American Asset Trust (NYSE:AAT) is a full-service, vertically integrated, self-managed real estate investment trust that operates high-quality office, retail, multi-family and mixed-use properties in attractive, high-barrier-to-entry markets.
The company’s portfolio includes twelve shopping centers, eleven office buildings, a mixed-use building consisting of a 369-room hotel and a shopping mall.
With its strong portfolio of properties, the company has produced considerably attractive returns over time and, despite this, the stock has traded at multi-year lows.
I believe the company is much more profitable with a well-maintained debt structure, but due to negative sentiments for the REIT sector among investors as well as the current inflationary environment, the stock has fallen significantly and has risen traded at a multi-year low valuation. As the economy stabilizes, the market will recognize its value, which will cause the stock price to appreciate significantly. AAT is a purchase.
Debt and equity financing
As a REIT, the company must pay more than 90% of its taxable income in the form of dividends. Consequently, debt and equity dilutions remain an important source allowing the REIT to grow its business and sustain itself in adverse economic conditions. If the REIT fails to generate substantial cash, it must rely on debt and equity dilution to sustain its operations. Under unfavorable economic conditions, fundraising becomes so costly and difficult that it could put significant pressure on the company’s financial condition.
But in the case of AAT, it appears that due to its strong presence and substantial cash flow, even in volatile market conditions, it managed to raise over $500 million at a desirable rate, which will further reduce interest expense, the company’s outstanding debt as of 2022 is approximately $1.6 billion.
In addition, over time, the company has reissued tickets at a very attractive price; it appears that as overall interest rates have risen in the market, the company has managed to hedge interest rates, which is why the company’s interest rates have not risen sharply.
It seems that the upcoming debt maturity is limited and the company can manage to comply with it, which gives a lot of strength to the business model of the company, also note that the company has ratings of Significantly stable financial credit with a strong financial position that will help the business raise funds moving forward.
The strength of the business model
As management indicates in the annual report, most of the company’s properties are located in an area where developable land is scarce, and current regulations limit new development, giving AAT substantial pricing power over its principles and help raise the rent as demand increases; these locations will not see a significant increase in capacity due to regulatory restrictions, which will provide the existing player with a strong moat around their chateau and desirable rental income over the very long term. Along with this, management’s capital allocation strategy regarding the buying and selling of assets helps the company achieve better margins.
In addition, the company has a portfolio of financially strong and stable customers such as Google LLC, LPL Holdings and Autodesk, which represents approximately 30.9% of the total annualized base rent of the office portfolio and Lowe’s, Nordstrom Rack and Sprouts Farmers Market, representing approximately 11.3% of our total retail portfolio annualized base rent. Having such a strong customer base provides the guarantee of regular payment without major defaults. Over time, management could secure new leases at even higher prices.
In addition, the company’s CEO, Mr. Rady owns approximately 35.2% of the beneficial interest in the company; It appears that his holdings have remained substantial despite significant dilution. That’s because Mr. Rady bought the company’s stock, which shows he believes in the company’s long-term prospects and AAT’s robust business model.
Note that the company’s ability to increase margins is totally dependent on increasing occupancy and its ability to sign new contracts at higher rent per square foot. In 2021, the company entered into leases for its office segment for approximately $50 per square foot and its retail unit for approximately $59.59 per square foot, showing that the company could sign new contracts at a higher price.
Since its IPO, revenues have grown at the rate of about 10%; and with revenue growth, gross margins grew steadily, but over the period, revenue and business growth could not translate into growth in shareholder returns.
During the period, the stock did not perform meaningfully, primarily due to continued stock dilution that resulted in a substantial reduction in shareholder earnings per share despite the growth in revenue.
The real estate business is very capital intensive and needs substantial cash to grow its operations, but since a REIT is required to pay out most taxable profits as a dividend, the only source of CAPEX and acquisition remains debt and equity dilution, so the investor should keep in mind that every time the company plans CAPEX or an acquisition, it will have to dilute substantial shares or will have to incur huge debt.
Additionally, to grow the business, management acquired and developed numerous properties during the period, such as the Torrey Point expansion in 2015 and the acquisition of La Jolla Commons, resulting in a substantial increase in real estate assets and overall rental income.
While net income remained volatile, funds from operations continued to grow due to its constant acquisitions and developments. but investors should recognize that since its inception the company has incurred substantial debt and diluted significant equity during the period for acquisition and investment purposes, therefore, as the company continued to increase its asset base, its outstanding shares also increased by nearly the same percentage, which is why despite significant growth in business, growth per share remained sluggish.
During the period, the dividend payout appears to be increasing but due to significant dilution, this effect of the dividend increase could not be translated into a dividend per share. Therefore, investors may not see major growth in dividends per share.
The company owns most of the properties in strictly regulated areas, and according to these regulations reconstruction is restricted in most areas, therefore any damage to the properties will result in significant losses as the company will face significant restrictions building regulations. these properties.
Also, as current economic conditions deteriorate, it may take longer for the stock to appreciate. Currently, the risk of permanent capital loss appears low as the company’s overall CFO is intact and has generated stable and strong earnings.
During the most recent quarter, the company reported net income of approximately $12.8 million and $33.9 million for the three and nine months ended September 30, 2022, respectively, funds from operations also increased by 11% on an annual basis in the last three months and more than 23% in the last nine months. Additionally, same store cash net operating income increased 10.7% year-over-year for the nine months ended September 30, 2022. In addition, management increased FFO guidance. 2022 per diluted share at a range of $2.30 to $2.34, showing that the company has retained its ability to generate significant funds.
Additionally, due to the pandemic, the stock fell in November 2019, from its peak price of around $48, since then the stock has been unable to reach its previous levels, this is in due to high inflation and unfavorable economic conditions. as the economy boomed in early 2021, stocks soared over 55% but fell significantly again and are currently trading at a low multi-year valuation despite a strong portfolio of diversified assets and earnings considerably stable compared to its peers.
It appears the company is trading at around 12 times its FFO, whereas historically it has been trading at a significantly higher multiple, I believe that due to the current inflationary situation the stock has fallen to levels considerably below -valued, and from this price the stock offers significant upside potential and considerably low risk of capital loss, AAT is a buy.