PSA - Extra Space Storage: Stock Bust Is Still Finding Its Bottom

2023-10-10 08:30:00 ET

Summary

• Extra Space Storage stock has seen a significant decline in its stock price, losing nearly 50% in value since December 2021.
• EXR has an "F" earnings revisions grade, the worst possible, and is rated by Seeking Alpha Quant as the worst pick in its peer set.
• It has also underperformed its peers significantly, corroborating the rating. However, Bulls could argue much pessimism could have been priced in.
• I assessed that EXR is no longer overvalued but seems, at best, fairly valued. Its forward dividend yield doesn't seem attractive enough compared to current Treasury yields.
• I explain why investors thinking about doubling down to catch the falling knives should remain patient, as it could be too early to do so.

Extra Space Storage Inc. (EXR) is one of the leading specialized REITs focusing on self-storage. It has a growing third-party management business, helping to diversify from its self-administered and managed base. Notwithstanding its scale, the self-storage market remains fragmented, suggesting price competition remains one of the critical driving forces on rental rates.

Extra Space Storage leveraged the pandemic boom, which saw its stock surge to $229, ultimately proving unsustainable. Its valuation reached bubbly levels then, driven by low interest rates and COVID tailwinds.

However, all the gains were eventually unwound, as EXR has continued to fall since it topped out in December 2021 without respite for holders. While there were moments of consolidation over the past two years, sellers returned with conviction to batter hopes. As such, EXR has collapsed nearly 50% in price-performance terms through this week's lows. It has also dropped well below its 50-month moving average or MA, losing its long-term uptrend.

As such, I'm not surprised that EXR is rated the worst of four self-storage REITs (as of October 8) in Seeking Alpha Quant's ratings.

As seen above, EXR significantly underperformed its peers in total return terms over the past year, scoring a negative total return of -28.1%. As such, investors shouldn't pin the blame solely on the market's dynamics, given EXR's troubling performance relative to peers.

In its second-quarter or FQ2 earnings release in July, management pointed out that it saw momentary weakness, which led to a downgrade in core FFO guidance. However, given relatively easier comps, it expects the second half to help support a growth inflection.

Despite that, EXR has declined since its Q2 call, suggesting investors have downgraded EXR's valuation further.

A glance over its peers' comparison could provide us with some clues on why investors could have shunned buying into EXR aggressively. As seen above, it notched an "F" in earnings revisions grade (the worst possible), well below Public Storage's ( PSA ) "B" grade. As such, I'm not surprised that PSA has performed relatively well in its peer set.

Notwithstanding EXR's waterfall decline, it's still not priced at an attractive discount relative to its peers. As seen above, EXR is, at best, fairly valued with a "C-" valuation grade, with no indication of a valuation dislocation to capitalize on. While it has robust profitability ("A") and growth ("A-") grades, it has not proved enough for investors, reflecting significant execution risks in the fragmented market.

Keen investors should recall that management pointed out that they were averse to lifting rental rates higher, given the competition from smaller players to maintain occupancy levels. In addition, I believe the market could also be pricing in higher execution risks as Extra Space Storage integrates its acquisition of Life Storage, which closed recently.

With a forward dividend yield of 5.6%, I believe the de-rating makes sense, as the 10Y Treasury yield surged to nearly 4.9% recently. The critical question is whether it's sufficient to appeal to income investors returning to the current levels when they have highly attractive "risk-free" rates to capitalize on. Therefore, we must assess EXR's buying sentiments to try and determine where buyers could be anticipated to return with more conviction, helping EXR to set up a more robust recovery.

Notwithstanding its dramatic price decline, EXR remains well above its January 2021 lows at the $106 level. It's also well above its COVID lows of $72.5 level, although EXR seems to have lost its long-term uptrend bias.

As seen above, the 50-month MA has underpinned its long-term uptrend over the past ten years. As such, EXR's price action indicates a structural change in long-term buying sentiments as investors reacted to the unprecedented rate hikes by the Fed.

Furthermore, I believe the downward de-rating from its July earnings release suggests that investors have correctly anticipated a higher-for-longer Fed, which could impede its execution in 2024.

I have yet to glean robust buying sentiments, giving me more confidence that buyers are keen to support the current levels. It's possible that EXR could fall further to re-test its January 2021 lows, leading to a consolidation and setting up an eventual bottom for a sustained recovery. As such, it's still too early to have a bullish opinion on EXR, and investors should remain on the sidelines.

Rating: Initiate Hold.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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