American Tower Corporation: Great Company But Not At That Price
- American Tower Corporation is a great company with a fantastic business model.
- The company has some impressive growth opportunities.
- The current valuation is a major risk for long-term investors.
I am always looking for new investment opportunities that will fit my dividend growth strategy. At the moment my portfolio lacks exposure to the consumer discretionary sector as well as the real estate sector. I analyzed several companies in the consumer discretionary sector, and now I am willing to look into more REITs.
I own four REITs at the moment in my dividend growth portfolio: Realty Income (O), W. P. Carey (WPC), Omega Healthcare Investors (OHI), and Digital Realty Trust (DLR). I am trying to increase my exposure to different types of REITs, and I analyzed Iron Mountain (IRM) in a previous article. This article will focus on another different REIT- American Tower Corporation (NYSE:AMT).
I will analyze the company using my methodology as described in the graph below. The graph represents how I analyze dividend growth stocks, and it allows me to compare between possible investments. I will analyze the company by looking at its fundamentals, valuation, growth opportunities, and risks, and I will try to determine whether American Tower Corporation is a good company and a good investment.
(Graph made by author)
According to Seeking Alpha company overview, American Tower, one of the largest global REITs, is a leading independent owner, operator, and developer of multitenant communications real estate with a portfolio of approximately 181,000 communications sites. The company is headquartered in Boston, Massachusetts.
The company has shown impressive sales growth in the last decade as it expanded both in the United States, its primary market, and globally. The growth rate was achieved mainly organically as the company built additional sites to deal with the increasing demand for data. While growth has been extremely fast in the last decade, according to the analysts covering the company, investors should expect a somewhat lower growth rate as sales will grow at a mid-single digits rate.
EPS is a less relevant metric when we look at companies in the REIT sector. The AFFO is a better metric and American Tower has been excelling on that front. The company more than tripled its AFFO in the last decade, and that is why we saw the share price appreciating so fast. However, the forecast by analysts covering the company is for the growth to slow, and while a 7% growth is still impressive, especially for a REIT, investors should not expect the robust growth they enjoyed in the previous decade.
The dividend is probably the crown jewel of every REIT. While most REITs attract investors using their high payout ratio, the yield here is lower than 2%, which is low compared to its peers. However, the growth rate in the past five years has been 20% annually. The company is growing AFFO and increasing the payout ratio. Even now, the payout ratio is conservative at roughly 50% of the AFFO.
Shares outstanding have been growing slowly, less than 1% annually in the last decade. The company is funding its growth mainly using its AFFO and debt and therefore doesn't dilute shareholders. REITs don't execute major buyback plans most of the time, and therefore, not being diluted is a great advantage that American Tower offers.
Price to adjusted funds from operations (P/AFFO) is the best metric to understand the valuation of a REIT. Right now the company is trading for 26 times its forecasted 2021 AFFO. This is a significant premium over other REITs that on average trade for less than 20 times the AFFO. To justify such a premium, the company has to grow its AFFO faster than other REITs. While this is the case here, I am not sure that the AFFO is growing fast enough to justify it.
The graph below from Fastgraphs.com shows how detached the valuation is from the average valuation and the growth. The company's average P/AFFO is 22.55, and since 2019 it has been trading for a premium above it. You can see that AFFO growth has slowed down since 2019, yet the valuation is higher. I don't think that it makes sense to pay such a premium for a company forecasted to grow around 8% annually in the short and medium term.
American Tower Corporation is probably one of the best-run REITs. The fundamentals are strong and sales are growing rapidly. Also, it translates the top line growth to AFFO growth, which is later turning into robust dividend growth. However, these fundamentals come with a premium valuation, which I find hard to justify at the moment.
Global diversification is a growth opportunity. Usually, REITs find it hard to diversify globally since being a good real estate investor requires a deep understanding of the market. American Tower has managed to deal with that challenge, and they are growing on every continent on the planet. The ability to diversify helps to mitigate the risk of exposure to one market, and allows to grow even if the American market is getting closer to saturation.
(Source: Q4 2020 Overview)
Another important growth opportunity is the growth in the number of providers. The company is owning the real estate used for the antennas, but it doesn't limit itself to use one operator on every site. Therefore, the company can attract higher revenues with more tenants using the same properties. In fact, it can increase revenues with a very limited increase in expenses.
Besides, the forecast for a massive increase in data usage will also drive demand for American Tower Corporation real estate. We see an increasing number of smartphones being purchased worldwide, and the chart below shows growth in the use of data by each device. Therefore, the company should expect more demands for new towers and for using its existing towers.
(Source: Q4 2020 Overview)
Leverage is a risk for investors in American Tower Corporation. The company in the last decade enjoyed significant growth with the AFFO almost tripling. However, the risk has also increased as the debt level has almost tripled as well. As we see the 10 years treasury yield on the rise, companies with higher debt load will have to deal with significantly higher interest payment and less flexibility.
The company is not a growth company anymore. Its sales growth has been slowing down and so is the AFFO. Investors who buy REITs usually look for either high dividend yield or significant AFFO growth, and the yield is not significant and the growth is slowing down. The graph below shows how growth slowed by over 50% in the last decade. The company is maturing, and it's great, but its price should reflect it.
The greatest risk for investors buying American Tower Corporation is the lack of margin of safety. The top and bottom lines are growing, but they are growing slower than they used to. Leverage is higher, and the valuation is higher. When the company in the previous decade grew much faster, its valuation was lower. Right now, investors pay a premium for a 2% dividend and 7% forecasted AFFO growth in the medium term, and in my opinion, it's too expensive and leaves no margins.
American Tower Corporation is a great company. It enjoys healthy sales growth and healthy AFFO growth and rewards its shareholders with decent dividend increases. The company has a great business model, and unlike most REITs is very diversified globally.
However, while the company is in a great position, I believe that it is a Hold at the moment due to the company's valuation. The bloated valuation leaves investors with very little margin of safety. Sales growth is slowing, the debt level is up, and AFFO growth is slowing. It doesn't mean that this is not a good company, but it means that the premium is unjustified.
This article was written by
Analyst’s Disclosure: I am/we are long DLR, O, OHI, WPC. 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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