STAG Industrial: Solid REIT, Fairly Valued (NYSE:STAG)

Shares of STAG Industrial (NYSE:STAG) have come under pressure in 2022, like so many REITs, amidst rising interest rates, despite a low leverage position and good positioning of the real estate. Nonetheless, shares have fallen in a meaningful fashion as well, mostly driven by higher interest rates induced by higher inflation.

STAG is acting from a position of strength and looks reasonably valued here after low interest rates drove multiples too high in recent years, yet expectations have been reset to largely fair levels here.

The Portfolio

STAG has seen solid growth, having been a decent steward of REIT capital since the company went public in 2011, with shares trading around the $13 mark at the time. Shares have risen in a steady fashion, peaking at nearly $50 by year-end 2021, now having settled around $32 as investors have priced in weaker demand for logistics and industrial space, but moreover higher interest rates.

Shares have nearly tripled while paying a compelling dividend yield, now running at 4.5% per annum, in the process. The company has seen very strong growth, having expanded its footprint from 14 million square foot at the time of the IPO to 111 million square foot today, with properties on average becoming larger while the ownership focus has increasingly been more on logistics and industrial tenants.

The average WALT approaches five years as the business is quite diversified in terms of tenants. Amazon (AMZN) is the largest tenant, responsible for 3% of sales, with the second-largest tenant responsible for less than a percent, including names like FedEx (FDX), Tempur Sealy (TPX), DS Smith (OTCPK:DITHF, OTCPK:DSSMY), and others.

Despite the near-term hiccups driven by weaker demand for e-commerce and higher interest rates, there are some offsetting factors. The logistics sector and e-commerce should benefit from re-shoring of production, greater inventory levels, and the secular trend at which e-commerce continues to increase. Moreover, the company employs relatively little leverage, insulating the company somewhat from higher interest expenses.

The Base

STAG reported $5.8 billion in assets for the year 2021, of which $5.6 billion is represented by land, buildings, and lease intangibles. This was financed by $2.4 billion (largely unsecured) in debt, and the remainder by equity, resulting in a lower LTV ratio.

The company generated $562 million in rental income, which translates into a roughly 10% yield. This was in part the result of relative steep $108 million in property expenses and $48 million in general expenses. Interest expenses totaled another $63 million and the company reported $239 million in non-cash depreciation charges.

GAAP earnings only came in at $1.15 per share, even inflated by a pretax $98 million gain on dispositions as investors focus on funds from operations. These came in at $344 million, equal to $2.06 per share based on 167 million shares outstanding for 2021.

The company continues to aggressively expand the portfolio, investing another $166 million in the first quarter of the year, growing the portfolio at a rate of 10% per annum, with funds from operations up five cents to $0.54 per share. Similar investment volumes were reported in the second quarter, with funds from operations up four cents to $0.56 per share. The company even sold some properties in July, announcing a substantial refinancing at a 3.3% effective interest rate (including swaps), which looks quite compelling.

Third quarter acquisition activity cooled down to $127 million as the balance sheet had expanded to $6.2 billion, now financed with $2.7 billion in debt and the remainder in equity, for an LTV ratio around 45%.

Revenues were reported at $166 million in the quarter, trending around $664 million a year, at a gross yield in excess of 10%. Offsetting the increase in property expenses and depreciation charges, STAG has been able to cut general and administrative expenses in a notable way.

The quarterly interest bill rose to $21 million, on the back of higher growth in the asset base, in combination with higher borrowing rates, with funds from operations up four cents to $0.57 per share, on track to post FFO of around $2.20 per share. The company pays out roughly two-thirds of these funds from operations, now paying an annual dividend of $1.46 per share in monthly installments to its investors.

With the book value of $3.5 billion translating into a valuation of around $19 per share based on 182 million shares outstanding, STAG still trades at a huge premium. Trading at $32 at the moment, the equity commands a $5.8 billion valuation, a $2.3 billion premium compared to the book value.

This implies that the assets are valued at $5.9 billion (book value) plus the premium of $2.3 billion, which together amounts to $8.2 billion. With revenues trending at $664 million, the cap rate comes in at 8.1%. The reason for that is somewhat simple as the company incurs some costs (outside the core depreciation and interest charges). Property and general and administrative costs run at roughly a quarter of the gross revenue base, lowering the rent yield to around 6%.

Concluding Remark

A current 4.5% dividend yield looks quite fair, nothing too exciting but a reasonable and competitive rate compared to risk-free rates at large. The company and portfolio are well positioned in terms of type of assets and lower leverage ratios, yet the company by its nature (in part because of some older buildings), incurs higher property expenses. This comes as buildings are a bit older, as these are not triple net leases, of course.

Nonetheless, I have to give management credits for keeping expenses low and refinancing at cheap interest rates this summer, insulating the company well from the headwinds as low leverage and more modest expectations create potential for a take-out as well.

After all, this was already a $27 stock in 2017, and while shares now trade at $32, they actually re-tested the levels seen in 2017 in recent weeks already. Over the last couple of weeks, shares have risen $5 apiece, or nearly 20%, in response to interest rates having leveled off. This furthermore comes as the company operates from a position of strength, with no big maturities coming up in 2023 and 2024. This sets the company up for a solid foundation to fund operational growth in the coming years.

Given where rates have moved, overall valuations look quite fair at best, as some pullback should be expected and is seen in 2022. Amidst all of this, I think STAG offers fair value here at best.