2023-06-12 08:05:00 ET
Summary
- Extra Space Storage offers an attractive value and income proposition, with a 4.5% dividend yield and potential for growth.
- The acquisition of Life Storage should bring strategic benefits and synergies, improving EXR's economy of scale.
- EXR's current undervalued price presents a good entry point for long-term investors seeking meaningful income.
Value may seem hard to come by now with the S&P 500 ( SPY ) being well in positive territory with a 13% rise since the start of the year. However, it's important to keep in mind that this index is market cap weighted, and is led by just a handful of tech juggernauts that have outsized influence over the market.
That's why it's good to keep in mind that it's a market for stocks rather than the stock market, and this is reflected by a good number of income stocks, especially those in the REIT sector, being materially down from where they were a year ago.
When all is said and done, I believe real estate is where investors want to be, especially when inflation eases and income returns from hard assets come back to focus.
This brings me to Extra Space Storage ( EXR ), which I last covered here back in November, noting its strong growth track record. EXR continues to trade weakly, having fallen by 15% over the past year, and currently close to its 52-week low, as shown below. In this article, I discuss why EXR is a good contrarian bet for meaningful income and value at the current price.
Why EXR?
Extra Space Storage a member of the S&P 500 ( SPY ) and will be the largest self-storage REIT after its planned acquisition of Life Storage ( LSI ). It owns and/or operates 2,388 self-storage properties across 41 U.S. States and Washington D.C.
EXR differentiates itself from the other self-storage juggernaut, Public Storage ( PSA ), in that it also has a 3rd party management platform, through which it generates a steady stream of recurring fees for managing self-storage properties for other private owners.
Self-storage is generally a resilient asset class, as demonstrated by the publicly-traded players not having to cut their dividends during the recession of 2020, when a number of shopping center REITs had to cut theirs.
Self-storage is indeed its own asset class. This is because unlike net lease REITs, they have far shorter rental contracts, enabling them to reset rental rates quicker. Unlike shopping malls and office buildings, they are far cheaper to build and set up, and do not need to be reconfigured for new tenants, thereby resulting in zero tenant improvement costs.
Plus, self-storage as an asset class has grown in demand over the years. As shown below, the percentage of households utilizing storage space has steady risen to 10.6% over the past three decades.
This sector is also ripe for consolidation. As shown below, EXR will own just 13.2% of all self-storage space in the U.S. (after consolidating with LSI), despite being the biggest player, with much of the remaining market being comprised of both non-REIT institutional and non-institutional quality players.
Meanwhile, EXR's properties are inflation-resilient, as they saw 7.4% YoY same-store revenue growth during the first quarter. Encouragingly, property-level revenues grew at a faster clip than expenses, as evidenced by same-property NOI growing at a higher 8.7% rate.
Unlike self-storage REIT National Storage Affiliates ( NSA ), which saw a few percentage points decline in occupancy, EXR's occupancy dipped by just 80 basis points YoY to 93.5%. Plus, EXR continues to grow its 3rd party management platform, with 44 net additions to 1,254 managed stores, thereby resulting in continued growth of this source of recurring revenues.
Looking ahead, the pending acquisition of Life Storage increase EXR's portfolio to over 3,500 stores across 43 states. This should bring a number of strategic benefits, not least of which includes a greater economy of scale. This is reflected by management's expectations of at least $100 million annual rate synergies.
Over the trailing 12 months, EXR carried an operating margin (with depreciation addback) of 69%, sitting ahead of the 66% of NSA, and 73% of PSA. With the aforementioned synergies, I would expect for EXR's op margin to improve to 70%+ over time.
Meanwhile, EXR carries a strong BBB rated balance sheet. However, EXR is seeing some pressure from higher interest rates as 29% of its debt is variable rate. EXR pays a respectable 4.5% dividend yield that's covered by a 77% payout ratio, and has 12 years of consecutive dividend growth. It's worth noting, however, that dividend growth slowed to 8% this year, due in part to higher interest rates.
Turning to valuation, I find EXR's current price of $144.50 with forward P/FFO of 17.0 to be appealing, as it sits under its normal P/FFO of 20.6. This valuation may be justified in the near term, as EXR is expected to generate just mid-single digit FFO/share growth in the near term.
However, I believe that when all is said and done, EXR could return to higher growth as inflation eases and interest rates normalize. At that time, EXR would essentially lock in the higher rental rates it's seen over the past couple of years while interest rates could stabilize or go lower. As such, I don't believe a forward P/FFO of 19, or 12% higher from the current price would be out of the question.
Investor Takeaway
At the end of the day, I believe EXR offers investors an attractive value and income proposition. Its current price presents a good entry point in my view, as it's undervalued and carries a respectable 4.5% dividend yield that should be able to grow with inflation over time. Plus, its acquisition of Life Storage should bring meaningful synergies and strategic benefits. All in all, I believe that EXR is a solid contrarian bet at the current price for patient long-term investors who can get a meaningful income kicker to boot.
For further details see:
Extra Space Storage: Left Behind With A Solid Yield