AAIC - Plymouth Industrial REIT: The Next Target In M&A?

2023-08-07 21:09:34 ET

Summary

• Real estate investors saw rents soar for apartments and industrial/logistics space before cooling down.
• Plymouth Industrial REIT is trading at a sub-sector multiple of just 12.4(x), but has outperformed its sector peers.
• Plymouth's redemption of its Preferred A Series in September may attract interest from other industrial REITs for potential acquisitions.

With the havoc of the pandemic fading further into the rearview mirror, looking back at what transpired might be informative about what is yet to come. Real estate investors saw rents soar for apartments and industrial/logistics space before they recently began to cool. During the shutdown, offices went vacant and, post-return, many will stay that way.

Industrial real estate became the hottest sector for investment and, with unlimited availability of free money, development. Quickly tacking 500 basis points onto the Fed Funds rate can change investment perspectives; development has slowed, demand is waning, and expectations of returns from Industrial REITs have come back to earth. With one exception, P/FFO multiples that once approached 40x have now compressed to the mid 20xs. That one exception, and today’s topic, is Plymouth Industrial REIT (PLYM).

The Valuation Spectrum

Examining current Price/FFO multiples of the industrial sector components, you will note that while the median multiple is 21.4(x), some issues like Americold Realty ( COLD ) or Terreno Realty ( TRNO ) are priced with great expectations. Toward the unloved end of the spectrum, we can see that Plymouth Industrial REIT is trading at a sub-sector multiple of just 12.4(x).

What is surprising is that being an unloved or overlooked issue doesn’t necessarily indicate that shareholders have suffered. In fact, over the las year PLYM shares far outperformed its sector peers.

Sector Spotlight: Industrial REITs – 1 year share price performance

Source: S&P Global IQ as of 08/04/2023

If we look back three years to when the world was first trying to navigate new logistics and supply chain bottlenecks, the pricing disparity was even more extreme. TRNO was trading at a whopping 38.6(x) forward P/FFO. PLYM’s 6.4(x) multiple may have implied doubts that it could be considered a going concern.

In the ensuing three years, resulting investor returns again defied expectations. Plymouth Industrial led the sector’s returns over this period as well.

Sector Spotlight: Industrial REITs – 3-year share price performance

Source: S&P Global IQ as of 08/04/2023

Point of Entry

Early in the pandemic, industrial became the hot real estate sector and retains broad appeal today. The reason returns have disappointed stems from the price point of entry.

From mid-2020 to the end of 2021, established, large-cap, growth companies in the hottest-growth sub-markets, like Rexford Industrial ( REXR ) in the Inland Empire, could roll-up lease rates by nearly triple-digit percentages while simultaneously enjoying unprecedently low costs of capital. For this opportunity investors were willing to pay upwards of 40 times forward FFO. Rexford has performed very well operationally, but the share price multiple has deflated.

In contrast, Plymouth Industrial was a micro-cap trying to bootstrap acquisitions in unglamorous markets like Memphis. To complete their growth ambitions, PLYM had to enter egregiously expensive, joint venture financing that often looked unsurvivable. For this opportunity brave, value investors were willing to pay 6 times FFO.

From our perspective, everything had to work perfectly for Plymouth to extricate itself from the constraints of their Preferred B joint venture financing to make the outsized Memphis acquisitions economic. Ford Motor ( F ) proceeded with its Blue Oval City Mega Campus in western Tennessee and PLYM resolved the Preferred B capitalization. For this opportunity brave, value investors are now willing to pay about 12.5(x) forward FFO.

Still Cheap

On August 3 ^rd , Plymouth reported their 2Q23 results and reiterated their full year guidance. Management described progress in new development projects and double-digit lease rate roll-ups. A material part of the news was that they would accretively redeem all shares of their 7.5% Series A preferred (PLYM.PA) when it becomes callable in September. Their aim is to streamline their capitalization in a way that makes their shares more attractive to investors.

We think this could play out positively in multiple ways. Sans the preferred, Plymouth will look a lot more like their near-peer STAG Industrial (STAG). STAG currently trades at about 16.1(x) consensus FFO; if PLYM can attach that multiple its shares would move from $22.75 to north of $29 a share.

The other avenue, we believe, could be PLYM emerging as an acquisition target in the nascent stock-as-currency M&A market. When share prices plunged and interest rates soared, Wall Street anticipated the demise of mergers and acquisitions. Over the last year or so, however, dozens of stock-for-stock deals have evolved.

Among them:

Prologis ( PLD ) used shares to acquire Duke Realty

Ellington Financial (EFC) is using shares to accretively buy both Arlington Asset Investment Corp ( AAIC ) and Great Ajax Corp ( AJX )

Though Life Storage (LSI) rejected Public Storage’s ( PSA ) overtures, they submitted to a merger with Extra Space Storage ( EXR )

The logic is that if you can acquire an asset that adds to your earnings per share, you don’t need to have access to low interest lending or be able to issue high priced shares. Both parties can win if the exchange brings value to the acquisition target.

If you consider that PLYM has consistently traded for an implied cap rate that is several turns higher than its industrial peer set, anyone of them could benefit from issuance of shares to acquire Plymouth.

Source: S&P Global IQ

Ugly No More

With the September redemption of the Preferred A Series, Plymouth can pursue growth with less compromise. We believe that the sector’s disparate valuations will inspire peers to pursue Plymouth.

For further details see: