Hirsch Industrial (DEER -2.04%) can be a real yawner. The Real Estate Investment Trust (REIT) acquires and operates single-tenant commercial properties throughout the country. It enters into long-term rental agreements with tenants who generate very stable rental income and thus have the necessary means to pay one monthly dividend This currently results in a return of around 4%.
While Stag Industrial has a relatively boring business model, the company is a pretty exciting investment opportunity these days. It’s selling at a bargain price and offers investors a great entry into what has been a great wealth creator over the years.
A silent wealth creator
Stag Industrial went public in 2011 with relatively little fanfare. That was back then Industrial REIT owned 91 properties with 13.9 million rentable square feet in 26 states. Since then, it has grown into a much larger company with 568 properties and 112 million square feet in 41 states.
Stag Industrial has primarily acquired income-producing industrial properties. However, in recent years the focus has been on value-adding acquisitions (acquisition of properties that can create added value through expansion projects, renovation or rental). The company has also become increasingly involved in fundamental development projects in recent years, which are investments with higher risk and higher profit potential.
The REIT’s growing portfolio has allowed rental income to increase significantly. This has allowed the company to offer its investors a slight pay raise each year while retaining an increasing amount of free cash to fund new investments. The dividend payout ratio had fallen from about 99% in the IPO to 73.9% this year, leaving the company with annual excess free cash flow of about $95 million.
The company’s ever-growing cash flow and dividend have resulted in a pretty compelling total return over the years:
The chart shows that the company has achieved a total return of almost 500% since its IPO, significantly outperforming S&P 500. A hypothetical $1,000 investment in the IPO would have become almost $6,000 today. That’s about $1,500 more than the same investment in an S&P 500 index fund.
A first-class added value at a bargain price
Companies with an excellent track record of creating value for their shareholders typically trade at a premium Evaluation compared to their peers. However, this is not the case with Stag Industrial:
As this slide shows, Stag Industrial is trading at a higher implied price Real estate capitalization rate (cap rate) than its competitors (meaning it has a lower valuation and a higher earnings yield). It also trades at a lower price Funds from Operations (FFO) Multiple (including adjusted FFO). This lower valuation is an important reason for the higher dividend yield.
This higher yield allows investors to earn a higher return on a new investment. For example, a $1,000 investment in Stag Industrial would generate about $40 in annual dividend income, while the same investment would only generate about $30 in annual dividend income at its competitors.
This revenue stream should grow as Stag’s FFO increases, driven by increasing rental income and continued acquisitions. The company’s legacy portfolio has a lot of built-in growth. The current leases have escalators that will increase rents by 2.6% per year.
Given the strong demand for industrial properties, even stronger rental growth is expected as long-term rental agreements expire. This has led to a rent increase of more than 30% this year as old leases expired and Stag Industrial signed new leases for the same space at a much higher market rate.
The company now has great financial flexibility to continue acquiring new properties. It has an investment-grade balance sheet supported by low risk Leverage ratio (4.9x at the end of the third quarter, compared to 5.2x at the end of last year). Add in the significant (and growing) post-dividend free cash flow and Stag Industrial can continue to buy properties when attractive investment opportunities arise.
A comprehensive investment opportunity
Stag Industrial has quietly done a great job of increasing shareholder value over the years. Still, it’s trading at a bargain price these days. This makes it seem like a very tempting investment opportunity at the moment. The company is in an excellent position to further expand its portfolio in the coming years and increase its high-yield dividend, which should allow it to further increase shareholder value.