Public Storage: A 'PSA' To Buy The Drop On This Self-Storage Giant

It's easy to paint REITs with a broad brush, as many have with concerns around commercial real estate. However, not all REITs are created equal, with respect to sectors in which they operate and their varying degrees of leverage.

This brings me to Public Storage (NYSE:PSA), which fell materially to end the trading week of April 14th, despite having strong balance sheet and operating attributes. In this article, I give a "PSA" (public service announcement) and highlight what makes PSA a good buy on the drop, so let's get started.

Why PSA?

Public Storage is an S&P 500 (SPY) company that's headquartered in Glendale, California, and is the largest self-storage REIT in the U.S. At present, it has ownership interest in 2,869 self-storage properties across 40 states covering 204 million rentable square feet. Moreover, PSA has a 35% equity stake in Shurgard Self Storage which owns 266 self-storage facilities across Europe.

For those unfamiliar with the self-storage space, it remains a highly fragmented segment with plenty of properties owned by small private market owners. Despite PSA's size, along with self-storage peers, it controls just 35% of the self storage market. As shown in peer CubeSmart's (CUBE) recent investor presentation, 45% of the self-storage market is comprised of non-REIT owned institutional quality properties, making them ripe for consolidation by the big players in the space, of which Public Storage controls 10%.

PSA has made the most of its size and scale over the past decade. Through both internal and external growth, it has more than doubled its total revenue over the past 10 years, as shown below.

As with most REITs, size and scale matters, as it enables the enterprise to spread corporate fixed costs over a wider asset base. This apparently holds true for PSA too, as it generated a 73% operating margin (with depreciation addback) over the trailing 12 months. This compares favorably to smaller peer Life Storage (LSI), which had a 63% operating margin over the same timeframe. It appears that scale is an important factor, as LSI recently agreed to be acquired by another self-storage REIT, Extra Space Storage (EXR) in an all stock deal.

Meanwhile, PSA has continued to demonstrate strength amidst economic uncertainty, with record financial results last year. This includes very impressive Core FFO per share growth of 22%, excluding the contribution to PSA's equity investment in P.S. Business Parks, which was sold to private equity giant Blackstone (BX) last year.

PSA's strong results were driven by a combination of both internal and external growth as well as positive operating leverage, with same store NOI margin improving by 180 basis points to 81.2%. Looking ahead, PSA should continue to see strong demand trends, as it has through various economic cycles in the past, combined with less new competition due to higher interest rates as noted by management during the recent conference call:

This is a needs-based business with demand drivers that are multidimensional and fluid throughout economic cycles. We also continue to benefit from a newer driver in the form of people spending more time at home, which has increasing permanence with remote and hybrid work here to stay.

Our customer lengths of stay are at record levels, a positive trend, given rent increases to existing customers are a key driver to our revenue growth. The outlook for new competitive supply is also in our favor. We are seeing less new property development nationally due to higher interest rates, cost pressures, difficult municipal processes and concern over the macro landscape.

Importantly for conservative investors, PSA is a rare REIT to have an A credit rating from S&P. This is due in large part to its low net debt to TTM EBITDA of just 1.98x, sitting far below the 6.0x level that ratings agencies generally consider to be safe for REITs. That's because PSA also relies on its preferred share issues for external funding.

Considering that its preferred issuances like (PSA.PF) and (PSA.PG) have initial yields (at time of offering) at around 5%, it's unlikely that PSA will be redeeming them anytime soon. Another advantage of using preferred shares is their perpetual nature, meaning that they don't have to be refinanced at higher rates. This can be a big advantage in a higher interest rate environment.

Moreover, the recent drop in PSA's share price has pushed the dividend yield to 4.1%. PSA raised the dividend by 50% last year, and the new dividend rate remains well covered by a 75% payout ratio (based on $15.92 Core FFO per share last year).

Admittedly, PSA isn't cheap at the current price of $290 with forward P/FFO of 17.4. However, I believe PSA is well worth the current price considering its very strong balance sheet and strong underlying performance. Sell side analysts who follow the company have a consensus Buy rating on the stock with an average price target of $338, which could translate to a potential 21% total return over the next 12 months.

Investor Takeaway

In summary, Public Storage contains many durable attributes, not least of which includes its scale and fortress balance sheet. It's also seeing strong growth and should see limited competition in the current environment, as private market buyers are priced out due to higher interest rates. Lastly, the recent share price weakness has pushed the dividend yield up to an appealing level, making the stock potentially attractive for long-term income and growth investors.

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