2023-11-15 07:00:00 ET
Summary
- Extra Space Storage Inc. shares have rallied 10% after the company beat Wall Street's expectations in its Q3 results.
- The company's acquisition of Life Storage has led to dilution in its adjusted FFO figure, but management expects further synergies to arise in the near term.
- Extra Space Storage stock is still attractively valued, with a 15.25x blended AFFO ratio, representing a discount to its historical averages.
Just a couple of weeks ago, I published for my investing group members an article titled, “Extra Space Storage: It's The Best Time In 14 Years To Buy This 6% Yielding Ultra SWAN”
At the time, Extra Space Storage Inc. (EXR) shares were trading for $108/share.
Today they’re much higher, at $119/share.
Having fallen more than 36% from its 52-week high in the $170 area, I noted that Extra Space shares were trading at their lowest valuation in 14 years.
Plain and simple, I knew this stock was a coiled spring.
Because of its historically low valuation and the company’s forward-looking growth prospects, I said that shares had a ~12% long-term annual total return potential.
I didn’t know when EXR would rally, but I was happy to recommend the stock because of its secure 6% dividend yield.
It wasn’t long ago that investors would have said a 6% yield attached to Extra Space Storage shares would have been too good to be true.
Well, the interest rate-driven real estate investment trust ("REIT") selloff that we’ve seen throughout 2023 has provided an opportunity that was previously unthinkable.
I don’t mind being paid a hefty sum like this while I wait for the market to come to its senses.
And in EXR’s case, I didn’t have to wait long for the market to realize its mistake.
When the REIT announced its Q3 results last week, shares popped 10%.
Extra Space rose by 12.7% on the week.
So today, I wanted to say congratulations to those who followed our lead after reading that recent article…and discuss why I’m still very bullish on EXR shares today.
Extra Space Storage Q3 Results
When EXR posted its Q3 results last week, it beat Wall Street’s expectations on both the top and bottom lines.
EXR’s quarterly revenue came in at $748.03m, up 49.9% y/y (largely driven by M&A activity), beating analyst consensus by $66.74 million.
EXR’s FFO was $2.02/share, $0.11/share above consensus estimates.
This $2.02/share adjusted FFO figure represented -8.6% y/y growth; however, this negative result was driven by the dilution that occurred when EXR acquired Life Storage back in July.
Management was clear in the conference call that this result was in line with their expectations and that they expect to see further synergies from this deal arise in the near term.
There were occupancy issues with the LSI portfolio, and EXR says that these rates are improving.
Management expects to see the total expected synergies in place by Q1 of 2024, which will bolster funds from operations ("FFO") growth. The stock’s rally last week points towards the market catching onto this as well.
It’s worth noting that EXR received a credit rating upgrade from S&P Global (to BBB+) after the LSI merger, and this should lower interest rate expenses moving forward.
That plays a significant role in longer-term profit growth related to the merger.
The lower cost of capital associated with a higher credit rating will allow EXR to grow (profitably) at a faster rate than smaller peers.
I don’t expect to see a tremendous amount of investment dollars going to new properties in the short term after the nearly $13 billion LSI deal; however, once the synergies come to fruition, EXR will be difficult to compete with.
Remember, after the LSI deal closed, EXR became the largest self-storage operator and a top-10 REIT on the MSCI US REIT index.
I’ve written about consolidation in the real estate world for years now, and this is yet another example.
The rich get richer from the benefits of size and scale when it comes to expanding these hard asset portfolios. That’s exactly what I see playing out for EXR in the years (and decades) to come.
Although its pace of acquisitions has slowed post-LSI, EXR is still expanding its empire. The company added 49 more storage facilities to its portfolio during Q3 (outside of the LSI deal).
At the end of the quarter, the company had 3,651 locations which generated 1.9% same-store revenue growth.
Overall, EXR increased their same-store revenue growth expectations for the full year by 25 bps during the quarter to 2.75%-3.5%.
They also maintained the mid-point of their same-store NOI growth forecast at 2.75%.
This same-store growth, combined with the ability to more efficiently manage its capital (due to the higher credit rating), and the growing size of the portfolio overall, leads me to believe that EXR has what it takes to compound its bottom-line at a mid-single digit clip for years to come.
And with that in mind, I believe that shares have gotten irrationally cheap as of late.
As I said in the introduction, even after EXR’s double-digit rally last week, shares are still attractively valued.
I think this stock has plenty of room left to run. In other words…there’s still time to catch this one before it leaves the station.
Valuation
The 13.5x AFFO (adjusted FFO) multiple that EXR was trading for in late October was entirely too cheap.
Today, EXR shares trade with a 15.25x blended AFFO ratio…and that’s still too cheap.
Yes, interest rates are much higher today than they’ve been in the last 10 years. And yes, EXR’s mid-single digit forward-looking growth expectations are below the stock’s 5 and 10-year averages (11.5% and 13.8%).
Both of these point towards a justifiable discount compared to EXR’s longer-term historical averages.
EXR’s 15-year average P/AFFO multiple is 20.25x. Its 10-year average P/AFFO multiple is 22.5x.
Today’s ~15x multiple represents a ~25% to ~33% discount to those levels.
And given the size and strength of this company’s portfolio, cash flows, and dividend yield, I believe that the market has pushed EXR shares entirely too low.
As you can see below, Extra Space Storage hasn’t traded with a ~15x multiple since 2010.
The stock was coming out of the Great Recession the last time shares were this cheap.
I wouldn’t argue with anyone who said they believed a recession was on the horizon.
I’m seeing macro slowdowns across multiple data points, and the lagging impact of the Fed’s historic (in terms of pace) rate increases that we’ve seen in recent years has yet to be felt fully by the economy.
But, I don’t believe that we’re staring down an economic environment that will be anywhere near as tough as the Great Recession was.
As I’ve said before, I expect the next recession to be of the “garden variety.”
And with that in mind, I don’t believe that fears associated with an upcoming recession justify EXR’s bargain barrel valuation.
I remain very bullish on EXR shares, and I wouldn’t be surprised to see them rise back up to a 20x multiple during the next year or so.
But, even in the event of a partial mean reversion, to say, 17 or 18x (which would still be a ~25% discount to EXR’s 10-year average valuation), it would still generate an annualized total return CAGR north of 26% between now and the end of next year.
That’s a pretty hefty return for a blue-chip REIT like this.
Heck, that’s a hefty return for any stock in the market.
The prospects to compound capital like that…with a fairly conservative, mature cash cow like EXR, is why I’ve been buying these shares lately.
The way I see it, you don’t need speculative tech to generate market-beating returns. You just have to take advantage of the attractive margins of safety attached to beaten-down blue chips like Extra Space Storage.
The Dividend
The best thing about waiting for mean reversion to occur when we’re talking about a blue-chip REIT like EXR is the fact that you get paid while you wait.
There is some confusion regarding EXR’s dividend yield currently.
Many investing sites list EXR’s yield as ~2% right now. But that’s wrong.
You see, because of the LSI acquisition EXR paid out two dividends in Q2…a $1.01/share payment and a $0.61/share payment.
The $0.61/share payment was made second, and that’s what many sites are annualizing when formulating their dividend yield for EXR.
But, they’re not accounting for the $1.01/share payment…and the fact that $0.61 + $1.01 = $1.62…which is in line with the quarterly dividend that EXR paid prior to the LSI acquisition.
When you annualize this $1.62/share payment you arrive at a forward dividend of $6.48.
$6.48 divided by EXR’s share price of approximately $119/share equates to a dividend yield of 5.4%.
Now that the LSI deal is complete, I expect to see EXR return to the normal one dividend per quarter payment schedule at the $1.62/share rate.
Furthermore, I expect to see this company provide investors with another dividend raise in early 2024.
If I had to guess, I’d say that EXR’s quarterly dividend will rise to the $1.70/share area (representing a 5% y/y raise), resulting in a forward dividend yield of ~5.7% at today’s prices.
That would mean a TTM AFFO payout ratio of 87.7% and a forward AFFO payout ratio of ~85%.
That ratio is a bit elevated but still secure.
There are a lot worse places to be in the market than being paid ~5.5% while you wait for 20%+ upside.
Conclusion
Far too often, investors miss the forest for the trees.
It’s impossible to time the exact bottom or top in the markets. And yet, people get upset about it.
The point of this piece was to highlight why it is that I’m still bullish on EXR, even after its recent rally.
I know that there are investors who have a hard time buying shares of stock after a move like we saw last week.
But, instead of stressing about missing the first 10% of a rally, I believe that investors should focus on the long-term potential of a company and where that fundamental growth will take the stock over time.
To me, EXR’s rally is likely just getting started.
I’m always happy to buy shares of a blue-chip REIT when they’re trading with a wide margin of safety attached.
I still believe that Extra Space Storage shares are cheap and, therefore, I’m still a buyer of the stock at today's valuation.
For further details see:
Extra Space Storage: I'm Hoarding The Dividends