Alexandria Real Estate: Stable Dividend With An Expected Raise
Summary
- More than 15% of the company’s total revenue comes from pharma and lab space rentals.
- ARE is yielding 2.2% and I expect a dividend raise of 2-7% in 2022.
- Q3 represented the second-highest leasing quarter of development and redevelopment square footage in the company’s history.
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Investment thesis
As the pandemic continues with different variants the healthcare and biotech sector can make great profits by developing new forms of vaccinations and pills against COVID-19 infections. Alexandria Real Estate Equities, Inc. (NYSE:ARE) has already taken its profit share from leasing labs and will continue to make massive rental income in the future. ARE entered into a strategic relationship with Moderna and more than 15% of the company’s revenue comes from biotech and lab office space leases. The price tag on its stock is high but there is fundamental support behind it. In addition, the company can raise the rental fees heavily (above inflation) which can make ARE a good stock to hedge against inflation.
Business Model
Alexandria Real Estate is an urban office real estate investment trust (REIT). The company is an S&P 500 investment-grade REIT (Moody's: Baa1 / Stable; S&P Global: BBB+ / Positive). They own, operate, and develop collaborative life science, agtech, and technology campuses in the top urban innovation clusters in North America. ARE has a total market capitalization of almost $35 billion as of January 2022, and an asset base in North America of 49.7 million square feet. The company’s revenue comes from 2 different sources. We can say that the rental income is the significant one as 99.76% of the revenue comes from office leases and only 0.24% from other sources such as construction management fees and interest income earned.
Source: The chart is created by the author. All the figures are from the company's financial statement of Q3 2021.
Financials & Earnings
Q3 results
The company had a good third quarter and also had a great 2021. The total revenues in YTD Q3 2021 grew by 8.1% compared to YTD Q3 2020 results. Funds from operations are also on the rise with the company outperforming YTD Q3 2020 by 6%. Rental rates increased (cash basis) by 22.3% in 2021 representing a very healthy profit margin for ARE. In addition, Q3 represented the second-highest leasing quarter of development and redevelopment square footage in the company’s history. Net operating income (cash basis) was $1.3 billion for 3Q21 annualized, up to $234.3 million, or 21.2%, compared to 3Q20 annualized.
In September 2021, ARE signed a 15-year full-building lease with Moderna, Inc. (MRNA) to develop, construct, and operate its new headquarters and core R&D facility. In October 2021, S&P Global Ratings upgraded their corporate issuer credit rating outlook to BBB+/Positive from BBB+/Stable as a result of their consistently strong operating performance and long-term positive fundamentals. ARE had $4.0 billion of liquidity as of September 30, 2021. Their Top 3 tenants are pharma and biotech companies that represent almost 8% of the company’s total rental income. In addition, more than 15% of ARE’s income comes from biotech companies.
Source: Earnings Supplemental Information
Valuation
There is no doubt that ARE is expensive at the moment. However, I do not think it is overvalued but rather fairly valued. The price to TBV is on the rise because the value underneath the surface indicates this growth. Funds from operations are also growing in line with the stock price. In terms of external fundamentals, the rise is reasonable with the still ongoing pandemic and ARE’s close relation to biotech companies and R&D lab rentals. We saw a 25%+ stock price appreciation in 2021 thanks to the amazing results and the Q3 representing the second-highest leasing quarter in the company’s history. With the continuing spread of the COVID-19 in 2022, the company can still be in a great position to raise rental income, providing further value and causing further stock price rise.
Comparing the tangible book value to ARE’s peers we can see similar trends forming. ARE is trading well above its TBV but that is normal for office REITs. ARE has reached pre-pandemic price to tangible book value ratios in December 2021 while its peers trade below their pre-pandemic valuation in terms of TBV. Boston Properties, Inc. (BXP) trades approximately 20% below pre-pandemic levels of price to TBV while Vornado Realty Trust (VNO) trades approximately 25% below its pre-pandemic TBV. This can indicate a high valuation for ARE but it is due to the nature of offices and industry they are in.
Source: Seeking Alpha
Company-specific Risks
ARE’s properties can be subject to increases in operating expenses, including insurance, property taxes, utilities, administrative costs, and other costs associated with security, landscaping, and repairs and maintenance of their properties. The company’s leases (on an RSF basis) were triple net leases, which require tenants to pay substantially all real estate and other rent-related taxes, insurance, utilities, common area expenses, and other operating expenses (including increases thereto) in addition to base rent. The cost of maintaining the quality of their properties may be higher than anticipated, which can result in reduced cash flows and profitability. This can especially be the case in the R&D and lab rentals as there are several regulations and requirements that ARE has to maintain.
ARE has a strategic relationship with Moderna from Q3 2021 which is great news for rental income and future property development. However, at the same time, this is a potential risk because if Moderna will have financial issues it will affect ARE as well. The exposure to the biotech and lab offices carries the same risk: sector risk. Due to more than 15% of Alexandria’s rental income coming from this sector, a future downturn will equally affect the company. Cost of capital will be a potential risk factor for the upcoming years because as the rate hikes happen in 2022 the cost of capital will also rise.
My take on ARE’s dividend
Current dividend
Alexandria will become a Dividend Payment Champion in 2022 if they continue to pay dividends. (Dividend Payment Champions: companies that pay dividends for at least 25 years, while Dividend Champions have at least a 25-year consecutive dividend growth history). ARE is not a Dividend Champion just yet but has an impressive 11-year consecutive dividend growth history. ARE has a 2.2% forward dividend yield and pays $1.15 per share quarterly. The most recent increase happened in December 2021 when the management declared a 2.7% rise from $1.12 per share to $1.15 per share quarterly dividend.
Future sustainability
A great indicator for REIT companies to determine the future stability of the dividend is the payout ratio but calculated with funds from operations. This is important because if we calculate with the standard EPS per dividend metric we can see false numbers just like with ARE. If we look at the payout ratio we can see an extremely high payout ratio according to Seeking Alpha (118.1%), according to Finviz (131.50%) and we can have an impression that the dividend is unsustainable. However, looking at the FFO per dividend metric we can see that the dividend is in the healthy levels with a 50-60% average payout ratio. This also indicates that there is room for future increases and I expect a dividend increase in 2022. Similarly, to 2021’s last increase I calculated a moderate 2% raise for Q3 2022. Seeking Alpha analysts estimate a bigger raise with a 7-9% dividend increase which can be realistic if the company can significantly increase its rental income.
Source: The table is created by the author. All figures are from the company's financial statements and SA Earnings Estimates.
Summary
Alexandria looks overvalued and it is expensive at the moment but there are several reasons behind its price so that is why I think the current valuation is reasonable. For an investor who wants to get exposure to biotech and lab offices and future biotech R&Ds via a REIT, Alexandria can be an ideal choice. In 2022 I also expect a small dividend raise but given the current profitability, the raise could be 7-9% which is an above-inflation return on dividends. The stock price experienced a 30% return almost in line with the S&P 500 total return so there is still room for growth. However, first and foremost I would buy ARE for the long-term dividend returns and stock price appreciation.
This article was written by
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