Some days before UDR (UDR) released its Q2 earnings on July 29, 2020, I made a case for a strong buy referring to the following three elements as potential value drivers going forward:
- Resilient rents – strong growth in the AFFO during Q1, 2020 coupled with almost unchanged occupancy rate despite a significant shock from the sudden outbreak of COVID-19 in mid-March.
- Rock solid balance sheet – healthy debt-to-EBITDA ratio of 5.1x, which is by 37% lower than the sector average.
- Safely covered dividend – 190 consecutive quarters of growing dividends, and TTM FFO payout below 75%.
The chart above depicts the YTD performance of UDR and the S&P 500. It is very clear that during the virus period UDR has massively underperformed the broader market, which has taken a complete opposite route and currently is trading above the year-end level.
Now, if we look at how the market has reacted to the recently published earning by UDR, we will notice a certain disconnect between the underlying performance and the stock price. Namely, the Q2 earnings as well as the overall financial position of UDR continue to be robust, but the market seems to neglect this and is not willing to send the stock higher. In essence, the same pattern can be applied for the entire period since the rock bottom in late March – i.e. the fundamentals have not changed and actually have improved a bit, while the stock price is significantly down and struggles to achieve some reversionary effect.
All this makes me question how justified the current valuation of UDR is, and whether it is only a matter of short time when the market acknowledges the resiliency of UDR. Moreover, it seems that BofA analysts have recognized this disconnect as well and thus are indicating a potential upside for UDR of 31% (based on the August 14 values).
I firmly believe that the three aforementioned elements should help UDR’s stock price catch up with the overall market relatively quickly. The robust rent collections should support continues growth in the AFFO (bringing the valuations down provided that there is no rally in the stock price, and certainly higher dividend), and the fortress balance sheet should act as a strong defense mechanism in the case of additional lockdowns and economic decline.
Let’s take a look at how the recent developments in the Q2 affect the rent structure, the balance sheet and the dividend.
Stable rents despite the slowdown in the economy
Not surprisingly, Q2 period did not bring any meaningful growth for UDR. The y-o-y AFFO declined by 2.1% mostly due to decrease in the same store NOI. If we look deep at the same store NOI figure, we will notice that actually a huge part of the overall decline is explained by the decreased occupancy rate, which is already starting to recover. An excerpt from the earnings call, Michael Lacy, SVP:
…our physical occupancy declined 50 basis points year-over-year in the second quarter. However, the reletting of approximately 150 corporate units during the quarter in primarily higher coastal market drove second quarter economic occupancy down by an additional 50 basis points. In total, lower economic occupancy accounted for 100 basis points of our year-over-year decline in combined same-store revenue. Importantly, our remaining corporate are well cap, thereby reducing forward economic risks associated with the homes.
Nevertheless, UDR has managed to increase the YTD AFFO result by ca. 2%. In my opinion, this is truly remarkable considering the immense economic consequences caused by the virus. Even in, perhaps, the worst quarter that we have faced, UDR was able to deliver stable results not putting the dividend at risk.
Going forward the Managements seems to be rather confident about the business operations, but refuses to provide a detailed guidance due to the various economic uncertainties. Thomas Toomey, Chairman and CEO explained it this way:
It would be easy to rush back into reinstating guidance. But for any guidance range to be useful, we need evidence that core stability in the regulatory environment we face case loads and the impact they have on the cadence of reopening as well as more insights into the economic impact of currently unemployment.
Lastly, there are some very clear tailwinds, which should boost UDR’s results. First, UDR has issued $400 million loan at 2.11% that will primarily be used to settle the previous loans, which are on average cost 3.75 – 4.64%. Second, UDR has already invested over $40 million in 534-home community yielding 13%. Third, traffic, qualified leads and applications are exhibiting substantial improvements month over month providing a huge support for the top-line.
Healthy balance sheet
In Q2, 2020, UDR slightly increased its borrowings mostly in connection with the previously mentioned loan proceeds, which partially was retained at the company to fund future investments. The most important thing is that UDR was not forced to leverage up to close cash flow gaps, but instead could act opportunistically by investing in abnormally attractive projects (as mentioned above).
If we compare the financial profile of UDR to the peers, the picture is still appealing. The net debt to EBITDA for UDR is currently at 6.2x, which is 24% lower than the peer average. Moreover, the debt to total assets is much better for UDR than for the peers – 34.2% vs 46.7%, respectively.
Having a sound balance sheet coupled with ample liquidity reserves (which UDR has of around $1 billion), is critical in times like this. Currently, the future outlook is unclear, especially in terms of future lockdowns that have a high potential to cause elevated unemployment levels and the associated knock-on effect on the whole economy. It must be appreciated that UDR carries a balance sheet that is safer than average; and thus is equipped with sufficient ammo to withstand decreased occupancy rates over a longer period of time. In addition, UDR has leveraged its fortress balance sheet to buy certain properties at depressed levels – something that should add long-term value in the case of another economic shock.
Secure dividend with stable growth prospects
In my opinion, UDR offers both an attractive dividend yield and growth. UDR can be also considered a dividend aristocrat distributing increasing dividends over 190 consecutive quarters. In the last five year period, the dividend CAGR has landed at 5.1%, and, most importantly, the dividends have not been sponsored by debt but from core business activities. Currently, UDR offers a dividend yield of 4.1% that has very low risk of being cut. The AFFO payout of 73% coupled with a strong balance sheet warrant a relatively secure dividend.
Lastly, the combination of attractive yield and growth could potentially act as a catalyst for reversion to at least the pre-virus market cap levels. If UDR continues to deliver strong results in a sustained manner, the market will sooner or later recognize this and assign a more appropriate multiple accordingly. The recent actions by the FED decreasing the interest rates to zero and the corresponding consequences on the overall yields create a very favorable environment for high yielding companies (and especially in combination of decent growth prospects).
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.