Extra Space Storage (NYSE: EXR) and VEREIT (NYSE: VER) are two of the most attractive dividend stocks, but like an ill-fitting suit, something about these companies feels a little off. However, with some minor alterations, they could be a perfect fit and are well worth keeping an eye on.
1. Extra Space Storage
For instance, if there’s something that we should all be able to agree on, it’s that most Americans have more stuff than they know what to do with. There’s no better sign of that than the runaway success of the self-storage industry. And it’s also a reason why I like that segment of the real estate investment trust, or REIT, universe.
Extra Space Storage is one such operator, and it, as of June 30, either owned, had an ownership interest in, or managed 1,147 self-storage facilities across 35 states plus Washington, D.C. and Puerto Rico. A quick glance at its results shows the company growing like gangbusters: Funds from operations (FFO) – a key cash-flow measure in the REIT industry – nearly tripled between 2011 and the 12 months ending this June. Throw in a steadily-growing dividend, and you can see why I’ve got this name on my watchlist.
But here’s the problem: The success of the self-storage industry is no secret. For a REIT like Extra Storage, we’d want to look at valuation on the basis of its price versus FFO -- or, stock price divided by annual FFO per share. Currently that stands at more than 25, which is at the high end of Extra Space's historical average, rich compared with other self-storage REITs that are trading about 22x FFO on average, and considerably more expensive than many of the top-self REITs in other industries, which are trading closer to 20x FFO.
Extra Space’s smokin’ hot growth does justify a higher-than-average multiple, but it’s far from a bargain at today’s price, which is why I'm just looking for the moment. However, if Extra Space Storage's FFO multiple falls in line with its self-storage peers -- which, based on today's numbers, would be a stock price around $63 -- I would view that as an very attractive price, and a great time to buy.
2. VEREIT
On the other side of that coin is a company like VEREIT, which is currently trading at the much cheaper valuation of 10x FFO.
Formerly American Realty Capital Properties, the $7.3 billion company owns a portfolio 4,645 single tenant retail properties spread across 49 states, Washington, D.C., Puerto Rico, and Canada. And although brick-and-mortar retail isn’t a booming industry, VEREIT’s simple business model has proven wildly successful for peer companies National Retail Properties and Realty Income who have increased their dividend for more than 20 consecutive years each.
One important piece of this business model is using sale leasebacks transactions. Essentially, VEREIT buys properties like convenience stores, gyms, and quick-service restaurants, and then leases the space back to the seller. The process is win-win, the seller frees up capital, and VEREIT gets a property with a tenant already in place and willing to sign a long-term lease -- which, in general, averages 10 to 20 years. This model is an important reason why VEREIT is able to keep its occupancy rate over 98%, and this helps to generate more consistent cash flows.
The catch is that VEREIT is the midst of a turnaround story. Under former management, the company aggressively grew assets from $2.5 billion in 2013 to a whopping $22.8 billion by October 2014, and this was done, in part, by aggressively taking on debt. This isn't unheard of for REITs, but the business came to a screeching halt when the company releases a statement on October 29th that they had falsely reported earnings during this time period. This led to the ousting of top executives and board members, and a big mess for the newly appointed CEO, Glenn Rufrano, to clean up.
Rufrano has been a steadying force since he took over this past April, but the combination of the accounting scandal and huge debt pile has led to the stripping of VEREIT's investment grade credit rating. In an industry where competitive advantage is hard to come by, a credit rating is like a good housekeeping seal of approval that gives companies better access to capital at lower costs. VEREIT is planning to sell off $1 billion in assets over the next year in an effort to pay down a portion of its $9 billion in debt and earn back its credit rating, and I’ll be watching and waiting until that becomes reality. However, if all goes according to plan over the next year, this is a large and diverse company that has the potential to generate a very reliable dividend, and could be a great buy.
