ALX - Alexander's Inc.: Increasing Profits Do Not Always Lead To Stock Growth

Summary

• Alexander's, Inc. is a REIT managing six properties in the New York City Metropolitan Area, one of which is home to Bloomberg L.P.
• A double usual debt/EBITDA of 10.7 raises red flags for the company and threatens its credit ratings.
• I rate it a Sell due to its declining cash flow, which is one of the most important factors of any REIT.

Investment Thesis

Alexander's Inc. ( ALX ) is a real estate investment trust ('REIT') with six properties in the New York City Metropolitan Area. ALX has leased its properties to high-end retailers and office tenants, one of which is Bloomberg L.P. The average duration of a lease is 8.5 years as of December 31, 2020. This gives a sense of stability and predictability of rental income, ensuring an attractive, stable stream of cash flow.

Growing wealth over time is a common investment agenda item. After 5 years of a severe downfall of 44% in the stock price, investors may have doubts about the survival of a business. There are no signs of recovery in the price, with a negative 2.51% return for the last 30 days. Having all of its properties concentrated in the New York City Metropolitan Area increases revenue risks in any distress situation like Covid-19, layoffs, downsizing, recession or change in state laws. On average, 52% of rental revenue comes from one single tenant, Bloomberg L.P, and no other tenant accounts for more than 10% of rental revenues. If Bloomberg does not fulfill its obligations as per the rental agreement, ALX's operations could be affected to a much greater extent, which, in my opinion, makes it risky to hold in a portfolio.

Real Estate and REITs

One of the most expensive real estate markets in the world is the United States. However, the commercial sector of this industry was severely impacted by the pandemic. Rental rates fell as more people started working from home instead of in offices, and demand fell significantly as businesses started cutting back on real estate leasing costs, particularly in metropolitan cities like New York. With a $36 trillion market, it is one of the largest sectors of the US economy. REITs specifically have a market capitalization of approximately $1.2 trillion as of December 2020. They are a real estate-based financial asset class which attracts investors with its ability to pool a strong cash flow by way of rental agreements. The industry, still feeling the effects of the pandemic, has enormous potential to expand in the foreseeable future, and REITs have a vital role to play in this development, particularly in the commercial sector where businesses choose to lease rather than purchase a property.

Increase in Funds from Operations

In the case of normal equity companies, investors look at EPS, whereas for REITs it's funds from operations ('FFO') that matters. The consensus for ALX's FFO has been decreasing since Q1 2022 and the forecast ahead is also negative, but this REIT manages to surprise every quarter not only by beating consensus but also by increasing FFO.

3 out of 4 quarters saw an FFO outperform, while the forecast ahead is still negative. This is accompanied by a revenue increase of $1.35 million. These signs give out positive indications to investors to stay invested in ALX.

Weak Debt/EBITDA and Cash Flow

ALX reported total revenues of $205.8 million, a decrease of 0.16% from the previous year. Net income of the REIT stands at $57.6 million as of December 31, 2022, which is the same as in 2021 and -56.64% in 2020. While ALX incurred a negative revenue, its peers NETSREIT Corp. ( NTST ), RPT Realty ( RPT ), Saul Centers Inc. ( BFS ) and The Necessity Retail REIT Inc. ( RTL ) all reported growth of 64.42%, 1.95%, 2.74%, 24.43% and 0.8% respectively.

Cash from operations, which is an important component of any REIT attracting investors, saw a decline of 13.44% from 2021 to 2022. Cash from investing declined 243.53% in fiscal year 2020. While an optimum value is anything greater than 1, operating cash flow per share for ALX is -3.1 which suggests that the business runs out of earnings after meeting its short-term liabilities. With a debt/EBITDA ratio of 10.7, ALX exceeds the preferred range of 4-5 for most REITs. Investors typically become alarmed by a high debt/EBITDA ratio because it has an impact on REITs' credit ratings, which are crucial because REITs need low-interest loans to operate with acceptable cash flows and profits.

The chart above shows the value of $100 invested in three different market instruments: ALX, S&P 500 and National Association of Real Estate Investment Trusts NAREIT (NAREIT) in 2016. While both NAREIT and S&P 500 give a positive return of 80% and 133%, ALX gives -20%.

Valuation

According to the P/E multiple stock valuation approach, the stock's intrinsic value was determined to be $334.03; using the EV/EBITDA multiple, it was $416.30. It averages out to $375.16, which is 66% more than the stock's current trading price.

This might seem like a higher valuation and slow growth prospects, but the impact of cash flow is not taken into consideration for both these approaches, an important component for valuing a REIT.

Conclusion

Prime locations, a solid tenant base and long-term leases put up a strong foundation for ALX's growth. A progressive real estate sector builds a strong case for the company's growth soon, but a detailed review of financials, declining share price despite earnings surprise and declining cash flow raises concerns for investors. Dependency on a single big tenant for rental income raises a red flag alongside the double than usual debt/EBITDA multiple. On its weaker cash flows and struggling revenue, I rate this REIT a sell.

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