2023-12-17 20:55:48 ET
Summary
- Sun Communities is a residential REIT with a track record of operational excellence and a diversified portfolio of properties.
- The company has strong demand and positive trends in its manufactured housing, RV communities, and marinas.
- Despite a low dividend yield, Sun Communities is undervalued and has a potential upside, making it a good investment opportunity.
Dear subscribers,
You recall I went positive on Sun Communities ( SUI ) for the first time ever a few months back and bought more going into October?
While it's not yet time to change my rating on the REIT, it's time to issue a bit of a "last call" warning on this single-family residential REIT. While the company is not without risk, at this time, the 15% annualized Upside that I look for in my investments is just still there at a normalized P/FFO upside that's not too premiumized.
In this article, I'll update you on Sun, show you why you should have bought a few months back, and why you should probably keep this company until it goes at least above a $150/share price.
This company has a clear upside, and aside from a valuation update, we'll also take the 3Q23 results into consideration, which is what was published not that long ago.
Sun Communities - Upside from Single-Family REITs
Sun Communities is a great REIT. 278% TSR over the last decade, with almost $12B worth of properties acquired since the GFC, and over 45 years as a public company makes this one of the oldest REITs in existence.
To remind you, what SUI does is own manufactured housing or RV community homes or marinas. This is not your typical "apartment" or multi-family REIT, and should not necessarily be directly compared to those - but should instead be partially considered as its own thing - because the trends are different. This is especially true with a revenue rental mix of 50% manufactured housing, and the rest split between RV communities and marinas.
The company has several "largest"-sort of track records. It's the largest publicly traded owner of Manufactured Housing communities in all of North America and is also the largest and most diversified owner of Marinas in the US, with over 48,000 wet slips and dry storage places. It owns marinas that have 81% coastal members with over 48,000 members in the company's network and a waiting list at over 89% of the company's marinas.
Demand is good, and trends are good.
Its RV communities rank as some of the best in the country with over 59,000 spots in good locations, with 10,000 sites for expansion and greenfield development.
In short, investing in SUI puts your money to work in a company that has a track record of operational excellence, comes with an IG rating, and at a yield of just south of 3%, with my own YoC closer to 3.3%.
I'm very happy with this investment, and despite a good short-term RoR, I'm not interested in rotating my investment here.
What's even better, the company is in areas where I do not see the same sort of pressure that we're likely to see in home sales or apartment rents. MH, RV, and Marina work different trends, and this has been proven over time. Take a look at the company's overall detailed mix.
SUI IR (SUI IR)
What's more, the company also has international diversification going for it. It has UK operations - at least some. And the mix isn't as illogical as you might first consider it to be. The reason is that Manufactured housing, RV, and Marinas share the common characteristics of having outsized demand, but very high entry barriers and relatively low demand. New supply to the market is extremely rare.
Also, we have 3Q23 results. Take a look at what sort of rental increases the company has been able to push, and you'll see why I'm not as worried about the growth potential of SUI as I am about other apartment or housing REITs out there.
SUI IR (SUI IR)
The company reported a Core FFO of $2.57 per share, which exceeded the high end of the company's guidance range. Also, same-property NOI growth of 6.7%, once again meaningfully outperforming. The company now expects between a 5.4% to a 7.1% rental growth for the year 2024 and given what trends we've seen the last year here, I view these as realistic.
The Balance sheet isn't as low-leveraged as I would have liked below 6x, which also explains why the company has only a "BBB", instead of a "BBB+", because we're at net debt to TTM EBITDA of 6.1%, with 17.5% floating rate debt. This is perhaps the one fundamental factor not as great as other REITs.
However, there is a change coming here and a potential catalyst for improvement. With the Ingenia stock sale debt paydown, new debt financing, and new hedging, the company now is able to on a forward basis communicate leverage of just 6.0x and a lower rate of 14% of floating rate debt. This is still above where other companies in the sector are, but at least the company is getting closer to going below 6x.
The same supply/demand fundamentals that I described with positive verbiage in my previous article are still relevant here. Also, the current economic climate actually means that more people are moving into MH communities. The same-property occupancy has been rising for years, and now stands close to 88%.
Simply put, when unemployment rises, so do people moving into the company's manufactured housing units.
And, by the way - the same is true in the UK. Economic and socioeconomic uncertainty pushes people to move towards so-called "Holiday homes", meaning the UK equivalent in this context.
SUI IR (SUI IR)
The company's appeal is the combined positive track record of same-property growth and the supply-demand fundamentals as well as the current global economic situation we're facing.
Based on these, I would view the company, following a better-than-expected 3Q23, as a continued positive potential portfolio stake, provided you can add it at the right value and hold it for a good upside.
Let's take a look at the Risks & the Potential upside here.
Risks & Upside
The risks to SUI are, at least as I see it, not operational in nature. We're talking about a relatively moderate growth rate - about 4-5% in FFO terms annually, but these are extremely safe over time. Historically speaking, SUI always either hits or beats its stated targets, so the 3Q23 trends are not a surprise or an outlier here.
The risks are valuation-related in nature. Because SUI trades at such a significant historical premium, the question becomes what premium should the company hold when money is no longer cheap, but the underlying growth is still solid? Estimating or going too high here could easily land you at a sub-par growth rate over time, and this is where we should be careful.
The upside is that at the right valuation, even a relatively conservative growth rate for the company ensures a double-digit growth rate that sees you beating the market, even if doing so likely isn't a product of the company's relatively meager sub-3% dividend yield.
Because the dividend is so low, entry valuation becomes even more important here.
Let's look at the valuation and upside here.
Valuation
In my last article, I gave the company a $170/share conservative PT. This implies, on a forward basis, a P/FFO of about 21x, which is also where I consider that this REIT should likely be trading within a few years.
21x P/FFO is well below the 5-year average, which lies above 26x P/FFO. However, in using 21x P/FFO as a target, we're using something far more conservative from the GFC, the 10-12 year average, which is around that 21x average.
To 21x, the upside is almost exactly 21x - and to the 10-year of 21.6x, the upside looks something like this.
SUI Upside (FAST Graphs)
Even at 18x P/FFO, the upside is very close to 9% per year. None of this is going to make you "rich" as an investor unless you already are rich with the capital you go in with. However, the company can provide safety to you - and will likely do so in the next few years as it enjoys the upsides of the current macro, which I do not see changing significantly.
Any catalyst for a downturn here is already baked into this price. The company could go down back to the sub-15x P/FFO level, at which point I would start heavily adding to this company - but I don't see anything that, with the latest trends, would push things far down beyond this.
Analysts are also positive about this company at this price.
The 14 analysts that follow the company here go from an average of $120 to a high of $175/share, with 12 out of 14 either at a "BUY" or a positive rating with an average PT of around $145/share. My PT for the long-term is $170, but to offer additional context here, I believe the company has a very strong potential at anything below $150/share. $170 is simply the price where I would start looking at actually trimming or buying something else in the sector instead.
What I would look at is rent increases, occupancy, and leasing trends apart from the company's pipeline for developments, to make sure that projects continue to meet the company's return goals. The one thing I might look at is some of the unorthodox sections of the company, such as UK home sales. The last quarter saw a downtick in sales profits as well as volumes - and it's a question of when we'll see the bottom - but as of the latest quarter, we've received a bit of a positive sign here with the UK segment going up as well.
This makes maintaining a positive thesis on SUI fairly easy even at a higher price.
Here is my current stance on the company.
Thesis
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Sun Communities is one of the more interesting residential REITs out there due to its significant stake in Marinas and RV parks. The company has not only good performance, but it also outperforms most of its comps. While its fundamentals aren't as ironclad as its peers, it's still a very safe bet, as I see it.
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This makes it, despite a sub-3% yield, one of the better investments in the space at this time. Consider also that SUI is actually undervalued here (as I see it) for the first time in over a year, and can still, as of December of 2023, be bought at what I view as a conservative upside while meeting my overall minimum return targets of 15% per year.
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For that reason, it's a "BUY". My PT is $170/share long-term, and I see a good upside here. Anything below $150/share is really quite attractive here.
Remember, I'm all about:
1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them (italicized).
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This company is overall qualitative.
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This company is fundamentally safe/conservative & well-run.
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This company pays a well-covered dividend.
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This company is currently cheap.
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This company has a realistic upside based on earnings growth or multiple expansion/reversion.
This means that the company fulfills every single one of my criteria except the "cheap" part, making it relatively clear why I view it as a "BUY" here.
For further details see:
Sun Communities: Reversal Has Come