Bet On America With 5.1%-Yielding SL Green Realty

Summary

• SL Green remains rather cheap and highly discounted from where it was before the pandemic.
• While challenges remain, I expect a return to normalcy in the latter part of this year, and SLG could see share price improvements.
• Meanwhile, the company is aggressively buying back shares; I also highlight the valuation and dividend safety.

In Warren Buffett's much anticipated annual letter, he said to "never bet against America". This brings me to SL Green Realty (NYSE:SLG), which I view as being a recovery play, as the country comes back from the pandemic.

While SLG has made up some ground in recent months, it still remains highly discounted since the start of 2020, with a 24.5% decline since then. In this article, I evaluate what makes SLG a good buy for both income and growth at the current price, so let's get started.

(Source: Company website)

Why SLG Is A Buy

SL Green Realty is well-known in the real estate industry as being New York City's largest owner of office real estate. It's an S&P 500 company, and is focused on owning, managing, and developing properties in Manhattan. At present, it has an interest 89 properties covering around 40M square feet.

It goes without saying that SLG has faced plenty of headline and realized risk from the pandemic, given the work- and stay-at-home measures adopted in one of the hardest hit areas by the pandemic. This was reflected in SLG's Q4'20 results, as same store NOI declined by 5.9% YoY.

One of the key drivers behind this weakness was SLG's retail property segment, which saw just 81% rent collection during the full year 2020. Combined with the office segment, SLG's overall rent collection in 2020 was 94.8%. In addition, the mark-to-market on the 27 signed Manhattan leases during the fourth quarter were 11.9% lower than the previous fully escalated rents on the same spaces.

While the above challenges do give pause for some concern, I see them as being temporary. Rent collection for the office segment remains strong, at 97.9% for the full year 2020, despite all of the headline risk around office space. Office occupancy also remained relatively stable, with 93.4% occupancy in Q4'20 compared to 94.2% in the third quarter.

For all of the doom and gloom around office space, SLG's office occupancy dropped by just 260 bps from 96.0% in Q4'19 (pre-pandemic), and I don't find this to be materially concerning. Plus, as seen below, 2020 leasing activity in Manhattan remains more or less on par with that of prior years.

(Source: December Investor Presentation)

Looking forward, I remain optimistic for NYC and the U.S. in general as COVID vaccinations can lead to a broad re-opening of offices. This is supported by the rapid development of vaccines, with President Biden pledging this month that there will be enough vaccines for all U.S. adults by the end of May. Plus, private sector office jobs have started to claw back from the depths of the pandemic, and management expects a significant recovery this year, as noted during the last conference call:

"The financial and tech sectors in New York City, which account for over half of the office space demand, are doing extremely well and added 5,000 office-using jobs in December alone. The city is forecasting a significant amount of new office jobs in 2021, such that we would return to pre-pandemic office employment levels by the fourth quarter of this year, recouping all of the 165,000 office jobs lost at the outset of the pandemic."

Meanwhile, management is taking advantage of the low share price by repurchasing shares at discounted levels. As seen below, SLG has reduced its share count by an impressive 27% since June of 2017, from 102M to 75M as of December 2020. Recently, the BoD authorized an additional $500M to the share repurchase program.

(Source: Seeking Alpha)

I see the share buybacks as being accretive to shareholders, given that SLG is currently trading at a P/FFO of just 10.9. This equates to an earnings yield of 9.2%, sitting far higher than the 4.0-4.5% cap rate range on investments that SLG expects to see on a going forward basis.

Meanwhile, SLG pays a well-covered 5.1% dividend yield, with a 56% payout ratio based on the 2021 forward FFO/share estimate of $6.54. Management expressed confidence in the dividend with a recent 2.8% dividend raise.

It's worth noting that SLG has a debt to EBITDA ratio of 6.9x, which sits higher than the 6.0x level that I prefer to see for REITs. I see potential for this ratio to trend down, as the NYC market regains its luster over time, and I'm encouraged by the $547M reduction in long-term debt during 2020. This is something worth monitoring.

Investor Takeaway

SL Green Realty is still trading well below where it was before the pandemic. While risks remain for this premier NYC landlord, I do see a light at the end of the tunnel, especially given the positive momentum around the vaccine. I expect for the office segment to begin returning to normalcy in latter part of this year, and SLG could see continued improvements in its operating results and share price as a result.

I find SLG to be attractively valued at the current price of $71.42, with a blended P/FFO of 9.9, which sits far below its normal P/FFO of 14.7. Meanwhile, I anticipate that SLG will continue to repurchase its shares at discounted valuations while paying a well-covered dividend. SLG is a Buy and a good bet that America and NYC will get back to normal.

(Source: F.A.S.T. Graphs)

Analyst’s 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.

This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.