2023-12-06 06:11:11 ET
Summary
- SL Green's management is making sound strategic moves to capitalize on the post-pandemic recovery of New York City's economy and the trend of employers forcing people to return to offices.
- SLG stock currently offers a 7% forward FY 2024 dividend yield, which I consider safe.
- My valuation analysis suggests the stock is substantially undervalued.
Investment thesis
As the U.S. economy demonstrates strength despite very tight monetary policy, I think the real estate industry is worth paying attention to. Office real estate investment trusts [REIT] look particularly interesting to me as the work-from-home trend appears unsustainable as more employers are asking their employees to return to offices. SL Green Realty Corp. ( SLG ) operates properties in one of the most high-profile New York City [NYC] locations, and my analysis suggests that the management's current priorities look sound as the city's economy is recovering after the pandemic. According to my analysis, the stock is very attractively valued with almost 20% upside potential and currently offers a forward FY2024 dividend yield of 7%. All in all, I assign SLG a "Buy" rating.
Company information
SL Green Realty Corp. is a self-managed REIT engaged in the acquisition, development, redevelopment, repositioning, ownership, management, and operation of commercial real estate properties, principally office properties, located in the New York metropolitan area, principally in Manhattan. The company's fiscal year ends on December 31.
Financials
The latest quarterly earnings were released on October 18, when the company missed revenue and EPS consensus estimates but delivered better-than-expected adjusted FFO.
Seeking Alpha
Revenue declined YoY by 7.3%, and the operating profit followed the top line by decreasing from $33 million to -$3 million. The decrease in revenue is due to the deconsolidation of 245 Park Avenue due to the sale of a joint venture interest during the second quarter of 2023. Despite revenue loss, operating expenses did not follow accordingly, which is the reason for a substantial drawdown in the operating profit.
Seeking Alpha
The balance sheet looks decent, with solid short-term liquidity metrics. There is a substantial level of leverage, though the major part of the debt is long-term. I do not consider high debt levels to be a significant risk, as the company's cash flow from operations is consistently positive. SLG has a strong dividend consistency grade from Seeking Alpha Quant, thanks to the 25 years of consecutive payouts. As the current payout ratio is slightly above 60% , I think the dividend is safe.
For the upcoming quarter's earnings, the consensus estimates a 25% YoY revenue drop as the management continues shaking up the portfolio of properties. The latest news regarding new property divestment was released just yesterday when the company said that it sold 625 Madison Avenue for $632.5M to be used to decrease the debt level. I like that the management narrows its focus toward the most commercially attractive properties because bigger does not necessarily mean better. In my opinion, the New York real estate market has experienced several shocks in recent years, and changes are inevitable for REITs like SLG. The management recently shared its vision for 2024 during the latest Investor Day , and I like the outlined priorities, which include the properties mix improvement and debt reduction. I think that the management's flexibility is quite important for the company to succeed in the current environment.
SLG's latest Investor Day presentation
I see several good trends for SLG. The most apparent one for the company is that employers continue calling people back to offices. According to CNBC , nine out of ten companies expect to return to offices by the end of 2024, which is a strong tailwind for companies like SLG.
As the company continues expanding tenancies with luxury retail brands, I see the steady NYC tourist traffic recovery as a growth potential. According to the summer 2023 data from Investopedia , traffic in the most popular NYC tourism locations was still double digits below the pre-pandemic level, which I think will finally recover in the foreseeable future. I am highly confident that New York City will experience a resurgence in tourist traffic, reaffirming its status as the top global destination. This conviction is supported by timeout.com , which ranks the city as the number one desired location for tourists worldwide.
Another positive sign for SLG is NYC's strong economy. Despite record-high interest rates, the city's employment data demonstrates strength and already recovered to pre-pandemic levels. This gives me a lot of optimism regarding SLG, as strong employment data means that the economic activity is strong and the increase in the demand for offices will be sustainable.
The latest news suggests that the company trimmed its monthly dividend by 7.7% . While this might disappoint current investors, it will likely be good for new potential investors. I think so because the dividend that has just been trimmed is safe, in my opinion, as the worst part has already happened. A dividend cut is an unpopular move, and I believe it was a well-weighted decision from the management to avoid repeating it again in the foreseeable future. The payout ratio has moderated, and SLG's dividend history suggests that the dividend returned to its growth path even after massive crises like the Great Recession.
Valuation
SLG rallied by almost 24% year-to-date, outperforming the broader U.S. stock market. Seeking Alpha Quant assigns SLG a high "B+" valuation grade, primarily thanks to the attractive dividend yield. Most of the metrics look attractive, which might indicate undervaluation.
I want to proceed with analyzing the dividend discount model [DDM]. During the latest Investor Day, the management guided for a $3 FY 2024 dividend, which I incorporated into my DDM formula. I use a 7% WACC as a required rate of return, which is one percentage point more conservative than the GuruFocus' suggestion. Dividend growth is always tricky, and the last five years' track record was significantly disrupted by the COVID-19 pandemic, especially for office REITs. Over the last decade, SLG delivered an 8.8% dividend CAGR, but it was the decade of the lowest possible federal funds rates, which was a big tailwind for the industry. I think that a 1% dividend CAGR would be fairly conservative for my DDM calculations.
Author's calculations
According to my analysis, the stock's fair value is $50, which represents an 18% upside potential. Considering the high dividend yield, the valuation looks very attractive to me.
Risks to consider
The current environment of high interest rates does not favor REITs, and there is a substantial level of uncertainty regarding the timing of the Fed's monetary policy pivot. As REITs need to invest substantial amounts in capex to fuel revenue growth, debt financing is essential to scale up. The current uncertainty surrounding the Fed's next moves introduces an element of unpredictability, influencing both the valuation and attractiveness of REITs as a stable income-generating asset.
The stock's substantial volatility is evidenced by its 52-week price range spanning from $19 to approximately $45. While volatility can present both opportunities and risks, investors should be ready to tolerate substantial short-term volatility.
Bottom line
To conclude, SLG is a "Buy". The management makes strategically sound moves to shake up the property portfolio to focus on the most economically attractive units. A strong commitment to aggressively deleverage in 2024 is also a solid bullish sign because a strong balance sheet is crucial for REITs to be able to expand the business. Several positive developments for the NYC economy suggest that the environment will be favorable for SLG in the foreseeable future. Furthermore, the valuation looks very attractive, and the stock offers an attractive 7% forward dividend yield.
For further details see:
SL Green: Solid Dividend Yield And Attractive Valuation