AJ_Watt
Real estate investment trusts (“REITs”) are appearing on the 52-week lows list left and right, and among them is a giant in the self-storage space called Public Storage (NYSE:PSA). Unlike some peers, Public is not as forthcoming through an investor presentation which includes all the details on its self-storage portfolio, at least not as of recent. However, do not be fooled, as this is one of the largest players in the segment.
The Business
Public Storage is a huge REIT which was founded in the 1970s. It runs thousands of buildings, with over a million garages let out to over a million customers across the U.S. With a nationwide coverage, the company has outgrown many of its peers, being larger than its peer Extra Space Storage (ESR) while being substantially larger than peers Life Storage (LSI) and CubeSmart (CUBE). The company claims superior rents and margins due to its positioning and scale, as this business is about scale to handle the many tiny rental contracts efficiently for the business, but also keep it easy to lower the hurdle for its customers.
The rise of the industry has been driven by a multi-decade trends, that of an increase in the U.S. population which uses self-storage solutions, having risen from about 3% in 1990 to 10% in 2020, meaning that the market has tripled in terms of volumes, even ahead of population growth and inflationary trends.
The company reported total revenues of $3.4 billion in the year 2021, up 17% on the year before as a result of a combination of organic and inorganic growth. The company incurred $1.8 billion in expenses, nearly half being actual expenses to run these operations, complemented by more than $700 million in depreciation charges, some general and administrative expenses and interest expenses. Occupancy rates trending around 95%, which is fair in this industry, while rents per square foot ran at $20 already late in 2021.
The company posted net earnings of $1.73 billion, equal to $9.87 per share based on 175 million shares outstanding. After adding back depreciation charges and making some other minor adjustments, the company posted FFO of $13.36 per share.
The balance sheet of the company measured $17.4 billion in 2021, comprised out of $15.3 billion in net value of property assets, complemented by some JV investments. This is financed by $9.3 billion in equity, resulting in conservative financial practices with just over half of assets backed by equity. On the back of investments and anticipated strong pricing trends in 2022, the company guided for funds from operations (“FFO”) in 2022 to rise to $14.75-$15.65 per share.
Some Perspective
A $200 stock ahead of the pandemic saw PSA’s share price peak around $400 in April of last year, peaking while other REITs were already seeing some softness amidst higher interest rates and some pullback in wider REIT markets. Shares quickly pulled back to $300 over the summer, having seen gradually more pressure to now trade at $270 per share.
In April, some big news arose, as Blackstone Real Estate acquired PS Business Parks, a company 41% owned by Public Storage. The deal was set to bring in $2.7 billion in cash proceeds, or $2.3 billion after-taxes, with some 4% FFO dilution seen as a result of the deal. Proceeds from the deal, amounting to $13.15 per share, were eventually paid out to investors in August of this year.
Just after this news announcement, the company posted first quarter results in which revenues rose 15% to $750 million, with Funds From Operations up 29% to $3.65 per share. FFO rose another 27% in the second quarter, to $3.99 per share, as the company hiked the midpoint of the FFO guidance from $15.20 per share to $15.35 per share, despite the divestment of the shares held in PS Business Parks.
Third quarter FFO rose 21% to $4.13 per share as the midpoint of the FFO guidance was hiked further to $15.55 per share, despite some headwinds on the horizon. Following the divestment the balance sheet remained quite stable, now showing $17.5 billion in assets, supported by as much as $10.0 billion in equity.
And Now?
With shares up to $270 per share and 176 million shares outstanding, Public Storage is commanding an equity valuation in excess of $47 billion, a huge multiple compared to the $10 billion book value for the properties. Adding the incremental $37 billion premium to the asset valuation of around $17 billion, the market is really valuing these assets (and the operating business) at around $54 billion.
The company is now on track to generate some $4.0 billion in gross revenues, or about $2.2 billion after depreciation charges, interest expenses, G&A, and even interest. Needless to say, these shares look a bit rich in relation to the gross valuation. Even if I add depreciation charges at around $900 million a year here, valuations are quite expensive in relation to the valuation of the properties.
This comes even as the valuation of the shares dropped with more than $20 billion already since the peak. A current $8 per share dividend amounts to a reasonable 3% dividend yield, although a bit low compared to some other REITs and risk-free alternatives.
The question is now about the concern of leverage as a result of higher interest rates, but still the valuation at large. The self-storage business has seen incredible momentum, evident in strong demand and huge comparable sales growth, yet the overall valuation remains steep. Based on FFO, valuations come in around 17-18 times. So, the issue is not about leverage (as this is relatively low), or profitability, as the business is really profitable, but more about a potential valuation retreat.
While Public Storage valuations are getting more reasonable, I fear that pandemic momentum will be reverting, resulting in less demand for goods and less demand for storage, as consumers are strapped for cash amidst inflationary pressures and a softer economy. All of this leaves me quite cautious, as the fat profits attract new competition as well, of course.
Amidst all of this, I am still leaning cautious toward Public Storage based on the fundamental performance. I fear that Public Storage valuation multiples might contract a bit further here, given how rates have moved and how strong the underlying performance has been over the past two years, making it a bit too early with Public Storage to dip my toes into the water.
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