Cousins Properties: 4.9% Dividend, 30% Upside Over Next 2 Years

Cousins Properties (NYSE:CUZ) has plunged 37% over the last 12 months due to strong business headwinds, namely the adoption of a work-from-home model from many companies and the expected impact of high interest rates on the interest expense of the REIT. In addition, due to the impact of nearly 40-year high inflation on the present value of future cash flows, the stock is currently trading at a nearly 7-year low price-to-FFO ratio of 9.6 and is offering a nearly 10-year high dividend yield of 4.9%. As inflation is likely to subside and the business of Cousins Properties will probably recover, the stock has 30% upside potential over the next two years.

The reasons behind the plunge of the stock

Cousins Properties was founded in 1958 and is a self-administered REIT that acquires, develops and leases office buildings in high-growth Sun Belt markets. It generates 53% of its operating income in Atlanta and 32% of its operating income in Austin. The REIT is 100% focused on Sun Belt markets, which are characterized by superior population growth as well as economic growth compared to the rest of the country.

While many REITs have recovered from the pandemic, Cousins Properties has not recovered fully yet, as many companies have adopted a work-from-home or a hybrid business model. The pandemic has subsided but the work-from-home trend has proved much more persistent than initially expected. As a result, the occupancy of Cousins Properties has remained suppressed, at 90.1%.

In addition, just like most REITs, Cousins Properties is currently facing another headwind, namely the surge of inflation to a nearly 40-year high level. Due to excessive inflation, the Fed is raising interest rates aggressively, in order to restore inflation to its long-term target of 2%. Higher interest rates are likely to significantly increase the interest expense of most REITs.

However, Cousins Properties has a leverage ratio (Net Debt to EBITDA) of 4.75, which is lower than that of most REITs, including Cousins Properties.

It is also important to note that only 1% of the debt of Cousins Properties matures this year. As a result, the REIT will not have to refinance a meaningful portion of its debt anytime soon and hence it is protected from the adverse environment of high interest rates for the foreseeable future. Moreover, its interest expense consumes 37% of its operating income. While such an amount of interest expense is material, it is certainly reasonable and manageable amid the prevailing interest rates.

Recovery

The work-from-home trend has persisted longer than initially anticipated and thus it has kept pressuring the business of Cousins Properties. However, the REIT has begun to recover from this downturn. Thanks to improving trends in the demand for its office properties, the trust is expected to post FFO per unit of $2.71 for 2022. This level of FFO per unit is just 8% lower than the pre-pandemic high of $2.94, which was achieved in 2019.

It is also remarkable that some large companies, such as Goldman Sachs (GS), Morgan Stanley (MS) and Disney (DIS), recently called their employees to return to their offices. It is thus reasonable to expect the work-from-home model to attenuate in the upcoming years.

Moreover, Cousins Properties greatly benefits from a secular trend, namely the superior population and job growth in Sun Belt markets, which results from the massive migration of people from other states to these areas. Thanks to this tailwind, Cousins Properties has grown its average rent per square feet by 33% since 2017.

As shown in the above chart, the average rent per square feet has grown significantly and consistently over the last five years. As the migration to Sun Belt markets does not show any signs of fatigue, Cousins Properties is likely to continue enjoying this tailwind for many more years. It is also worth noting that only about 11% of the leases of the REIT are set to expire within the next two years. Therefore, the trust has good visibility in its revenues for the foreseeable future.

Valuation

Cousins Properties is currently trading at a nearly 7-year low price-to-FFO ratio of 9.6, which is much lower than the 10-year average of 12.6 of the stock. The exceptionally cheap valuation of the stock has resulted from the surge of inflation to a nearly 40-year high. High inflation reduces the present value of future cash flows and thus it compresses the FFO multiples of REITs.

However, the Fed is determined to restore inflation to its long-term target of about 2%. Thanks to its aggressive interest rate hikes, the central bank is likely to accomplish its goal, probably within the next two years. Its efforts have already begun to bear fruit, as inflation has moderated from a 40-year high of 9.1% in the summer to 6.5% now.

When inflation reverts towards its normal range, the stock of Cousins Properties is likely to revert to its historical average level. Analysts expect the REIT to post FFO per unit of $2.73 in 2024. If the stock trades at its 10-year average price-to-FFO ratio of 12.6 in that year, it will trade at $34 (=12.6*2.73). This means that the stock has 30% upside potential over the next two years.

Dividend

Thanks to its exceptionally cheap valuation level, Cousins Properties is currently offering a nearly 10-year high dividend yield of 4.9%.

When a stock offers such a high yield, it usually signals that the dividend is at the risk of being cut. However, the REIT has a reasonable AFFO payout ratio of 68% and a manageable amount of debt. As a result, its dividend appears safe in the absence of a severe recession.

A point of concern is the short dividend growth record of the REIT, which has grown its dividend for only 4 consecutive years. This means that management is not likely to exhaust its means to defend the dividend in the adverse scenario of a deep recession, unlike other REITs. Nevertheless, the dividend seems to have a meaningful margin of safety under normal economic conditions, including a shallow recession.

Risks

Cousins Properties will be severely hurt in the adverse scenario of a prolonged recession. In such a case, the occupancy rate and the rent hikes are likely to come under pressure and thus the REIT may decide to slash its dividend. However, such a scenario is unlikely, as the Fed is closely monitoring the economy and has always proved determined to stimulate the economy during rough economic periods. Even in the unlikely scenario of a deep recession, Cousins Properties may cut its dividend but it is likely to endure the downturn thanks to its decent balance sheet and emerge stronger after the downturn.

Another risk is the adverse scenario of persistently high inflation for years. In such a case, the valuation of the stock will remain under pressure for an extended period. In addition, the REIT will be adversely affected by high interest rates, which will remain in place longer than currently anticipated. Fortunately, thanks to the aggressive stance of the Fed, inflation has begun to moderate significantly and is likely to revert to its normal range within the next 1-2 years.

Final thoughts

Cousins Properties is offering a nearly 10-year high dividend yield of 4.9% and is trading at an exceptionally cheap valuation level. Whenever inflation approaches its normal range, the stock is likely to offer 30% upside potential from its depressed current price. Nevertheless, as the stock is highly sensitive to the path of inflation, only patient investors, who can ignore stock price volatility and maintain a long-term perspective should consider purchasing this stock.