First Industrial Looks Buyable As Market Conditions Improve

seekingalpha06-20

Industrial REITs face challenges due to high supply and low demand, leading to increased vacancy rates and disparity between buyers' and sellers' expectations.However, the market conditions will shift...

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GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4700092-first-industrial-looks-buyable-as-market-conditions-improve><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Industrial REITs face challenges due to high supply and low demand, leading to increased vacancy rates and disparity between buyers' and sellers' expectations.However, the market conditions will shift...</p>\n\n<a href=\"https://seekingalpha.com/article/4700092-first-industrial-looks-buyable-as-market-conditions-improve\">Source 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America A-SGD (hedged)","LU0980610538.SGD":"Natixis Harris Associates US Equity RA SGD-H","IE00B7SZLL34.SGD":"Legg Mason ClearBridge - Value A Acc SGD-H","TRNO":"Terreno Realty"},"translate_title":"随着市场状况改善，First Industrial看起来值得买入","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"TRNO":1,"FR":1,"EGP":1,"COLD":1,"PLD":1,"STAG":1,"CFA.SI":0.9},"content_text":"Industrial REITs face challenges due to high supply and low demand, leading to increased vacancy rates and disparity between buyers' and sellers' expectations.However, the market conditions will shift due to significantly decreased new construction starts.FR is well-positioned to benefit from the improvement in market conditions, with no debt maturities until 2026, vast land bank, and solid business metrics.Moreover, the Company offers well-covered, dynamically growing dividends and has an upside potential resulting from the multiple appreciation.   Lari Bat/iStock via Getty Images Investment thesis I believe that the recent drop in First Industrial Realty Trust (NYSE:FR) left the valuation detached from its business fundamentals and long-term ability to generate cash flows. The Company has clear growth drivers resulting from:  ability to significantly bump its rents upon termination strategically located, large land bank expected improvements in the supply-to-demand relationship  Moreover, it has no debt maturities until 2026, delivered an impressive dividend per share growth, and is capable of securing attractive initial cash yields on its investments. That's an opportunity to lock in a business paying dynamically growing, well-covered dividends with a potential for multiple appreciation - I'm bullish on FR. Introduction Industrial REITs have shared some headwinds regarding the market environment. As indicated within the Wells Fargo report, the industrial properties sector has been accompanied by an unfavourable supply-to-demand relationship since ~ mid-2022. Earlier, the market was supported by a post-COVID demand surge. However, the first FED interest rate hikes and high net completions (totalling over 100m sq. ft. each quarter since Q3 2022) changed the narrative. The growing disproportion between the buyers' and sellers' expectations and high new supply coming into the markets with a slowdown in net absorptions drove the Q1 2024 market vacancy rate to the highest level since 2015 - 6.2%. CoStar Inc. and Wells Fargo Economics With the Q1 2024 results and comments of Prologis (PLD), the largest industrial REIT in the world, on the market conditions, investors' sentiment towards the sector declined further. To quote PLD's CFO, Tim Arndt during the Q1 2024 Earnings Call:  That said, as we evaluate the market, persistent inflation and high interest rates have kept more customers focused on controlling costs. The resulting delay in decision making, easily observed through the first quarter's below average net absorption, will translate to lower leasing volume within the year. (...) Net absorption in the US, for example, was very low this quarter at just 27 million square feet. So while the macro landscape and supply chains continue to generate a need for space, we think it's prudent to expect continued headwinds on overall absorption over the next few quarters. The interest rate environment and its associated volatility have weighed on customer decision making, especially as the 10 year has increased 70 basis points from its level just 90 days ago and expectations for Fed rate cuts have moved from potentially six to now possibly zero.  As a result, the stock prices of leading industry players, including FR, decreased YTD. Data by YCharts However, there are signs of the shifting market conditions in terms of supply-to-demand relationship and FR's business looks well. Enjoy the read! FR looks buyable - investment rationale #1 Supply-to-demand relationship will improve While the developers continue to deliver solid new supply of ~100m sq. ft. per quarter, the new construction starts decreased significantly. According to the Wells Fargo report, the new industrial construction starts were below 50m sq. ft. during Q1 2024, down from over a 100m sq. ft. commenced during Q1 2023. Should this trend be upheld, it will soon turn into the foundation of an increasingly favorable supply-to-demand relationship as the new supply will seize to outpace the demand. The above will translate into lower vacancy rates, stronger negotiating position of landlords, and better growth prospects for the key market participants. CoStar Inc. and Wells Fargo Economics The unfavorable supply-to-demand relationship with a high vacancy rate causes rent growth to slow down; however, the growth is still there, and as PLD indicated within its Investor Presentation, there's room for rent growth even with a market vacancy rate at ~7%. Moreover, many of the industrial property rents are below the market levels, as the market rent growth outpaced the rent growth resulting from contractual rent escalations during recent years (generally). This means that renewing leases or acquiring new tenants upon lease terminations creates an opportunity to bump the rents to the market levels, which FR is certainly capable of. The Company secured a cash rental growth rate of 58.3% and 44.8% during FY 2023 and Q1 2024, respectively. PLD's Investor PresentationFR's 10-K 2023 and 10-Q Q1 2024 filings On the demand side of the equation, it will be supported by several factors, including rising income, growing population, and increasing significance of e-commerce. With increasing demand and lower supply levels, the market conditions for industrial REITs will improve, which will also benefit FR. However, not every REIT has been created equal, so let's explore FR's business. PLD's Investor Presentation #2 The business looks solid FR is a US-oriented industrial REIT with 425 industrial buildings totalling a leasable area of 68.1m sq. ft. across 15 key logistics markets. The Company concentrates on coastal markets with ~58% of rental revenue derived from them. FR has a well-diversified tenant structure, with the Top 20 tenants responsible for ~25.7% of ABR. As indicated within the Investor Presentation, the in-service occupancy rate amounted to 95.5% (97.0% excl. not fully leased developments placed in-service in Q3-Q4 2023). For reference, this metric stood at:  96.2% for Terreno Realty (TRNO) 97.7% for STAG Industrial (STAG) 97.0% for PLD 97.7% for EastGroup Properties (EGP)  Therefore, given the capabilities of its peers, there's some room for improvement; however, it is still a solid occupancy level considering the market conditions. FR's Investor Presentation Looking at the financial performance, FR delivered an impressive FFO per share growth, which marked a CAGR of 8.8% during the 2019 - 2023 period (with 2018 as a base year). The Company assumes achieving an FFO per share of $2.59 in 2024 (mid-point guidance), which would constitute a 6.1% growth. While the year-over-year growth dynamic is guided to be lower than the one recorded during 2021, 2022 or 2023, one has to consider the headwinds accompanying the industry and the fact that they will likely uphold within 2024. The headwinds described earlier related to the current oversupply of the market have the potential to turn into an undersupply with the gradually more favourable supply-to-demand relationship, and thus - tailwinds. For details regarding the FFO per share of FR, please review the table below.             Entity 2018 2019 2020 2021 2022 2023 2024E (on midpoint)   FR $ 1.60 $ 1.74 $ 1.84 $ 1.97 $ 2.28 $ 2.44 $ 2.59   Click to enlarge The above translated well into the dividend per share, satisfying income-oriented investors - especially those pursuing high DPS growth. FR's dividend per share marked a CAGR equal to 8.0% during the 2019 - 2023 period. I don't see any reason why the DPS growth would slow down in the upcoming years. Moreover, FR has a low forward-looking AFFO payout ratio of ~69.9%, so dividends are also well-covered. For details regarding the FR's dividends per share, please refer to the chart below. Own compilation based on FR Another thing worth highlighting within FR's business is an impressive bank of land, totalling 15.7m sq. ft. The land is strategically located across the most significant markets, with ~65% of the area in coastal-oriented markets. While the land doesn't generate any cash flow, the Company will benefit greatly upon realizing developments within the upcoming years, as it's proven its effectiveness in realizing development projects at attractive initial cash rates. FR's Investor PresentationFR's Investor Presentation Regarding the balance sheet, FR has a BBB credit rating with no debt maturities upcoming in 2024 and 2025 (assuming the exercise of two 6-month extension options). Its weighted average debt maturity term equals 4.5 years, which is in line with its peer group (STAG - 4.3 years, TRNO - 4.1 years). It has a fixed-rate-oriented debt structure with 86.3% of debt at a fixed interest rate, with a revolving credit facility ($306m) being the only floating-rate debt source. The fixed charge coverage ratio has declined since 2022; however, it remains at a solid 4.4x level while the Debt to EBITDA metric improved to 5.3x, and the total leverage remains stable at ~25.8%. FR's Investor PresentationFR's Investor Presentation #3 Valuation outlook As an M&A advisor, I usually rely on a multiple valuation method that is a leading tool in transaction processes, as it allows for accessible and market-driven benchmarking. As mentioned earlier, FR's stock price has dropped significantly YTD. Given the expected shift in market conditions and the state of FR's business, the multiple has detached from its business fundamentals and long-term ability to generate cash flows. For reference, please review the table below, within which I presented the forward-looking P/FFO multiple for selected entities.   Entity P/FFO multiple   FR 18.4x   PLD 20.3x   STAG 14.9x   TRNO 24.4x   Americold (COLD) 21.9x   EGP 20.1x   Click to enlarge Considering FR's:  below market rents with embedded opportunities for significant increases vast land bank impressive FFO per share and DPS growth with a low AFFO payout ratio upheld solid balance sheet value drivers underlying the industrial properties sector  I believe the market's perception of FR's value isn't accurate, and there's room for a multiple appreciation of the 20.0-21.0x range, assuming no material adverse changes. Reaching just the lower end of this range would mean ~9% upside; however, I consider it a conservative scenario. Risk factors Naturally, any potential tenant issues that would significantly impact FR's business metrics could lead to a shift in my investment thesis and a higher stock price volatility. However, this risk remains limited as the Company has a well-diversified tenant structure. Prolonging the high interest rate environment or unfavourable supply-to-demand could lead to the weakening of my investment thesis and FR's business performance. Assuming the FED upholds relatively high interest rates until at least 2026, the Company could be forced to refinance its debt at a higher cost. The bottom line FR is well-positioned to benefit from the upcoming shift in market conditions. It has clear growth drivers resulting from:  ability to significantly bump its rents upon termination strategically located, large land bank expected improvements in the supply-to-demand relationship   I believe that FR currently offers an opportunity to lock in a dynamically growing dividend with several factors supporting the business development (and further DPS growth) and a potential for multiple appreciation.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.24.2","shortVersion":"4.24.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2444293643"}