- Public Storage has been avoided by many as the company hasn't hiked its dividend in years - most major REITs have hiked consistently.
- However, the company finally seems to have entered a new growth phase as it is seeing the benefits from successful acquisitions and subdued operating expenses.
- The valuation is a bit lofty as investors have been frontrunning the good news. Nonetheless, I advise investors to add on any weakness.
Right now, I own just one REIT. While this is about to change this year, it is no surprise given my articles on Seeking Alpha that I am extremely picky when it comes to REITs. I want a company like Public Storage (NYSE:PSA), which just released its quarterly earnings. America's largest storage REIT offers everything I'm looking for. The company uses debt and preferred equity to fund new acquisitions, does not cut its dividend but only raises it when it has the ability to do so and operates in what I think is one of the best places to be right now: storage. In this article, I am going to walk you through my bull case using the latest quarterly results and tell you why I think that the new all-time high is more than justified. So, bear with me!
Dividend Hikes Will Come Soon Enough
I have to admit that it feels a bit off, but I am really excited about a company that hasn't hiked its dividend since 2017 - while having 90% of my assets in a dividend growth portfolio. Imagine that.
As a matter of fact, prior to and shortly after the Great Financial Crisis, Public Storage did not significantly raise its dividend. The company's dividends were raised between 2010 and 2017. During these 7 years, dividend hikes were high enough to result in roughly 10% average annual dividend growth between 2004 and 2020. So, while I am not a huge fan of companies with inconsistent dividend growth, investors still got close to double-digit payout hikes per year (on average) over the past 17 years.
On top of that, the company hasn't diluted its common shares during the same period as it consistently used debt and preferred equity to fund its operations.
So far, and after decades of growth, the company is the 6th largest REIT in the United States based on enterprise valuation with 49 years of operations, 5,600 employees, more than 2,500 properties across 38 states, and an A2/A credit rating.
Basically, this company breaks two rules I have for companies in my portfolio. Dividend growth is the first one, while the second one is high entry barriers to operate in a certain industry. Storage isn't rocket science. However, scaling storage and leveraging operating capabilities is a tough job, which is why I still added the stock.
Additionally, I don't mind a steady dividend as long as the company is able to execute great real estate deals while maintaining an extremely healthy balance sheet.
On April 13, PSA announced the acquisition of ezStorage. This $1.8 billion deal was funded using unsecured debt and allowed the company to quickly incorporate these assets into its own business as there was a lot of overlap. This deal also allows the company to further develop these assets. Since 2019, the company has expanded its portfolio by 13% or 22 million square feet through acquisitions worth $4.3 billion.
The overview below accomplishes a few things. First of all, it shows the company's diversification and most of its key financial numbers per market. Needless to say, 1Q21 was a great quarter as the company was able to boost its average occupancy by 2.8% to 95.6%. In this case, all markets are close to the mid-90s with strong growth even in markets that are currently seeing a population shift to other areas (i.e., California -> Arizona). Realized rent per occupied square foot (incorporating utilization rates) improved by 1.7% while net operating income soared by 6.7%.
Source: PSA 1Q21 Earnings Financials
On a same-store basis, total revenues improved by 3.4%. This in itself is a good number, which gets better given that the company handled its expenses very well. The company saw a 5.7% decline in operating expenses, resulting in a 6.5% higher direct net operating income. Note that this includes favorable tax timing, which will continue in Q2 and Q3 and turn into a headwind in Q4.
With this in mind, the company was able to boost funds from operations (per share) by 18% to $3.08 as net income rose by almost $70 million.
Source: PSA 1Q21 Earnings Financials
On a full-year basis, the company sees FFO per share between $11.35 and $11.75 based on at least 4.8% net operating income growth - up to 7.3% growth. This would mean that the company finally breaks out of its sideways trend and allow the company to hike dividends again. I believe the company has waited until they were in control of costs and were able to turn acquisitions into sustainable long-term growth. Right now, it seems that we are at a point like that.
I think we could see dividends rise to at least $9.00 over the next 2 years. Likely higher. However, keep in mind that estimating a company's dividend growth is close to impossible, so take this with a grain of salt.
Based on this context, I expect the company to further reduce leverage. In 1Q21, the company reduced preferred equity by roughly $300 million while notes payable rose by $600 million due to acquisitions. As a result, debt to EBITDA is at 1.4x. Including preferred equity (and we should), gross debt to equity is at 3.2x.
Another thing worth mentioning is that debt-funded acquisitions will allow the company to use (future) recessions to buy attractive deals without having to dilute common stock at depressed prices - assuming that the next recession will pressure the PSA stock price. This, of course, is only possible as long as the company maintains a healthy balance sheet.
After many discussions with investors and followers, I know that PSA is flying under the radar as investors don't like flat dividends for multiple years. However, that didn't keep the stock from reaching a new all-time high last week. The company has added more than 20% to its market cap since the start of the year as investors like the company's growth prospects.
This is where the bad news starts. Based on 2021 analyst FFO expectations (within the company's own guidance range), the company is trading at 24x FFO, which is rather high given the company's historic valuation range. Even when using next year's expected value of $12 FFO per share the stock is trading at a lofty valuation.
The good news is that the company is still yielding close to 3.0%. That's fairly close to the 10-year average yield after briefly touching 4.5% during the COVID crash in 2020.
No, this title isn't clickbait (it never is), but I really love my PSA investment despite zero dividend growth since 2017. I believe that PSA is one of the best REITs on the market as it gives investors the chance to benefit from what I consider to be one of the best real estate segments as storage will continue to benefit from a rapid rise in housing prices and the need for storage. I didn't discuss this in this article, but I believe that the ongoing trend in advanced delivery methods (like same-day delivery) will only benefit companies that have storage facilities in all major cities.
Right now, the stock isn't cheap. If you are new to this company, I advise you to wait for the next 10% pullback as that's what I'm doing before I buy more stock.
The company is doing extremely well and I have little doubt that the recent improvements in FFO are just the start of a renewed long-term uptrend. This will more than likely result in new dividend hikes.
Also, the company has a phenomenal balance sheet and will without a doubt withstand any recession we might encounter on our investment journey and even use these recessions to its advantage.
(Dis)agree? Let me know in the comments!
This article was written by
Leo Nelissen is an analyst focusing on major economic developments related to supply chains, infrastructure, and commodities. He is a contributing author for iREIT on Alpha.
As a member of the iREIT on Alpha team, Leo aims to provide insightful analysis and actionable investment ideas, with a particular emphasis on dividend growth opportunities. Learn More.
Analyst’s Disclosure: I am/we are long PSA. 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 serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.
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