2 blue-chip REITs set to soar

zimmytws

For years, market participants and pundits have wondered when, if ever, value stocks would make a comeback over and against growth stocks.

This time has come.

Unfortunately, this return does not mean that value stocks are doing well in absolute terms. basis, just that they outperform growth stocks. See, for example, the year-to-date price performance gap between the Vanguard Value ETF (VTV) and the Vanguard Growth ETF (CUV):

Chart
Data by Y-Charts

This bifurcation between value and growth also exists in commercial real estate. Admittedly, the main difference in price performance between real estate investment trusts (“REITs”) (VNQ) currently sits between the most heavily indebted names and the least indebted names.

But there’s also a difference between “growth REITs,” which typically trade at high multiples and low dividend yields, and “value REITs,” which typically trade at low multiples and high dividend yields.

Just as growth stocks have generally sold off more heavily this year, so have many growth REITs. This creates rare buying opportunities in which normally expensive blue-chip REITs have become ultra-cheap relative to their historical valuations. In the past, these industry-leading owners have bounced back the strongest and fastest from market downturns.

Today, we’re adding more capital to two high-quality, industry-leading REITs that have suffered huge losses this year and are now presenting rare value propositions.

EastGroup Properties, Inc. (EGP)

EGP is an industrial REIT specializing in multi-tenant urban industrial complexes in Sunbelt states such as Texas, Florida and Arizona. About half of its properties were developed in-house.

EGP Markets

East Group Properties

These hand-picked markets are among the fastest growing in the country, with both strong rental growth and high barriers to entry.

Additionally, even though many commercial real estate sectors are slowing in the second half of 2022, industrial remains hot. Here is some information from the National Association of Realtors showing that the strength of the industry continued in the third quarter of this year:

industrial rents continue to rise

National Association of Realtors

The 12-month rent growth figures for retail downstairs are 2.7% in Q3 2021 and 4.4% in Q3 2022. While retail is also doing well, the particularity is clearly industrial. This bodes well for EGP’s continued strong performance in the second half of this year and into 2023.

A 99% occupancy rate, combined with cash ROI growth of almost 10%, shows just how high demand for EGP’s space continues to be. Additionally, a few of its peers have already released third quarter results and they were exceptionally strong.

And yet, despite very low leverage (19% of total market capitalization), EGP fell back near its COVID-19 lows, although it is clearly Beneficiary of the pandemic!

EastGroup Properties valuations are at an all-time low

Y-GRAPH

It may not seem this cheap, given that EGP traded at a lower multiple than operating cash flow at times in 2018. But if you weigh valuation against growth rate, EGP has never been better market in recent years as current growth is much hotter than it was in 2018. Its rents remain deeply below market and as leases expire rents increase by 20-30% EGP also owns a large land reserve for new development projects which benefit from a high yield of 6 to 7%.

We estimate EGP’s fair value to be around 28x FFO (funds from operations), while the stock is currently trading at just under 20x FFO, giving it an upside of around 40 %. Meanwhile, EGP offers a dividend yield of 3.6% and annual dividend growth of 13-14%. We are also bullish on peers like Prologis (PLD), but overall, EGP currently offers the best risk-reward ratio in our opinion.

Crown Castle Inc. (ICC)

CCI is a telecommunications infrastructure REIT that owns and operates 40,000 cell towers, 115,000 small cell nodes and 85,000 miles of fiber route across the United States.

Given that US mobile carriers are still in the early stages of rolling out 5G technology across the country, there’s likely still a long, attractive growth streak for companies like CCI.

That said, the REIT is selling off due to temporary and relatively minor headwinds, resulting in a reduced growth rate for the next few years.

This year, revenue growth is expected to reach 10% while AFFO per share increases by 6%, but next year these measures are expected to drop to 4% and 4%, respectively.

Crown Castle grows slows

Crown Castle

A major reason for CCI’s slower growth rate next year is the expected resizing of Sprint’s tower network following its acquisition by T-Mobile (TMUS). This is obviously a one-time event and probably won’t happen again, as the wireless telecommunications industry is effectively an oligopoly between Verizon (VZ), AT&T (J), and T-Mobile. Further consolidation would likely be blocked by antitrust regulators.

The market also did not seem to like CCI’s recent dividend hike of only 6.5%, as it is below the long-term target range of 7-8% per year. Worse still, on the Third Quarter Conference CallCEO Jay Brown mentioned that because Sprint’s tower rationalization isn’t expected to end until 2025, the REIT expects its dividend growth to also be below its target range in 2024 and 2025.

However, since initiating its dividend growth target in 2017, CCI has increased the dividend at a CAGR of 9%. The REIT can withstand a few years of slower growth and still achieve its long-term average growth objective.

Here is the CEO:

Against the backdrop of 6.5% growth in our dividend per share this year, it is remarkable to consider that the underlying strength of our business can absorb the significant headwinds of rising interest and short-term Sprint cancellations without disrupting long-term business growth.

The CEO also mentioned that, despite a short-term headwind from a major customer cutback, the long-term demand outlook for his infrastructure assets remains strong:

Over the past few decades in the wireless industry, we have experienced periods of network rationalization by our customers, following consolidation events. In each of these cases, we have seen an increase in demand for our assets over time, as our clients have reinvested the synergies from these combinations into their networks to further improve their competitive position and keep pace with the growth of the wireless data. I expect to see a similar dynamic play out this time around.

…I believe we are still in the early stages of 5G development, providing a long streak of growth and demand for our comprehensive communications infrastructure, offering [access to] towers, small cells and fiber.

But, of course, the proof is in the pudding – or, in this case, the ROI. CCI has achieved an average return on investment of 12% for its tower segment, which it has operated for decades. And already, after only 5 years of weighted average life to date, CCI’s small cells have an average return on invested capital of 7%. Management expects yield from these to hit the low double digits once the smaller cells add a second tenant in the coming years.

Despite only a small decline and a temporary reduction in the dividend growth (not a dividend To cut), CCI is selling off as if its growth prospects were dead. In fact, CCI now offers the highest dividend yield already in its history as a REIT:

Chart
Data by Y-Charts

The chart above shows CCI’s trailing twelve-month dividend-based dividend yield, but its forward dividend yield based on its last declared dividend actually equates to a dividend yield of around 5%.

Contrary to what a market sell-off would imply, CCI remains fundamentally sound and recession-proof. Its Investment Grade balance sheet is solid, with a net debt to EBITDA ratio of 4.9x, 85% fixed rate debt and a weighted average debt maturity of 9 years.

We are happy to take advantage of the market overreaction and buy more of this blue chip REIT with a long growth streak. As its growth rate accelerates in the coming years, we expect its FFO multiple to widen its dividend yield to approach that of growth REITs, unlocking over 50% upside from here.

Conclusion

Growth stocks have been beaten so far this year, and the two REITs discussed above are among them:

Growth REITs underperform the REIT market in 2022

YCHARTS

We believe that these two names should be significantly overachieving the average rather than doing less well than that. Indeed, they have better quality portfolios, management teams and balance sheets than the average REIT. They also continue to grow at a good pace, especially EGP, and weren’t particularly expensive even before the sale.

We are taking advantage of the panicked sellers and buying more shares in these blue chip REITs. We believe that we will be richly rewarded for this in the long term in the years to come.

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