(Published by Nicholas McCullum on May 16)
For investors seeking yield, the real estate industry is a great place to look.
Intuitively, this is not surprising. Real estate owners collect predictable income from their tenants. Thus, the real estate business is qualitatively geared for business owners that want to collect periodic income.
This characteristic extends to the security level. One of the best ways for retail investors to gain exposure to the real estate industry is through real estate investment trusts – or REITs for short. REITs are required by law to pass the majority of their income onto shareholders as dividends.
Stag Industrial Inc. (STAG, Financial) is one example of a REIT that looks to be a very attractive investment right now. The company’s current dividend yield of 5.3% is nearly three times as high as the average yield in the S&P 500.
You can see the comprehensive list of all established 5%-plus yield stocks here.
Further, Stag Industrial pays monthly dividends rather than quarterly. This is highly beneficial for retirees and other investors who rely on dividend income to cover life’s expenses.
You can see the list of all monthly dividend stocks here.
Because of the trust’s high yield and monthly dividend payments, Stag Industrial has the potential to be a great investment for income-oriented investors.
Business overview
Stag Industrial is a REIT that specializes in industrial commercial real estate. The trust became publicly traded in 2011 after spinning off from its predecessor, Stag Capital Partners (formed in 2004).
Since the initial public offering, Stag has grown substantially – from 105 buildings to its current asset base of 324 buildings in 37 states rented to 279 tenants.
More details about the company’s current business model can be seen below.
Source: Stag Industrial Investor Presentation, slide 2
The trust specializes in owning and operating single-tenant industrial real estate properties. Most REITs view single-tenant properties as highly risky. This creates mispriced assets, which Stag can then add to its portfolio at attractive valuations.
Source: Stag Industrial Investor Presentation, slide 3
Since single-tenant properties are riskier than multi-tenant properties, investors should be rightly concerned about the impact of vacancies on the company’s bottom line.
So how does Stag Industrial mitigate this risk?
The trust owns a diversified portfolio of single-tenant assets, which has the same aggregate effect as owning multi-tenant properties. The trust’s focus on diversification at both the portfolio and enterprise level helps generate stable, predictable cash flows that can be passed on to investors.
Source: Stag Industrial Investor Presentation, slide 7
Stag’s stated goal is to grow its portfolio by 25% per year. While that seems like a lofty goal, the company has a robust acquisition pipeline exceeding $1.9 billion. The company raises capital to fund these acquisitions through debt offerings and an at-the-market (ATM) equity sale process.
To identify additional acquisition opportunities, Stag Industrial has a very precise selection process.
Of more that 1,250 potential transactions that passed the initial triage stage in 2016, Stag Industrial invested in only 35 properties at a weighted average capitalization rate (net operating income divided by market value) of 7.9%.
Source: Stag Industrial Investor Presentation, slide 6
Moving on, we will discuss the growth prospects of Stag Industrial.
Growth prospects
Stag Industrial’s growth since its IPO in 2011 has been impressive from both a fundamental and an investor return perspective.
Fortunately, this real estate trust still has a strong growth runway.
Take its most recent earnings release, for instance: the company saw full-company core funds from operations (FFO) increase 27% compared to the same period a year ago. On a per-unit basis, Stag saw core FFO increase 5.1% (partially offset by the trust’s ATM equity issuances, which dilute existing shareholders).
Looking ahead, the company will likely continue to grow at a similar mid-single-digit clip. The trust still has a very small market share in its target market of real estate assets, leaving plenty of room for expansion.
The size of Stag Industrial’s target asset universe can be easily determined by working backward.
First, narrow the aggregate real estate industry to only industrial real estate properties (~$1 trillion). Of these industrial properties, only about half (~$500 billion) are single-tenant, as Stag desires. Of this $500 billion of single-tenant industrial properties, only about half – or $250 billion – are of high enough quality to merit an investment from Stag Industrial.
Amazingly, the company has a market share of this $250 billion target market of less than 1%.
If this explanation was hard to visualize, I encourage you to consider the following diagram.
Source: Stag Industrial Investor Presentation, slide 4
The company’s small market share and willingness to own single-tenant industrial properties will ensure it has plenty of opportunities to expand over the years to come.
Competitive advantage & recession performance
As mentioned already, Stag Industrial’s main competitive advantage is its willingness to venture into the single-tenant industrial real estate space. The perceived risk of this class of real estate, though mitigated by Stag’s diversification, causes assets to be mispriced and the company’s internal rate of return to be higher.
It is difficult to assess how recession resilient Stag is because the REIT was not a publicly traded entity during the financial crisis of 2007 to 2009.
With that said, Stag is currently well-positioned to withstand the next economic downturn.
The REIT is well capitalized with 64% of its balance sheet financed with common equity and 4% with preferred equity.
Source: Stag Industrial Investor Presentation, slide 15
Stag Industrial also has some imminent opportunities to further improve its balance sheet. Namely, upcoming debt maturities give the company the potential to meaningfully reduce its interest expenses.
The company’s most expensive debt (as measured by weighted average interest rate) expires in 2017 and 2018. The REIT will almost certainly be able to refinance this maturing debt at a more attractive interest rate.
Looking further out, the trust’s remaining debt maturities are a healthy combination of low interest and long yield.
Source: Stag Industrial Investor Presentation, slide 16
With all this in mind, Stag Industrial appears well poised to endure any future recessions.
Valuation & expected total returns
Future returns for Stag Industrial’s shareholders will come from changes in the company’s valuation, dividend yield and growth in its per-share funds from operations.
Valuing REITs is different than corporations because earnings are not a meaningful indicator of the underlying earnings power. For REITs, earnings per share are highly depressed because of the large depreciation and amortization charges.
The simplest way for investors to value REITs is to compare their current dividend yield to their historical dividend yield. Stag Industrial currently pays annual dividends of $1.41 (divided into monthly installments of 11.75 cents), for a yield of 5.3% based on the current share price of $26.38.
The following diagram compares Stag Industrial’s current dividend yield to its historical dividend yield.
Source: YCharts
The company’s dividend yield is on the low end of its historical range. Thus, the REIT appears to be trading at a slight premium to its historical valuation based on dividend yield alone.
With that said, one of the reasons why Stag Industrial’s dividend yield is currently lower than normal is because the company has been reducing the pace of its dividend growth. Stag’s most recent dividend increase was less than 1%.
Looking at other metrics – such as the price-FFO ratio, the REIT equivalent of the price-earnings ratio – Stag Industrial appears to be trading at a discount to its peers in the REIT industry.
Source: Stag Industrial Investor Presentation, slide 17
Based on fundamental metrics, Stag appears to be attractively valued and valuation expansion might provide a slight tailwind to the REIT’s future shareholder returns.
Other than dividend payments and valuation changes, the remainder of Stag Industrial’s future shareholder returns will be driven by growth in the underlying company’s earnings power, as measured by FFO per unit.
Looking at the company’s historical growth as a publicly traded entity can help to estimate the future growth rate of the funds from operations.
In 2012 (Stag’s first full year as a publicly traded entity), the company reported funds from operations of 88 cents per unit. In 2016 – the most recent fiscal year – Stag Industrial reported funds from operations per unit of $1.26 – which represents a compound annual growth rate of 9.4%.
In the long run, I expect this rapid rate of growth to slow. Stag Industrial’s FFO per unit will likely increase by 4% to 6% over full economic cycles.
To conclude, the REIT’s expected shareholder returns will be composed of:
- 5.3% dividend yield.
- 4% to 6% annual growth in funds from operations.
For expected shareholder returns of 9.3% to 11.3% before the effect of valuation changes.
Final thoughts
Stag Industrial has two characteristics that will immediately appeal to income investors: a 5.3% dividend yield and regular monthly dividend payments.
Despite the company’s impressive performance in recent history, this REIT is still an attractive value at today’s price.
Thus, Stag Industrial makes a good addition to a high-yield portfolio because of its high dividend yield, monthly dividend payments and leadership in the single-tenant industrial real estate market.
Disclosure: I am not long any of the stocks mentioned in this article.
Start a free 7-day trial of Premium Membership to GuruFocus.
