VNQ - Public Storage: REIT For Investors Looking To Collect Dividends For The Long Term

2024-01-11 08:00:00 ET

Summary

• Public Storage, being the world's largest self-storage REIT, stands to benefit from the growth of the self-storage industry.
• The company has a strong dividend history of paying uninterrupted dividends.
• FFO is projected to grow in the high-single digits over the next two years, signaling more dividend raises ahead.
• If the economy does fall into a recession, PSA may suffer a decline in rental income similar to the Great Financial Crisis.
• With interest rates expected to decline, the stock offers a strong double-digit upside using the Dividend Discount Model.

Introduction

Despite the REIT sector ( VNQ ) experiencing a lot of volatility in 2023 due to surging interest rates, Public Storage ( PSA ) was in the green over the year. That speaks not only to the quality of this REIT, but to the management team as well. However, PSA did experience a dip last October but has since seen its share price bounce back over 26%, another sign of their high quality in my opinion. REITs are known for their income, having to pay out 90% of their earnings by law. But every REIT is not made equal. Public Storage is the perfect one for buy-and-hold investors. And in this article, I discuss why they are one of the best in the sector to hold for the long term.

Brief Overview

Public Storage is the world's largest owner, operator, and developer of self-storage facilities. They are a member of the S&P 500 and currently own more than 3,000 properties in 40 states. They were founded in 1972 and have storage locations in major U.S. cities like Los Angeles, Las Vegas, Atlanta, Chicago, and Seattle to name a few. Internationally, they have storage facilities in France, Germany, and the United Kingdom as well as others. Chances are you've seen their storage located in major cities throughout the world.

Growth Outlook For Self-Storage Industry

One reason PSA is a great buy for long-term investors is the outlook of the self-storage industry. Despite the current macro environment, the outlook for the industry looks auspicious. The global market is expected to grow at a CAGR of roughly 7.5% through 2027 and 5.3% through 2032 . With the U.S. and Europe being the leading markets in self-storage, this will greatly benefit PSA.

One reason is the high cost of housing. Living in the country's most expensive city, San Diego, I can tell you firsthand that more people are looking for creative ways to cut costs. And more people are taking advantage of self-storage facilities as they downsize. As more and more people continue to downsize, the self-storage industry only stands as a beneficiary of this changing behavior.

Strong Dividend History

Currently, Public Storage has more than 42 years of paying uninterrupted dividends. And the REIT shows no signs of slowing down for the foreseeable future. In early 2023 Public Storage raised the dividend 50% from $2.00 a share to the current $3.00. This not only shows the company's quality but their financial strength as well.

Even with the 50% increase, the dividend was well-covered by FFO of $4.33 the REIT brought in during Q3 earnings back in October. This represents a growth rate of 5.6% from the year prior and allowed PSA to raise their full-year FFO guidance to $16.60 to $16.85.

As you can see from the chart above, PSA has been growing its dividend at a steady rate since the Great Financial Crisis, and I expect this to continue for the foreseeable future. With a current annual payout of $12.00, PSA's payout ratio would only be roughly 72% if FFO came in on the lower end of guidance at $16.60.

Below are FFO estimates for Public Storage over the next 2 years. Even if the company wanted to conduct another huge increase of 25% for this year, this would still give PSA a very safe payout ratio of roughly 82%. Seeking Alpha currently anticipates an $0.11 per share dividend increase for this year, but I'm projecting a $0.20 - $0.25 increase a share in the coming months.

Fortress Balance Sheet

If PSA's dividend history and 50% increase don't make you consider them a long-term buy, maybe their A-rated balance sheet will. The company is one of the few A-rated REITs in the sector. Furthermore, the company had roughly $630 million in cash and a low net debt-to-EBITDA ratio of just 2.7x, well below what I like to see for REITs.

This is in comparison to peers CubeSmart ( CUBE ) and Extra Storage Space's ( EXR ) ratio of 4.1x and 5.0x respectively. Additionally, PSA increased its borrowing limit to $1.5 billion during the quarter. The company's debt maturities are also well-laddered with $700 million worth of notes due in April of this year, and $400 million in 2025. The U.S. note is floating rate, and the company plans on refinancing sometime this year. These had average interest rates of 5.791% & 5.932% respectively, and their total debt amount stood at roughly $9.1 billion.

Appetite For Growth

For large-cap companies like Public Storage, growth is a huge factor. They also have to make large acquisitions to fund their growth to ensure the dividend is sustainable for the long term. The REIT closed on its acquisition of Simply Self Storage from Blackstone Real Estate Income Trust for $2.2 billion by issuing senior unsecured notes. This added an additional 127 properties comprising 9 million square feet across 18 states.

This is expected to be immediately accretive to FFO. Over the past year, PSA has acquired $2.6 billion worth of properties according to their CEO during Q3 earnings call, and they continue to make digital & operating model transformations. In Q3, the Public Storage app had 1.4 million users, proving to be a significant win for the REIT. Some investors tend to worry about growth opportunities for gargantuan companies like PSA and Realty Income ( O ), but these companies also enjoy competitive advantages that their peers can't due to their sheer size & scale. Over the next two years, management projects $1 billion of development projects, which will continue to drive growth for the long-term for PSA.

Valuation

At a price of $297 at the time of writing, Public Storage is trading at an attractive valuation, especially for long-term investors. Additionally, their dividend yield of 4.03% currently trades higher than their 5-year average of 3.44%, signaling the REIT may be slightly undervalued. With the company's strong outlook and low risk, I think PSA is a buy at this price.

Using the Dividend Discount Model, the stock offers a double digit upside of more than 19% to the price target of $355. This is slightly above the high price target of $344 analysts currently have for the REIT. Over the past, PSA's dividend growth has been slow but the company increased the dividend by a whopping 50% last year!

Analysts expect this to slow this year with an annual payout estimate of $12.44. I decided to be a bit conservative to manage expectations with a 4.5% growth rate. But with interest rates expected to decline this year, I think PSA's share price is poised to go higher if rates indeed are cut.

Catalysts & Risks

Although PSA has experienced some headwinds during the recent macro environment, I think those have somewhat subsided and the company will continue its appetite for growth in the coming months. The self-storage industry also has experienced a decrease in demand, which impacted PSA negatively .

But during Q3 the company narrowed the occupancy gap from 250 basis points at the beginning of 2023 to 60 bps in the third quarter. This is also a 50% decrease from 120 bps at the end of September. Also, I think they will continue to benefit from not only consumers' downsizing, but also the remote & hybrid work environment. For some businesses, this model is here to stay, at least for the foreseeable future.

A risk the company faces is if the economy does fall into a recession that some are predicting. No one knows for sure if one will happen, but a recession would likely cause a further drop in occupancy ratings as the job market may suffer losses. As consumers suffer even more financial constraints because of a recession, they will likely be forced to cut extra costs such as paying for storage units, especially if interest rates also remain elevated.

During the Great Financial Crisis, PSA did experience a slight drop in rental income. And although the company could face short-term headwinds if we do enter an economic downturn, self-storage business models are fairly resistant, and I expect the company to navigate just fine.

Bottom Line

Public Storage is the perfect buy-and-hold for income investors. Even during economic downturns such as the GFC, the REIT navigated this with precision, maintaining the dividend while several businesses were forced to cut during that time. And although 2023 has provided some headwinds for the REIT and the sector as a whole, PSA did extremely well against its peers due to the strong business model.

With the self-storage industry expected to grow at a 5.3% CAGR for the next 8 years, Public Storage will only continue to benefit from this. The company also has a fortress balance sheet and an appetite for growth, which will only continue to provide opportunities for the foreseeable future. With a conservative payout ratio, strong FFO growth rate over the next two years, and an A credit rating, I think PSA is the perfect REIT to continue collecting dividends for the long term.

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