Interview With STAG Industrial

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Interview With STAG Industrial

I recently attended the NAREIT REITweek conference in NYC and got to meet with many REIT management teams. This includes STAG Properties (STAG), which is our biggest industrial REIT investment.

We invest so heavily in it because:

1. It owns a portfolio of industrial properties that benefits from the growth of e-commerce and the trend of onshoring. Unique to STAG is that it is heavily invested in secondary markets of sunbelt states that have attracted relatively little new supply, but could benefit more than others from onshoring as companies look for industrial space in cheaper and tax-friendlier markets.

2. STAG follows a value-add approach, buying discounted assets, and then it fixes issues such as short leases, deferred capex, and poor layouts to create value for shareholders. This differentiated strategy has historically resulted in significant outperformance relative to the likes of Prologis (PLD).

3. Today, its rents are deeply below market, and it allows it to hike its rents by ~30% as its leases gradually expire, providing a secure bank of growth.

4. For most of its history, STAG was priced at a steep discount relative to its peers and one of the lowest valuations of its sector because it had more leverage and a high payout ratio which limited its growth and prevented it from hiking the dividend.

5. But all of this has now been resolved and the valuation gap has started to close, but it remains significant because this transformation has been largely overlooked. Today, the shares are priced at 15x FFO compared to about 25x for its peers. Industrial REITs are pricey for a good reason: they enjoy above-average long-term growth prospects.

6. We believe that as STAG starts to finally grow its dividend, this will serve as a catalyst and push the valuation higher, unlocking about 50% upside as it reprices at about 22x FFO, and while we wait, we wait to earn a ~10% annual total return from the 4.5% yield and the ~6% annual growth in FFO per share.

I got to sit down with the company's CEO, William Crooker, and its CFO, Matts Pinard, for a good 45 minutes to talk about various topics, and below, I share all my main takeaways and conclusions.

In case you are not familiar with the company, we recommend that you first read our investment thesis by clicking here.

My Takeaways From The Interview:

• They have now almost completed their transformation. Their leverage is down to a conservative 5x EBITDA, their payout ratio is down to a low 65% of FFO, and their organic growth is stronger than ever with ~30% rent hikes as leases expire, resulting in ~5% annual same property NOI growth.

• Therefore, they are now in a position to start hiking their dividend at a rate that's equivalent to their FFO per share growth. They gave us strong hints that they could announce a ~5% dividend hike later this year, which would change the narrative on the company as lots of investors see STAG as a boring REIT that isn't growing its dividend. In that sense, the coming dividend hike could help them reach a higher valuation and lower cost of capital.

• One other catalyst that they are working on is building their own property development arm. That's the last piece of the puzzle that would make them comparable to their peers. So far, they have focused on value-add acquisitions, but in the future, as they continue to grow, they would like to also add some ground-up property development to the mix. This makes sense since it would give another funnel of opportunities to grow and they often come across compelling development opportunities but they currently aren't able to act on them. To that end, they recently poached a talented individual from Prologis who is a specialist in property development and he is now doing all the hard work to build their own development arm.

• If they now start to grow their dividend and develop their own properties, then the market won't have an excuse anymore to price STAG at a large discount to peers. Today, the two reasons for the discount that keep coming up are the lack of dividend growth and the inability to develop properties to create value. These reasons will soon be gone.

• They continue to believe that their focus on secondary markets is a winner on both sides: the supply and the demand. Today, most of the new supply is coming into the very big primary markets like LA. At the same time, a lot of the new demand is coming to cheaper and tax-friendlier markets, which is where many of STAG's assets are located. Let's take the example of a US consumer brand that manufactures a lot of products in China. If it decides to bring back a production plant to the US, it will likely look for a market where resources are relatively inexpensive and taxes are relatively low. Therefore, the growing trend of onshoring could benefit STAG more than some of its peers.

• Their guidance is conservative. Last year, they included 40 basis points of bad debt but ended up having 0. This year, they again put 50 basis points of bad debt, but as of right now, they are doing just fine. They prefer to be conservative given that we live in an uncertain world.

My Conclusion

We maintain our Strong Buy rating.

STAG has risen recently, but this is well-deserved given that they have now largely completed their transformation.

Moreover, they have clearly signaled that they are working on two more catalysts to unlock value:

• Hiking the dividend

• Developing their own assets

Yet, they remain discounted relative to peers and this is why we believe that STAG remains a compelling investment opportunity.

As the discount narrows over time, we will then reconsider our rating and keep you updated on that. For now, we are happy to keep accumulating more shares.

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Sincerely,

Jussi Askola

Analyst's Disclosure: I/we have a beneficial long position in the shares of all companies held in the CORE PORTFOLIO, RETIREMENT PORTFOLIO, and INTERNATIONAL PORTFOLIO either through stock ownership, options, or other derivatives. High Yield Landlord® ('HYL') is managed by Leonberg Research, a subsidiary of Leonberg Capital. All rights are reserved. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. The newsletter is impersonal and subscribers/readers should not make any investment decision without conducting their own due diligence, and consulting their financial advisor about their specific situation. The information is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. The opinions expressed are those of the publisher and are subject to change without notice. We are a team of five analysts, each contributing distinct perspectives. Nonetheless, Jussi Askola, the leader of the service, is responsible for making the final investment decisions and overseeing the portfolio. We do not always agree with each other and an investment by Jussi should not be taken as an endorsement by other authors. Past performance is no guarantee of future results. Our portfolio performance data is provided by Interactive Brokers and believed to be accurate but its accuracy has not been audited and cannot be guaranteed. Our portfolio may not be perfectly comparable to the relevant index. It is more concentrated and may at times use margin and/or invest in companies that are not typically included in REIT indexes. Finally, High Yield Landlord is not a licensed securities dealer, broker, US investment adviser, or investment bank. We simply share research on the REIT sector.