REXR - Rexford Industrial: Multiple Compression Halfway Through

2023-04-05 13:40:38 ET

Summary

• We had speculated that Rexford would provide poor to very poor returns for bulls chasing at high valuations.
• Growth has been stronger than expected since then, but the stock has still done poorly.
• We look at the compressing forward multiples vs. growth prospects and tell you where you are likely to get a buy point.

When we wrote about Rexford Industrial Realty, Inc. ( REXR ) in 2021, we scoffed at the idea that buying it at 35X funds from operations (FFO) would make you money.

At 35x 2022 FFO, we now rate this as a sell. We are rapidly reaching a point where the growth rates are likely to disappoint and investors should hit the exit before that. While we don't deny the quality here, the numbers just don't make sense at this stage of the cycle.

Source: Stretched Valuation Creates Poor Risk-Reward

The stock price journey since then was quite interesting, as the euphoria took a good while to die-off. REXR was up 35% at one point but finally succumbed to the realities of the situation.

We examine where we stand today and tell you where we would likely buy this.

The Company

Rexford has been the play for industrial properties. The southern California-focused REIT has grown rapidly and produced spectacular returns for its shareholders.

It also has done that while keeping leverage levels extraordinarily low. Beating peer FFO growth rates by such a huge margin without gorging on debt is certainly applause-worthy.

Driving this performance has been an extremely tight industrial market in Southern California.

According to Rexford, the tightness will continue for the foreseeable future. Lack of developable land and high barriers to entry make Rexford's future about as secure as it can get.

Quantifying this is not an easy task for investors. After all, where do rents go in such a tight, unbalanced market. Fortunately, Rexford helps out there as well. The latest reported net operating income (NOI) for Q4-2022 is expected to increase by $200 million!

Valuation

One of the best ways to look at this story is to see how FFO estimates panned out. Back in 2021, when we wrote the bearish piece, FFO was expected to come in at $1.92 for 2023. It was expected to jump to almost $2.50 in 2025.

Fast-forward to today and Rexford will exceed the 2023 number by 13%. It also will probably hit the $2.50 mark a year ahead of schedule. This is despite interest rates having moved up aggressively since then.

But those pictures just underscore how stupid the valuation was back in 2021. We're still at 23X 2024 FFO levels. Now, for a fast-growing industrial REIT, we're approaching more reasonable levels. Rexford also appears to be one of the rarer REITs that's producing massive growth even now. Other REITs like Crown Castle Inc. ( CCI ) and Digital Realty Trust Inc. ( DLR ) are well past their glory days and will show a flat FFO profile for the near future. So, unlike the past, we can no longer argue that Rexford is expensive. Hazel View, a bull on the story, puts the embedded growth in this context.

Rounding out our investment thesis for Rexford in 2023 is valuation, which we feel is highly compelling today. Rexford currently trades at a 22% discount to our forward NAV estimates and an implied cap rate of approximately 4.1%. While the implied cap rate might seem low on the surface, we again note that Rexford's in-place rents portfolio-wide sit 60% below current market rents. If this in-place income stream was marked-to-market today, that implied cap rate would be closer to 6.6%. Although there is some degree of murkiness regarding where cap rates are today for industrial assets, we have a high degree of confidence that the right number is several hundred basis points below 6.6%, especially in Rexford's Southern California market, which is arguably the most attractive in the United States.

Source: Hazel View

Again, there's nothing we can argue with over there. Rexford has grown into the valuation and likely presents a good, compelling upside story, in the next boom.

Verdict

Our take-home message comes down to "in the next boom." While Rexford appears fairly valued for its growth, we don't think the cycle will end with just fair valuation. Excesses in one direction create excesses in the other, and that's just as certain as day follows night. That pendulum never stops right in the center, and that was a comforting thought when we issued the Sell rating two years back. At present, we're likely to see a sub-20X FFO multiple, at the minimum as the cycle reaches its conclusion. We would look to buy around $45 in the next 12-18 months, as that is likely to be a ballpark of the capitulation lows.

The Preferred Shares

Rexford has two sets of preferred shares outstanding.

1) Rexford Industrial Realty, Inc. 5.875% PFD SER B ( REXR.PB )

2) Rexford Industrial Realty, Inc. 5.625 CUM PFD C ( REXR.PC )

They yield about 6.5% each based on their last closing prices and represent a way to take moderate interest rate risk, with virtually zero credit risk.

Rexford's balance sheet is the best ( not one of the best, the best ), among REITs we follow and by buying the preferreds you have a solid 6.5% yield and prospects for capital appreciation (since both are about 10% under par) in the next rate cutting cycle. We had recommended investors switch to Rexford preferreds from those of DLR recently, as we see an actual existential threat to DLR down the line. As a direct purchase, we would look to buy if either of those two yields over 7%.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

For further details see: