I recently published an article entitled “The Best Monthly Dividend Stocks” where I evaluated 17 C-corporation stocks that pay dividends monthly.
In that previous article I covered the benefits of monthly dividends and provided the reader with a red/yellow/green recommendation on investment potential and a brief rationale for the recommendation on each of the 17 stocks.
To provide more granularity on those stocks ranked green in the previous article, I’m covering in more detail the four stocks I consider “The Best of the Best Monthly Dividend Stocks”.
This article covers the first stock in the series, Stag Industrial, Inc. (STAG). Out of the four stocks, why am I choosing to cover STAG first?
I believe STAG is currently the most undervalued of the four stocks I intend to highlight. In the spirit of providing currently actionable investment recommendations, I’m planning to cover the four “best of the best” stocks in order from most undervalued to least undervalued. The investment thesis for STAG is laid out in the following paragraphs and charts.
Stag Industrial Investment Thesis
STAG is a triple net lease REIT with the primary objective of acquiring and leasing single tenant industrial properties, primarily warehouses and light industrial manufacturing.
The triple net lease agreements places the responsibility for all real estate taxes, building insurance, and maintenance costs directly on the tenant. STAG has been growing rapidly since it went public in 2011. The chart below shows that STAG has nearly tripled the number of buildings under management.
Today STAG owns more than 54 million square feet of industrial floor space in 40 states. For 2016, STAG has a target growth of $300M – $400M in new and accretive acquisitions.
STAG maintains a BBB investment grade credit rating with a stable outlook from Standard and Poor’s and its debt metrics are solid if not stellar. STAG currently as a debt to EBITDA (1Q2016 run rate) of 5.3x which is a bit higher than I like to see but STAG’s fixed charge coverage ratio of 3x is comfortable.
STAG’s most recent 1Q16 financial report shows STAG is continuing to perform. STAG grew net operating income (NOI) by 19% over 1Q15 and funds from operation (FFO) at 17%. The chart below shows adjusted FFO (AFFO) for the last 5 years.
STAG has grown AFFO by 10.9 % annually and is guiding for full year 2016 AFF of $1.56, a growth of 2% over 2015. Readers should note that STAG more frequently than not beats their own guidance.
For REITs, growth in AFFO is the basis for growth in dividends paid. STAG has continually grown its dividend each year since going public. The chart below shows STAG’s dividend history for the last 5 years.
STAG has been more conservative in growing their dividend in order to lower their dividend to AFFO payout ratio from its current 86.9% to a target range of 80% plus or minus a couple percent.
Even with the conservative dividend growth strategy, STAG has been able to grow their dividend at a 5.4% clip over the last 5 years. At current prices, STAG yields 6.7%.
So, STAG is growing at a significant clip, keeping its debt conservatively under control, and managing to grow its cash flow and its dividend payout to investors. What makes STAG a compelling valuation today?
When you look at STAG’s dividend yield or price per dollar of FFO, it is clear that STAG is currently undervalued compared to its industrial REIT peers. The two charts below show both metrics with STAG highlighted in green.
In comparing STAG to its peers on dividend yield, STAG is paying out well more in terms of yield than most of its peers. Likewise, STAG’s stock price is low on a per dollar of FFO comparison.
Given STAG’s growth history, solid balance sheet, investment grade credit rating, and strong outlook, I believe STAG is currently undervalued. It is one thing to be able to identify an undervalued stock. I find it much more difficult to estimate a fair value assuming the market comes to its senses on the stock in question.
Considering the average price/FFO of all of STAG’s peers is about 16.3, my estimate for a fair value for STAG is about $25.50. At a price of $25.50 and STAG paying out a $1.39 annual dividend would put the yield at 5.44% which is reasonable given our current ultra low interest rate environment.
What Are the Risks?
I would be remiss if I failed to discuss the possible risks of an investment in STAG. STAG is a solid company with a strong management team but there are external risks that could impact an investment in STAG.
The first risk is the potential for interest rates to rise significantly. STAG is primarily an income investment; slow growth with a significant dividend yield. It therefore falls into the category of bond surrogate and will likely see its share price fall if interest rates begin to rise.
Because STAG is able and expected to grow along with the economy, a fall in STAG’s valuation due to rising interest rates would likely be temporary. The second impact of a rising rate environment would be an increase in STAG’s borrowing costs to continue to grow its real estate footprint.
STAG does have an advantage over some of its peers in that STAG maintains an investment grade credit rating giving STAG access to lower loan and bond issue rates. But, STAG’s cost of growth capital would go up in a rising rate environment.
All that said, I don’t expect the US Federal Reserve will make any significant move to raise interest rates. It is an election year, the US economy is soft, the employment metrics have turned down over the last couple of months, and the rest of the world is still trying to juice their economies via loose monetary policy.
The second risk would be a general economic slump or recession in the US. An economic downturn would negatively impact many of STAG’s tenants and STAG’s revenue and earnings would likely be adversely impacted. STAG is not a recession-proof stock. I’m not expecting to see a recession or significant economic downturn in the US.
My expectation is for more of the same low interest rate and slow grow environment that we have had over the last few years. I found the latest retail sales numbers promising with respect to STAG’s continued growth. Retail sales were up but the real story was that retail store sales were down 3.1% while retail non-store sales were up 8.1%.
In order for those non-store sales to get from the seller to the buyer quickly, sellers need to have regional warehouses and distribution centers. Just the type of facility STAG owns. My bottom line is that I’m not expecting a general business downturn in the near term that would impact STAG’s operations.