2023-05-30 07:17:23 ET
Summary
- American Assets Trust's Q1 2023 results show a strong operating performance despite the macroeconomic challenges.
- Office REITs declined by an average of 18% during the first four months of the year following a 37.6% decline in 2022.
- As of Q1 2023, AAT trades at a forward price-to-FFO ratio of 8.33, still below its five-year average of 18.7, and also down from Q4 2022's low of 11.6.
American Assets Trust ( AAT ) continues to showcase resilience in Q1 2023 amid economic challenges, maintaining a robust property portfolio and delivering solid financial results despite the -28% price return YTD. The firm navigates market turbulence with strategic investments and remains optimistic, backed by a promising dividend yield and potential for long-term growth. As inflation starts to ease, AAT's valuation exhibits significant upside potential. Despite uncertainties, this REIT proves itself as a resilient contender worth investors' attention, while demonstrating its capacity to weather macroeconomic storms in my opinion.
Property Portfolio
American Assets Trust, a diversified REIT, has reported good results in the first quarter of 2023, despite widespread market pessimism, particularly toward REITs with significant office exposure. Office REITs declined by an average of 18% during the first four months of the year following a 37.6% decline in 2022.
AAT's YTD decline of 28% was a bit of an overreaction in my opinion but the price return from the beginning of 2022 is approximately -50% which is in line with the office REIT sector's average 55% decline. Key to the company's durability is its portfolio of high-quality office, retail, multifamily, and mixed-use properties in high-barrier, growth-oriented markets. AAT's 55-year history provides a backdrop of adaptability and robustness through various economic cycles despite hectic price returns. The first quarter of 2023 saw some shifts in AAT's portfolio structure. Amid a volatile tech industry and regional bank failures, AAT managed to maintain consistent leasing and operational performance, as the firm's management mitigated potential risks and maintained strong relationships with tenants. The company's retail segment reported a healthy 9.5% increase on a cash basis and a 28% increase on a straight-line basis for Q1 deals. In the multifamily segment, leasing rates in San Diego increased from 92% to 94%, with net effective rents 30% above pre-COVID levels.
First Quarter Results
AAT's Q1 2023 results show a strong operating performance despite the macroeconomic challenges. The company reported a first-quarter 2023 FFO per share of $0.66 and a net income attributable to common stockholders per share of $0.27. The retail sector reported a 6% increase in same-store cash NOI, largely attributable to the leases starting at Carmel Mountain Plaza, South Bay Marketplace, and Lomas Santa Fe properties. Notably, the multifamily segment achieved a stellar 13% increase in same-store cash NOI, driven by higher rents at the San Diego multifamily properties. Despite the effects of hybrid work and tech layoffs, the office portfolio occupancy rate was resilient at 88%, with same-store occupancy reaching 91.4%. I believe that the 88% occupancy rate is strong among the office REITs however the question remains about the whole sector's future with the rise of hybrid work and the spread of the gig economy. Will the office REITs ever return to pre-pandemic levels? AAT is in a good position because they are not only an office REIT but has other strong segments such as multifamily houses which are likely going to provide strong returns in the next years.
Management expectations going forward
Looking ahead, AAT remains cautiously optimistic about the remainder of 2023. Despite the ongoing market turbulence, the management anticipates a potential upswing in leasing activity, underpinned by the strategic investments made into the portfolio, including exceptional new amenities at most of its office properties. As I see it, the management has been focusing on longer-than-average office rentals to keep its tenant base in place. In some cases, they work with the same companies for more than 2 decades and had only 2 expirations due to the 10+ year lease agreements. This strategy worked in the past, we will see if it is going to work going forward. AAT's management is confident in its resilience, projecting a net debt EBITDA of 5.5x or below and indicating the potential to perform at the high end of its revised guidance range of $2.23 to $2.33 per FFO share for 2023. The strength AAT has demonstrated is a reflection of its commitment to top-tier assets, prudent financial management, proficient operations, and a workforce with exceptional talent.
Bob said earlier that our target is to reduce our net debt to EBITDA. We also are a midsized REIT, but on the small side, we'd like to get larger if we could, for the economies of scale." - Ernest Rady - CEO
Dividend
Perhaps the most compelling testament to the management's confidence in the underlying growth of AAT's portfolio is the approved and maintained quarterly dividend of $0.33 per share for the second quarter of 2023. A dividend yield reflecting steady, consistent returns not only supports the firm's financial results but also underscores the management's confidence in the company's long-term prospects. The company has been constantly increasing its dividend for more than 10 years except for the pandemic. However, they were one of the fastest companies that reinstated their dividend to pre-pandemic levels. By the third quarter of 2021, AAT has paid the same amount of dividend per share as in Q1 2020. The management does not plan any share repurchases, they rather allocate that capital somewhere else:
Stock repurchases are really not on our agenda." - Ernest Rady - CEO
Valuation
In Q1 2023, AAT has shown steady performance with improving metrics across its office, retail, and multifamily segments. AAT's adaptability and solid property portfolio remain their strong suit, offering the potential for long-term stability and growth. As of Q1 2023, AAT trades at a forward price-to-FFO ratio of 8.33, still below its five-year average of 18.7, and also down from Q4 2022's low of 11.6 due to the share price drop in February and March 2023. The normalization of inflation will play a vital role in improving the present value of future cash flows and should, therefore, positively impact AAT's valuation. Based on purely mathematical formulas the stock is heavily undervalued. If the price-to-FFO ratio were to revert to its five-year average of 18.7, this would imply an upside potential of approximately 120% (18.7/8.33 - 1) from its current levels. I think it is not the case it is rather too positive. However, I believe that the stock is undervalued with an almost 7% dividend yield and a price-to-book value of 0.95x, the lowest figure in 10 years.
The key risks for AAT revolve around prolonged high inflation and a potential recession, so I see mainly external risk factors at the moment. Persistent high inflation could lead to sustained high-interest rates and maintaining a low valuation for AAT. The question is how inflation will behave after the Fed stops raising interest rates which are just around the corner. In case of a severe recession, the demand for AAT's properties could decline significantly and in case of a mild recession, the demand could still suffer.
Final thoughts
Despite market skepticism, the company showed resilience in Q1 2023. Amid macroeconomic headwinds, AAT reported a strong operational performance, with positive NOI growth across all sectors. The company projects confidence in future growth, maintaining a steady dividend payout and showing promise of high-quality asset management. Its valuation trades below its five-year average, indicating potential undervaluation and potential upside. It's worth considering AAT's positioning amidst possible external risks such as prolonged inflation and recession. All in all, I think that the company could be an attractive choice for bit skeptical office REIT investors so they can buy diversified REITs instead to lower their office exposure but still gain quality office space.
For further details see:
American Assets Trust's Earnings: Solid Performance Amid Economic Headwinds