EUR 850.00 For Business Accounts Only

Morningstar | SBA Delivers on All Fronts in Another Impressive Quarter, but It's Tough to Justify the Valuation

We liked everything we saw in narrow-moat SBA's first-quarter report. U.S. revenue growth continued to accelerate from already high levels, margins were excellent, and management impressed us with prudence in its capital allocation. The ongoing strength in spending from U.S. carriers helped to drive the growth, and management raised its full-year revenue and EBITDA margin outlook. While we plan to raise our $144 fair value estimate by $5-$10 to account for the time value of money and a stronger 2019 than we had forecast, that will still leave the stock looking materially overvalued.

In our view, the firm currently has an ideal operating environment, with a need for carrier network upgrades and a good U.S. economy driving SBA's customers to spend heavily. We expect industry spending will remain high as carriers enhance their networks over a multiyear stretch, but we have a difficult time believing the spending growth will accelerate further and stabilize at higher levels, and we think that assumption is necessary to justify the recent stock runs of SBA and its peers in the U.S. tower industry.

Gross revenue growth on existing U.S. towers (which account for three quarters of the firm's total revenue) was 7.5% in the quarter, the highest level in nearly three years and the fourth straight quarter of acceleration. The firm continued to benefit from all four U.S. carriers spending heavily to enhance their networks. Given the explosion in mobile data demand from U.S. consumers that we expect to persist and a long runway of 5G spending, we anticipate the environment will remain strong. However, we are already projecting organic U.S. growth in excess of 7% each year throughout our five-year forecast, which would be an unprecedented run of strength. We think evolving technology will help to support this growth, but we are not willing to assume carriers can continually accelerate their spending levels.

Margins expanded for SBA in the quarter as well, consistent with the tower business operating model, which displays substantial leverage, as incremental tower revenue brings little cost. Tower operating margin (which excludes depreciation, amortization, and SG&A expenses) reached 79.5%, the highest level we can ever recall seeing, and we believe there is room for further expansion. Because contractual escalators, which we estimate to be about 3% annually, and carrier amendments, which comprised 68% of new leasing activity in the quarter, bring with them virtually no associated marginal costs, revenue should continue to outpace SBA's cost inflation by a wide margin. We project tower operating margin to expand 350-400 basis points over the next five years while adjusted EBITDA margin rises 200-300 basis points.

International growth remains strong as well, although it continues to be overshadowed by the U.S., and it faced currency headwinds in the quarter. Gross revenue growth on existing international towers exceeded 10%, but a 10% currency headwind resulted in cash revenue growth of only 2% (with churn and new tower revenue being the other contributing factors). We expect gross revenue growth to stay above 10% annually throughout our forecast, as most of SBA's international markets are well behind the U.S. in their network buildouts. We expect them to follow the trajectory the U.S. has already taken in building out more robust 4G networks.

We were also encouraged to see management refrain from any share repurchases during the quarter and express their view that, despite their articulated strategy of staying highly leveraged to enable significant share repurchases, they are opportunistic, rather than mechanical, buyers of stock. As was the case with its peers, SBA's stock went virtually straight up throughout the first quarter, with its shares gaining 25%. The firm is not deviating from its buyback strategy, but we applaud the discretion. We have penalized the firm for its leverage and share repurchase strategy via a higher assumed cost of capital, as we think the firm's target net debt to EBITDA ratio of 7.0-7.5 makes its stock risky. If and when the firm brings its leverage ratio down, we would consider reassessing our cost of capital assumption.