Summary –
- Occupancy in the company’s Hawaii properties has not fallen below 98% since 2003. Hawaii’s land development is limited by its geography.
- E-commerce will act as a tailwind for the company’s properties. The company has been pretty aggressive having acquired over $1 billion worth of properties since 2019.
- The company currently has a forward yield of 5.9% which is great in this low-interest-rate environment.
I wanted to explore income-generating REITs to add more cash flow into my portfolio. I wanted REITs that could do well in the new post-COVID environment so I have purposefully stayed away from retail and offices in certain geographies. I think Industrial Logistics Properties Trust (ILPT) with its decent yield and solid business is one to consider.
Just a brief background on the company, Industrial Logistics Properties Trust is a REIT that, as it’s named, focuses on industrial and logistics properties. The company owns 301 properties (43.8 million square feet) in Hawaii and 75 properties (27 million square feet) in 30 other states. Given the current economic uncertainty, I typically check the distribution of lease expirations of a REIT’s customer base. The good news is that the bulk of the company’s shorter-term lease, roughly 17% of revenue, is expiring all the way to 2024. Only 5.1%, 8.2%, and 6.4% of the company’s leases in terms of annualized rental revenue are expiring in 2021, 2022, and 2023 respectively. As of September 2020, the company’s properties were 98.8% leased with an average remaining lease term of 9 years. This is good news for the company as it would not have to negotiate and set lease in the middle of the coronavirus induced recession. The company currently has a vacancy rate of 1.2% which is impressive given the impact the coronavirus pandemic had on retail establishments.
The company’s properties are typically service/distribution centers and warehouses. Examining the company’s client exposure risk, we can see that its properties are rented out to 264 clients. Amazon (AMZN), FedEx (FDX), and P&G (PG) being the largest at 15.9%, 3.7%, and 3.7% of annualized 2020 revenues. Investment-grade tenants make up 64.4% of annualized rental revenues from the company’s mainland properties ensuring the credit safety of the company’s revenue stream. The company’s customer list is pretty impressive as it has the logistics departments of several well-known corporations. The company is also well-diversified as its top 25 clients only make up 53.6% of the company’s annualized 2020 revenue. This means that the loss of a single client would have minimal impact on the firm.
As of September 2020, the company’s non-Hawaii based properties made up 59.3% of annualized rental revenue. The remaining amount 40.7% of revenue is from the company’s Hawaii properties. Surprisingly, the company’s Hawaii footprint is actually an asset for the company. My initial worry was that rents could be unstable as the Hawaiian economy is very dependent on tourism which tends to be cyclical. The reverse is true actually as occupancy in these properties has not fallen below 98% since 2003. The reason I believe is that Hawaii’s land development is limited by its geography. Regardless of the current economic situation, industrial and logistic properties are still needed to move goods to the people who live there. It just so happens that there is limited ability to relocate to an alternative location.
The Hawaii properties are interesting as the company doesn’t really own the land but rather the company leases it from the state. In fact, 90.6% of Hawaiian properties based on annualized revenues are from lease lands. These leases are reset every 10 years or so and the increases are based on fair market values. The company generally is able to pass on those increases to its customers but given the economic situation, this assumption could be at risk.
With regard to short-term results, Industrial Logistics Properties Trust had a decent quarter. Revenue (i.e. Rental Income) for Q3 2020 vs. Q3 2019 increased by 4.3% on a comparable property level. Year to date results were similar to comparable property. Rental income grew by 4.4% compared to the same time last year. Overall, YTD revenues were up by 16.4% to $194.5 million due to some property acquisitions the company had done for the year. Comparable property operating income only rose by 2.6% YTD due to an increase in Real Estate taxes. Net income for the nine months ended September 2020 was $41.8 million, or $0.64 per share, which is more or less the same compared to $40.8 million or $0.63 per share earned for the same time last year. Normalized FFO was $1.40 per share.
These results demonstrate the resiliency of the company’s business model. This is not particularly surprising as even during the height of the coronavirus lockdowns industrial activity and logistics never stopped. In fact, the company believes that e-commerce, which has been boosted by the coronavirus lockdowns, will increase demand for industrial and logistics space up to 3x when compared to retail sales from brick and mortar stores. This will stimulate demand for the company’s properties and create a favorable investment environment. The company has been pretty aggressive investing in this space as well having acquired over $1 billion worth of properties since 2019.
Financial Analysis and Conclusion
In terms of valuation, for REITs, I check the leverage and coverage measures as those are important indicators of a company’s financial flexibility and long-term viability. The total liabilities/total assets percentage is an indicator of debt serviceability and leverage. Industrial Logistics Properties Trust has total liabilities/total assets of 56.8% and a Net Debt level to annualized EBITDA of 7.3x. These measures indicate an above-average level of debt.
The fixed charge coverage ratio is an indicator of a firm’s ability to pay interest from its operating performance and is defined as net operating income divided by interest expense, preferred dividends, and other required distributions. The company had YTD interest expense of $40.6 million and no other required distributions. Using the company’s YTD adjusted EBITDA of $137.2 million, we can calculate an interest coverage ratio of 3.38x. This ratio is about average for a REIT.
REITs are required to distribute most of their taxable net income to shareholders through dividend payments. The dividend payout ratio (“Dividends/FFO”) is calculated in order to check if the REIT can meet this obligation moving forward. Based on the company’s financials, for the nine-month YTD, the company had an FFO per share of $1.40 and paid a quarterly dividend of $0.33, implying a payout of the ratio of 70% which is on the high side.
In conclusion, I like the overall business of the company and I believe its revenue streams are relatively safe. The company’s Hawaii portfolio acts as a solid base as it pursues aggressive expansion. While its financial ratios are not the best, I believe these are a consequence of the company’s growth strategy. The company currently has a forward yield of 5.9% which is great in this low-interest-rate environment. Income-focused investors should consider Industrial Logistics Properties Trust.
