2023-10-27 15:19:01 ET
Summary
- STAG Industrial is a major industrial REIT with advantages over its peers.
- The company reported strong Q3 results, with increased FFO and high tenant retention and rent spreads.
- I explain why STAG is my favorite industrial REIT.
Dear readers,
STAG Industrial ( STAG ) is a major industrial REIT which enjoys a number of advantages compared to its peers. Last time I covered the stock at $35.50 per share and discussed why I think STAG is likely to outperform Prologis ( PLD ) over the next couple of years. Since then, both stocks have sold off, but so has the REIT index ( VNQ ).
STAG reported their Q3 2023 earnings earlier this week and because they have been quite good I want to take the opportunity to update my thesis here at $32 per share.
STAG Overview
Before diving into recent results, let's quickly recap what makes STAG interesting.
It operates in a growing sector, which is likely to grow by a double-digit CAGR for the rest of the decade. The growth will mostly come from increase e-commerce penetration which is expected to increase in the US from 14.8% today to 30% by 2030. I think this is very achievable, especially when compared to the UK which already has a 26.5% penetration.
Beyond e-commerce growth, part of the double-digit growth is expected to come from inventory normalization as businesses increase the currently artificially depressed (due to supply chain shortages) inventory-to-sales ratio of 1.25x back to the historical average of 1.5x.
STAG Presentation
The sector is currently completely dominated by Prologis which has a market cap of well over $100 Billion. That's triple the market cap of its ten biggest competitors combined . But there are differences, that make STAG quite appealing despite its much lower $6 Billion market cap.
Most importantly, it's the location of STAG's properties. PLD's properties are heavily concentrated near legacy ports that mainly cater to imports from China, think Los Angeles or San Francisco.
STAG's properties, on the other hand, are located more strategically in locations that are likely to benefit from the government's recent on-shoring efforts. The REIT has a high exposure to properties near the Mexican border which are likely to benefit as imports shift from China to Mexico and 30% of their portfolio is located within close proximity to Megasite projects (aka big newly opened factories).
STAG Presentation
Recent Results
During the third quarter, STAG reported quarterly FFO of $0.59 per share, 3.5% above Q2 results and expectations of $0.57 per share. This increase was mainly driven by an acceleration in same-store NOI growth from 4.5% YoY in Q2 to 5.3% YoY, as well as very strong leasing.
STAG Supplement
I always like to look at recent leasing to try to determine if tenants value the space. And in the case of STAG, they obviously do as evident from very high retention of nearly 75% and extremely good rent spreads of nearly 40% on a cash basis. And these numbers are not a one-off either as year-to-date the REIT has leased 11 Million sft of space at an average cash rent spread of 30%.
Such strong leasing has enabled STAG to maintain solid 98% occupancy, which could increase slightly in Q4 as 98% of all 2023 lease expiration have been re-let by October 24th.
STAG Supplement
During the third quarter, STAG has continued to acquire properties at the expected pace and at the cheaper-end of guidance. In particular, the REIT has acquired 12 strategically located buildings at an average cap rate of 6.7% (6.2% on a cash basis), increasing their total portfolio square footage by 1.3% quarter-over-quarter.
During Q3, the company settled $60 Million related to previously issued shares, but didn't issue any new stock. They have maintained a balance sheet with a net debt/EBITDA of 5x, but their cost of capital has continued to increase gradually from 3.39% in Q4 2022 to 3.72% today.
Going forward, I don't expect significant further increases at the company has fixed the rate on all debt except for the $325 Million outstanding in the credit line and debt maturities next year are minimal.
STAG Supplement
Valuations
Full year results are now almost locked in and call for an FFO of $2.26-2.28 per share, up 2% YoY. Beyond this year, consensus calls for 4-5% annual growth.
I see that as conservative given the 30-40% cash spreads that STAG has been getting on their new leases. With about 10% of leases expiring each year, this alone can increase rental revenue by 3-4%. Add to that build-in rent escalators of 1-2% and several new acquisition in line with the management's $300 Million per year target and I think STAG could easily grow its FFO per share by 5-6% per year.
Moreover, despite no dividend increases over the past 5 years, the company is now well positioned to hike its 4.6% dividend. The dividend remained flat for year as management was trying to de-leverage the company and lower their payout ratio. Both have been accomplished. The dividend has been declared for the rest of this year, but with a payout ratio of just 65%, I think there's plenty of room for 5%+ dividend growth next year.
In addition, the valuation has declined to 14.3x FFO, which is below PLD's multiple of 18x, despite STAG's higher growth prospects. The implied cap rate stands at 6.9% which is about 200 bps above the 10-year treasury yield.
Fast graphs
While none of these metrics scream under-valued, the 4.6% dividend + 5% FFO growth alone can deliver 10% annual returns.
Moreover, if management finally decides to increase the dividend next year, the stock could get over its bad reputation for not increasing the dividend and could provide further upside as it re-rates to a higher multiple.
STAG is a fairly conservative play and it's one that I prefer to Prologis due to a better positioned portfolio and a lower valuation. I reiterate my BUY rating for STAG here at $32 per share.
For further details see:
STAG Industrial Records Sector Leading Rent Spreads