DLR - Crown Castle: Growth Story Done Look Under $100

2023-03-23 14:10:29 ET

Summary

• Crown Castle has struggled over the last 12 months.
• The stock has been hit with dual forces of a terminating growth story and valuation compression.
• We review the numbers and see the price this becomes buyable.

Over the last 12 months, our stance on high multiple REITs has generally been negative. We have expressed that mainly through Sell ratings on closed end funds that own such REITs as their top names . Crown Castle ( CCI ) fits this description perfectly as well. As a former growth darling, it held a too-high multiple for the problems coming down the pike. On our last coverage of this REIT, we had suggested a defensive way of playing this REIT, namely the $150 covered calls.

That might have seemed too defensive for some tastes but actually did quite well on a relative basis. While the stock itself delivered negative 10% returns till Jan. 20, 2023, (closing at $148.03), the option actually made 8%, outperforming by 18% in a difficult period. We look at the fundamentals today and update our view.

Q4-2022

CCI's momentum from the strong capex cycle of 2022 continued into the fourth quarter. Revenues exceeded previous guidance slightly, though adjusted EBITDA and adjusted funds from operations (AFFO) fell marginally short.

Guidance for 2023 was for a small bump in revenues, EBITDA, and AFFO.

Coming on the back of a strong inflationary year with rapidly-rising interest rates, it was clear that CCI's own expenses would rise quickly. CCI's bridge explained the big drop in expected 2023 AFFO growth relative to the previous outlook.

Going off midpoint numbers, AFFO growth has dropped by about 66% relative to the last outlook. The good part is that CCI is really stingy with expanding its share counts, so AFFO per share will expand at the rate of AFFO.

Longer-Term Growth Story

CCI, like many other growth darlings of 2021, has suffered from extrapolation of past trends. Analysts just drew straight extensions of lines and assumed the growth would come, rain or shine. This is easy to do in boom times and all you need is a few catchphrases like "5G," or "total addressable market," or "99% untapped," to get the crowd on board.

What's often lost in the discussion is that CCI revenues are someone else's expenses.

Imagine if AT&T ( T ) and Verizon ( VZ ) came out in their investor presentations and told you that they would grow capex 10%-15% a year for the next 10 years. Both stocks would probably tank hard on the news, as no investor would appreciate such a silly commitment. But when growth stock analysts tell you the same story from the other side, people "buy" it. Well, they're not buying it anymore and that explains the malaise here.

Longer-term numbers are coming down in a hurry. If the estimates are to be believed, 2027 funds from operations (FFO), will be lower than what we saw in 2022.

As bad as that sounds for a growth story, we think there's downside to those numbers in a recession. If you hear the guidance for capex from both Verizon and AT&T, it should create additional caution for these numbers. In other words, there is downside to these and the growth crowd will really freak out if they see an AFFO number beginning with a "$6."

Valuation

On an AFFO or FFO multiple basis, the stock does not look very expensive. We're looking at about 17X-18X on a 2023 basis. The stock is not very debt-heavy either. Its revenues are quite predictable, although there might be some downside, as we mentioned above. We agree with Fitch's rating methodology here and think the firm should be able to access capital markets at will. But what the valuation lacks here is pricing for a company that has stopped growing. Even if take that 2023-2027 forecast and bump it for another imaginary boom, you're unlikely to come close to even 3% annualized growth from here. Historically, these transitions from teen percentage growth to numbers that come in under the inflation rate, are very painful. Markets tend to overshoot on the downside. In this scenario, with the probability of a recession being close to 99% in our view, we see a 14X multiple as the bare bones that you will get in a flush. So $100 or thereabouts looks in the cards at this point.

Verdict

2023 is likely to be the year when the full impact of the rate hikes flows through into the economy. These tend to act with a big lag, and they will hit hard in Q3 and Q4. Alongside that negative, keep in mind that many closed-end funds are leveraged into these kinds of names. Most own CCI, Prologis, Inc. ( PLD ), American Tower Corporation ( AMT ), and Digital Realty Trust, Inc. ( DLR ) as their top picks. That leveraged nature, alongside the need to pay completely unsustainable distributions, makes some heavy downside fireworks probable. Funds like CBRE Global Real Estate Income Fund ( IGR ) and Aberdeen Global Premier Properties Fund ( AWP ) have relied on capital appreciation to fund those massive yields and as stocks slide they are forced to sell every month to balance their leverage ratios and fund distributions. We see these as major forces for the sector, and CCI will be impacted more than other REITs. We rate the stock a hold at present and would get more constructive under $100. In the interim. The $100 Covered calls would be the best "option" for those wanting some income.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

For further details see: