Denis_Vermenko
Growth companies don’t have to invent some new technology that’s going to change the world. Rather, they simply need to have a differentiated business model with a long runway. While most investors don’t think of REITs as being growth stocks, some of the best-performing companies in the space have been able to deliver steady growth for their investors.
This brings me to STAG Industrial (NYSE:STAG), which has a unique business model that sets it apart from its larger peers. In this article, I highlight why STAG remains a reasonably low-priced stock for potentially strong long-term gains, so let’s get started.
Why STAG?
STAG Industrial is an industrial REIT with a national presence, with 559 properties covering 111 million square feet across 40 states. Its strategy is to acquire and lease out properties in secondary markets, where it’s able to obtain more favorable deal pricing due to less competition from bigger players such as Prologis (PLD) and Rexford Industrial (REXR), which are focused on the more competitive Tier 1 markets.
This differentiated strategy enables STAG to take advantage of property mispricing, as its target markets are more fragmented and consists primarily of private owners that may own just a handful of properties.
Given its single-tenant focus, the binary occupancy risk of a single property is more risky to a private owner than to STAG, which is able to diversify away this risk across its portfolio. This is what management calls “shades of gray” versus simple “black and white”, and is what makes a single property more valuable to STAG than to a single private owner.
STAG has grown its portfolio significantly since IPO from just 93 properties to 559 at present. It’s also stayed true to its objective of being a pure-play industrial landlord by reducing the percentage of flex office/industrial properties from 21% at time of IPO to just 0.1% at present.
STAG is demonstrating respectable growth, with Core FFO per share growing by 7.7% YoY to $0.56 in the second quarter. This was driven by another quarter of robust acquisition activity, in which 9 properties were acquired at a straight-line GAAP cap rate of 5.7%, and by respectable same store cash NOI growth of 4.0% YoY.
Tenant demand for STAG’s properties remains strong. This is reflected by the respectable 89.6% retention rate on 2.1 million square feet of leases expiring last quarter. Moreover, STAG is seeing a high 98.1% occupancy rate and strong lease spreads, with cash rent and straight-line rent growing by 14.1% and 21.9%, respectively. For reference purposes, straight-line rent is based on the average rent of the entire lease term whereas cash rent is based on the initial rent of the lease.
While STAG’s relatively low share compared to the prior 12 months raises its cost of equity, it’s able to grow through leveraging its balance sheet. That’s because it has a low net debt to EBITDA ratio of just 5.1x. In addition, management has been strategic in reducing its payout ratio in recent years so that it’s not as reliant on funding growth through equity sales.
At present, STAG’s dividend payout ratio is just 65% (based on Q2 Core FFO/share), leaving it with plenty of retained capital to fund growth. These contributing factors were highlighted by the CFO during the Q&A section of the recent conference call:
Q: Does your acquisition require more common equity at the higher end of the range? And just if you can comment on funding debt versus equity.
A: Absolutely, it’s a great question. We have not issued equity since the beginning of January. We don’t need to issue equity this year, which is implied in our guidance. We increased the leverage range this quarter. We have strong internal growth. We have material retained cash from earnings now, and we have the opportunity to accretively recycle capital. We’re going to continue to evaluate all options, but our guidance can be achieved without common equity this year.
Lastly, STAG remains attractively valued at the current price of $35.03 with a forward P/FFO of just 16.0, sitting well below that of Prologis and Rexford Industrial, which trades at multiples of 27x and 35x, respectively. Analysts have a consensus Buy rating with an average price target of $39.29, equating to a potential one-year 16% total return including dividends.
Investor Takeaway
STAG Industrial is a differentiated and growing industrial REIT that’s demonstrating strong tenant demand and healthy fundamental growth. It’s not entirely reliant on the equity market to fund growth, as it maintains plenty of balance sheet capacity and has ample amounts of retained earnings. Lastly, it remains attractively valued. Income investors are paid a well-covered 4.2% yield and I see potential for more meaningful dividend growth considering the low payout ratio.
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