2023-08-06 08:05:00 ET
Summary
- Extra Space Storage is currently trading at a bargain valuation and carries competitive advantages through its scale.
- It's the largest self-storage operator in the US, with over 3,500 locations, and is well-positioned to consolidate the fragmented self-storage segment.
- EXR has a strong balance sheet, attractive dividend yield of 5.2%, and offers long-term growth potential.
Stocks fall in and out of market favor all the time, and it’s when the latter happens that makes for the best bargains. For example, only in the stock market can a multi-billion dollar business be worth 42% less than its peak valuation within the span of 12 short months, while the fundamentals remain relatively unchanged.
Such is the case with Extra Space Storage ( EXR ), which as shown below, now trades 36% below where it was a year ago, and 42% below its 52-week high of $216. I last covered EXR here back in June, highlighting the anticipated benefits of its acquisition of Life Storage. In this piece, I discuss why the recent drop opens an excellent buying opportunity for income and value seekers, so let’s get started.
Why EXR?
Extra Space Storage is headquartered in Salt Lake City, Utah and is a member of the S&P 500. Since completing its merger with Life Storage on July 20, EXR has become the largest self-storage operator in the U.S. with over 3,500 locations, sitting ahead of the 2,888 locations of the next biggest peer, Public Storage ( PSA ).
What makes self-storage an appealing segment to be in is the low cost nature of setting up properties and re-leasing them. Unlike office properties, self-storage properties require no tenant improvement costs when one tenant vacates and another moves in.
Moreover, the percentage of U.S. households utilizing self-storage has increased over the years, from 5.5% twenty years ago to 10.6% at present. EXR has been able to capture much of this growth through its well-located and growing portfolio. As shown below, EXR has produced sector-beating same-store revenue growth every year since 2010.
Meanwhile, near-term growth appears to be muted, as EXR saw same-store revenue and NOI growth of 2.7% and 2.6% YoY, respectively, during the second quarter. Occupancy dipped slightly by 130 basis points YoY to 94.5%. Core FFO per share declined by 3.3% YoY due primarily to higher interest expense. Overall, this marks a slowdown in growth as EXR was able to achieve 5% and 5.5% same-store revenue and NOI growth for the first half of the year.
Looking ahead, management has reduced its full year same-store NOI growth to 2.75%. While this may be disappointing for those accustomed to the higher growth business, it’s also not too surprising, considering the very strong two prior years that EXR and the overall self-storage industry had, as reflected in the earlier graphic. During those years, many Americans cleared out space in their homes to make way for extra living space in wake of the pandemic, and it seems that self-storage has reached a near-term saturation point as a result.
Nonetheless, I see the long-term growth drivers for EXR as being intact, considering Americans’ propensity to accumulate things and the long-term increase in self-storage utilization over the past 10+ years. Also, self-storage remains the most resilient asset class among REITs due to their simplicity and widespread need, and the space remains ripe for consolidation as the market remains dominated by non-REIT properties that comprise 65% of the market, as shown below.
Importantly, EXR carries a strong balance sheet with a net debt to EBITDA ratio of just 4.9x, sitting well below the 6.0x level from 2017. It also carries strong fixed charge and interest coverage ratios of 4.4x and 4.7x, respectively, and has a weighted average interest rate of 4.3%. EXR was recently recognized for its strong balance sheet by S&P, which recently bumped its credit rating up to BBB+.
Notably, currently yields an attractive 5.2%, based on its quarterly run-rate dividend of $1.62, and not including the special $1.01 per share dividend that was paid in July. The dividend rate is also covered by a 79% payout ratio, based on management’s Core FFO/share guidance of $8.25 at the midpoint. As shown below, EXR is now yielding at its highest in over 10 years.
(Note: The following dividend yield includes the special dividend paid in July)
Lastly, EXR represents solid value at the current price of $125.70 with a forward P/FFO of 15.1, sitting well below its normal P/FFO of 20.6 over the past decade. The current valuation makes in mid-single digit FFO/share growth expectations by analysts next year. However, patient investors may benefit from potential faster growth in 2+ years, after EXR and the broader self-storage industry normalizes for the strong demand that it saw in recent years.
Risks to the thesis include potential for higher interest rates, which would increase refinancing costs and may pressure the bottom-line in the near term. Plus, a recession may cause consumers to pull back from self-storage demand, and materially lower interest rates in the future may spur competition from new supply in the industry.
Investor Takeaway
Extra Space Storage has seen a big drop over the past year and since its earnings release, and now offers investors an attractive buying opportunity. The company is well positioned for long-term growth given its strong balance sheet, large economy of scale, and market consolidation opportunities from non-REIT properties. It also offers an attractive yield of 5.2%, which is covered by a payout ratio that’s below 80%.
While near-term growth may be muted, normalization of self-storage trends over the next 1-2 years can result in a resumption of the long-term growth thesis. Meanwhile, with the stock trading at 15x forward P/FFO, investors can now purchase a solid REIT at an attractive valuation. All-in, Extra Space Storage stock is a great pick for those seeking income and value in the self-storage space.
For further details see:
Extra Space Storage: It's The Best Time In 10 Years To Buy