Terreno Realty: Too Much Focus On Growth Vs. Growth Per Share (NYSE:TRNO)

Shares of Terreno Realty (NYSE:TRNO) have fallen out of favor recently again, certainly after peers warn about slower rental growth, declining occupancy levels, all while the Fed seems to hold rates steady for a longer than anticipated time period.

This all hurt the share price as of recent, and while high occupancy and low leverage provide no reason to be concerned, the higher valuation argument remains a cause for concern, with the latest pullback not enticing me to get onboard just yet here.

A Unique Approach

Terreno acquires, owns and operates warehouse and industrial real estate across major coastal areas in the US, as that includes both coasts. On the West Coast this involves markets like Seattle, the San Francisco Bay Area and Los Angeles. On the other sides, this includes especially the region of New York, and to a lesser extent Washington D.C. and Miami.

The company focuses on a mix of value-added and core, no greenfield developments, no complex (joint-venture) structures and focuses heavily on discounts to replacement values in order to build in safety in its model.

The company specially focuses on these densely populated areas, with strong population demand having to be facilitated amidst tight supply, in some cases even shrinking supply. In fact, some 80% of the buildings are seen in markets which show stable supply, or net declining supply.

Over three quarters of these buildings include warehouses and distribution centers, with the remaining involving improved land, transshipment and flex solutions. These are leased out to a diverse range of tenants including names like Amazon and FedEx, but also Danaher, the US government, Meta and Northrop Grumman.

The tightness in the supply is seen in the cash same store NOI growth, which in the last five years has come in higher single digits, and even in the lower double-digits in 2022 and 2023.

Despite the strong rental growth, the company reported occupancy rates in excess of 98% in 2023, with the portfolio measuring over 16 million square feet as of the end of 2023, comprised out of 259 existing buildings.

The company has been publicly traded since 2010. Shares have been stuck in the mid-teens until 2014, peaked around the $80 mark in 2021 as the pandemic warehouse boom was in full effect, and have largely traded around the $50-$60 mark in recent years.

Some Valuation Perspectives

For the year 2023, the company posted a 17% increase in full year rental revenues (including tenant reimbursements) to $323 million and change, driven by a combination of asset purchases and same stores rent growth.

The company reported GAAP earnings of $150 million, equal to $1.81 per share, but that does not say much as the number is inflated by asset gains, as well as depreciation charges which hurt the bottom line. The so-called FFO metric, which cancels out these items, was reported at $185 million, or $2.22 per share.

The 88 million shares of the business are currently valued at $55, granting equity of the business a $4.8 billion equity valuation. Net debt is relatively modest, seen at $610 million by year-end 2023, for a $5.4 billion enterprise valuation. To put this into perspective, this implies that the assets trade around a 6% gross yield.

This picture is a bit mixed given the investment activity, as annualised fourth quarter revenues came in at $346 million per annum, which implies a gross yield around 6.4%.

An Active First quarter

Terreno announced various acquisitions and development projects in the first quarter of the year and subsequently announced the sale of another 5.5 million shares at $62 per share in March, to shore up the balance sheet and finance these acquisitions and developments.

Early in April, the company announced some key highlights for the quarter. Occupancy rates fell to 96% and change, as Terreno announced that on top of the equity offerings from March (which eventually involved the sale of more than 6.3 million shares), another near 2.4 million shares were sold under the ATM program, all needed to fulfil on nearly half a billion in acquisitions under contract.

Soon after this announcement, Terreno announced a $42 million investment in Hialeah, Florida with an estimate cap rate of 6% that should add another $2.5 million in annual rent. This was followed by an $84 million acquisition in Virginia. The 5.3% cap rate feels a bit low, adding another $4.5 million in annual rent.

What Now?

Leverage is no issue at all, as leverage ratios are low, and the company continues to issue equity to fund more developments and acquisitions. The willingness to incur dilution however means that the focus seems to be really on growth, perhaps more than growth on a per-share basis, which is really what investors are after.

This is seen in the results over the past decade, as while Terreno has five-folded its revenue base over the past decade, as the actual number of outstanding shares has three-folded as well, making growth on a per-share basis still look decent, but nothing as spectacular as the reported sales growth.

The willingness to dilute is certainly painful for investors, certainly in the light of recent acquisitions taking place at a low 5% cap rate, while the shares trade at 6% and change. Hence, a pause of acquisition activity would be more welcomed, or even buybacks (but that looks very strange in the light of recent issues).

While the structural dynamics of the markets, on which the company focuses are real and positive, there are some risks as well related to concentration, but still mostly about the valuations. This comes as the shares trade at 25 times FFO, as the payout ratio is very high, with dividends of $1.80 per share coming in around 80% payout ratios.

Amidst all of this, I am still taking a somewhat cautious stance. While the fundamental real estate strategy is sound, overall valuations remain very demanding, even as shares have been lagging for a while, like so many REITs here.

Hence, this is really about a play on key real estate in these areas, with perhaps potential over time to convert into higher valued usage cases. Furthermore, continued rental growth amidst tight supply is expected, a trend which is already seen, but the cold hard numbers paint a less impressive picture at tighter cap rates, as very strong rental growth will cast pressure on some of the tenants as well.