STAG Industrial: Dividend Growth In Sight (NYSE:STAG)

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Strap in, buckle up, put on a helmet and do no matter else you’ll want to do as a result of that is going to be an extended one as we current an in depth evaluation of STAG Industrial (NYSE:STAG). We’ve adopted the Boston based mostly industrial REIT since its IPO in 2011 and have owned it for a lot of that point.

We are going to start with the purchase thesis however this text may even include dialogue on issues and dangers.

The Purchase Thesis

STAG is nicely positioned for the approaching surroundings with a few years of development forward. It’s among the many extra conservative performs within the industrial sector and present market pricing facilitates a considerably above market return. Particularly, I see 4 benefits to proudly owning STAG as in comparison with industrial friends.

  1. Superior acquisition course of
  2. Long run development
  3. Glorious steadiness sheet
  4. Undervalued

Truthful worth is nearer to an 18X FFO a number of or about $40.50 per share. Market value could possibly be catalyzed to get there by a close to time period enhance to the dividend which has been lengthy awaited by shareholders.

Administration and Acquisition Course of

We initially purchased STAG on valuation and had been impressed by former CEO Ben Butcher’s acquisition acumen. This firm has a novel course of centered round maximizing IRR of acquisitions over the whole thing of the property’s lifecycle. Whereas most REITs concentrate on a mode field corresponding to Class A in secondary markets or logistics warehouses in coastal port cities, STAG deliberately stays agnostic on market and property age.

This agnosticism doesn’t imply they don’t care about these elements, however relatively that property age, high quality and site are simply amongst many issues that go into deciding what to purchase. Via forecasting, STAG estimates the influence of every particular person issue on the IRR of a property over its lifecycle.

Simply utilizing numbers off the highest of my head this is able to be pondering alongside the strains of a property that’s 10 years older ought to commerce at a cap charge about 50 foundation factors wider than the youthful model, all else equal. Thus, if the market is buying and selling the older property solely 30 foundation factors wider, the youthful property is the higher deal, but when the market is buying and selling the older property at 100 foundation factors wider, the older property is the higher deal.

Taking a look at acquisitions on this means makes STAG’s acquisition mannequin extra sturdy as a result of it really works in any surroundings. Corporations that centered on a selected submarket or kind of property could have completed very nicely when that specific kind of property was opportunistic, but when these properties turn into totally valued or the submarket outlook deteriorates there may be not a lot alternative.

In distinction, STAG’s acquisition mannequin flexes to wherever the chance is. As of most up-to-date knowledge STAG’s acquisition pipeline is $2.4B.

I feel I’ve at all times appreciated this mannequin as a result of it’s much like the way in which we decide shares at 2nd Market Capital. It’s by no means about liking a selected inventory or a selected sector. All of it will depend on whether or not a inventory is priced cheaply relative to the elemental outlook.

Ben Butcher performed a big function in creating this acquisition mannequin at STAG and the corporate preserves its focus with a promote from inside philosophy. Butcher handed the reigns over to Invoice Crooker who has been steeped within the course of for years and Crooker’s CFO spot was received by Matts Pinard.

We first met Pinard when he was the Investor Relations man and he was clearly fairly completely different than most IR personnel. Investor relations specialists sometimes keep on with a extra organizational function, establishing conferences, reaching out to potential traders and guiding the way in which an organization is introduced to the investor group.

In our conferences with STAG, Pinard would ceaselessly step in with solutions to detailed questions on properties and technique. He was straight ahead and I’m blissful to see him promoted to a outstanding determination making function.

Total, STAG has persistently been centered on growing shareholder worth over time and I view them as one of many extra reliable administration groups.

Industrial Sector and STAG’s Place Inside it

Industrial has secular development within the type of e-commerce which is anticipated to succeed in a market share of about 30% within the subsequent decade from slightly below 15% now.

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FRED

The pandemic pulled ahead e-commerce market share which dropped again down after, however appears to have returned to the development line.

This after all advantages all industrial REITs, not simply STAG so I feel it’s price mentioning some STAG particular variations. Total, I feel STAG will develop extra slowly than friends through the increase occasions however extra steadily than friends through the dangerous occasions.

Many of the industrial REIT market cap is concentrated in port cities and excessive density city areas each of which have obtained outsized profit from e-commerce. E-commerce orders coming from China are likely to undergo the port of Los Angeles which had actually extraordinary industrial hire and occupancy development.

STAG’s portfolio is a little more diversified than friends with areas all through the whole nation.

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As such, STAG grew slower than friends through the increase. STAG’s roughly 20% will increase in hire merely couldn’t compete with the 80% hire development popping out of L.A.

If e-commerce continues to achieve market share as I believe it would, Los Angeles and the opposite main hubs will proceed to be good markets however there are a two rising developments that disproportionately profit different markets.

  • Onshoring of producing
  • Switch of import quantity from China to Mexico

The rust belt is being revived with manufacturing of all kinds returning to U.S. soil. It is a double profit to industrial actual property because the manufacturing amenities themselves are industrial together with the logistics warehouses that provide these amenities.

Considered one of STAG’s bigger exposures is Columbus Ohio

Columbus

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Marcus and Millichap

That is certainly one of few markets that has web absorption nonetheless outpacing provide development and it’s anticipated to develop hire by 7.7% in 2023 even after rents went up 35% in 2022. Main manufacturing move-ins are driving elevated exercise, pulling jobs and demand for warehouses to town.

A mix of transport prices and geopolitical strife is shifting a considerable portion of producing from China to Mexico which ought to profit industrial amenities alongside the border.

STAG has properties close to Tijuana, Tucson, the Texas border with Mexico and an enormous focus in Ciudad Juarez which is on the southern tip of New Mexico.

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S&P World Market Intelligence

I’d anticipate these properties outperforming over the following decade.

A part of having a diversified portfolio is that it is usually publicity to a few of the weaker markets.

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Marcus and Millichap

Chicago is a excessive demand industrial market, however it has a rare quantity of provide coming in at round 30 million sq. ft in 2023. That is anticipated to tick emptiness as much as about 4.5% (nonetheless pretty low) which might sluggish hire development to about 5% from nearer to 11% final yr.

Cawley estimates Chicago building even larger at 38 million sq. ft with 70% of that being delivered on spec.

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Marcus and Millichap

Milwaukee is one other STAG market with heavy provide development. Funding right here is pushed by considerably larger cap charges in comparison with different main metros. Certainly STAG additionally obtained into the market at excessive cap charges, however the elevated building exercise is taking down rental charge development to an anticipated 5% from 12% in 2022.

Challenges to Industrial

Provide appears to be the principle problem to industrial actual property proper now. Roughly 400 million sq. ft are anticipated to be delivered nationally in 2023.

I feel STAG is healthier positioned for the provision surge than most for 3 causes:

  1. Medium footprint buildings
  2. Gentle manufacturing publicity
  3. Cheaper price level

Greater than half of the event pipeline over the following few years is in very giant footprint buildings north of 500K sq. ft.

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Marcus and Millichap

STAG’s portfolio is a bit smaller footprint with a median sq. ft per constructing simply under200K. Thus, they is probably not in direct competitors with the majority of the brand new provide.

Many of the new provide is focused as logistics warehouses and whereas STAG does have warehouse publicity in addition they have 74 mild manufacturing properties.

Lastly, and I feel that is the largest cause, value level goes to be big in being resilient to produce. Newly constructed warehouses are overwhelmingly class A and seeking to compete with excessive hire properties. As such, will probably be the properties making an attempt to cost $10-$15 per foot which might be more than likely to be hit with competing provide.

The consequences of a lower cost level can already be seen with emptiness considerably larger in newer warehouses (publish 2000) and lowest emptiness within the 1970-2000 classic.

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Marcus and Millichap

Whereas industrial stays cheaper than different actual property varieties as a result of its comparatively less complicated bodily construction, building prices have risen considerably and it now prices round $150 per foot to construct in most MSAs.

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Statista

STAG has an enterprise worth per sq. foot of $75.42 utilizing MRQ knowledge. Its portfolio merely can’t be changed for wherever close to that value and I feel that’s the reason STAG can have steadier development going ahead than larger finish industrial friends.

The opposite REITs have massive stunning properties, however they should deal with different massive stunning properties being constructed throughout the road.

Lengthy Time period Progress Fairly Than Brief Time period Growth

So over the previous 5 years STAG’s mid teenagers to 30% hire rollups obtained outpaced by the 50%-80% hire rollups of some friends, however I feel there may be larger sturdiness in STAG’s diversified method.

Throughout the Monetary Disaster, smaller submarkets considerably outperformed the super-premium MSAs. I do not know if we’re headed for a recession, however the economic system is trying extra like tepid development than increase development.

STAG’s steering requires 4.5%-5% identical retailer NOI development ensuing from 25%-30% hire will increase on new leases/renewals.

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STAG

To this point in 2023 STAG is barely beating steering as per their replace on leasing exercise:

“61.5% of anticipated 2023 new and renewal leasing has been addressed, consisting of 8.4 million sq. ft, attaining money hire change of 31.6%”

How does the 4%-8% rental charge development within the particular person submarkets for 2023 that we simply mentioned observe with 31.6% hire rolls?

Effectively, it’s a matter of lease classic.

Most of STAG’s leases are 5+ years in time period or a minimum of had been traditionally. So when a lease rolls the rise to rental charge shouldn’t be 2023 versus 2022, however relatively the delta between present market rents and each time that lease was initially signed.

Thus, rental charge will increase are the composite market charge will increase of the final 5 to eight years or nonetheless lengthy the expiring lease was. So over the following 5 years, STAG’s lease rolls should not simply going to be future market hire development, however may even seize the market hire development that has already occurred.

In different phrases, present rental charges are considerably under market charges which implies FFO/share is considerably under stabilized FFO/share. I feel this idea is broadly misunderstood and I feel the market will likely be stunned at how briskly the commercial REITs can proceed to develop regardless of the provision coming in.

Curiosity Price Headwinds (a Relative Benefit to STAG)

Increased rates of interest enhance expense for everybody, however STAG is comparatively much less vulnerable as a result of a well-manicured steadiness sheet.

Total debt ranges have been lowered considerably.

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S&P World Market Intelligence

The debt that is still has been mounted both straight or by way of swaps and termed out. Over the following few years STAG has minimal debt maturity which implies little debt should be refinanced in right now’s excessive rate of interest surroundings.

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STAG

STAG can journey its comparatively low cost mounted charge debt via this surroundings and proceed to take pleasure in good spreads.

Placing Collectively the Progress Outlook

Over 2023 and 2024 I feel STAG will develop at a reasonable tempo and possibly be outpaced by peer industrial REITs. Long run, STAG’s diversification and comparatively extra resilient place with respect to incoming provide will kick in to take care of STAG at reasonable development whereas friends may show to be extra increase and bust. STAG’s income development ought to filter properly to the underside line as a result of it has largely mounted charge debt locked in via what I consider would be the remainder of the excessive rate of interest surroundings and company bills are low. G&A as a share of NOI is guided to say no to a really cheap 10%.

Given slower however nonetheless robust development now and extra resilience later, I feel STAG ought to commerce barely under the peer common a number of.

Valuation

At 14.8X 2023 estimated FFO, STAG is less expensive than the remainder of the sector which trades at a median a number of of twenty-two.1X.

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S&P World Market Intelligence

With STAG’s tempo of development rapidly catching as much as that of friends I feel the distinction in a number of is relatively excessive.

For my part, honest worth for STAG is round 18X FFO or a market value of $40.50.

That might nonetheless be a 4-turn low cost to the median industrial REIT however would give STAG credit score for its robust basic place and observe file of development.

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The versatile acquisition mannequin affords amassing a positive unfold on new funding in any surroundings which has traditionally created the regular upward slope in FFO/share.

The ahead surroundings is completely different, however the alternative is comparable. Value of capital is up, however so are cap charges. The unfold remains to be there and STAG’s $2.4B acquisition pipeline ought to accrete to FFO/share.

Dangers to Thesis

There are two major dangers:

  1. Recession

Whereas industrial has secular tailwinds, it’s nonetheless cyclical in nature. Each logistics demand and manufacturing quantity are correlated with GDP. So whereas the long run demand for industrial sq. footage is far larger than right now’s demand there’ll seemingly be bumps alongside the way in which.

I feel each tenants and landlords are ready for a light recession which appears to be the consensus for both 2023 or 2024, so in a base case state of affairs not a lot injury can be completed. The danger is {that a} recession could possibly be considerably worse than anticipated which might trigger emptiness to tick up. Something over 92% occupancy is a wholesome surroundings for the REITs, but when occupancy ticks under 90% there could possibly be charge lower discussions or a minimum of extra issue renewing leases on expiry.

2. Irrational growth

Though provide development is pretty excessive proper now, it seems to be well-planned and rational. Builders are constructing to fulfill demand relatively than constructing on hope or greed. So long as builders keep in tune with the economic system and demand developments, the sector ought to stay robust. The danger is that builders may get overly formidable and construct an unreasonable quantity. I will likely be monitoring allow and building exercise to attempt to catch an early glimpse within the occasion that is on the horizon.

Catalyst for Value Appreciation

Our honest worth estimate of $40.50 is about 22% upside to the present market value of $33.22 on the time of writing. The transfer to get there could possibly be catalyzed by an extended awaited dividend enhance.

REITs are closely owned by earnings centered traders and there was some frustration with STAG for its largely stagnant dividend. It has grown persistently over time, however at a snail’s tempo.

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Traders have anticipated considerably extra dividend development given the elemental success of the corporate.

Effectively, I consider STAG is on the cusp of considerably sooner dividend development. The explanation it has been so sluggish up to now is as a result of the payout ratio was far too excessive. Notice the underside line within the picture under.

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STAG

In the present day, with free money movement of $80 million and a CAD payout ratio of 77.8%, STAG can now elevate its dividend linearly with FFO/share development.

This might pull within the earnings centered traders sitting on the sidelines who’ve been ready to see some dividend development.

The Backside Line

STAG stays the most important weight within the Portfolio Revenue Options actively managed portfolio as a result of it has a fantastic mixture of high quality, worth and development.

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