Today we want to take the opportunity to review a leading company that struggled in the first quarter. STAG Industrial (NYSE: STAG) is a net lease REIT focused on acquiring and managing single-tenant industrial assets across the United States. Net lease REITs come in many shapes and sizes. Larger and more established operators such as Realty Income (O) to emerging brands such as NETSTREIT (NTST), there are a variety of differentiating factors. Although the pool is deep, there are few with such specialized focus as STAG
What is STAG Industrial?
STAG owns over 100 million square feet of real estate across the United States with a portfolio of over 540 assets. When you imagine the average portfolio asset, imagine large, slant-walled warehouses with large footprints, typically over 250,000 square feet. Many of these are core logistics facilities occupied by established domestic tenants and most are located in strong secondary markets. STAG offers investors the opportunity to operate a high-quality portfolio of institutional-grade assets in a liquid and efficient format.
The industrial asset class has become the center of attention as the world emerges from the pandemic. As retail closures plague the economy, businesses across all sectors are recognizing an urgent need to expand their logistics footprint. For the majority of companies, this meant significantly expanding their existing warehouse footprint, often in smaller markets with greater accessibility to the end consumer. Luckily for STAG, it’s often markets and assets, but the company has spent years acquiring. Below is a photo of a 331,845 square foot distribution center owned by STAG in Piedmont, SC.
Portfolio and balance sheet
STAG’s portfolio is predominantly single-tenant, meaning properties are occupied by a single period of use. The company owns diversified real estate in 40 states and, as mentioned, is primarily located in secondary markets. These include recognizable cities like Indianapolis, Houston, and Memphis. Although these markets do not necessarily have the same strength as the Inland Empire or other major locations, they represent a crucial part of the national supply chain. STAG’s established footprint is strong and will benefit from the organic growth drivers that have begun to materialize as we emerge from the pandemic.
The leasing portfolio is well diversified and strong in terms of quality. The majority of the portfolio is publicly rated and much of it is investment grade, indicating strong operators. Additionally, 54% of the portfolio is publicly listed, 83% of tenants have revenues over $100 million and 59% of tenants have revenues over $1 billion. In fact, the industrial lessor’s largest tenant is Amazon (AMZN) at 3.2% of base rent.
Another important point is that STAG’s portfolio is well placed to withstand inflationary pressures. STAG’s bias in favor of triple leases protects by placing the responsibility for maintenance on the tenant, property tax and insurance. All are impacted by inflation. In contrast, STAG benefits from rolling leases that will reset to high rents due to long-term growth in market rents.
STAG is disciplined in its use of leverage, reducing in the face of rising rates. As it stands, the company is conservatively capitalized. 80% is equity and the remaining 20% of the portfolio is funded by unsecured debt. There are no preferred shares in a very limited amount of secured debt. In addition, the majority of the debt in the portfolio is fixed rate at approximately 85%. This means that short-term fluctuations in interest rates do not immediately affect STAG, but rather have an impact at the time of refinancing. With only 24% of debt maturing until 2024, the company is not in a strong position to refinance itself in the face of rising interest rates.
STAG pays a level monthly dividend of $0.1217 per share corresponding to a dividend yield of approximately 3.66% based on recent stock prices. Like many REITs, STAG has elected to pay a uniform monthly dividend that incentivizes shareholders to provide reliable monthly income that should grow over time. STAG’s dividend income is ultimately supported by corporate tenants paying rental income into their portfolio properties. These long-term leases provide a format for strong long-term dividend growth and consistent rental income.
The company has been consistent with the dividend since its IPO more than 10 years ago. Since then, STAG has grown its revenue year after year without fail. For shareholders, this was crucial because the dividend represents a significant part of the total investment return.
A point of criticism that is often imposed on the company is the painfully slow growth of dividends. Over the past five years, the dividend has grown slowly at less than 1% per year. STAG opted for a single dividend increase at the end of the year, which over the past few years has been somewhat disappointing. It’s important to understand why so many different REITs have different strategies when it comes to their dividend.
STAG is a relatively young company having turned 10 years old in 2021. As such, and with a portfolio of only 500 properties, STAG is still in growth and portfolio stabilization mode. While the company has remained very disciplined in consistently increasing revenue and satisfying shareholders along the way, that has clearly not been the primary focus. STAG has always maintained an aggressive posture when it comes to acquisitions. By regularly issuing debt and equity, STAG has been able to acquire new properties on a consistent annual basis since its launch.
The second factor that contributed to weak dividend growth was the historically slow performance of the industrial asset class. Before the introduction of e-commerce, industrial assets were limited in their desirability for various reasons. First, logistics facilities are often capital intensive, which means owners must be heavily involved in the staffing and management of individual properties. This limits economies of scale and poses a challenge for industrial operators. Triple net lease structures and single-tenant facilities alleviate some of these challenges for the business. Second, other industrial facilities are often highly specialized, which means the possibility of freeing up individual assets is often daunting. The outcome can be difficult and sometimes correlated with rent reductions or substantial capital investments needed to redevelop facilities for market use. Historically, the solution to this problem has been longer term leases with a tenant staying in these facilities for perpetual periods of time.
The industrial asset class has been a major beneficiary of the continued development of the internet and e-commerce. The need for bulk logistics space has grown for retailers from incredibly large regional facilities that ship end stores to smaller strategic assets that can ship products directly. This shift has dramatically increased the demand for industrial assets across all fields and shines a spotlight on the market today. The market failed to meet the huge demand and the trend is correlated to two main things. First, there is record industrial development taking place across the country, much of which is speculative. Second, industrial rents are rising sharply in almost every market in the United States. Specifically, JLL notes that industrial rental rates increased 11.3% year-over-year across the country. Keep in mind that this growth even exceeds the high inflation rate of the same period. While there is certainly no direct impact on STAG’s income, rising rents inevitably have a positive impact on portfolio income as the landlord re-lets vacant assets.
As mentioned, the start of the year has been difficult for the company. Stock prices have fallen more than 10% as geopolitical risks, rising interest rates and other risk factors begin to materialize across the economy. However, significant value remains in STAG’s core business due to the benefits that have come over the past two years. Today, shares of STAG are trading below the midpoint of their 52-week range, well off the all-time high of over $48 per share. Current prices correspond to an attractive price/FFO ratio of 18.34x compared to the last 12 months. For long-term shareholders, this represents an opportunity to take advantage of what could become stronger dividend growth. In any case, the company’s conservative management, its quality rating and its solid portfolio protect against short-term risks.