2023-11-09 10:20:23 ET
Summary
- Gladstone Commercial Corporation's stock has been declining, attributed to challenges posed by the pandemic and inflationary environment.
- Q3 2023 earnings showed a decrease in revenue and FFO, but also improvements in net income and interest coverage ratio.
- The company's turnaround initiatives, such as capital recycling and selling non-core assets, may have positive and negative impacts on its performance.
- Based on my technical analysis, I recommend selling or shorting the stock for now because the bears appear to be in control.
Investment Thesis
Gladstone Commercial Corporation ( GOOD ) has been moving downward, especially since the onset of Covid 19. It has lost about 30% over the last year, something I attribute to the challenges posed by the pandemic and the inflationary environment, such as some tenants requesting rent deferrals, abatements, or concessions, which reduced the company’s cash flow and revenues. I am bearish on the stock, perhaps in the short and medium term, because the company’s fundamentals within this time horizon, in my view, are too weak to turn the stock into a bullish trend.
However, looking at the Q3 2023 earnings report and upon evaluating the company’s turnaround strategies , such as its capital recycling and selling non-core assets, I am optimistic about the stock in the long run. Based on this information, I recommend selling the stock as the company works on its turnaround strategies or shorting it as it is likely to continue its downward trend in the near term.
Q3 2023 Performance: Highlights And My Take Aways
Gladstone reported its financial results for the third quarter ended September 30, 2023, on November 6, 2023. Here are some of the highlights and my thoughts on the report:
- Its total operating revenue was $36.5 million, down 5.7% from the previous quarter and up 6.2% from the same quarter last year. The decrease from the previous quarter was mainly due to the sale of two properties in August 2023, which resulted in a gain of $4.7 million. Acquisitions, rent escalations, and lease renewals drove the increase from the same quarter last year.
- The company’s net income was $1.8 million, compared to a net loss of $4.6 million in the previous quarter and a net income of $0.6 million in the same quarter last year. The improvement from the previous quarter was mainly due to the gain on the sale of properties and lower impairment charges. The improvement from the same quarter last year was mainly due to lower interest expenses and higher rental income.
- Its funds from operations ("FFO") available to common stockholders and non-controlling OP unit-holders were $13.2 million, down 20.1% from the previous quarter and up 3.9% from the same quarter last year. The decrease from the previous quarter was mainly due to lower real estate depreciation and amortization and higher preferred stock dividends. The increase from the same quarter last year was mainly due to higher rental income and lower interest expense.
- GOOD’s core FFO available to common stockholders and non-controlling OP unit-holders was $13.6 million, down 17.4% from the previous quarter and up 4.6% from the same quarter last year. The decrease from the previous quarter was mainly due to lower real estate depreciation and amortization and higher preferred stock dividends. The increase from the same quarter last year was mainly due to higher rental income and lower interest expense.
- The company’s occupancy rate was 96.9%, up from 96.7% in the previous quarter and 96.4% in the same quarter last year. Its weighted average lease term was 6.7 years, down from 6.8 years in the previous quarter and 7.0 years in the same quarter last year.
- Its share price closed at $12.66 on November 3, 2023, down 1.9% from the previous day and down 36.9% from the 52-week high of $20.12 on December 2022. The company’s price-to-book ratio was 2.7, lower than the industry average of 3.
Given these highlights, I have several takeaways from this earnings report. To begin with, the report shows that the company has a stable portfolio of net leased properties that generate consistent cash flows and rent growth. The company has also maintained a high occupancy rate and a long lease term, which reduce the risk of tenant turnover and vacancy. It has also continued to execute its acquisition strategy, adding two properties with a weighted average cap rate of 9.54% in the third quarter.
Further, the earnings report also shows that GOOD has improved its net income and FFO from the same quarter last year despite the challenges posed by the COVID-19 pandemic and the economic downturn. It has also reduced its interest expense and increased its interest coverage ratio, which enhances its financial flexibility and credit profile.
However, despite these positive observations the report also shows that the company has experienced a decline in its revenue, FFO, and core FFO from the previous quarter, mainly due to the sale of two properties and the increase in preferred stock dividends. It has also decreased its lease term, indicating a lower quality of tenants or a higher risk of lease expirations. I believe so, because a tenant who is unsure about their financial stability or business prospects may prefer a shorter lease term to avoid being locked into a long-term commitment they may not be able to fulfill. This, in my view, may signal a lack of confidence or reliability on the part of the tenant.
Additionally, GOOD has also underperformed the market and the industry in terms of share price, which may reflect a lack of investor confidence or a negative sentiment. Therefore, the report suggests that the company has some strengths, opportunities, weaknesses, and threats that may affect its share performance and shareholders’ returns. In my opinion, GOOD needs to balance its growth and income objectives and address its valuation issues to enhance its competitive advantage and shareholder value.
Turn Around Initiatives: The Two Sides Of The Coin
Gladstone implemented a capital recycling program and is selling non-core assets as part of what I can call turnaround initiatives aimed at efficiency and resource optimization. It is a program in which it sells its non-core properties, uses the proceeds to de-lever its portfolio, and acquire properties in target growth markets. The company has successfully exited six assets in 2023 and anticipates selling additional non-core assets in the next one to two years. The company has also borrowed $9.0 million in fixed-rate mortgage debt at a weighted average interest rate of 6.10%, maturing on September 1, 2028.
According to the company’s financial results for the third quarter ended September 30, 2023, it has raised $19.0 million from the sale of three non-core properties in the third quarter. It has used the proceeds to repay $9.0 million of fixed-rate debt at an interest rate of 4.04% and to acquire two properties with a weighted average cap rate of 9.54%. GOOD has also used the proceeds to reduce its net debt to adjusted EBITDA ratio from 7.0x to 6.8x.
With this initiative in effect, I see it as a two-sided coin, and here is my assessment of the strategy. First, the program may improve the quality and diversity of the company’s portfolio, as it focuses on acquiring net leased industrial and office properties that generate consistent cash flows and rent growth. GOOD may also benefit from lower interest rates and higher cap rates in the target markets, which may enhance its returns and margins.
Secondly, the program may also reduce the company’s leverage and improve its financial flexibility and credit profile. It may be able to lower its interest expense and increase its interest coverage ratio, which may improve its net income and FFO. It may also be able to maintain or increase its dividend payments to its shareholders, as it has a high dividend yield of 9.5%.
However, despite the positives that I believe the initiative may bring forth, I also envision potential downfalls of the program. First off, GOOD may face difficulties in selling its non-core properties in a timely and profitable manner, especially in the current economic environment. They may also incur transaction costs, impairment charges, and loss on the sale of real estate, which may negatively affect their net income and FFO. They also face competition and regulatory hurdles in acquiring new properties in the target markets.
Moreover, the capital recycling program may not be sufficient to address its low price-to-book ratio of 2.7, which may reflect a low valuation or a lack of investor confidence. The company has also underperformed the market and the industry in terms of share price, which may reflect a negative sentiment. In conclusion, I support the company’s initiative. However, I believe it still has a long way to go to reverse its fortunes because its capital recycling plan only tackles part of the problem.
Technical Analysis
This section covers my technical analysis of GOOD based on several indicators. To begin with, the stock is currently trading in a downtrend, as indicated by the lower highs and lower lows. The stock is also below its 50-day and 200-day moving averages, which act as dynamic resistance levels. The stock has recently bounced off the support level of $11.26, which coincides with the 61.8% Fibonacci retracement level of the previous uptrend from $7.20 to $19.80. However, the bounce was weak, and the stock failed to break above the 50-day moving average and the downtrend line.
Author Analysis On Market Screener
The oscillators, such as the relative strength index [RSI] and the stochastic, also show bearish signals. The RSI is below 50, indicating that the sellers have more power than the buyers. The stochastic is declining and close to 20, indicating that the stock is oversold and may face a reversal. However, both indicators point downwards, suggesting the downward momentum is still strong.
Author Analysis On Market Screener
The chart patterns, such as the head, shoulders, and descending triangle, also confirm the bearish outlook. The head and shoulders pattern was formed between June and August 2023, with a neckline at $13.21. The stock broke below the neckline in September 2023, signaling a reversal of the previous uptrend. The descending triangle pattern was formed since Jan 2023, with a horizontal support at $11.26 and a descending resistance at $18.92, and appears to be stretching downward further, confirming the bearish momentum.
Author Analysis On Market Screener
Conclusion
Based on this analysis, the Q3 points out some positives, which in my view mark a possible onset of a potential reversal to a bullish stance. This can be backed by the company’s turnaround strategy in the capital recycling program. However, regardless of these positive signs, the company has a lot of grey areas it needs to address to strengthen its fundamentals to support a bullish trajectory. Given the uncertainties surrounding the company’s turnaround efforts, I am bearish on its short-term and medium terms.
With this outlook in mind and considering the technical analysis, I recommend selling or shorting the stock as it is likely to continue its downward trend in the near term. The target price for selling or shorting is about $8.80, which is calculated by subtracting the height of the head and shoulders from the breakout point. The stop-loss price for selling or shorting is $12.80, which is slightly above the support level of $11.26.
For further details see:
Gladstone Commercial Corporation: Sell Or Short For Now