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Actions of Terreno Real Estate (NYSE:TRNO) have fallen out of favor again recently, particularly after their peers warned of slower rent growth and falling occupancy levels, while the Fed appears to be holding rates steady for a longer period than expected .
This All of this has hurt the stock price of late, and while high occupancy and low leverage provide no reason for concern, the higher valuation argument remains a source of concern, the latest withdrawal does not yet encourage me to launch here.
A unique approach
Terreno acquires, owns and operates warehouses and industrial buildings in the major coastal areas of the United States, as this includes both coasts. On the West Coast, this includes markets like Seattle, the San Francisco Bay Area and Los Angeles. On the other hand, this mainly concerns the New York region, and to a lesser extent Washington DC and Miami.
The company focuses on a mix of value-add and core, with no new developments, complex structures (joint venture) and a strong focus on discounts to replacement values in order to integrate security into its model.
The company particularly focuses on these densely populated areas, where high population demand must be met in a context of restricted, and in some cases even decreasing, supply. In fact, around 80% of buildings are located in markets that have stable or significantly declining supply.
More than three-quarters of these buildings include warehouses and distribution centers, with the remainder involving improved land, cross-docking and flexible solutions. These are leased to a wide range of tenants, including names like Amazon and FedEx, but also Danaher, the US government, Meta and Northrop Grumman.
The supply crunch is reflected in same-store NOI growth, which over the past five years has reached high single digits, and even low double digits in 2022 and 2023.
Despite strong rental growth, the company has reported occupancy rates above 98% in 2023, with a portfolio measuring over 16 million square feet at the end of 2023, comprised of 259 existing buildings.
The company has been publicly traded since 2010. Shares remained stuck in the mid-teens until 2014, peaked around the $80 mark in 2021 as the pandemic warehouse boom was in full force, and are largely trading around the $50 to $60 mark lately. years.
Some valuation prospects
For 2023, the company reported a 17% increase in full-year rental income (including tenant refunds) to $323 million and change, driven by a combination of purchases of assets and growth in same-store rents.
The company reported GAAP earnings of $150 million, or $1.81 per share, but that doesn’t mean much because that number is inflated by gains on assets, as well as depreciation charges. which harmed the results. The so-called FFO measure, which cancels these items, was reported at $185 million, or $2.22 per share.
The company’s 88 million shares are currently valued at $55, giving the company’s equity a valuation of $4.8 billion. Net debt is relatively modest, estimated at $610 million at the end of 2023, for a company valuation of $5.4 billion. To put this into perspective, this implies that the assets are trading around a 6% gross yield.
This picture is a bit mixed given the investment activity, since fourth-quarter annualized revenues came in at $346 million per year, implying a gross yield of around 6.4%.
An active first trimester
Terreno announced various acquisitions and development projects in the first quarter of the year and subsequently announced the sale to issue an additional 5.5 million shares at $62 per share in March, to strengthen the balance sheet and finance these acquisitions and developments.
At the beginning of April, the company announcement some highlights of the quarter. Occupancy rates fell to 96% and changed, as Terreno announced that in addition to the March stock offerings (which ultimately involved the sale of more than 6.3 million shares), nearly An additional 2.4 million shares were sold under the ATM program, all needed to complete nearly half a billion in contract acquisitions.
Shortly after this announcement, Terreno announcement a $42 million investment in Hialeah, Florida, with a estimated cap rate of 6%, which is expected to add an additional $2.5 million in annual rent. This was followed by an investment of $84 million acquisition in Virginia. The 5.3% cap rate seems a bit low, adding an additional $4.5 million to the annual rent.
And now?
Leverage is not a problem, as leverage ratios are low and the company continues to issue shares to finance more developments and acquisitions. The willingness to suffer dilution, however, means that the focus really seems to be on growth, perhaps more than growth per share, which is what investors are actually looking for.
This can be seen in the results over the last decade, because even though Terreno quintupled its revenue base over the last decade, the actual number of shares outstanding also tripled, making the growth per share still visible. decent, but nothing as spectacular as the reported sales growth.
The desire for dilution is certainly painful for investors, especially in light of recent acquisitions made at a low cap rate of 5%, while the shares trade at 6% and move. Therefore, a pause in acquisition activities would be more welcome, or even buybacks (but this seems very strange in light of recent issuance).
Although the structural dynamics of the markets in which the company focuses are real and positive, there are also some concentration risks, but still primarily related to valuations. This comes as the stock trades at 25 times FFO because the payout ratio is very high, with dividends of $1.80 per share representing a payout ratio of around 80%.
In the midst of all this, I remain somewhat cautious. While the fundamental real estate strategy is strong, overall valuations remain very challenging, even though stocks have been lagging for some time, as has been the case for many REITs here.
So this is really a play on key real estate in these areas, with perhaps the potential to convert over time to higher value use cases. Additionally, continued rental growth amid tight supply is expected, a trend already observed, but the cold, hard numbers paint a less impressive picture in the event of tighter cap rates, as very strong rental growth will exert also puts pressure on certain tenants.
