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Morningstar | NSR Updated Forecasts and Estimates from 27 Feb 2019

No-moat National Storage REIT’s fair value estimate is unchanged at AUD 1.72 per security after broadly in line first-half fiscal 2019 results. The key takeaway from the results was a higher-than-expected AUD 135 million worth of acquisitions offset by lower like-for-like revenue per square metre, or REVPAM. This leads to a modest adjustment lower to our forecast fiscal 2019 underlying net profit after tax, or NPAT, to AUD 62.6 million from AUD 63.8 million, within management’s reaffirmed guidance of between AUD 62.5 and 64.5 million. However, this is compensated for by higher expected earnings in the outer years from the forecast revenue generated by the acquisitions. At our fair value, the REIT has a fiscal 2019 underlying P/E of 17.6 times and a dividend yield of 5.6%. While we maintain our positive longer-term view on the business, it appears slightly overvalued at current prices.

We have increased our forecast acquisitions in fiscal 2019 to AUD 165 million from AUD 110 million following the AUD 135 million of acquisition in the first half. The 11 new acquisitions in the half indicate there is plenty of scope for management to execute its core strategy of building scale and consolidating the highly fragmented self-storage industry. Most of the new acquisitions were primarily located in the central coast, Hunter Valley and Newcastle regions of New South Wales, with properties also bought in Victoria, Western Australia, Queensland, and South Australia. We expect these acquisitions to support future earnings growth, although we only expect a relatively flat 1.1% underlying earnings per security growth in fiscal 2019 due to the AUD 175 million equity raising completed in September 2018.

We expect acquisitions as well as development opportunities at NSR’s now extensive portfolio of 146 storage centres across Australia and New Zealand to be the key driver of earnings growth. However, we forecast more moderate 1.8% compound annual growth rate or CAGR of price per square metre at its storage centres over the next five years, which compares to our estimate of 2.1% CAGR over the previous four. One disappointing feature of the half-yearly announcement is the 2.2% fall in REVPAM on a like-for-like basis to AUD 215 in the first half of fiscal 2019 compared with AUD 220 in fiscal 2018, although it was only more moderately lower than the first half of fiscal 2018 (AUD 216). The first half 2019 REVPAM fall was driven by what management believes is short term fluctuations in occupancy as well as modest discounts to entice customers to their self-storage centres. Lower occupancy was primarily in discrete areas in Sydney and Melbourne which have suffered from lower house prices, partly offset by stronger occupancy growth in Western Australia, Tasmania and the ACT.

Continuing falls in house prices and slowing economic activity which in turn impacts occupancy and may require more discounting is a key risk for the business. While we believe self-storage is less discretionary than typical non-staple type retail items, we don’t believe it will be immune from house price declines and slowing economic activity. The recent moderate fall in REVPAM may be evidence of this. We project slowing results for NSR in the near-term on the back of likely continuing house price declines. Consequently, a near-term risk to our forecasts is a steeper fall in house prices and economic activity than expected. Nonetheless, we believe the REIT’s long-term fundamental drivers remain intact. This includes its extensive portfolio of self-storage properties, the largest in Australia and New Zealand, and pipeline of acquisition opportunities that should benefit from Australia’s strong population growth currently averaging 1.6% per year and the Australian economy’s proven ability to generate strong sustainable growth.

The REIT also maintained a sound balance sheet with gearing (net debt/total asset – cash - finance lease) reducing to 34% as at Dec. 31, 2018 from 38% as at June 30, 2018 and within target gearing range of 25%-40%. The reduction in gearing is primarily due to the AUD 175 million equity raising offset by the higher than expected AUD 135 million of acquisitions in the first half of fiscal 2019. Management had indicated at the time of the AUD 175 million equity raising in September 2018 that they did not expect to come back to the market for at least the next 12-18 months. Nevertheless, acquisitions at the at the level of AUD 135 million per half is unlikely to be sustainable without a further equity raising within the next two years, particularly in the context of falling house prices and a slowing in economic activity. However, our modelling is forecasting a lower level of acquisitions over the next few years at about AUD 110 million per year.