Postal Realty Got Cheap Again

May 17, 2022 9:14 PM ETPostal Realty Trust, Inc. (PSTL)24 Comments26 Likes

Summary

  • Postal Realty continues to grow nicely.
  • Its fundamentals are quite steady.
  • As its price dipped, PSTL is once again opportunistically priced.
  • Looking for more investing ideas like this one? Get them exclusively at Portfolio Income Solutions. Learn More »
United States Post Office in San Antonio, Texas

Gunther Fraulob/iStock via Getty Images

It seems as though nothing has been spared from the market carnage. Postal Realty (NYSE:PSTL), due to its post office leasing contracts with the Federal government, is largely immune to macro changes so its fundamentals are still strong, but its market price has fallen with everything else. At this now lower price point, I think it is once again quite opportunistic.

In particular, I think there are 3 aspects of its business that are getting overlooked.

  • Over-equitized heading into market crash
  • Re-leasing opportunity – mark to market with inflation
  • AFFO vs FFO compared to peers

Cash pile is looking great right about now

I was a bit grumpy when Postal decided to issue a boat load of equity in November. Specifically, they issued $83 million worth of shares at $17 per share on 11/15/21.

tabl

S&P Global Market Intelligence

Noting that even after the issuance PSTL has a market cap of about $300 million, it was quite massive.

The issuance was technically accretive in the long run in that once they get it fully invested in properties the cap rate on acquisitions is likely to exceed the dilutive cost of the capital. So, it was not a bad issuance necessarily, but I thought the accretion to FFO/share could have happened much faster if they instead broke that into multiple smaller issuances closer to the time at which the capital would be deployed.

See what happens when a big chunk of equity is issued and then it takes a while to put together the acquisitions that the company operates in an over-equitized fashion until it gets deployed. This shows up in the data as debt to total capital dropped well below 20% in 4Q21.

Chart, bar chart Description automatically generated

S&P Global Market Intelligence

This is not an efficient level of leverage in that it is not minimizing cost of capital. PSTL has access to rather cheap debt and its equity is fairly expensive. Somewhere around 30-40% debt to total capital is a much more efficient level, even on a risk-adjusted basis.

This over-equitization has been leaving money on the table for the past few months.

However, that whole analysis changes with the market crash. After the market’s freefall, companies are finding it much harder to raise capital so it would potentially be difficult to match fund fresh equity raises with acquisitions.

Given this new information, Postal’s giant equity raise during the good times looks prescient. I’m not sure if it was a case of Andrew Spodek (their CEO) having precognition or if they just happened to issue and then got lucky that it turned out to be the right move.

Either way, this cash hoard is about to pay dividends to PSTL as they get to continue to execute on their accretive acquisition pipeline while much of the rest of the market has to slow down.

Accretive acquisitions

Given the sharp rise in interest rates, I suspect that will keep cap rates relatively high in the postal property space. Cap rights were already in the 7s for PSTL, and they might rise to around 8% if the Fed keeps doing what they are doing.

With its extremely low leverage, PSTL is positioned to buy as much as $100 million of post offices without issuing any more equity. That would simply take them up to a more normal leverage level.

At cap rates of 7.5-8%, this would be incremental annual NOI of $7.5-8 million. Netting out $4 million of interest expense assuming a 4% cost of debt that is incremental accretion to FFO of $3.5-4 million.

That is about a $0.20 increase to FFO/share at the midpoint.

Why I think the market is missing this info

The analyst consensus is calling for steady growth at PSTL, but at a more moderate pace.

Graphical user interface, application Description automatically generated

S&P Global Market Intelligence

They have PSTL going from $0.97 in 2022 to $1.07 in 2023.

I think this is wrong.

See 2022 is a trough year due to timing of the dilution from the massive equity raise. PSTL had already crested $0.25 quarterly in 2021 but simply got knocked back down heading into 2022 from that November issuance.

Chart, bar chart Description automatically generated

S&P Global Market Intelligence

I think the analysts are calling for the ~$100 million of acquisitions to be financed with a blend of equity and debt but they are missing that the equity component is already in the numbers.

Since they are coming from this point of over-equitization it means the acquisitions can and should be financed entirely with debt to get back to a more normal level of leverage. Since debt is significantly cheaper than equity, it means the spread between ROIC and WACC is closer to 350-400 basis points rather than the more normal 200 basis points that the analysts seem to be factoring in to their FFO estimates.

Thus, from the acquisition side alone, I think PSTL will blow by the consensus analyst estimates. The market tends to follow the street, so I don’t think the higher FFO/share I’m estimating is priced into the stock.

Further, there is significant upside to FFO from organic growth.

Mark to Market Opportunity

PSTL has significant lease roll-over in the next few years.

Table Description automatically generated

PSTL

Leases with the post office are significantly different than most commercial real estate leases. The government tends to sign flat leases rather than the normal escalators.

During the lease term this is clearly a negative, but when the lease rolls it is rolling from that flat level rather than an escalated level. Thus, the new lease factors in the cumulative inflation of the entire duration of the previous lease term. If it was a 5-year term which is fairly typical for post offices, the new lease will be higher by approximately 5 years of inflation give or take a bit for other mark to market forces.

Well, for the leases coming due in 2022, 2023 and 2024, 5 years of inflation is a huge number. I would anticipate lease roll-ups in the vicinity of 20% with perhaps a bit more for the 2024 rolls and a bit less for the 2022 rolls.

Between the primarily debt financed acquisitions and significant organic lease rate growth, I think PSTL will beat consensus FFO/share estimates by a significant margin.

Valuation – PSTL’s FFO goes further than that of peers

Neither FFO nor AFFO is a perfect earnings metric for REITs, and we usually have to make a couple adjustments to get to a clean number.

FFO is nice because it is NAREIT defined, so companies cannot sneak things in there. However, it is notably lacking in its accounting for tenant improvement and leasing commission costs (TI and LC).

AFFO is better in this regard, because it accounts for maintenance costs such as TI and LC. However, it too has problems because it is not a defined metric and companies can throw in unclean things.

For most REITs there is a gap between FFO and AFFO due to the TI and LC. The gap is enormous in office where these expenses are as much as 20% of revenue, but still quite prevalent in Postal’s industrial sector. Note below that the average industrial REIT trades at 30.1X AFFO.

Graphical user interface Description automatically generated with medium confidence

S&P Global Market Intelligence

In contrast, the sector trades at 26.2X FFO.

A screenshot of a computer Description automatically generated with medium confidence

S&P Global Market Intelligence

The FFO multiple is significantly lower because FFO is significantly higher than AFFO due to TI and LC.

Postal Realty is the exception. The government renews its post office leases at a very high rate around 98% whereas most of the sector has retention of about 50-70%. So, this means there is a lot less leasing to do and the post office also generally doesn’t require TI or LC to renew their leases.

As such PSTL’s AFFO is actually a bit higher than its FFO/share. This means that PSTL has a higher quality of FFO in that it does not lose a chunk to TI and LC.

Despite this advantage, it trades at a steep discount at 16.7X ($16.18/ $0.97) while the average industrial REIT goes for 26.2X.

I find this to be an opportunistic multiple given the growth PSTL has ahead from both acquisitions and roll-ups on renewed leases.

PSTL also looks attractive from a NAV standpoint with NAV around $18.25

Chart, line chart Description automatically generated

S&P Global Market Intelligence

Wrapping it up

Postal is still quite small so there is some risk inherent to that, but I think its size is also a plus in 2 potential ways.

  1. As PSTL crosses about $600 million it will be added to REIT indexes and the associated ETFs which tends to cause a flux of new buyers.
  2. It is a bite size acquisition making it a potential M&A target.

Overall, PSTL strikes me as undervalued and well positioned to handle this environment.

Make your money work for you

At Portfolio Income Solutions we do the rigorous analysis to determine which stocks will work and which won’t. We then curate a portfolio of the most opportunistic individual stocks and provide members with continuous analysis to help keep their investments in shape. We constantly watch the market in order to buy and sell the right stocks at the right times.

Start investing with the aid of dedicated research by joining Portfolio Income Solutions.

Not sure yet? Grab a free trial. Canceling is easy and there are no obligations.

This article was written by

Dane Bowler profile picture
21.03K Followers
Access professional analysis and a curated high yield portfolio

2nd Market Capital Advisory specializes in the analysis and trading of real estate securities. Through a selective process and consideration of market dynamics, we aim to construct portfolios for rising streams of dividend income and capital appreciation.

Our Portfolio Income Solutions Marketplace service provides stock picks, extensive analysis and data sheets to help enhance the returns of do-it-yourself investors.

Investment Advisory Services

We now offer a way to directly invest in our Proprietary Investment Portfolio Strategy via REIT Total Return, which replicates our activity in client accounts. Total Return client’s brokerage accounts are automatically invested simultaneously and at the same price when we make a trade in the REIT Total Return Portfolio (also known as 2CHYP).

Learn more about our REIT Total Return Portfolio.

Dane Bowler, along with fellow SA contributors Simon Bowler and Ross Bowler, is an investment advisory representative of 2nd Market Capital Advisory Corporation (2MCAC). As a state registered investment advisor, 2MCAC is a fiduciary to our advisory clients.


Full Disclosure. All content is published and provided as an information source for investors capable of making their own investment decisions. None of the information offered should be construed to be advice or a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. The information offered is impersonal and not tailored to the investment needs of the specific person. Please see our SA Disclosure Statement for our Full Disclaimer.

Follow

Disclosure: I/we have a beneficial long position in the shares of PSTL either through stock ownership, options, or other derivatives. 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.

Additional disclosure: Important Notes and Disclosure
All articles are published and provided as an information source for investors capable of making their own investment decisions. None of the information offered should be construed to be advice or a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person.
The information offered is impersonal and not tailored to the investment needs of any specific person. Readers should verify all claims and do their own due diligence before investing in any securities, including those mentioned in the article. NEVER make an investment decision based solely on the information provided in our articles.
It should not be assumed that any of the securities transactions or holdings discussed were profitable or will prove to be profitable. Past Performance does not guarantee future results. Investing in publicly held securities is speculative and involves risk, including the possible loss of principal. Historical returns should not be used as the primary basis for investment decisions.
Commentary may contain forward-looking statements which are by definition uncertain. Actual results may differ materially from our forecasts or estimations, and 2MC and its affiliates cannot be held liable for the use of and reliance upon the opinions, estimates, forecasts, and findings in this article.
S&P Global Market Intelligence LLC. Contains copyrighted material distributed under license from S&P
2nd Market Capital Advisory Corporation (2MCAC) is a Wisconsin registered investment advisor. Dane Bowler is an investment advisor representative of 2nd Market Capital Advisory Corporation.

Recommended For You

Comments (24)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.