80, which would be a 3-to-1 upside/downside ratio relative to the 5-year price range I estimated. A $173.71 target price would be a more favorable 5-to-1 upside/downside ratio within this projected range. Each investor must choose an appropriate margin of safety.

Some things to watch for with AvalonBay

Watch for progress on AvalonBay's plan to redirect some assets to their new markets in Denver and South Florida, as well as a small expansion within their existing Pacific Northwest. The following map from a recent Investor Update sketches AVB's target allocation for the next decade.

AVB Map of Growth Markets

(Slide 39 from June 2019 Investor Update on AVB website)

Watch for signs of a weaker economy. AVB depends on a growing job market for their high wage-earning residents. Since AvalonBay leases are for one year or less, AVB earnings calls provide insight about regional leasing patterns. This is a good indicator of job market strength.

Watch for increased activism by municipalities or advocacy groups in support of rent control or rent stabilization laws and regulations that could limit the company's ability to raise rents based solely on market conditions.

Watch for any new financing through tax-exempt bonds. Some AVB communities are financed with tax-exempt bonds that require some apartments to be available to lower income households. As of December 31, 2018, 5.2% of AVB apartments were under such income limitations.

Watch for threats from weather-related, geologically-related or human-generated causes to any of AvalonBay's properties. Of AVB's 269 apartment communities, 119 are in earthquake zones along the West Coast.

The following two items likely are minor footnotes, but potentially of concern to investors:

Watch for final resolution of the few remaining lawsuits following a January 2015 fire that destroyed 240 apartments at one of two buildings in AvalonBay's Edgewater, New Jersey development.

Watch for failure by AvalonBay to maintain ownership, and secured financing, on 14 assets from the 2013 Archstone acquisition. An action by AVB to trigger prior owners' tax liability would cost the company up to $48.3 million.

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.

Additional disclosure: This article was written by Ted Leach (Dividend Sleuth) with input from Kirk Spano and David Zanoni. The article is for informational purposes only (not a solicitation to buy or sell stocks). Ted is not a registered investment adviser. Investors should do their own research or consult a financial adviser to determine what investments are appropriate for their individual situation. This article expresses my opinions and I cannot guarantee that the information/results will be accurate. Investing in stocks involves risk and could result in losses.