2023-10-26 09:05:00 ET
Summary
- Postal Realty Trust offers a unique opportunity for investors seeking a recession-resistant and inflation-protected income stream.
- PSTL stock has underperformed due to market concerns about high interest rates, but PSTL offers a durable income stream with high retention and inflation protection.
- PSTL has opportunities for rent increases, demonstrated growth, and a strong liquidity position, making it an attractive investment option with long-term value at its discounted price.
Nobody said stock investing was easy, and while anybody can pick stocks based on perceived value, sticking with your convictions requires having the right mindset and philosophy in place.
One philosophy that may be beneficial to investors is one in which is implemented by the investor Mohnish Pabrai, who advocates for buying companies with high uncertainty but low risk. This fits into his overarching goal of "heads I win, tails I don't lose too much".
Such may be the case with Postal Realty Trust ( PSTL ), which I last covered here with a 'Strong Buy' rating back in January, noting its mission-critical properties and solid underlying growth. In this piece, I provide an update and discuss why value seekers may be inclined to buy this stock at the current discounted level, so let's get started!
Why PSTL?
Postal Realty Trust is a self-managed REIT and the largest pure-play owner of properties leased to the U.S. Postal Service. It owns 1,375 properties with very high 99.7% occupancy, and they are geographically dispersed across 49 states with higher concentrations in the Midwest and Southern regions of the U.S., as shown below.
PSTL stock hasn't been my best performer as it's price has declined by 12% since I last visited it in January (-7.8% thanks to dividends offsetting some of the losses). While I can't pinpoint to specific reasons for the decline, it's fair to say that the market has fallen out of favor with income stocks such as REITs due to concerns around high interest rates, since higher rates result in higher cost of debt and competition from "risk free" investments such as Treasury Bonds. As shown below, PSTL has underperformed both the Vanguard Real Estate ETF ( VNQ ) and the S&P 500 ( SPY ) over the trailing 12 months.
I believe the market has overly-punished PSTL stock, however, considering its unique attributes that gives it a durable, recession-resistant income stream with inflation protection. That's because PSTL employs double-net leases on its properties, with the tenant responsible for the majority of expenses, including real estate taxes, utilities, and certain maintenance. Unlike the military, the USPS is not subject to annual budget appropriations which can be politicized in nature.
Plus, PSTL also enjoys a sticky relationship with the USPS due to the limited availability of alternatives upon lease expiration. PSTL carries leases with a short weighted average lease term of 3 years. While that may be viewed as a negative compared to the ~10-year lease terms of net lease REITs such as Realty Income ( O ), it's actually a positive in an inflationary environment, as this gives PSTL the ability to raise its rent to market rate.
The USPS doesn't have a profit motive like that of corporations, and being a government entity, it should be easier for PSTL to convince it to pay CPI-adjusted market rents upon lease expiration, especially considering the lack of alternative options in most markets. USPS operating lease payments amount to just 1.7% of its total operating budget, and as shown below, PSTL has seen a high historical 99% tenant retention rate at lease expirations.
PSTL has significant opportunities to raise its annual rents in the coming years. As shown below, 44% of its leases based on annual rent is expiring in the 2024-2026 timeframe.
Meanwhile, PSTL has continued to demonstrate both top and bottom-line growth, with 21% YoY revenue growth and 12.5% YoY AFFO/share growth to $0.27 during the second quarter. The company also continues to see attractive investment opportunities by purchasing 39 properties for $16 million at a weighted average cap rate of 7.3%.
This is accretive to shareholders as it sits above PSTL's 3.95% weighted average interest rate with 100% fixed rate debt. PSTL carries strong liquidity with a fully undrawn revolving credit facility and a net debt to adjusted EBITDA of 5.6x, sitting comfortably below the 6.0x level considered safe by ratings agencies.
Looking ahead to Q3 results and beyond, I wouldn't expect to see much surprises for Q3, considering the recession-resistant business model of leasing to the USPS. At the same time, I see potential for higher negotiated rents through continued lease expirations and the 3.5% annual rent escalation on non-expired leases that PSTL agreed upon with USPS at the end of last year.
Over the next few years, PSTL should continue to see growth opportunities as the biggest player in a fragmented market. This is considering that PSTL owns 6% of all USPS properties in a market with over 17,000 lessors, and the next 20 biggest lessors own just 11% of the market.
Plus, e-commerce continues to serve as a growth tailwind for USPS, with its mission critical and irreplaceable distribution network that serve as a high barrier to entry. Perhaps unbeknownst to some, UPS ( UPS ), FedEx ( FDX ), and DHL ( DHLGY ) all tap into the USPS network on a daily basis.
Risks include PSTL's high AFFO payout ratio of 88%. This means that PSTL doesn't have as much retained capital with which it can use to grow its property count. Also, PSTL's currently depressed share price of $13.20 translates to a forward P/FFO of 14.7. This equates to a higher cost of equity of 6.8% which when combined with a higher cost of new debt funding could equate to less earnings accretion on new property acquisitions.
Nonetheless, I view these as being short-term headwinds, and see value in the current price. Applying an NPV analysis, I arrive at a fair value of $17. This is based on a conservative 3.5% annual growth rate over the next 15 years, which doesn't bake in any potential upside from external growth (through debt and equity issuances).
The model also factors in a 2% discount rate based on the long-term annual inflation target and the durability of the income stream due to high tenant retention rates. The fair value is calculated based on the sum of the annual cash flows over the 15-year period with the 3.5% exponential growth and 2% exponential discounting factored into the equation.
Investor Takeaway
PSTL presents a unique opportunity for investors seeking a recession-resistant and inflation-protected income stream. With its double-net lease structure and sticky relationship with the USPS, PSTL has potential for positive rental growth in the coming years.
While there may be short-term headwinds such as high AFFO payout ratio and current share price, I believe that PSTL's long-term value is not fully reflected in the market price. As such, it can be a good investment option for those looking to diversify their real estate holdings with a reliable income stream and growth potential, all while getting paid a 7.2% dividend yield. Reiterate 'Strong Buy' rating.
For further details see:
Postal Realty: Take Delivery Of This 7.2% Yield On The Cheap