Description

National Storage REIT (NSR AU)

PT: AUD 2.50ps (+20%)

NSR’s brand & leadership position in AUS/NZ, combined with the low penetration of storage in the region, position it to capture abnormal returns from development and consolidation over the coming decade. The private market recognized this opportunity in early 2020, leading to a bidding war between Gaw Capital, Warburg Pincus & PSA, with PSA’s $2.40 bid offering nearly 20% upside to the current price (and 25%+ upside to the unaffected price). The deal fell apart due to COVID, but the business is performing strongly (record occupancy & rate), and is likely worth more today, despite a 5% value-dilutive equity raise along the way. We expect this business to continue to compound at an above-average rate and ultimately be taken private in the next year or so for a tidy premium.

This thesis has three key points: (1) NSR is an attractive business with above-average real estate economics; (2) there has been (and still is) robust interest in acquiring NSR at prices above the current; and (3) NSR is worth MORE today than it was then. This is a very similar thesis to our last pitch on VIC (RESI: +90%), albeit with less upside and correspondingly less risk, in our view.

Merits:

• Market Leader – NSR is the largest owner-operator of self-storage in Australia (~20% share): the operating platform has benefits of scale, brand recognition, and consolidation opportunity.  The next two largest players are Abacus REIT (Storage King) and Kennards; combined, the top three own roughly one-third of the Australian self-storage market.

• Storage has better unit economics than most forms of commercial real estate: high margins, low CapEx, operating platform value, a long tail of sticky/price-insensitive tenants; there are also some zoning & NIMBY barriers (though these barriers are less significant for new, modern facilities).

• Strong fundamentals – after an initial shock, COVID has been a boon for self-storage in Australia (just as it has been in the US and in Europe).  NSR entered 2021 near record occupancy and starting to push price after a few relatively weak years.

• Lease up opportunity – NSR should be able to get occupancy up another 500bps, which would translate to a 10% increase in AFFO

• They have a development pipeline that should increase NLA by 10%+ at 10%+ development yields; between development and consolidation, NSR should be able to double its footprint over the next five years.

• Management – CEO Andrew Catsoulis is the founder of NSR and its predecessor entities; he was effectively one of the founders of the industry in Australia when he built his first storage facility on family land over 25 years ago. Returns, strategy, and capital allocation have all been strong, but his ownership is modest (1.5%) for a founder.

• Low penetration – storage is a small niche in Australia (compared to the US). Penetration is low @ 2 sqft per capita vs. 10 sqft per capita in the US, though higher than in Europe, which is still less than 1 sqft per capita.  Market cap rates for storage in Australia are 100bps+ wider than in the US & Europe.

• Inflation benefits – average tenant turnover is less than 12 months, meaning storage reprices quickly and can respond faster to inflation that other CRE. Relatedly, it may be desirable to not hedge the AUD, as the currency may benefit from commodity inflation.

• Portfolio quality is good, but not spectacular.  Locations are a mix of 70% primary, 30% regional. Average in-place rents of $18psf are ~10% below ABP AU (Storage King), while a bit above US peers and far below European peers.  Leasehold percentage used to be large but is now below 5%.

• Valuation:

• AFFO yield of 4.5%; dividend yield of nearly 4%

• Market implies ~USD 200psf, which is less than all major global peers, save LSI

• Gross implied rental yield of 8.8% is the highest of all major global peers

• Left behind – as the recent fundamental tailwinds of self-storage have become clear, global peers have rallied hard: 50%+ LTM and +25% YTD, while NSR has returned less than 20% and 10%, respectively, over those periods.  This is especially important, given that PSA & EXR – the most-likely buyers of NSR – now have materially lower costs of capital.

• Strong interest from strategic & financial buyers – the company confirmed bids from Gaw, Warberg, and Public Storage in early 2020 at prices above current.  BX was also rumored but not confirmed.  Peer ABP.AU has a 9.9% stake, purchased over 2020/21 at a VWAP of 163, with highest purchases in March 2021 @ 190.

Issues & Why it Appears Cheap:

• Strong AUD – the Australian dollar is up ~10% versus USD since the start of 2020, making the price a bit higher for USD-denominated buyers (though tenants pay in AUD, so this shouldn’t affect valuation)

• Dilutive raise – the equity raise in May 2020 destroyed some value; management had let the balance sheet stretch a bit early in the year (as they were in buyout discussions), then were caught by COVID, leaving them to feel compelled to de-lever.

• Leverage – the company reports gearing of slightly over 30% on an LTV basis, but this is still a high multiple of cash flow (~8x EBITDA), given the modest scale, occupancy, and pipeline

• Their last few reporting periods have shown declines in AFFOps. This is largely an artifact of the timing of COVID & two equity raises (i.e., not reflecting any deterioration in the business), but may be weighing on the stock.

• Up until June 2020, reported rate & occupancy trends had been flat-to-down for several years. These numbers partially reflected some cyclical headwinds in certain markets, but they were also an artifact of how the company reports certain KPIs: rather than use like-for-like year-over-year pools as US SS REITs do, they mixed whole-portfolio KPIs (which are being constantly diluted by the addition of new, immature facilities) with inconsistently-reported cohorts. 

• Liquidity is modest @ ~$5mn/day

Catalyst

Earnings in a few months

Sale of company