2023-10-02 10:49:35 ET
Summary
- CubeSmart is a major self-storage REIT in the US with a well-diversified portfolio in urban centers.
- The stock used to be overvalued, but it has reached better levels now.
- I present my bullish analysis of the stock.
CubeSmart ( CUBE ) is a major self-storage REIT in the US. The last time I wrote about the company was back in May, when I issued a hold rating because the stock was slightly overvalued relative to the historical spread to treasury rates. At an implied cap rate of 5.4%, the spread to 10-year treasury yields of just over 200 bps didn't justify the elevated risks from a potential recession and relative over-saturation of the market. Since my initial call, CUBE has underperformed both the REIT index ( VNQ ) and the S&P 500 ( SPX ) and the spread to treasuries has widened. Today I want to publish an updated thesis for the stock from this lower price point based on the Q2 2023 result .
Portfolio Overview
Recall that CUBE is the 3rd biggest self-storage REIT in the US and is present in 39 states. The company owns most of the properties it manages (around 90%), but also manages a handful of third-party assets. Notably, the portfolio is well diversified between legacy markets on both coasts and the recently more popular Sunbelt region. Also, the majority of assets are located in large urban centers, which is where demand for self-storage tends to be concentrated. This is great as most customers are people living in apartments as opposed to houses.
CUBE
CUBE has grown a lot over the years, almost tripling the number of properties over the past 10 years to now over 1,250. Historically the sector has done very well, but here's the thing - we now find ourselves in a situation where the US market is starting to be very saturated, especially when compared to the rest of the world, with almost 10 sft of storage space per capita, compared to less than 1 sft in the UK and just 0.16 sft in Europe.
CUBE
Not only that, but there is a lot of competition in the self-storage space and since the product is pretty homogenous, companies tend to compete on price. This creates a potential risk if demand slows, for example, because the economy falls into a recession and people try to cut costs. With all of this, I want to be careful not to overpay for CUBE, because I think the future may not be as bright as the past.
Recent Results
The REIT's recent performance has been okay . Occupancy has remained stable at 92.7% and same-store NOI has increased by 5% YoY, driven by revenue growth of 4.6% YoY and an increase of 3.6% YoY in OPEX. Notably, the growth has slowed significantly from last year, when it reached double digits, which may be indicative of the fact that demand is slowing.
Moreover, management has lowered their revenue growth forecast from 4-5.5% to 4-4.5% which led to lower full year FFO guidance of $2.66, compared to $2.68.
Beyond 2023, revenue growth is expected around 5% per year. That's not bad, especially when underpinned by a solid balance sheet with low interest rate risk. CUBE currently has the lowest leverage ever of 4.3x EBITDA, and it enjoys a low cost of debt of just 3%. Moreover, with 98% of the debt fixed-rate and no debt maturities next year, there won't be any surprises related to an increase in interest rate. In 2025, if rates remain high, CUBE will have to refinance $300 million of debt, but by that point, their revenue will have grown by 10%+, more than offsetting the effect of increased interest expense. As such, I think CUBE's interest rate risk is very low, and I expect their cash flow to increase over the next couple of years.
Increasing cash flow means that the current dividend of $0.49 per quarter should be safe. It yields just over 5% and represents a reasonable payout ratio of 74% which is in line with the low end of management's target. The dividend has grown at a CAGR of 10%+ over the past 5 years, but going forward, growth will most likely slow below 5% as revenues are expected to grow at this pace.
Valuation
All things considered, CUBE has a quality portfolio, but with the market saturated, a lot of competition, and a tough economic situation today, I think future growth is not very likely to be as spectacular as in the past. I expect CUBE to continue paying the 5% dividend and deliver 4-5% FFO growth on top of that.
In terms of upside, the stock trades at 14.5x FFO, which is well below the historical average of 19.5x. While I'm not comfortable forecasting a return to that multiple, I don't see CUBE as overvalued anymore. This would be confirmed by an implied cap rate of 6.3% today, which is about 300 bps above the 10-year treasury yield and therefore the spread is in line with historical valuation relative to interest rates.
Since CUBE should deliver 9-10% without any sort of multiple expansion and seems to be fairly valued relative to interest rates, I upgrade my rating to a buy here at $38 per share.
For further details see:
CubeSmart: Fairly Valued With Potential Growth