Whitestone: Growth at a High Price (NYSE:WSR)

Whitestone REIT (NYSE:WSR), founded in 1998 and headquartered in Houston, TX, owns and operates retail properties in major metropolitan areas.

The company has very good growth prospects based on a favorable supply/demand picture and results that reflect this. More importantly, though, it is The stock trades at a discount to NAV and is cheaper than its peers on an FFO-multiple basis, making it a good option for value investors.

Portfolio and Outlook

The REIT’s portfolio consists of 57 properties totaling 5,055,050 square feet and spread across 5 markets. Specifically, it operates in Phoenix, Austin, Dallas-Fort Worth, Houston and San Antonio. The portfolio, although relatively concentrated, is nevertheless well diversified between these markets; as of late 2023, Houston had the largest, but not overwhelming, exposure, with 12 properties out of 57 total.

Either way, Houston is suffering from the slowdown in population growth that may continue in the coming years:

It also has higher than average unemployment. However, all other markets have a relatively low unemployment rate:

The tenant base also appears to be of high quality as it is diversified across many different industries with a focus on small space businesses (75% of ABR):

Of 1,465 tenants, the largest accounted for just 2.1% of the REIT’s annual rental income in the six months ended June 30, 2024.

Furthermore, the terms of the leases that Whitestone underwrites range from less than a year for small tenants to up to 15 years for large ones, but since they focus on small businesses, 23% of GLA is linked to leases that will expire before the end of the next month. year. Overall, this would imply high risk to its bottom line, but the lease spreads enjoyed by Whitestone over the past two years instead introduce the prospect of significant near-term upside potential:

Judging by market dynamics here, this trend is likely to continue and Whitestone will have no problem replacing expiring leases in the short term.

Focusing tenants on small spaces is generally problematic in theory because of the greater appeal that full e-commerce has for such businesses, but this REIT leases space to tenants who can’t (won’t) operate fully online; restaurants, pharmacies, beauty retailers, fitness centers, clothing stores, etc. Favorable demand is also supported by the currently expensive financing of store ownership by tenants to some extent; at the same time, this fact supports the argument for a delay in supply to catch up, as higher interest rates must discourage significant competition.

Relatively tight supply is reflected in the REIT’s rising occupancy rate:

But it can also be deduced from the record low growth rate of new construction:

So, overall, the outlook for Whitestone’s business is positive. But we’ll have to examine how well the same factors supporting the REIT have shaped the REIT’s past performance.

Performance

Over the past 10 years or so, Whitestone has managed to deliver very attractive total returns, outperforming most of its peers:

Its more recent results, along with guidance, also point to strong returns that will persist, despite what some numbers may lead one to think at first glance. First, the average annual base rental income in 2023 was 5.86% higher on an annual basis and the occupancy rate remained at 94%. Although same-store NOI increased 2.68%, underlying FFO/Share decreased 11.65% to $0.91, but that was primarily due to unusually higher G&A expenses related to the departure of the former CEO and higher interest expense.

The rent per square meter in the last quarter marked an increase of 5.36% compared to the same quarter last year. Although occupancy is down 50 bps to 93.5% from the reported rate at the end of 2023, it is 20 bps higher on an annualized basis. Finally, same-store NOI growth accelerated as it rose 6.59% YoY, and basic FFO per share increased 20%, reflecting the significant impact of legal expenses related to the former CEO’s departure in 2023.

Regardless, management’s low-end 2024 core FFO guidance range ($0.98 per share) implies growth of 7.69% over last year, and this is both supported by NOI growth projections of 3 to 4.5%, as well as the favorable market dynamics discussed above. .

Leverage and liquidity

Whitestone’s long-term debt of $667 million funds 49% of its total assets and 87% of that is fixed rate, carrying an interest rate of 5.1%. Its debt/EBITDAre of 8x and interest coverage of 2.29x reflect adequate liquidity, although to be fair there are certainly plenty of retail REITs that represent a greater degree of safety when it comes to this.

However, fixed-rate notes maturing in 2024 do not represent a very large portion of the debt, there are no maturities in the next year, and the larger debt maturities have not been due for some time, limiting short-term refinancing risk. term:

Dividends and valuation

WSR currently pays a monthly dividend of $0.04 per share, yielding a forward yield of 3.66%. Although the yield is low, the coverage is very strong, as indicated by the low payout ratio of 48.98%. Additionally, management has raised the dividend since cutting it in 2020 at a conservative pace:

While its dividend profile may be attractive to income investors with a long-term focus, WSR is an even better option for value investors, as reflected in its core FFO yield of 7.49%. The FFO multiple is also lower than its peer average (12.90x vs. 14.84x).

Finally, the default cap rate is quite high at 7.45%, compared to the projected 6.9% rate for retail asset transactions in 2024.

Using this average as a more appropriate cap rate to value WSR, the NAV is $15.13 per share, so the current price represents a decent discount of 13.53%.

risks

One of the most significant risks here is the potential opportunity cost. The market may be slow to adjust the price upward as future results become available, and the dividend yield is too low to significantly offset such an opportunity cost. Other larger retail REITs with less potential may enjoy greater price growth because there is more efficiency in pricing their shares.

Another risk is related to interest rate changes. The WSR has almost fully recovered since interest rates started to rise in 2020, and yet the Fed has not started the policy rate cuts that the market expects.

So it is evident that the market has become more and more confident in short-term discounts; if such an expectation is not met, WSR is likely to experience short-term pressure on its price.

Two other risks are presented by the REIT’s small-cap status and market concentration. The growth opportunities may be great for this company, but the business risks are just as great, likely resulting in higher volatility for WSR than stocks issued by larger, more established and diversified retail REITs.

Verdict

All in all, I think WSR has great potential in both the short and long term. The outlook supported by a positive market outlook, good growth momentum and a very good price make this a strong buy.

what do you think Do you own this stock or prefer another REIT? I would love to know! Also, please leave a comment if you found this post helpful; it means a lot. Thank you for reading.