2023-11-29 07:00:00 ET
Summary
- Americans just set a record on Thanksgiving shopping, spending $5.6 billion.
- I expect Industrial REITs to reap strong rewards from the growth in eCommerce shopping that we're seeing during the holidays.
- And right now, two of our top three highest-rated industrial REITs are offering attractive, double-digit margins of safety.
Santa can’t deliver every gift this Christmas.
He’s busy enough already, and we just set a record on Thanksgiving Day shopping.
According to Adobe Analytics , Americans spent $5.6 billion on Thanksgiving , taking advantage of the discounts that retailers provided.
That represented ~5.5% y/y growth.
And, it was roughly twice the $2.87 billion that U.S. shoppers spent on Thanksgiving Day just 6 years ago in 2017.
On Black Friday, U.S. shoppers spent $9.8 billion online .
That represented 7.5% y/y growth.
That’s another all-time record.
So, who are the major beneficiaries here?
It’s clear that credit card companies, such as Visa ( V ) or Mastercard ( MA ), are doing well (they operate tollbooth models and make money anytime someone makes a transaction on their payment networks).
These have been great investments for decades; however, they offer very low dividend yields (currently, Visa yields 0.82%, and Mastercard yields 0.55%).
Logistics companies, such as United Parcel Service ( UPS ) and FedEx ( FDX ), are also set to benefit.
These are both great companies; however, like Visa and Mastercard, FedEx offers a relatively low yield (1.96%). While UPS shares yield an attractive 4.26%, they’re coming off a major labor dispute which has led to significant earnings decline in 2023 (and I know that this sort of fundamental volatility may turn risk-averse investors off).
Looking at longer-term trends, it appears that UPS is a bargain here, but I think there’s a strong argument to be made that industrial REITs are going to reap the strongest rewards of the record-setting trends that we’re seeing around the growth of eCommerce during the holidays (and throughout the rest of the year as well).
These companies own thousands of warehouses and shipping centers that make this holiday shopping rush possible.
The eCommerce growth story is far from over…and as you can see below, this bodes especially well for industrial real estate investment trusts, or REITs, because the eCommerce business model requires much more industrial real estate than the traditional brick-and-mortar model.
Prologis, Inc. ( PLD ) owns roughly 1.2 billion square feet of industrial real estate.
Rexford Industrial Realty, Inc. ( REXR ) owns roughly 45 million square feet of industrial real estate.
First Industrial Realty Trust, Inc. ( FR ) owns roughly 69.4 million square feet of industrial real estate.
These are the 3 highest-rated industrial REITs within our coverage spectrum.
iREIT®
They’re all blue-chip REITs in my opinion, with our proprietary ratings of 99/100, 99/100, and 94/100, respectively.
Frankly, as far as quality metrics go, it doesn’t get much better than these 3 companies.
And from a value perspective, 2 of the 3 offer investors attractive, double-digit margins of safety.
The easiest way (that I’m aware of, anyway) to make money in the stock market is to buy and hold blue chip dividend stocks when they’re trading with steep discounts attached.
In these scenarios, not only do investors get to benefit from rising fundamentals (which result in annual dividend growth), but also, abnormally high dividend yields (due to the inverse relationship between share prices and dividend yields), and the potential for mean reversion to result in multiple expansion, pushing share prices much higher.
In other words, discounted blue chips are akin to coiled springs.
And with all of the positive headlines popping up this weekend about holiday shopping trends, I couldn’t help but put a spotlight on the wonderful bargains that I see in the industrial REIT space.
Industrial Real Estate: Santa’s Biggest Helpers
As you can see below, First Industrial Realty Trust manages a well-diversified portfolio.
This company offers investors exposure to major population centers from coast to coast, and these buildings are performing well.
At the end of its most recent quarter, FR posted a 95.4% occupancy ratio with 7.4% same-store NOI growth.
Overall, FR’s fundamentals remain strong. This chart speaks volumes when it comes to the reliable earnings and dividend growth that First Industrial has provided to investors recently.
Without doubt, this is a great company. However, FR shares trade at a premium to my fair value estimate (I believe that FR is worth $40/share, meaning that they’re overvalued by approximately 15%). Therefore, I have a “Hold” rating on shares right now.
Thankfully, I have “Strong Buy” ratings on both Prologis and Rexford, the two highest-quality companies in the space.
Unlike First Industrial, Rexford Industrial does not operate a diversified portfolio.
Instead of spreading its properties around the country (or the world, in Prologis’s case), Rexford has used its expertise in the southern California market to build a dominant portfolio that surrounds the Port of Los Angeles (the busiest seaport in the Western hemisphere).
REXR’s portfolio makes it the largest (by market cap) American pure-play industrial REIT.
This geographic concentration bothers some investors. However, the fact is, REXR has proven, again and again, that there is no better industrial real estate to own than the infill properties that it focuses on in SoCal.
As you can see here, the high demand created by the Port of Los Angeles (which is where the majority of shipping between the U.S. and Asian markets occurs) has created a great supply/demand trend for REXR to take advantage of.
SoCal market has vacancy rates well below the U.S. infill averages…yet, there simply isn’t enough land available to develop new supply to meet demand.
This dynamic has allowed REXR to consistently generate above-average same-store ROI growth, leading to industry-best fundamental growth and total shareholder returns.
Southern California is the largest U.S. industrial market ($42 billion), dwarfing its competitors:
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New York/New Jersey ($13 billion)
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Chicago ($13 billion)
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Philadelphia ($12 billion)
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Dallas/Fort Worth ($11 billion)
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Atlanta ($8 billion).
Rexford is the dominant player in the best industrial market in the U.S.
Historically, this competitive position has resulted in high cash flow multiples being applied to REXR shares. For years, I thought this stock was overvalued.
However, the carnage that industrial REITs have experienced throughout 2023 has created a unique opportunity for investors to accumulate REXR shares at a steep historical discount.
As you can see below, REXR shares are trading at a significant discount to their historical average (the blue line).
Shares haven’t been this cheap since early 2016.
Some may look at REXR’s ~28x adjusted funds from operations, or AFFO, multiple and think that’s rich. But this company continues to produce double-digit bottom-line growth, and when a blue chip is able to compound its AFFO at this sort of rate, I think a 30x+ multiple is fair.
If REXR were to experience mean reversion back to its long-term 35x P/AFFO multiple, investors buying shares today would see their investment generate an annualized rate of return of nearly 33% per year during the next couple years.
That’s an amazing upside for a mature, cash cow REIT like Rexford.
I believe that REXR shares are worth $75.00/share.
That means REXR is undervalued by approximately 36%.
That’s a Cyber Monday deal if I’ve ever seen one.
I can’t predict when the market will realize that REXR shares are too cheap and place a higher premium on shares. But, in the meantime, REXR investors can sleep well at night collecting its safe, 3.19% yield.
Admittedly, a ~3.2% yield might not be exciting for yield-hungry investors drawn to REITdom. But you can’t ignore Rexford’s dividend growth.
REXR’s 5-year DGR is 18.4%.
Its most recent dividend raise was 20.6%.
REXR went public roughly 10 years ago, and since then it has compounded its dividend at a 22% annual rate.
Using the rule of 72, this means that REXR’s dividend has doubled every 3.2 years since then.
Moving forward, I don’t expect to see REXR compound its dividend at a 22% annual rate.
Looking at our fundamental growth outlook, I think a ~15% dividend growth CAGR moving forward is more likely.
But, a 15% DGR still means that REXR’s dividend will double every 4.8 years.
Therefore, investors with a medium- to long-term time horizon should be focused on the dividend growth potential here and not their initial yield on cost.
Give REXR a few years and your yield on cost should be much higher.
Prologis offers slightly slower growth prospects than REXR; however, it's one of the largest REITs in the world with a $105 billion market cap… offering investors exposure to a truly global real estate portfolio.
American assets still generate the vast majority of PLD’s NOI; however, its growing expertise in the top international logistics markets provides an unmatched long-term runway for growth.
Remember, secular eCommerce growth isn’t just happening in the U.S. Prologis’ forward thinking, when it comes to international expansion, provides peace of mind.
In recent years I’ve touched upon my bullish outlook on Realty Income’s ( O ).
Not only does international investment offer more expansive growth opportunities, but it allows these very intelligent management teams to chase lower interest rates in foreign debt markets.
In a sector where cost of capital is everything, having more flexibility when raising debt can meaningfully change bottom-line results.
Prologis’ strategy (combined with the secular growth tailwinds bolstering all of the major players in the industrial REIT industry) has allowed the company to generate solid historical growth.
There’s a reason this company has a nearly perfect (99/100) quality score.
Not only does PLD sport an A-rated balance sheet …it has generated positive annual FFO growth during 16 out of the last 20 years.
On an adjusted FFO basis, PLD’s performance record isn’t quite stellar; however, its bottom-line growth is still very reliable, leading to a 9-year dividend increase streak.
Currently, PLD shares yield 3.11%. The company’s 5-year DGR is 12.58%. Its most recent dividend raise came in at 10.1% (in February of this year). And moving forward, even though PLD’s AFFO growth is expected to be flat in 2023, I believe that the stock’s relatively low 75% AFFO payout ratio implies ongoing dividend growth during the years to come.
I don’t believe that PLD has what it takes to post the ~15% annual dividend growth that REXR is capable of; however, I think that this dividend will compound at a high single-digit/low double-digit rate over the next 5-10 years. That means that the size of PLD’s dividend could double between now and the end of the decade.
It’s true that you sacrifice some growth here, relative to REXR, because not all of PLD’s markets offer the same sort of supply/demand imbalance that the southern California infill market brings to the table, but there’s a strong argument to be made that PLD’s cash flows are more durable because of the more diversified nature of its income stream.
I believe that PLD’s size and scale advantages over its peers should result in a strong valuation premium; however, once again, after the 2023 industrial REIT selloff, that’s not the case.
Over the last 10 and 20-year periods, PLD’s average P/AFFO ratios have been 27.95x and 25.44x, respectively.
Today PLD trades for roughly 24x.
The historical discount here isn’t quite as steep as we saw with REXR. But, it’s important to note that Prologis is trading at a level that has been very rare for investors to find during the last 10 years or so.
Anytime that I’m able to buy shares of a blue chip, A-rated REIT like PLD at a historical discount, I’m happy to do so.
Right now, I believe that PLD shares are worth $150/share, meaning that today’s share price of $112 implies a 25% discount.
If consensus AFFO growth targets prove correct and Prologis shares were to rebound to the ~28x AFFO level over the next couple of years, then investors buying today would be setting themselves up to generate ~18% annual returns.
Anyone who compounds their wealth at that sort of clip over the long term will retire a very wealthy individual.
These are growth-stock-like returns, and yet, they’re coming from a mature cash cow of a REIT.
How could this happen?
In short, the market has become entirely too pessimistic when it comes to the industrial REIT industry. As I’ve said many times before, when others become fearful, I become greedy (especially when we’re talking about best-in-breed types of REITs).
For further details see:
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