Jernigan Capital: Self Storage Means More Stability
- Jernigan Capital not only finances the development of self-storage properties but also acquires them.
- The company has gone through a loss-making first quarter but management has consolidated the capital structure to face the forthcoming uncertainty.
- It has liquidity to finance investments and add rental revenues.
- According to my estimates, the company will again be profitable in the first half of 2022 and this, using a worst-case scenario.
- At current prices, JCAP is a Buy.
The self-storage industry and Jernigan's positioning
Storage space is quickly becoming a necessity for many US homes. As home designs change, finding a home large enough to hold everything an individual or a family owns is getting tougher.
The answer to this problem is self storage and for many families, it is advantageous to rent a storage unit that is much cheaper than a mortgage. In addition, business owners are renting more and more storage to store their archives and excess items for later use.
In terms of investment, owning a self-storage business is an alternative to traditional real estate investments as it provides investors with a better return on investment (less maintenance costs) and more security in an uncertain economic environment.
Figure 1: Customer profiles for Self Storage space
Now, like all industries, self-storage has been impacted by confinement measures but the impact should also be temporary as the reasons for which customers lease self-storage space are strong.
First, most of the customers are residential ones and many of them who have to work from their homes will need more self storage as they make way for more space in their home. Also, there are students who have leased space as they have to vacate campuses and the same is the case for workers affected by layoffs.
Furthermore, in some states, self storage has been designated as an "essential business" and customers have been allowed to access their belongings.
As for Jernigan Capital (NYSE:JCAP), the company finances and makes equity investments in self-storage development projects (existing and recently constructed) and is increasingly owning self-storage facilities.
It has been mostly viewed by investors as a specialty finance company only, that is one which loans funds to property developers. However, looking under the hood, there is more. The company wants to make the transition to an equity REIT, more specifically as an owner and developer of self-storage properties.
Figure 2: Self-storage properties owned by JCAP
Source: Commercial Property Executive
The management has already made concrete moves in this direction with the latest one being the acquisition of developers' interests in nine self-storage properties. The company had financed the construction of these properties earlier on.
Another move to be more of an equity REIT play, namely internalization of some core corporate functions which was previously being accomplished by another entity has resulted in a significant revenue drop.
Significant revenue drop in Q1-2020
JCAP has known a very difficult quarter, financially compared to Q1-2019. Most investors would think that this is because of the coronavirus. However, this is far from the case and the most important reason for this is internalization expenses. In fact, the revenues from rental have increased significantly in comparison to the same quarter last year.
Figure 3: Income statement
Source: Q1-2020 report
Now, for a company which makes quarterly revenues in the order of $11 million, that internalization expense of $38 million must have looked surrealist. Also, it resulted in an operating loss of $40 million compared to an operating income of $4 million in Q1-2019.
However, on the other side, this will result in long-term benefits of $4.8 million per year.
There is much more as according to me, this is a key move by the company’s shareholders as the company now has the core competencies to conduct its operations with respect to investment strategy, acquisition, portfolio management and financing. Also, JCAP has hired two employees in the third quarter to look after its self-storage real estates.
In terms of corporate structure, this means that JCAP is now an internally advised REIT with capability to manage its assets.
Now, also taking into consideration a loss in market value because of the effects of COVID-19, the company has adjusted the fair values of its development property investments downwards. The reason is longer time to lease properties.
In other cases, rent increases have been suspended and vacant spaces could not be filled resulting in elevated occupancy rates.
Taking into consideration those exceptional expenses incurred in the first quarter and the fact that we are amidst a period of uncertainty created by the coronavirus and civil unrest which have impacted economic activity to levels not seen since the great depression, I make a "worst-case" projection of the revenues in the second quarter and beyond.
Future outlook using a worst-case scenario
From a net loss of over $50 million for Q1-2020, I estimate that JCAP's loss will only be $18 million for Q2-2020. The main driver for this improvement in the second quarter is the absence of the $38 million internalization expenses.
Figure 4: Income statement for Q1-2020 and Q2-2020
Source: Table built from JCAP Quarterly report for Q1-2020 and projected net income for Q2-2020 built from earnings report and earnings call transcripts.
Second, the "Fees to managers" expense will cease as from Q2-2020 because of internalization.
Thirdly, the company incurred a net unrealized loss on investments of $11.0 million because of a significant increase in the number of properties owned (the properties recently acquired) and because of a delay in leasing storage space as well as significant widening of credit spreads near the end of the first quarter. I keep these risks at the same level for Q2 despite the re-opening of the economy.
Finally, the goodwill impairment loss is a special cost added because of the COVID-19 pandemic-related events impacting the goodwill. I assume the same loss for the second quarter. The reason is because of civil unrest in two locations where JCAP has properties.
Figure 5: Hotspot cities and JCAP properties
Source: The Guardian
Moreover, it is worth noting that there will be a fall in interest income resulting from JCAP having acquired properties where it initially acting as a creditor. Also, the reduced rental income due to increased risks of delinquencies should be partly offset by monthly proceeds from the additional eleven self-storage facilities hitting the market as from this quarter and the next one.
In conclusion, I envisage that the company will be back to profitability in the first half of 2022. However, as I pointed out earlier, this is a worst-case scenario ignoring the fact that the company will start to derive revenues from properties currently being developed and which will hit the market in 2020 and 2021.
Figure 6: Current income and projection until the year 2022
Source: Chart built from data from Seeking Alpha plus Keylogin Earnings simulator
Therefore, since this is a longer-term investment, there are risks other than the net unrealized losses I already considered.
Risks, risk reduction, balance sheet and valuations
Unforeseen events may throw ice-cold water on JCAP’s ability to put more properties for lease in the market. Here, I have in mind the five investments which had to be foregone (abandoned) during the last quarter and where $57 million had been committed. A total of $15.7 million had already been invested despite construction works not having begun.
Now, the company has already funded a further $113 million in ten planned developments mostly in New York. These projects were started back from 2017 to 2019 and commitment is much more ($113 million invested out of a total commitment of $168 million).
However, given the high degree of commitment and the fact that three of these projects are scheduled to hit the market as early as the third quarter of this year are strong positives in terms of additional rental revenue streams for the years 2020 and 2021.
On an even brighter note, the fact that the JCAP partners with third party managers like Cubesmart (CUBE) for some properties is that the latter has invaluable expertise in managing self-storage properties. For additional peace of mind, I checked Cubesmart’s results for the last quarter and found that they beat both revenues and earnings expectations. In fact, the impact of COVID-19 on Q1-2020 earnings was not material even as the company adopts a more prudent approach for the rest of the year.
Therefore, while there are risks, these are not blocking and it becomes important to consider the company’s balance sheet and liquidity position in order to evaluate whether it can be financially sustainable till the net results become positive in 2022.
Firstly, the company has been reducing the debt portion on its balance sheet by injecting more equity with the latest one being the issue of $15.4 million of common stock in January 2020. Furthermore, the Total Debt to Equity stands at only 41 when compared with peers.
Figure 7: Comparing JCAP with Life Storage (LSI), Extra Space Storage (EXR) and Medallion Financial (MFIN).
Source: Seeking Alpha
Secondly, the company has further bolstered its liquidity position by increasing the revolving credit facility by $140 million ($235 to $375 million) and reducing dividends from $0.35 to $0.23 per share (announced in February 2020) because of internalization expenses and which makes sense in an uncertain environment.
Figure 8: Capital structure
Source: Earnings call presentation
To sum up, given that JCAP had cash of only $7.3 million as of March 31 2010, and quarterly expenses totaling $11 million on payment of dividends (Preference A and B shares and commons) and its loss for Q2-2020 is estimated to be $17 million, the $375 million will provide it with plenty of ammunition to effect debt payments as well as make investments in properties amounting to $39 million for this year, but for 2021 as well.
Investors will note that the company has $41 million of secured term loans maturing in 2021 and 2023. This repayment of $198 million for the year 2023 means that the company expects to be profitable sometime in 2022, which is aligned with my own projection.
Figure 9: Secured term loans
Source: Earning Call presentation
For shareholders holding the stock since one year (like myself), it would have been great if the dividend could have been maintained at $0.35. According to my calculations, this was a possibility. However, I understand the management's perspective and will not indulge in a blame-game on distributions. The priority of the moment is to prevent further debt increase and conserve liquidity for growth and not to unnecessarily weaken the company’s long-term finances.
Finally, as for valuations, the market seems to have punished JCAP more as a financial stock than one which is already deriving 40% of its revenues from renting self-storage properties and looking forward to improving significantly on that number. Hence, by averaging down the downsides undergone by the four stocks (figure 10), I come to a target price of $16.5-19.5 for JCAP which represents more than 20% upside at the time of writing.
Figure 10 : Evolution of the share price
Data by YCharts
This upper range of this target is aligned with analysts' price targets on yahoo finance. However, I believe that there could be some sell-off after the dividend payments for Q2-2020 as the company has suspended guidance for the full year.
Putting it all into perspective, JCAP has incurred a huge one-off internalization expense but in return, stands to benefit significantly from core functions (with respect to the property portfolio) being carried out internally and therefore, more smoothly and efficiently.
I believe that the well-structured capital will allow JCAP not only survive the dramatic economic downturn resulting from the coronavirus and civil unrest but also thrive as things start to recover.
I make an income projection using a worst-case scenario which shows the company back to profitability in the first half of 2022.
A cash dividend of $0.23 per share for the second quarter is also being paid. The dividend is payable on July 15, 2020 to shareholders of record on July 1, 2020.
This article was written by
Analyst’s Disclosure: I am/we are long JCAP. 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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