2023-09-05 05:27:56 ET
Summary
- Extra Space Storage is a company that provides self-storage facilities for individuals and businesses.
- The company has seen a significant increase in demand for storage units during the COVID-19 pandemic.
- Due to the good operating business development and the current undervaluation, Extra Space Storage offers an excellent buying opportunity.
The Extra Space Storage ( EXR ) stock price has fallen by more than 40 percent from its all-time high. This means the stock is trading lower than it has since the first half of 2021. In my view, this is an excellent opportunity to add the stock to your portfolio at a fair price. And this is the very reason why I have been investing in Extra Space Storage with a savings plan for several months.
Why does the stock suffer?
There are many reasons why investors avoid REIT shares in particular. One is the general interest rate environment under which many REITs are suffering. Capital-hungry REITs in particular could have trouble servicing their debt if interest rates rise.
For another, the acquisition of competitor Life Storage for $145.82 a share could unsettle investors. The deal will increase Extra Space Storage's portfolio by more than 50 percent. It will make Extra Space Storage the largest self-storage operator in the U.S.
Further, many investors may be fearful of a deteriorating economy causing people to clear out their storage facilities.
In my view, the market is punishing all REITs across the board for rather macroeconomic reasons. This makes it all the more worthwhile to take an individual look at the companies, and this is where investors get their money's worth with Extra Space Storage.
Great business model gets better through Life Storage Acquisition
First, Extra Space Storage has a very tangible and compelling business model. The company offers a wide range of storage options, as well as additional services. Also including the Life Storage acquisition, the company will operate more than 3,500 locations and also gain a larger presence in growth markets such as Texas (up 2.8 percent), Florida (up 2.1 percent), and Southeast (up 0.8 percent) while exposure, and therefore dependencies, to California and Hawaii, will decrease. In addition, the acquisition will unlock synergies of $ 100 million in minimum. Marketing expenses per store will decrease and the penetration rate is also expected to improve.
Having said that, let's zoom out a bit and take the big picture into consideration. What I really like is that Extra Storage Space is benefiting from the ever-increasing demand for storage space options. For example, demand from all U.S. households for off-site storage has doubled over the past 20 years.
Steady demand growth (Investor relations)
In this respect, sales and AFFO have also developed very well in recent years. For example, revenue is expected to rise from $238 million in 2007 to $2.4 billion in the current fiscal year. For 2025, analysts even expect revenues to reach $3.2 billion. As I will show in a second, this positive outlook is justified.
It's worth noting that Extra Space Storage has outperformed the market in revenue growth nearly every year over the past 18 years, with few exceptions. This continuity speaks to a far-sighted management team and gives reason for optimism that the outperformance will continue.
Resilient revenue growth (Investor relations)
As an investor, I like the business model of self-storage operators overall. For one thing, I like the fact that customers store their items for a very long time and have no great incentive to change this. In addition, self-storage operators don't need a large number of employees to manage the storage locations. Once set up, operating costs are kept to a minimum.
Admittedly, it cannot be denied that people may liquidate their stored inventory in the event of an economic crisis. Nevertheless, the risk seems manageable. For example, both in the financial crisis and in 2020, the decline in sales was limited. However, both were exceptional events with high unemployment rates. The fact that sales here fell by a low single-digit percentage speaks for the strength of the business model.
The market is giving you a historic discount right now
For the valuation of the Extra Space Storage share, I mainly look at the average AFFO multiples.
Based on the current AFFO of $8.4, the Extra Space Storage stock seems undervalued and, with a current P/E ratio of 16, trades below the fair value of 21.4 based on the last ten fiscal years.
Fair value of Extra Space Storage (Data is taken from third-party data provider FactSet Research data sheet / picture is taken from aktienfinder.net)
Based on this valuation scenario and the expected AFFO for 2024, a current purchase price of $128 would result in a potential annual ROI of 34 percent. Long story short: The only time in the last 20 years that there has been such a large discrepancy with fair value was at the time of the financial crisis.
And in retrospect, this was an excellent buying opportunity. Even if investors bought Extra Space Storage shares at the high in 2007 at almost $19 per, they are still looking at an annual performance of over 14 percent despite the recent setbacks.
A word about the dividend
Somewhat unclear is the depiction of the dividend on many portals or sites. As part of the merger with Life Storage and due to contractual provisions, Extra Space Storage had to split the dividend for 3Q. In July 2023, the company announced a distribution of $1.01. Recently, management has confirmed it will make the remaining distribution of the quarterly dividend in September. Thus, the split payment is only a one-time event. It does not represent a reduction in the dividend, nor does Extra Space Storage change the quarterly distribution intervals.
Overall, this has opened up a more than attractive window of opportunity for dividend investors. The share is currently attracting investors with an above-average dividend yield of 5.25 percent. This is significantly above the 5-year average of 3.4 percent.
Dividend Yield (For visualization, 5-year average yield is based on third-party data provider FactSet Research)
And that is not the last good news. The dividend is also safe in my view. Measured by AFFO, the payout ratio is currently 76 percent. The cash payout ratio is even below 70 percent.
For a REIT, that's a very good figure that leaves room for further increases. In recent years, Extra Space Storage has increased its dividend in February. Given AFFO's expected growth, I think dividend growth in the high single digits is possible. But even an increase of just 7 or 8 percent would put the yield in the 5.5 percent range and higher.
Conclusion
Due to the good operating business development and the current undervaluation, the Extra Space Storage share offers a unique buying opportunity in my view. In addition to the share price potential, investors can secure a historically high dividend yield of over 5% with the potential for further increases.
Currently, however, the stock is in a clear downtrend. It may continue to go downhill. I see this risk above all if interest rates continue to rise or there is an economic slowdown. In this respect, it is difficult to identify or forecast a bottom here. For these reasons, I am currently stubbornly and steadily investing an amount in the stock every month, collecting the dividends, and looking forward to further prices.
For further details see:
Extra Space Storage: I Buy Shares Each Month