Image Shown: Public Storage, a longtime idea in our High Yield Dividend Newsletter portfolio, has seen its share price skyrocket over the past year with room for additional upside, in our view.
By Callum Turcan
After the market close on May 3, the self-storage real estate investment trust (‘REIT’) Public Storage (PSA) intends to report its first-quarter earnings for 2022, which will be followed up by an earnings conference call a day later. Shares of PSA have been a long-time idea in the High Yield Dividend Newsletter portfolio, and we continue to be enormous fans of the name. The high end of our fair value estimate range sits at $445 per share of Public Storage, indicating that shares of PSA have room to keep running higher. As of this writing, shares of PSA yield ~1.9%.
Why We Like Public Storage
The self-storage industry, particularly firms with significant exposure to the US market such as Public Storage, is an incredibly attractive space to operate in. In our March 2022 article Public Storage Is a High-Quality Income Generation Idea, we covered the secular tailwinds that underpin the industry’s promising growth outlook, how REITs like Public Storage have substantial pricing power, and ultimately why these factors underpin our bullish thesis towards the name. We strongly encourage our members to check out that article (link here). Here are some key excerpts from that note:
Growth in U.S. housing prices and rents has encouraged a greater number of households to maximize their living space in an economical manner in recent decades, a trend that in our view has long legs. The percentage of the US population using self-storage services grew from 3% in 1987 to 9% in 2020, according to third-party data from the U.S. Census and Self-Storage Almanac cited by Public Storage. By capitalizing on a powerhouse secular tailwind, Public Storage’s growth runway has become immense…
Self-storage services represent a relatively small portion of the average monthly household budget while providing an incredibly valuable service. Raising the rental rates of these services without running into major customer churn problems is a relatively easy endeavor, as compared to raising the prices of goods or services that represent a much larger slice of the average household’s monthly budget (such as housing/rent costs or grocery expenses)…
Public Storage sees ample room to improve its operations and ultimately its financial performance by taking advantage of its digital initiatives. For instance, Public Storage’s eRental program was launched in November 2021 and offers its customers contactless move-in options where most of the administrative tasks are completed online (including signing the digital lease). Investing in digital property access systems so customers can use their smartphones to enter self-storage facilities and developing a comprehensive mobile app (that was launched in December 2020) to keep everything under one platform supported Public Storage’s efforts on this front.
Looking ahead, Public Storage is working on further optimizing its customer care and customer relations operations. That includes rolling out remote customer care centers at its self-storage properties with digital interfaces that can assist in a variety of tasks while also enabling customers to video conference with remote customer service personnel. AI and chatbot investments are being pursued to answer customer questions online to limit the need to run large and often expensive call center operations…
Growing adoption of self-storage services, favorable supply-demand dynamics, and efforts to use digital initiatives to improve productivity and enhance the customer experience are forecasted to drive Public Storage’s same-store NOI higher 3.0% annually over the long haul with room for upside. The REIT notes that “margin expansion from operating model and efficiency investments” could lead to its long-term annual same-store NOI growth climbing to 3.5%-4.0% according to its May 2021 investor day presentation.
On March 30, Public Storage was happy to announce that it had crossed the 1 million contactless customer move-in milestone via its eRental operations. Public Storage continues to innovate and has been firing on all cylinders of late.
Financial Considerations
Self-storage REITs are generally companies that can fully cover their dividend obligations with their free cash flows. Many other kinds of REITs generate substantial free cash flows, but their free cash flows can still fall short of their total payout obligations at times, unlike strong general operating companies such as Microsoft (MSFT) or Apple (AAPL), which have huge net cash positions and generate substantial free cash flows in excess of their cash dividends paid.
For instance, in 2021, Public Storage generated $2.0 billion in free cash flow and spent $1.6 billion covering its total payout obligations. Due to its sizable net debt load which stood at ~$6.7 billion (inclusive of short-term debt) at the end of December 2021, and its growth ambitions (the REIT spent over $5.0 billion on acquisitions in 2021 to scale up its operations in attractive markets), Public Storage remains a capital-market dependent entity. That means Public Storage needs to retain access to debt and equity markets to refinance maturing debt and cover its growth ambitions (such as acquisitions) while continuing to make good on its total payout obligations.
But there may be no reason to worry about this when it comes to Public Storage.
In light of the company’s share price booming higher over the past year, its ability to fully cover its total payout obligations with its free cash flows, and recent capital market activities (I, II), we expect that the REIT will be able to tap debt and equity markets at attractive rates going forward. Furthermore, Public Storage has a nice ‘A-rated’ investment grade credit rating (A2/A). At the end of December 2021, Public Storage had over $0.7 billion in cash and cash equivalents on hand along with revolving credit facilities to meet its near term funding needs.
Looking ahead, management issued favorable full-year guidance for 2022 during Public Storage’s fourth quarter of 2021 earnings call. Among other things, Public Storage expects its core funds from operations per share to grow by 17.5% year-over-year (at the midpoint of guidance) in 2022. That guidance is supported by its forecasts that call for 13.5% year-over-year same-store revenue growth in 2022 (at the midpoint of guidance), a product of recent pricing increases and strong same-store occupancy rates of late. Same-store operating expenses are expected to grow by 6%-8% this year on a year-over-year basis, allowing for 15.7% year-over-year same-store NOI growth (at the midpoint of guidance).
Recent Events
On April 25, Blackstone Inc (BX) and PS Business Parks Inc (PSB) announced that affiliates of Blackstone Real Estate had agreed to acquire PS Business Parks for $187.50 a share in cash through a deal that is expected to close in the third quarter of 2022. Public Storage has a sizable equity stake in PS Business Parks, which is a REIT that owns commercial real estate in the US including multi-tenant industrial, industrial flex, and low-rise office properties in the suburbs along with some residential units as well. Here is what Public Storage’s press release had to say on the matter (emphasis added):
Upon consummation of the transaction, Public Storage, like all holders of PS Business Parks’ common shares and units, would receive $187.50 in cash per PS Business Parks common share or unit. Public Storage holds an approximate 41% common equity interest in PS Business Parks through approximately 7.2 million common shares and 7.3 million limited partnership units.
Public Storage expects to receive approximately $2.7 billion of cash proceeds and recognize a $2.3 billion tax gain on sale upon consummation of the transaction. Public Storage expects to distribute the $2.3 billion gain to its shareholders.
Public Storage estimates annual Core Funds from Operations would be lower following the consummation of the transaction to a degree approximating its $101 million pro rata share of PS Business Park’s Core FFO in 2021, which comprised approximately 4% of Public Storage’s total Core FFO during the year.
We like this news. Once completed, the deal will effectively increase Public Storage’s exposure to the self-storage industry while simplifying its corporate profile. PS Business Parks has the option to continue making good on its quarterly payout obligations until the deal is finalized. There is a 30-day “go shop” period that expires on May 25, which allows PS Business Parks to go find another suitor willing to make a better offer. Should a better deal emerge, that would be good news for both Public Storage and PS Business Parks, though affiliates of Blackstone Real Estate offered a decent premium of 15% versus the average share price of PS Business Parks over the past 60 days.
PS Business Parks noted that “Public Storage has agreed to vote its shares of PS Business Parks common stock, which represent 25.9% of the outstanding shares, in favor of the transaction, subject to the terms of a support agreement between Public Storage, PS Business Parks and an affiliate of Blackstone” in its April 25 press release. As Public Storage is supportive of this transaction, it appears likely that the deal will go through as planned.
Concluding Thoughts
We will have more to say on Public Storage once its upcoming earnings report is published. Its ‘Property of Tomorrow’ program seeks to modernize Public Storge’s asset base (such as adding LED lighting, low-water irrigation, and enhanced digital security to its self-storage facilities while making these facilities look more aesthetically pleasing) to improve its cost structure while enhancing its revenue generation abilities, and we are keeping an eye out for additional commentary on how that program is going. That’s all for now.
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Real Estate Investment Trusts (REITs) Industry – CONE, DLR, FRT, O, REG, SPG, WPC, PEAK, HR, LTC, OHI, UHT, VTR, WELL, PSA, EQIX, CUBE, EXR, IRM
Tickerized for PSA, PSB, BX, VNQ, and various other REIT-related ETFs and stocks.
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Callum Turcan owns shares in DIS, FB, GOOG, VRTX, and XLE and is long call options on DIS and FB. American Tower Corporation (AMT), CubeSmart (CUBE), Life Storage Inc (LSI), Digital Realty Trust Inc (DLR), Public Storage (PSA), and Vanguard Real Estate Index Fund ETF (VNQ) are all included in Valuentum’s simulated High Yield Dividend Newsletter portfolio. Digital Realty Trust and Realty Income Corporation (O) are both included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.