11/06/22 04:00 PM EST

SUNDAY NIGHT REIT READ | POSITION MONITOR UPDATE + SBAC REVIEW | 11.6.22 (ADC, O, NTST, SBAC)

Rob Simone, CFA

@HedgeyeREITs

Takeaway: Adding ADC, O & NTST to Active Long list

Hedgeye Cartoon of the Day: Hike!

It is 11.6.22, and Active Short MPW is overvalued by... whatever the current share price is.

WEEKLY VALUATION HANDBOOK PDF LINK

Tickers: ADC, O, NTST

Company Names: New Active Longs Agree Realty Corporation, Realty Income & NETSTREIT, Inc.

Subsector: Triple-Net

Headline: ADC, O & NTST joining NNN among triple-nets on the Active Long list

Adding triple-net REITs ADC, O & NTST to the Active Long list. Barring something dramatic with 4Q22 results, which we do not expect, we imagine keeping these long duration names + NNN on the long side for the duration of Quad 4 (see Figure 1 below).
While we have been clear that it is VERY hard to find long ideas right now, we are regardless trying for those clients who need relative longs / pairs against core shorts. We are asking the following questions of ourselves constantly:

Who can grow in this macro environment? Similarly, who has access to capital?
Who are the best capital allocators?
Who is the most conservatively levered?
Which REITs fit best in the Quad 4 style factor mix - duration, size, low beta, etc?

Select triple-nets check these boxes, in our view. Specifically and somewhat conversely, in triple-net the names that appear the most "expensive" i.e. have access to cheaper capital relative to the yields being offered in the market / allocate that capital prudently / have relatively little credit issues, are best positioned to grow earnings and cash flow at an above-average rate. We expect at the very least relative outperformance from these names as we move through a deepening Quad 4, which may be the best we can do.
At the same time, we are hearing about problems in the private triple-net markets, specifically around funding issues and busted / blown-up deals. This offers the public REITs an opportunity to pick-off transactions and/or take advantage of any distress.
ADC in our view has the best platform, management team and multiple advantage. O and NNN are the most seasoned, also with attractive costs of capital, and NNN being the more disciplined of the two. NTST is a really interesting smaller cap name - recent multiple pick-up and its small size offer an opportunity to grow faster than the rest of the space, and we think there is a chance of an eventual take-out by one the larger players looking to scale-up. Just remember - "expensive" equals ability to grow and outperform for a public triple-net REIT when we are in a capital-constrained environment.
This is the opposite side of the argument that we made in the late-Summer on Active Short MPW, which is a "Frankenstein" triple-net REIT that has completely lost its cost of capital in the market as well as its credibility. Whenever that happens, triple-nets completely lose their ability to grow or, in MPW's case, paper over holes and prior disasters in the portfolio.

Figure 1: Select Triple-Net REIT Quad 4 Performance

Source: Hedgeye Macro Team, Bloomberg

Ticker: SBAC

Company Name: Active Short SBA Communications

Subsector: Towers

Headline: Notes from 3Q22, working on updating numbers which we will do next week

Notes:

As we said on the call, we thought SBAC had a relatively good quarter. As it stands right now, the only thing we very much disagree with is the capital allocation decision to lever up and increase Brazilian exposure via GTS, which already happened earlier in 4Q22. In our view it would be preferable from a capital allocation perspective for the company to use its significant cash flow generation to de-lever first, followed by increasing the dividend payout. Generally we do not like REITs buying back stock given the challenges with retaining capital under the REIT structure and the inherent increase in financial leverage, and think its preferable to give excess capital (of which SBAC has a lot, to be clear) back to shareholders and let them allocate accordingly. If you want to classify yourself as a REIT, play the game like a REIT.
We do not think SBAC should increase leverage further for the purpose of increasing international exposure in an attempt to "buy up" the multiple, and we do not think REIT management teams should play stock manager. The international tower business to us is very much inferior to the domestic model, not being supported by a government enforced oligopoly at the top of the credit stack, and investors should not extrapolate the U.S. experience to non-domestic markets. Credit risk and the level of competition are much different, and each incremental dollar invested in Brazil, Tanzania, etc. should be valued at a lower multiple than the domestic portfolio.
To be clear, the short is much less attractive here versus when we first added, and so while we think there is additional downside amidst a much higher cost of capital, we have been moving it down in priority on the Active Short list. SBAC has lost about ~3x turns of EBITDA multiple since we added to the short side.
SBAC saw less churn than expected domestically, with merger-related decommissioning churn expected to shift into FY23. As we have written about previously, we think that SBAC is a few quarters behind AMT which took its T-Mobile/Sprint churn medicine earlier.
While the absolute level of leasing activity and growth is relatively attractive versus other REIT sectors to be clear, we still think there is not enough focus on the RoC here. The timing of domestic churn moving into FY23 only adds to that, compounded by where we are in the MNO capex cycle (the peak, by their own admission). We think SBAC at its core is a +3% to +4% sustainable compounder on an unlevered basis over a TAIL duration in the U.S., which still comprises the overwhelming majority of the business.
On Oi in Brazil, SBAC left its anticipated total churn unchanged at ~$20 to $30 million on the legacy portfolio, with an additional +$3 million coming from the addition of GTS. GTS has less Oi exposure than legacy SBAC.
Management noted that leasing results "will be strong into next year," but the question is will they accelerate or decelerate? We think the latter. That would not be management's fault, of course, rather the result of upstream spending deceleration + lapping comparisons + increased churn.
We are updating numbers and do not expect any drastic changes.