2023-06-12 10:00:00 ET
Summary
- Rexford Industrial Realty has dropped another 12% since our last article.
- While the growth story has played out as expected, investors are still smarting from paying premium multiples for future revenue.
- Things are getting interesting as we head into a recession and large industrial supply hits California markets.
The Rexford Industrial Realty, Inc. ( REXR ) story has played out in a textbook manner so far. It had all the promise of a unique "can't lose" growth play. It also has delivered the fun of an unnecessary root canal for those that chased it/or held it into the 2022 highs.
The "textbook" part here is also underscored by our "Sell rating" in August 2021. It goes to show that timing these things in the short term is very difficult as crowd euphoria often surpasses all norms. The stock went almost 35% higher after our sell call. But in textbook manner, eventually valuation won.
Seeking Alpha
In our last coverage, we noted that we would get interested at $45 per share.
Excesses in one direction create excesses in the other, and that's just as certain as day follows night. That pendulum never stops right in the center, and that was a comforting thought when we issued the Sell rating two years back. At present, we're likely to see a sub-20X FFO multiple, at the minimum as the cycle reaches its conclusion. We would look to buy around $45 in the next 12-18 months, as that is likely to be a ballpark of the capitulation lows.
Source: Multiple Compression Halfway Through
The stock has dropped halfway to our target price and we examine the Q1-2023 results to see if we can hold on that prospective entry price.
Q1-2023
Rexford had a strong quarter with significant growth in its net operating income and core funds from operations (FFO).
Company share of Core FFO of $102.7 million, an increase of 34.0% as compared to the prior year quarter.
Consolidated Portfolio Net Operating Income (NOI) of $142.3 million, an increase of 32.8% as compared to the prior year quarter.
Source: Q1-2023 Press Release
Those numbers do sound terrific but investors are of course interested in growth per share.
Company share of Core FFO per diluted share of $0.52, an increase of 8.3% as compared to the prior year quarter.
Source: Q1-2023 Press Release
8.3% vs 34%? What madness is this? Well anyone following the story here knows that Rexford has been on a stock issuing spree for the last 3 years.
To be clear, we are not criticizing the issuance. Rexford has traded at silly multiples quite often and at a huge premium to even optimistic NAV estimates. So they should be issuing shares when they can. But if you do issue shares and buy even more expensive properties, you will have a tough time creating high growth per share. Rexford is also likely now moving past peak pricing and peak demand for its properties. Occupancy levels have peaked and have started to trend down.
Outlook
What we have seen so far are small moves for occupancy but they make a big difference in pricing and they make a big difference when you are projecting 3-5 years ahead. If you assume ending occupancy of 96% you will likely see Rexford deliver 6-8% FFO growth a year at best. If you assume ending occupancy of 99%, it might be able to deliver 15% plus growth rates. The one thing going for Rexford is that the Southern California region is still very space constrained. Even though we have had a massive supply boom in industrial properties, Southern California has a very modest share of this.
Commercial Edge, Link In Article
So this supply boom is likely to be a bigger problem for other industrial REITs. Despite our call for a recession, we think Rexford likely grows through it and we expect FFO to keep climbing in 2024 and 2025. The key question though is what do you want to pay for it. In the case of both Rexford and Terreno Realty Corp. ( TRNO ), if you paid 40X multiples for growth in 2020, you came away with a lower price 3.5 years later.
This is despite both actually delivering better growth than what estimates would have projected back then. Pay silly multiples, win silly returns. But the story is better today as Rexford is now down to just 20X 2024 estimates. Rexford is likely to show a far better growth profile than Prologis, Inc. ( PLD ) and TRNO, despite being slightly cheaper on 2024 estimates. Rexford is also the cheapest on a price to consensus NAV basis. It trades 15% below current NAV estimates whereas PLD and TRNO are hovering right near their NAV estimates. So among the solid growth names in industrial REITs, Rexford is leading the pack. If you are looking for a long term growth name for industrial properties we think Rexford is your best pick.
Verdict
The "best" here unfortunately will still mean relatively low returns. We estimate 10 year annualized returns in the 6-8% range for Rexford. You are likely to see far better returns if we first see a normalization of the FFO multiple. You have three choices here if you like Rexford.
1) You hold your nose and buy. If you are content with 6%-8% annual returns, and can accept some serious volatility, you are good. You might get a buyout over here as well as the NAV discount might be appealing to some private buyers.
2) You wait for $40-$45. Your returns improve dramatically if you get that price in the next 12 months. The $45 strike options are not terribly liquid, but one could explore that avenue as a way of getting paid to wait for buying at that price.
3) You choose to get similar returns with virtually zero risk by buying Rexford's preferred shares. Rexford Industrial Realty, Inc. 5.875% PFD SER B ( REXR.PB ) and Rexford Industrial Realty, Inc. 5.625 CUM PFD C ( REXR.PC ) offer about 6.4% yields currently. Rexford has easily one of the best (if not the best) balance sheets in industrial REITs and the preferred shares are about as bulletproof as you can get. One could also argue here that one requirement for Rexford common shares to do well is a rate cutting cycle. If we get that and REXR.PC trades near par in 5 years, its return would be about 8.7% annually (dividends plus price appreciation).
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
For further details see:
Rexford Industrial: Pay Silly Multiples, Win Silly Returns