2023-09-06 08:30:00 ET
Summary
- Alexandria Real Estate stock has formed a long-term bottom, as the Fed is expected to be near the peak of its rate hikes.
- The company's second-quarter results and forward guidance suggest improvement in the second half, with more robust occupancy rates.
- ARE's conservative AFFO payout ratio and narrowed AFFO guidance range provide clarity and confidence for dividend investors to remain vested.
- I argue why buyers have returned to ARE as the market looks past the Fed's rate hikes.
- As such, while the market got the battering of ARE right, it's time for buyers to ignore the fear and add ARE confidently as it emerges from its hammering. Upgrade to Buy.
I assigned Alexandria Real Estate Equities, Inc. ( ARE ) a Hold rating in my previous coverage in June, as I hadn't yet gleaned a decisive bullish reversal from dip buyers. Despite that, I reminded high-conviction investors anticipating a robust defense at the $110 level to consider adding more positions.
I'm pleased to highlight to these investors that I assessed such confidence demonstrated by buyers since ARE formed its June 2023 lows. Even though the malaise affecting the commercial real estate or CRE market battered ARE's valuation, it seems to have formed its long-term bottom convincingly.
Alexandria's second-quarter or FQ2 earnings release corroborated investors' confidence that its business model remains sound. Occupancy rates remain in line with expectations, and its forward guidance suggests things could improve in the second half.
Moreover, management reminded us that the company's focus on AAA locations provides a defensible competitive advantage with the leading biopharma players. While the company indicated near-term challenges in the life sciences industry, given the macroeconomic headwinds, it seems transitory.
As such, I believe investors are confident that management's conservative AFFO payout ratio of 55% in Q2 underpins the confidence in its ability to drive further improvement as economic conditions are expected to improve moving ahead. Moreover, the company narrowed its AFFO guidance range, providing more clarity to investors and bolstering its recovery thesis.
Accordingly, Alexandria indicated an AFFO guidance range of $8.93 to $8.99, with a midpoint outlook of $8.96. The revised consensus estimates are aligned with management's outlook, pointing to a 6.6% YoY growth. As such, it provides substantial coverage to an estimated FY23 dividend per share of $4.93 (55% payout ratio), providing confidence for dividend investors to remain vested. I believe the company's capital allocation priorities are well-balanced, so investors need not be unduly worried about unanticipated dividend cuts, leading to significant volatility for income investors.
Despite that, the battering in ARE is justified to reflect the surge in the 10Y Treasury yield over the past year. Moreover, the 10Y recently re-tested its October 2022 highs, reaching 4.36%. However, the upward momentum faced significant resistance, suggesting investors have already priced in a hawkish Fed. As such, I believe the risk/reward on the 10Y increasingly points to the downside, providing a welcomed relief for ARE's battered valuation.
Accordingly, ARE last traded at a forward dividend yield of 4.27%, well above its 10Y average of 3.13%. However, with the 10Y still yielding 4.19% after the recent pullback, it should be clear why the market significantly de-rated ARE downward to reflect these headwinds. Income investors have attractive high-yielding Treasuries as viable options to diversify their income portfolios.
Therefore, I assessed that despite ARE's solid fundamentals and robust operating performance, the market is correct, although the worst seems to be over. That said, I also gleaned that the opportunity for an upward re-rating in ARE is due, as the market looks forward, implying that the Fed is likely at or near the peak of its rate hikes.
As seen above, the recent pullback from ARE's July highs was well-supported at the $113 level, as ARE formed its August lows. Therefore, it marks a higher high market structure, corroborating the long-term lows ARE formed in June and robustly holding the $110 support level.
I expect ARE to continue moving upward, potentially re-testing the $130 level moving ahead as the 10Y yield is expected to unwind further from its recent highs. However, the recovery is expected to take time. Therefore, investors must remain patient as interest rates are expected to stay higher for longer, suggesting that ARE's forward dividend yield must appropriately reflect the competitive appeal from the risk-free Treasuries.
That said, I'm ready to turn bullish on ARE as it seems well-primed to recover from the worst hammering since its 2020 COVID lows.
Rating: Upgraded to Buy. Please note that a Buy rating is equivalent to a Bullish or Market Outperform rating.
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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For further details see:
Alexandria Real Estate: The Market Got This Right, But The Turnaround Is Here