TRNO - First Industrial: Buy The Dip On This Fast-Growing REIT

2023-10-07 00:47:14 ET

Summary

• First Industrial is a self-managed REIT specializing in distribution centers and light industrial properties in large, supply-scare MSAs in the U.S.
• The company has a strong balance sheet, high occupancy rates, and a robust development pipeline.
• The stock is reasonably priced with a very well-covered and growing dividend, especially considering its very high cash rent growth.

There are some stocks in growth industries that one can put on the back burner, and that may be the case with First Industrial ( FR ). It’s been a while since I last visited the stock here with a ‘Buy’ rating back in February of 2021, highlighting its strong execution and attractive development pipeline.

It appears that my bullishness around the stock has paid off, as the stock has given investors a 16.6% total return, surpassing the 10% rise in the volatile S&P 500 ( SPY ) over the same timeframe.

Like most REITs, FR’s stock price has fallen over the past 30+ days, but has held up well on a 12-month basis with flattish performance. In this piece, I discuss why growth investors may want to consider buying the stock on the dip, so let’s get started!

Why FR?

First Industrial is a self-managed REIT that specializes in ownership of distribution centers and light industrial properties across the U.S., with 69 million square feet of industrial space. With an equity market cap of $6.3 billion, FR is larger than peer Terreno Realty ( TRNO ), smaller than Rexford Industrial ( REXR ) and industry giant, Prologis ( PLD ).

Like its aforementioned peers, FR targets large, supply-constrained markets with higher focus on coastal regions. As shown below, FR’s properties are concentrated around 15 target metropolitan statistical areas, with a quarter of rents coming from Southern California and a fifth coming from the Northeast.

Unlike other REIT classes like office properties, the industrial segment has seen strong demand and FR is no different, with occupancy sitting at a high 97.7%. Moreover, FR set a company record cash rental rate increase on new and renewal leases of 74% during the second quarter, and this contributed to a robust 11% YoY same store NOI growth.

These strong trends are supported by low vacancy rate of just 3.7% across the U.S., driven by tailwinds such as e-commerce, tenant needs for supply chain diversification as a result from the pandemic, and reshoring trends of bringing manufacturing back to the U.S. As shown below, FR’s high occupancy is in line with that of recent years, while its cash rental rate and same store NOI have accelerated.

The supply and demand imbalance is further exacerbated by the fact that many higher leveraged private market developers are priced out due to higher rates. FR is well-positioned to benefit from this dynamic with its strong balance sheet and existing property base in property-scarce markets along the coasts. As shown below, industry-wide construction starts are down 47% from the peak in the third quarter of 2022 and the number of properties in the construction pipeline (industry-wide) is shrinking.

Meanwhile, FR carries a strong BBB rated balance sheet with a reasonably low debt + preferred stock to EBITDA ratio of 5.2x, sitting well below the 6.0x level generally considered safe for REITs by ratings agencies, and has a high fixed charge coverage ratio of 5.0x. This gives FR capacity to support its developments, with expected completion rates ranging from Q3 FY23 to Q3 FY24 at an attractive weighted average estimated cash yield of 7.9% across 9 development sites. As shown below, FR has plenty of development pipeline across its ‘land bank’ in its existing portfolio, giving it plenty of runway in supply-scarce markets.

While FR’s 2.7% dividend yield isn’t particularly high, it has grown its dividend every year over the past 5 years, with it having grown by 47% since 2018. This has been nearly in lock step with FFO/share, which grew by 49% over the same timeframe. At the current annual dividend rate of $1.28, the dividend is well-protected by a 54% payout ratio, leaving plenty of retained capital as a source for internal funding.

Risks to FR include the fact that the industrial segment is cyclical in nature, and a hard landing resulting in a recession would impact nearly every industry, and could suppress rent growth. In addition, while FR carries a strong balance sheet, it isn’t immune to higher interest rates, which could offset some of the benefits from rental increases.

Lastly, I see value in FR at the current price of $46.63 with a forward P/FFO of 19.3. While FR isn’t cheap, it’s not expensive either, considering its moat-worthy property base with plenty of development opportunities, its strong balance sheet, and recent growth metrics. Plus, analysts estimate 8% to 14% annual FFO/share growth over the next 3 years, and considering the above, I believe FR has the potential to trade in the 20 P/FFO range, which is its normal valuation over the past decade.

Investor Takeaway

In conclusion, FR appears to be a strong self-managed REIT with its specialized, irreplaceable properties in supply-constrained markets along the coasts and key inland markets. I would expect for strong rent growth and occupancy trends to continue due to secular tailwinds in e-commerce, reshoring trends, the supply/demand imbalance, and the company’s development pipeline. As such, investors seeking quality real estate and income ought to consider FR at the current price.

For further details see: