2023-12-18 03:55:13 ET
Summary
- Terreno Realty Corporation owns and operates industrial real estate properties across 6 U.S. coastal markets.
- The company's portfolio is well-diversified and its operating results have been consistently strong.
- However, the dividend yield is low and the shares are trading at a large premium to NAV.
Terreno Realty Corporation ( TRNO ) specializes in the acquisition, ownership, and operation of industrial real estate assets located across 6 U.S. coastal markets.
Its portfolio is well-diversified both geographically and based on the property type, operating results keep making new highs, leverage is extremely low as well as cheap, and liquidity is incredibly high. Regardless, the dividend yield is too low and the shares are trading at a large premium to NAV. Below I aim to provide the thesis that supports these statements for investors interested in TRNO.
Portfolio
First of all, Terreno owns 257 buildings with a total size of 15.8 million sqft which are located in Los Angeles (17.5 % concentration based on sqft), Northern New Jersey/New York City (16.6 %), San Francisco Bay Area (19.2%), Seattle (17.6%), Miami (17.8%), and Washington, D.C (11.3%).
Its portfolio consists of various types of industrial properties, such as warehouses (76.3% concentration based on ABR), flex (~3.8%), transshipment (~6.7%), and improved land (~13.2%).
The company serves large corporations such as Amazon ( AMZN ), FedEx ( FDX ), and Meta ( META ), as well as the U.S. Government. Moreover, its 20 top customers contribute to 26.1% of its ABR; a low enough concentration to not materially affect the REIT's profitability if some big tenant stops doing business with it.
Performance
Regarding occupancy, 98.3% of the properties and 96.3% of the improved land parcels were leased as of September 30. Considering the national average 4.6% vacancy rate , I believe that Terreno is very efficient in the management of its assets.
Additionally, its operating performance has been nothing sort of spectacular in the past, with a definite trend of revenue, operating income, and FFO depicting them restlessly growing:
The more recent operating results also add to the growth story here. Below, I compare the most recent quarterly figures on an annualized basis with the average annual figures from the last 3 fiscal years:
Rental Revenue Growth | 45.26% |
Same-Property Cash NOI Growth | 42.39% |
AFFO Growth | 79.56% |
Not surprisingly, TRNO's price has grown as well throughout the years:
Of course, it also experienced a fall since last year about the time the Fed started raising the rate. But as far as I can see, there was a non-fundamental driver at work.
Leverage
What's interesting here is that Terreno managed to grow so much by funding its operations with very low leverage. Its assets are only 21.65% financed with debt, and its debt-to-EBITDA ratio sits at 3.19 times. Plus, interest coverage is 8.1x which represents more than adequate liquidity.
Below, it's clear that the REIT has decreased its leverage and increased its liquidity over the years:
Moreover, debt consists of term loans and unsecured notes which have a weighted average interest rate of only 4%. And such a low cost of debt is unlikely to significantly increase from upcoming maturities as only $100 million of notes mature in 2024 (~13% of total debt), there are no maturities in 2025, and the sum of $50 million maturing in 2026 along with the $150 million maturing in 2027 also represent a small portion of the total debt (not to mention these maturities are very far into the future and it's unlikely that the current situation of high interest rates will remain unchanged by then).
Dividend & Valuation
Terreno currently pays a $0.45 dividend per share which translates into a 2.88% forward yield. While the yield is very low in the current environment, I need to note that the company has been steadily increasing it since 2012:
To put this into context, the payout was just $0.1 per share in 2012 and $0.24 per share in 2018 (just 5 years ago).
Regardless, I need to note that the payout ratio is very high; 79.58% based on FFO and 97.88% based on AFFO. So even though the track record doesn't make it look likely, a dividend suspension or cut during unexpected adverse periods shouldn't be out of the table.
Now, the yield is not the only one that is low here. TRNO is currently trading at a 3.14% implied cap rate. Consider that the median implied cap rate for industrial REITs reached 8.2% in the second quarter of 2023.
Sure, cap rates for industrial assets have been lower than other types like retail, office, and residential properties recently, but nowhere near 3%. In fact, they seem to have been and forecast around 5% . Even if I assume a 4% rate for Terreno's assets, it would be trading at a 25.09% premium to NAV ($46.76 per share).
Risks
Therefore, we first and foremost have a risk of repricing. No matter how much the management of Terreno's portfolio deserves the premium the market assigns to it, a potential investor is faced with a lack of margin of safety. In the advent of an unexpected event that will negatively affect the business, a falling stock price may shake an investor's confidence if there's no margin of safety and result in a realized loss of capital. Mind you, I used a 4% cap rate to calculate the premium. If the average of ~5% is closer to reality, the premium to NAV could be more than 40%.
Now, this doesn't have to necessarily result in a decreased price. There is also an opportunity risk here. With so many currently undervalued REITs out there, one may realize an opportunity cost with TRNO that its low dividend yield simply won't be able to significantly offset.
Speaking of which, the payout ratio is dangerously high based on AFFO as we've seen. Even though the payment record depicts an ever-increasing dividend, a suspension or cut can be conceived as possible if something impairs Terreno's cash flow. It hasn't happened before with this REIT but it hasn't been in business for decades and there's always a first time for everything.
Verdict
For these reasons, I am assigning a HOLD rating on TRNO stock. It is highly unlikely I will ever be able to buy it as I have no doubt the business is going to keep growing and the stock price along with it. In fact, we may never see the price at such low levels again. But part of the success during our investment journey is the ability to say "no" whenever appropriate.
What about you? Do you own the TRNO or intend to? Why or why not? Leave a comment below and I'll make sure to get back to you soon. Thank you for reading!
For further details see:
Terreno Realty: Quality Is Expensive