ELS - Equity LifeStyle: Wait For A Better Entry Point

2023-07-07 08:30:00 ET

Summary

• Equity LifeStyle Properties owns high quality locations and has a demonstrated track record of growth.
• However, ELS's growth is slowing down due to lower transient stays and cost inflation.
• Although ELS maintains a strong balance sheet and pays a safe dividend, the shares appear to be expensive at present.

It's always nice to be in a long-term winning REIT segment, especially when other asset classes like office properties are currently showing weakness. This holds true for the manufactured housing segment, which continues to demonstrate growth trends. However, even this segment is showing signs of a slowdown

This brings me to Equity Lifestyle Properties ( ELS ), which I last covered here back in fall of 2020, highlighting its demographic tailwinds. The stock has given investors an 18% total return since then, slightly underperforming the 21% rise in the S&P 500 ( SPY ). In this article, I revisit the stock and discuss the valuation at which I'd be interested.

Why ELS?

Equity LifeStyle Properties is a leading REIT that invests in manufactured housing, RV, and campground sits across North America. It's also one of the oldest REITs around, having been founded in 1969 and has since grown to an enterprise value of $16.5 billion. At present, ELS has 450 properties comprising 171K sites across 35 U.S. states and 1 Canadian province.

ELS's investment strategy is to own high-quality properties in retirement and vacation destinations. This includes 110 properties with lake, river, or ocean frontage and over 120 properties within 10 miles of coastal U.S. Most of ELS's properties are also retiree-friendly, with over 70% of them being age-restricted at an average age of 55+. California, Arizona, and Florida represent ELS's 3 top states, comprising 55% of its properties. Those 3 states are also projected to have above average growth in the age 65+ population, as shown below.

Moreover, it's an open secret that MH REITs like ELS are essentially a "land bank", in which it owns the underlying land with plenty of development potential. This also results in sticky tenant relationships, as renters on MH sites tend to have significant equity stakes in their manufactured home, and rent the land from ELS. The combination of development and durable tenant relationships have translated into strong operating performance for the company. As shown below, ELS has grown its NFFO/share at an impressive 9% CAGR between 2006 and 2022.

However, it appears that growth is slowing down, with total revenue rising by just 2.8% YoY to $370 million during the first quarter. This was due in part to lower transient stays. NFFO per share also grew by just two cents over the prior year period to $0.74. While core property operating revenues grew by a respectable 6.4% YoY, ELS has also been bit by cost inflation, as core property operating expenses grew at a faster rate of 7.4%, resulting in core income from property operations growing by just 5.7% YoY.

Nonetheless, ELS maintains a strong balance sheet, with a safe debt to adjusted EBITDAr ratio of 5.2x, sitting below the 6.0x level generally considered to be safe for REITs by ratings agencies. It also has a strong 5.5x interest coverage ratio with a low 3.8% weighted average interest rate, and just 7.5% of its debt is floating rate. ELS also has low refinancing risk in the near term, as it carries a long weighted average debt maturity of 10 years, with just 6% of debt maturing over the next 3 years.

Importantly for income investors, the 2.7% dividend yield is well-protected by a 63% payout ratio, and comes with a 10.6% 5-year CAGR. However, I would expect for dividend growth to be muted in the near-term considering the slower growth and higher operating expenses.

Looking ahead, cost inflation may persist for some time, considering that U.S. layoff fell to a seven-month low in June, which could result in difficulties in retaining and attracting employees for ELS. Also, ELS has significant exposure to Florida's coastline, which has come under pressure in recent years from hurricanes. Insurers have taken notice by raising premiums in Florida, which already has 4x the national average, and this could be another cost headwind for ELS going forward.

Turning to valuation, I view shares as trading at a premium at the current price of $66.43 with a forward P/FFO of 23.3, sitting well above the stock's normal P/FFO of 20.3. Considering the far lower valuations of net lease REITs such as Realty Income Corp ( O ), with a forward P/FFO of 14.5, and the potential headwinds facing ELS, I don't find the current share price to be appealing. As such, I think ELS would be more attractive in the current environment should it fall by 10-20% from the current price.

Investor Takeaway

Equity LifeStyle has given investors strong shareholder returns over its history. However, it's not immune to current headwinds, which the market does not appear to have fully baked into the valuation. While it carries a strong balance sheet and pays a safe dividend, I don't see much catalysts propelling the stock forward in the near term. As such, value investors ought to wait for a better entry point as the shares currently appear to be expensive, especially compared to other REIT sectors.

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