Extra Space Storage: Solid Q1 Growth, But Competition Will Intensify – Extra Space Storage Inc. (NYSE:EXR) No ratings yet.

Investment Thesis

Extra Space Storage (EXR) delivered strong Q1 2019 with mid-single digit top and bottom lines growth. The company’s growth outlook is positive, thanks to favorable demographic trends. However, elevated supply in many of its major markets will likely weigh on its result in the near term. We think investors should wait patiently on the sidelines for a pullback before initiating a position.

Data by YCharts

Recent Developments: Q1 2019 Highlights

Extra Space Storage delivered a strong Q1 2018 with same-store revenue growth of 4.2%. Similarly, its same-store net operating income increased by 4.8% year over year despite a 20-basis point decline in occupancy ratio (91.6%). In the quarter, the company acquired two stores and purchased joint venture partner’s interest in 12 stores for a total investment of about $222.3 million. This should allow Extra Space Storage to grow its revenue and improve its operating efficiency through synergies. The company has also added 46 stores to the company’s third-party management platform. This should allow it to increase its revenue from management fee.

Earnings and Growth Analysis

Long-term favorable demographic trend

Extra Space Storage should benefit from several demographic trends. In the United States, homeownership rate has been on a declining trend since 2005 (see chart below). PwC, a research organization, believes that this has to do with many people, whether retired or millennial, who prefer to live in “high-end, highly amenitized, connected, urban-chic communities.” Because these urban communities that they prefer to live in have limited home spaces available, self-storage spaces are needed to store many of their personal items.

(Source: June 2019 Camden Living Investor Presentation)

Another demographic trend that is favorable to Extra Space Storage is the ageing population in the United States. As populations in United States continue to age, more and more seniors opt for senior residences and downsize their homes. This should result in higher storage demands. Together with those who prefer to live in urban communities, we have seen an increasing utilization for self-storage spaces. As can be seen from the chart below, the percentage of U.S. population using self-storage has increased to 8% in 2018 from less than 3% in 1987. We believe this trend should continue well into the next decade.

(Source: June 2019 Investor Presentation)

Expected more supply to flock to the market in 2019

Despite favorable long-term demographic trends, Extra Space Storage will face the headwind of elevated supply in the near term. In fact, management indicated that the impact of new supply will be greater in 2019 due to the cumulative impact of several years of elevated development. Increasing supply in many of its key markets means that Extra Space Storage will have to increase its marketing expenses in order to defend its market share. In fact, management has indicated in the latest conference call that marking expenses will ramp up in 2019 by about 15% (due to increased costs of search engine bidding). As a result, the company’s same-store expense is expected to grow by 3.75% to 4.75% in 2019 (see table below). This is much higher than its same-store revenue growth expectation of 2-3%. Increasing supply will also mean that it will be more challenging to grow its rental revenue from its existing customers.

(Source: Q1 2019 Supplemental)

Management business for third-party owners is capital-light

Extra Space Storage’s properties include wholly-owned, joint venture, and managed properties. We particularly like its management business for third-party owners, as this part of its business is capital-light. In Q1 2019, the company added about 46 new stores to its third-party management platform. This results in a total of 577 managed sites for third-party owners. The company collects about 6% of the revenue from its managed sites. Management expects to collect management fee of about $52-53 million from this business in 2019. We expect Extra Space Storage to continue to add more managed sites to grow its revenue, as it requires minimum investment capital.

(Source: June 2019 Investor Presentation)

Sound balance sheet

Extra Space Storage has a solid balance sheet. About 72% of its debt is fixed debt and has a low weighted average interest rate of 3.5%. The current rate hike cycle has resulted in a declining interest coverage ratio. However, the interest rate is not expected to move up anytime soon. Hence, we think the company’s balance sheet is sound in this environment. This balance sheet should also allow the company to pursue future acquisitions in order to increase its scale (and thus improve the operating efficiency and grow its sales).

(Source: June 2019 Investor Presentation)

Valuation: Fairly Valued

Extra Space Storage expects its adjusted funds from operations to be in the range of $4.76-4.85 per share in 2019. Using the midpoint of the guidance, we have a price-to-AFFO ratio of 22.5x. This is slightly higher than Public Storage’s (PSA) 21.9x.

A growing 3.2%-yielding dividend

Extra Space Storage currently pays a quarterly dividend of $0.90 per share. This is equivalent to a dividend yield of 3.2%. The REIT has increased its dividend by 8 times since 2011. As can be seen from the chart below, Extra Space Storage’s dividend yield of 3.2% is in the middle of its yield range since 2011.

Chart

Data by YCharts

Risks and Challenges

Extra Space Storage faces the risk of elevating supply in several of its key markets, such as Florida, Dallas, Portland, Washington, D.C., and New Jersey. This elevated supply may continue for several years as the market gradually absorb these new properties.

Investor Takeaway

Extra Space Storage is a well-managed self-storage REIT with an excellent track record of growth. We like its long-term outlook due to favorable demographic trends. However, we continue to believe new supplies in many of its key markets will weigh on its growth, especially in the second half of 2019. Hence, we suggest investors wait on the sidelines.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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