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Morningstar | Corporate Action: National Storage’s FVE Increases on Acquisitions; Recommend Participating in SPP. See Updated Analyst Note from 08 Jul 2019

No-moat National Storage REIT’s fair value estimate increases to AUD 1.77 per security from AUD 1.72 after its acquisitions and capital raising. An unprecedented AUD 371 million of self-storage centres and development properties were acquired in Australia and New Zealand in fiscal 2019. The REIT also expects to complete a further circa AUD 100 million of acquisitions in Australia by the end of the first quarter of fiscal 2020. To help fund the historically high level of purchases and reduce financial leverage, about 99.4 million new National Storage securities have been placed with institutional and professional investors at a fully underwritten price of AUD 1.71 per security, raising AUD 170 million. Retail shareholders now can acquire up to AUD 15,000 worth of new securities at the same price via a non-renounceable Share Purchase Plan, or SPP. The SPP should raise a further AUD 20 million.

At our fair value estimate, the REIT has a fiscal 2019 distribution yield of 5.4% and fiscal 2020 yield of 5.6%. However, new SPP securities will not be eligible for the final fiscal 2019 distribution of AUD 5.1 cents per security. At the current trading price of about AUD 1.76 per security, the REIT screens as fairly valued. Notwithstanding, we recommend participation in in the SPP given our positive long-term view on Australia’s self-storage industry and due to the SPP being priced moderately below our fair value estimate and the REIT’s current trading price.

Management expects further tightening of capitalisation rates will result in average capitalisation rates of about 6.9% for the portfolio in fiscal 2019, compared with 7.3% in fiscal 2018. This is likely to provide a circa AUD 100 million valuation uplift. The combination of lower for longer interest rates, growing institutional investor awareness of Australian self-storage as an asset class, and rental increases via the REIT’s dynamic occupancy and price management should continue to support its property values.

Although the number and value of acquisitions are much higher than previously guided to, the acquisitions are nevertheless consistent with the REIT’s strategy of consolidating a fragmented Australian self-storage industry. The REIT has an excellent history of acquiring centres with low occupancy and dynamically managing them to increase revenue per available square metre, or RevPAM. We understand from management that non-development or expansion properties were bought with an average occupancy of about 75% and on average passing yields of about 6.5%. National Storage aims to increase the average yield to above 8% in about two years by first increasing occupancy and then storage rents.

While we’re positive on the longer-term outlook for self-storage assets in Australia, the near-term fall in housing turnover due to recent house price falls is likely to place pressure on RevPAM. Furthermore, the initial average passing yield of about 6.5% on the recently acquired properties is significantly lower than the passing yield the REIT was able to acquire self-storage assets in the recent past. We estimate the passing yields it was able to acquire self-storage assets in the three-year period between fiscal 2014 to 2017 averaged about 8.5% and above 9% in fiscal 2014. We expect the lower passing yields reflect the increasing demand for Australian self-storage assets and historically low interest rates. Nevertheless, we still believe an average passing yield of 6.5% is attractive given the interest rate outlook and the prospect of increasing yields given the average 75% occupancy rate and management’s proven success in applying its dynamic pricing strategy.

Following the circa AUD 190 million equity raising, acquisitions, and fair value increases in the REIT’s existing property portfolio, gearing (net debt/total assets less cash and finance leases) is expected to fall to about 32% from about 40% on a pro forma basis. During the second half of fiscal 2019, National Storage also added ANZ Bank to its banking syndicate. It now includes all four of Australia’s major banks as well as Australia’s largest industry superfund, AustralianSuper. The REIT also added banking facilities totaling AUD 147 million during second half of fiscal 2019 and extended its existing facilities. Management continues to work through a previously announced potential capital partnership initiative to house the REIT’s portfolio of New Zealand properties in a fund. This could release an additional circa AUD 150 million to AUD 200 million of capital to further reduce gearing and/or support its acquisition strategy.