Alexandria Real Estate: A Diamond In The Rough With Upside (NYSE:ARE)


Currently, healthcare REITs are experiencing near-term headwinds, as nursing homes have been on high-alert in containing and preventing COVID outbreaks in their facilities. In this article, I’m focused Alexandria Real Estate Equities (ARE), which is also in the healthcare space, but doesn’t come with the risks of the overall sector. I explore what makes ARE worth owning at the current price; so let’s get started.

(Source: Company website)

A Look Into Alexandria Real Estate

Alexandria Real Estate Equities is a leading REIT with a focus on Life Sciences, Technology, and Agricultural Technology. Its business model is focused around developing urban innovation clusters that are adjacent to the nation’s top academic institutions. As seen below, its properties are generally located near leading research institutions in the Northeast and the West coast. Last year, the company generated over $1.5B in total revenue.

(Source: Company website)

What I like about Alexandria is that while many of its healthcare REIT peers are working to contain COVID outbreaks in their facilities, Alexandria’s tenants are working to enhance testing, and are developing therapies and vaccines. This is supported by Alexandria’s leading tenants, which includes Abbot Laboratories (ABT), Johnson & Johnson (JNJ), Amgen (AMGN), Pfizer (PFE), and Moderna (MRNA), to name a few. This helps to put Alexandria’s properties at the cutting edge of scientific innovations.

In addition, the company is currently developing its OneFifteen project, which is a sprawling campus in Dayton, Ohio. This is an outpatient campus that is meant to help tackle the opioid crisis, and includes a residential and rehabilitation facility for patients suffering from opioid addiction. I see this as being a good example of the innovative and forward thinking ways that Alexandria approaches development projects.

Alexandria’s rent collection rate is currently very healthy, with a 99.5% collection rate during the latest quarter. What’s more impressive is the strong rental growth rate, which, during the second quarter, saw a 15% YoY increase on a cash basis. In addition, the occupancy rate remains strong at nearly 95%, with no significant subleases coming to the market during the pandemic. For reference, subleases are an indicator that a tenant is having trouble meeting its financial obligations and/or is looking to downsize.

Alexandria’s portfolio is supported by the fact that 51% of its tenants have investment grade credit ratings, with a 7.8 year average lease term. Currently, 94% of its leases contain annual rent escalations, and 93% of its leases are on a triple-net leases basis. This helps Alexandria to have relatively higher operating margins (compared to non-triple net lease REITs), with a last reported 72% operating margin.

In addition, as seen below, Alexandria is seeing double-digit lease spreads on renewed/re-leased spaces. This is an encouraging indicator of strong market demand for its properties, and is a contributing factor to the 5.5% YoY growth in FFO/share that the company saw in the first half of 2020.

(Source: Company Earnings Presentation)

Alexandria also maintains a strong balance sheet with a BBB+ credit rating from S&P. It has $4.2B in liquidity and a weighted average maturity of 9.9 years on its debt. Currently, it has no debt maturities until 2023 and the fixed-charge coverage ratio is at a healthy 4.2x.

The net debt to EBITDA ratio is at 5.8x, which is below the 6.0x barometer that I use for determining a safe amount of leverage. Management’s goal is to reduce the leverage ratio to below 5.3x by the end of this year.

(Source: Company Earnings Presentation)

Risks To Consider

One of the risks I see for Alexandria is related to the tech sector, which management noted as having seen a 50% drop in demand compared to last year. This is mitigated by the fact that Alexandria is primarily focused on pharmaceutical and life sciences tenants, with technology representing just 14% of its annual rental revenue.

In addition, as with all REITs, increases in interest rates pose as a long term risk, as that would increase Alexandria’s cost of funding. However, I don’t see this as a near term risk, as the Fed Chairman has committed to keeping the interest rates low until at least 2023.

Valuation

Turning to valuation, I don’t see the shares as being particularly cheap at the current price of $156.53 and a blended P/FFO of 21.7. However, I do see upside potential, as the company’s properties are in prime locations that are difficult to replicate. In addition, I see plenty of growth potential for the life sciences sector given the continued need for medical innovation, especially during these times. For reference, data center REITs such as Digital Realty Trust (DLR) are also growing and are trading at higher valuations that what Alexandria is currently trading at.

Analysts seem to share this bullish sentiment, and have a consensus 4.5 rating (on a scale from 1 to 5), with an average $185 price target, which sits 18% above where the shares are trading at now.

Investor Takeaway

Alexandria is a premier REIT with high quality life sciences properties in prime locations. Its tenants are solving some of today’s most pressing problems with innovative approaches. Unlike its healthcare REIT sector peers, Alexandria isn’t experiencing occupancy issues nor rent collection problems from its tenants. For this reason, I see Alexandria as being a diamond in the rough.

I see further upside potential for Alexandria’s share price, due to the high quality nature of its properties, the strong balance sheet, and the healthy lease spreads that it is seeing on renewed/re-leased properties, which is indicative of strong demand. As such, I see Alexandria as being a good investment candidate at the current price.

(Source: F.A.S.T. Graphs)

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform their own due diligence prior to making any investment decisions.

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