It’s time to combine two topics that I like to talk about: industrial markets and real estate.
In this article we will discuss CERF Industrial (NYSE:DEER)one of America’s largest real estate investment trusts (“REITs”).
With a market capitalization of $7 billion, the company boasts consistent dividend growth and a 3.7% yield, making it a suitable investment for income-seeking investors.
It has also significantly outperformed its real estate peers since its 2011 IPO.
Additionally, not only does this company enjoy a rock-solid business, but it also enjoys secular growth in the industrial real estate sector.
Unfortunately, after rebounding 27% from its 52-week low, the stock has reached a valuation that I would consider “fair”, meaning that at current prices, I would rather wait for a decline, or I would opt for undervalued, higher yielding alternatives.
In this article, I’ll expand on all of that, starting with the big picture.
So let’s go !
The industrial giant
As I already have briefly mentionedSTAG went public in 2011. Since then, it has grown into an S&P 400 Mid-Cap giant with nearly 570 buildings, covering 112 million square feet in key markets.
As of the third quarter, the company had a presence in 41 states, with nearly 90% of its buildings operating in Tier 1 and Tier 2 markets.
A quarter of its assets benefit from multi-tenant agreements, which reduces operational risks.
In addition, since this year, it has benefited from rent indexations close to the current inflation rate and a weighted average lease duration of 4.5 years.
- The company has a well-diversified geographical diversification. Its largest market is Chicago, which accounts for 7.7% of its 2022 rent.
- Philadelphia accounted for 7.2% of total rent, making it the second largest market.
- 10.9% of its rents came from Air Freight & Logistics, followed by Containers & Packaging, representing 8.2% of the total rent in 2022.
- Its largest tenant is Amazon (AMZN), which represented 3.0% of the total rent. Number two was Eastern Metal Supply, which accounted for 0.9% of the total rent.
What’s interesting is that STAG benefits from a very important trend in the United States: economic reshoring.
Even if the United States does not completely dissociate itself from China, we are seeing an accelerating trend for companies to reduce supply chain risks. They are moving part of their supply chains to North America to reduce their dependence on China.
This trend is accelerated by the fact that foreign countries are relocating their production to the United States. European companies, for example, benefit from a strong customer base in the United States and more favorable economic conditions (i.e. lower energy prices).
Since October, the United States has imported more goods from Mexico than from China, which includes Chinese companies setting up shop in Mexico to avoid (future) tariffs.
In the United States, this trend has led to massive growth in manufacturing construction spending as new buildings are needed for megaprojects like semiconductor production, warehouses, and everything related to this reshoring trend and risk reduction.
In the case of STAG, the company benefits from mega-site projects. 30% of its portfolio is located within 60 miles of these projects.
That said, the industrial market is large, which still makes it very dependent on macroeconomic trends.
According to Wells Fargo 3Q23 Commercial Real Estate reportThe industrial real estate sector faces a dynamic landscape shaped by changing economic conditions.
While the commercial real estate market as a whole is experiencing a slowdown, industrial properties faced unique challenges and opportunities in the third quarter of 2023.
Despite a considerable drop in demand, the industrial market maintained positive momentum with 33.5 million square feet of net absorption in the third quarter.
This means a moderation in demand compared to previous years, but demonstrates resilience in the face of economic uncertainties.
Additionally, a notable development in the third quarter was the influx of new industrial deals, marking the largest increase since at least 2001.
The 132 million square feet of new projects entering the market reflect the impact of industrial construction efforts in recent years.
However, a subsequent decline in housing starts is expected, suggesting a potential slowdown in future deliveries, which bodes well for prices.
The vacancy rate in the industrial sector rose to 5.1% in the third quarter, in line with pre-pandemic levels.
All things considered, the industrial real estate sector has demonstrated resilience in the face of economic uncertainties, maintaining positive absorption and managing supply dynamics.
How attractive is STAG?
In light of the challenges and headwinds, STAG’s industrial leasing business is poised for one of the best years on record, benefiting from the aforementioned secular tailwinds such as nearshoring, onshoring and e-commerce. .
However, market rent growth has normalized due to a changing landscape, which was confirmed by the Wells Fargo report.
Deliveries in 2023 are expected to represent 3% of overall industrial inventory, contributing to a national vacancy rate of 4.4% by the end of the year.
Despite this, strong conditions lie ahead and STAG expects high single-digit market rent growth across its portfolio for 2023 and mid-single-digit growth for 2024.
Additionally, STAG reported record cash and GAAP rental spreads in the third quarter.
As of October 24, 98% of expected leases for 2023 have been completed with cash rental spreads of 30.1%. For 2024, 37% of leases (5 million square feet) achieved cash releasing spreads of 30%.
This is good news for rent growth in the quarters and years to come.
Additionally, in the third quarter of 2023, the company reported that Core FFO (funds from operations) per share was $0.59, representing an increase of 3.5% from the same period of the year. last year.
Base FFO includes a $900,000 settlement with a former tenant, contributing an additional $0.01 to base FFO for the quarter.
Cash available for distribution for the quarter was $96.8 million, with retained cash flow of $71.4 million after dividend payments through September 30.
In other words, its dividend was well covered.
Speaking of its dividend:
- STAG has a yield of 3.7%, based on a dividend of $0.1225 per share per month.
- The dividend is protected by an adjusted FFO payout ratio of 73%.
- The five-year dividend CAGR is just 0.7%.
The low dividend growth rate is a drag, but it hasn’t stopped the company from outperforming its peers, as I showed at the start of this article.
Note that the company did not reduce its dividend in 2013. At the time, it went from a quarterly distribution to a monthly distribution.
The dividend is also protected by a healthy balance sheet.
In the third quarter, leverage was reported just below the lower end of the guidance range, with net debt to annualized adjusted EBITDA at 4.9x. Liquidity in the third quarter was $683 million.
The company has virtually no maturities before 2025 and benefits from fixed-rate debt of 87%.
The total weighted average interest rate of its debt is 3.7%, with a weighted average maturity of 4.5 years.
It benefits from an investment grade rating from Fitch and Moody’s.
So, what about valuation?
Despite the industry’s challenges, the company’s strong execution led to higher guidance.
Beginning in the third quarter, guidance for core FFO per share was adjusted upward to a range of $2.26 to $2.28 per share, indicating an increase to the midpoint of $0.02 .
When it comes to adjusted FFO, the analysts (not the company) expect:
- 6% growth in 2023.
- 3% growth in 2024.
- 7% growth in 2025.
These figures can also be found in the table below.
In addition to that:
- STAG trades at a blended P/AFFO multiple of 19.7x.
- The long-term normalized valuation multiple is 16.4x.
- A return to its normalized valuation by incorporating expected AFFO growth would result in a fair price target of around $36, which is below its current price of $39. Including dividends, the total return over the next few years should be moderate. The current consensus price target is $37.60.
While I think STAG could return more than 0% through 2025, I’m not a fan of the risk/reward after the recent stock price surge.
If I were an investor in this company, I would sit tight to add more exposure once the stock drops a bit.
At this price, I would prefer higher yielding alternatives and cash while waiting for buying opportunities.
That said, longer term, I remain bullish on STAG and believe it has the ability to continue to outperform its real estate peers.
STAG Industrial’s dividend reveals an impressive player in industrial real estate, standing out with a market cap of $7 billion and a yield of 3.7%.
Strategically positioned with nearly 570 buildings spanning 112 million square feet, STAG’s focus on Tier 1 and Tier 2 markets and multi-tenant agreements mitigate operational risks.
Of note is its alignment with the US trend of economic reshoring, allowing the company to capitalize on the boom in manufacturing construction.
Not only is it showing resilience in the face of economic uncertainties, but the company is also excelling with high single-digit market rent growth and record rental spreads.
Despite caution regarding its current valuation, STAG’s unique positioning makes it a key long-term player in the industrial real estate landscape.