PSA - Building Wealth With Public Storage: My High-Conviction Dividend Play

2023-05-24 15:27:49 ET

Summary

• Public Storage is a strong self-storage operator with consistent outperformance, a solid balance sheet, and an attractive dividend yield of 4.2%.
• The company benefits from a highly fragmented market, strong brand recognition, and technological advantages, contributing to its success.
• Despite economic headwinds, the self-storage industry maintains strong fundamentals, and PSA's valuation is attractive with a consensus price target indicating a 20% upside.

Introduction

I started buying real estate investments in 2020. Since then, I have bought two REITs. Both of them are self-storage REITs. One of them is Public Storage ( PSA ) , which used to be the nation's largest operator before Extra Space Storage ( EXR ) bought Life Storage ( LSI ).

While having 100% real estate exposure in the self-storage industry is somewhat unorthodox, I made that decision based on a number of factors.

• I believe this low-entry barrier industry can be exploited rather efficiently by strong operators.
• I like the benefits that come with self-storage assets, including potential last-mile logistic operations and (related) micro-warehousing.
• Secular benefits like housing shortages and population growth benefit the need for self-storage.
• Furthermore, self-store assets can be bought in bulk, which attracted a lot of capital when rates were low.

However, right now, headwinds are mounting. Rates are increasing, consumer sentiment is terrible, and the Fed isn't likely to return to low rates anytime soon - not unless something breaks in the economy.

While these developments aren't fun, they offer great buying opportunities, which is why I have been expanding my real estate holdings.

In this article, I will explain why I am such a big fan of Public Storage and why I expect it to generate tremendous shareholder value on a long-term basis.

So, let's get to it!

What Makes PSA So Special

Public Storage is the second-largest self-storage operator in the United States. It has accumulated roughly 2,900 owned properties in its 50 years of operation.

The company serves 1.8 million customers in 40 states. Since 2019, the company has expanded its portfolio by 28%, making it the fastest-growing self-storage REIT since then (excluding the takeover of peers).

The company's expansion is the reason why its dividend growth over the past few years was rather disappointing.

In 2016, the company hiked its dividend by 11.1%. It then took roughly seven years until the company hiked again. This excludes last year's $13.15 special dividend as a result of a major asset sale.

The good news is that the company made up for poor historical dividend growth.

Earlier this year, it hiked its dividend by 50% to $3.00 per share per quarter, which implies a 4.2% dividend yield. This dividend is backed by a 64% FFO (funds from operations) payout ratio, which is below the sector median of 75%.

This is less than ten basis points below the yield of the Vanguard Real Estate ETF ( VNQ ), which I like to use as a benchmark.

PSA has outperformed this ETF by roughly 100 points over the past ten years. This outperformance has been steady, as the company has outperformed the ETF on a very consistent basis.

Note that this significant outperformance happened despite consistent underperformance versus all of its major stock-listed peers.

Year-to-date, PSA is up 2.6%, excluding dividends. VNQ is down 2.9%.

This is backed by net operating income outperformance. Since 2004, PSA's NOI has increased by 5.1% per year, beating the real estate sector average by 240 basis points.

With that in mind, there are a number of reasons that make PSA a great company.

First of all, the company believes that a highly fragmented market offers the ability to grow quickly. I briefly highlighted this at the start of this article, as the top five owners in the industry own just 20% of the total self-storage market.

Second of all, PSA has strong brand recognition. Wherever a new PSA store pops up, people know what to expect.

Thirdly, the company has strong technology integration. The company has invested heavily in technological capabilities that smaller (private) peers cannot compete with. This gives the company an edge in the industry and allows for market share gains.

Key technological advantages include:

• Convenient Shopping Experience : Customers can easily browse and compare available storage spaces, locations, amenities, and pricing through PSA's website, customer care center, and in-store kiosks. The website serves as a primary source of customers, with approximately 79% of move-ins in 2022 originating from online interactions.

• eRental Move-In Process : PSA offers an eRental process that allows customers to execute rental agreements from their smartphones or computers. This streamlined move-in experience was utilized by more than half of PSA's customers in 2022.

• Public Storage App : PSA maintains a leading customer smartphone application, providing digital access to properties, payment options, and other account management functions. This app enhances convenience and accessibility for customers.

• Centralized Information Network : PSA utilizes a centralized reporting and information network, allowing them to quickly analyze changing market conditions, operating trends, and customer data. This network enables efficient pricing adjustments, promotions, and targeted marketing efforts.

On top of that, the company has high acquisition and development yields.

• Despite high rates, acquisition yields have remained strong, backed by high occupancy rates and strong rent growth.
• Development yields are even stronger, as improving existing assets has led to strong growth in occupancy rates and average rents.

It also helps that PSA has an exceptional balance sheet with an A2/A credit rating.

The company has $5.3 billion in USD debt, $1.7 billion in EUR-denominated debt, and $4.4 billion in preferred equity. The net leverage ratio (including preferred equity) is 3.4x EBITDA, which is below the company's target range of 4.0-5.0x. It indicates that PSA has additional capacity to fund inorganic growth.

With all of this in mind, it's important to assess the health of the self-storage industry to make sense of the company's valuation.

Industry Health & Valuation

According to Yardi Matrix 's recent May self-storage report, the self-storage market maintains strong fundamentals despite recent challenges. While occupancy has declined from pandemic highs, demand remains firm, and street rates are rising during the busy leasing season.

REITs reported higher-than-expected operating income and competition from new supply is expected to slow as developers face rising costs. Although the slowing economy and housing market could impact demand, the self-storage sector has historically shown resilience during economic stress, which is one of the reasons why I own self-storage stocks.

With regard to new supply, the self-storage pipeline shows stable construction but expanding planning stages, indicating challenges in starting new projects due to financing costs, stricter standards, and uncertainty.

Yardi Matrix has revised the forecast for new deliveries in 2025 to 2.4% growth. Orlando stands out with the largest supply under construction, driven by in-migration and investor interest.

These developments are supported by PSA's results. The company experienced a strong operating performance in the first quarter, with existing customers performing well and a nearly 13% increase in same-store move-ins.

The length of stays remained long, resulting in a nearly 10% year-over-year increase in same-store revenues.

The company's non-same store acquisition and development pool, accounting for nearly 25% of the portfolio, continued to outperform.

According to the company, the needs-based nature of the self-storage industry and the increasing permanence of remote and hybrid work contributed to the favorable demand drivers.

As a result, the company lifted its outlook for the year, driven by increased same-store revenue assumptions and encouraging performance to date.

Furthermore, during its earnings call , analysts asked the company about non-payment issues and economic weakness.

The company explained that while there has been an increase in late payments compared to the previous year, the delinquency levels remain well below 2019 levels.

The uptick in late payments is also attributed to the significant move-in volume growth, which includes administrative fees charged to new customers. The increase in the late charges line item reflects these factors.

Using the company's guidance, PSA shares are trading in the 17.1 to 17.8x FFO range.

While economic risks are persistent, the company's valuation is attractive.

The current consensus price target is $343, which implies a 20% upside. The latest price target is from Bank of America ( BAC ), with a buy rating and a $365 price target.

While I do not expect PSA shares to rally suddenly, I agree with these price targets and will continue to accumulate shares at current levels.

Takeaway

Public Storage is the second-largest self-storage operator in the US, serving 1.8 million customers in 40 states. Despite facing headwinds such as increasing rates and consumer weakness, PSA offers great buying opportunities due to its strong position in the industry.

The company has a track record of consistent outperformance, beating the real estate sector average and the Vanguard Real Estate ETF over the past ten years.

PSA's success is based on factors like its ability to exploit the highly fragmented self-storage market, strong brand recognition, and technological advantages.

The company has a solid balance sheet, high acquisition and development yields, and an attractive dividend yield of 4.2%.

Furthermore, the self-storage industry maintains strong fundamentals, and PSA's results reflect a favorable operating performance, with increased same-store revenues and positive demand drivers.

Despite economic risks, PSA's valuation is attractive, with a consensus price target indicating 20% upside potential.

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