STAG Industrial: Solid Outperformance, Perhaps Too Much (NYSE:STAG)

At the start of this year, I believed that STAG Industrial, Inc. (NYSE:STAG) was a solid real estate investment trust, or REIT, although fairly valued. The REIT has been a solid value creator in the industrial and logistics space, yet it was hurt by higher interest rates, although a solid positioning and low leverage have limited the pain.

Since the start of the year, shares have been trading rangebound, as relatively little investment activity was performed so far this year. All this and a relative outperformance versus other REITs, while its cap rate is contracting, all while interest rates moved higher, has reduced the relative appeal here.

About STAG

STAG has turned out to be a decent steward of capital for REIT investors since it went public in 2011, at the time trading at $13 per share. Following a steady move higher, shares rose to the $50 mark in 2021, having settled around $32 per share in January.

On top of the solid capital gains, STAG paid out a compelling dividend yield of 4.5%, paid from rental proceeds from a nationwide portfolio, being geared to major urban areas, which measured 111 million square feet at the time. Amazon (AMZN) was the largest tenant, responsible for about 3% of sales, but the second-largest tenant was responsible for less than a percent of sales, a testament to the diversification of the portfolio.

The business was hurt by lower demand within e-commerce clientele as well as higher interest rates, but there were some green shoots as well, including re-shoring of production, higher domestic inventory levels, and still long-term growth in e-commerce. The impact of higher interest rates was somewhat mitigated, as the company employs relatively little leverage.

The company reported $5.8 billion in assets for the year 2021, financed by $2.4 billion in debt, with the remainder financed with equity. The $562 million in rental income translated into a near 10% yield, although that this was based on the book value, as the company has incurred quite some expenses to obtain these proceeds, including $108 million in property expenses and $48 million in general expenses.

The so-called funds from operations metric came in at $344 million, equal to $2.06 per share based on a 167 million share count.

Revenues trended at $664 million per annum through the most recent quarter in 2022, as the company traded at a premium to book. Trading at $32 in January, the company commanded a $5.8 billion valuation, a $2.3 billion premium to the book value. This implies that assets were valued at $8.2 billion in the market, for an 8.1% cap rates based on annualized revenues coming in at $664 million, although that property and overhead costs are relatively high.

While these costs are relatively high, leverage was low, as the company has taken on some cheap debt as well over the summer of 2022, as the long term growth was solid and prospects for growth remained intact, with a solid foundation seen. Given all this, I offered a cautious but positive undertone.

Trading Stagnant

Since the start of the year, shares of STAG have traded in a $32-$38 trading range, now trading at $36 per share. The company started the year on a relatively solid note in what is a rather uneventful quarter. Core funds from operations, or FFO, advanced by two cents in the first quarter, with revenues up 9% to $173 million.

Second quarter revenue growth slowed down dramatically as revenues were down a bit on a sequential basis to $171 million and change, with core FFO flat at $0.56 per share. Contrary to the first quarter, when no acquisition activity took place, STAG acquired two buildings at a combined cost of $40 million.

Third quarter revenues grew to $179 million, with core FFO up two pennies to $0.59 per share. Acquisition activity picked up meaningfully, with 12 buildings acquired at a combined cost of $204 million at a 6.2% cash capitalization rate, with $67 million spent on deals so far in October.

Gradual dilution meant that the company now has 181 million shares trading and a $3.4 billion equity position (book value), which works down to $18 per share. With shares trading at double that amount, the company commands a $3.4 billion premium on the market, suggesting that the $6.0 billion valuation of these assets is really valued at $9.4 billion on the market.

A run higher in the shares has reduced that cap rate some 50 basis points since the start of the year, to 7.6% here. This actually came as Treasury rates have widened still quite a bit since the start of the year, and while they have come in a bit in recent times, they are still up some 70 basis points for the year.

And Now?

The truth is that I am somewhat surprised by the recovery in STAG Industrial, Inc. shares so far this year. The company has benefited from low leverage, giving it an opportunity to go buy assets at solid yields here. Low leverage and a solid performance meant that shares have done quite well this year, despite yields on a net basis widening out (although they have fallen quite a bit in recent times).

On the other hand, the gross implied cap rate of 8% at the start of the year was quite high, but Stag’s existing buildings carry some expenses, which stood at the basis of my cautious/neutral tone at the start of the year.

With STAG Industrial, Inc. shares having done well this year, the implied cap rate has come down, while many peers have seen share price declines. This makes me cautious, a conclusion which is furthermore amplified by the fact that recent acquisition activity takes place yields of 6% and change. This makes me cautious to get too upbeat about STAG Industrial, Inc. shares, as I am taking a balanced and cautious approach here.