Big Yellow - Big potential?!

Big Yellow PLC, a UK-based storage Real Estate Investment Trust (REIT), operates 83 facilities under its primary brand and 24 under its subsidiary, Armadillo Self Storage. The company also owns Kator Storage Limited and The Last Mile Company Limited. Over recent years, Big Yellow has experienced consistent revenue growth and increased operating profits. This growth is due to a combination of organic expansion, strategic acquisitions, and appreciating property values.

Despite the overall positive financial performance, Big Yellow has frequently diluted its shares to finance its expansion.

The company experienced notable success in 2021 and 2022. However, 2023 marked a downturn, likely attributable to the influence of increased interest rates on their yield-based property valuations. I anticipate that this effect will partially reverse in 2024 and 2025, coinciding with a return of interest rates to the levels standard before 2023.

The Net Asset Value (NAV) per share demonstrated a consistent upward trajectory until 2023, at which point it plateaued. I expect that this upward trend will resume in the forthcoming years.

Interim Report – 30th September 2023

The 6 months to 30th September show the following figures:

Revenue growth for the period was reported at 6%, with like-for-like store revenue showing a 5% increase, attributable to higher average rents. Like-for-like occupancy experienced a rise of 1.5 percentage points since 1 April 2023, yet it saw a decline of 2.2 percentage points from the same time last year, resulting in a current rate of 84.6% (compared to September 2022's 86.8%). The closing occupancy, which includes the capacity from newly opened stores, was recorded at 81.4% (September 2022: 84.2%).

The average net rent per square foot increased by 8% period-on-period, with the closing net rent rising by 6.5% from September 2022. Adjusted profit before tax witnessed a 2% decrease, settling at £53.5 million. The statutory profit before tax stood at £119.6 million, in stark contrast to the £6.8 million seen in the previous period, primarily due to a revaluation surplus of £67.2 million in the current period (2022: deficit of £47.7 million).

The company declared an interim dividend of 22.6 pence per share, marking a 1% increase. Additionally, it raised £107 million (net of expenses) through a placement of 6.3% of its issued share capital, aimed at funding its development pipeline.

Further expansion was seen as the company acquired a freehold property in Leicester, increasing its pipeline to 11 development sites and two replacement stores, totaling approximately 0.9 million square feet (14% of current MLA), with 11 situated in or near London.

The occupancy rates have raised concerns, continuing into the third quarter as announced in December. The company attributes this largely to vacancies in newly developed sites. In my opinion, this may not fully explain the situation. I consider that they might also be facing lower volume demand for their space, but I expect this issue to be relatively short-lived. On a positive note, the company increased rental prices. The benefit of short-term leases is evident here, as it allows for quick adjustments in pricing due to shorter tenant durations. However, there is a potential downside: during unfavourable market conditions, their yield could rapidly decrease.

Development Plan

In June 2023, the company acquired a 0.8-acre property on Belgrave Gate, central Leicester, for £1.85 million for development. During this period, they secured planning consent for a 132,000 square foot self-storage centre and 114 flats in Wapping, London, following an appeal. The anticipated yield for this new store is a 9% net operating income return on the total capital of £56 million, which includes an estimated £36 million construction cost.

In May 2022, construction on all projects not already underway was halted due to unfavourable conditions in the construction market. However, recent declines in steelwork and cladding prices, along with the stabilization of other material prices, have significantly improved these conditions. Consequently, construction has resumed on six sites, including Farnham Road, Slough, Wapping, Wembley, Queensbury, Staines, and Slough Bath Road, all with planning consent, involving an additional expenditure of £90 million. In my opinion, this decision by the top management is very positive. I believe that many UK listed REITs took too long to recognize the risk of higher interest rates on the horizon. Once the higher interest rates were in effect, they took actions such as freezing development or selling parts of their portfolio. Big Yellow, however, while initially freezing new site developments, was quick to restart them and plan for further development. I agree with the management's assessment that the current lull in the property market presents opportunities for companies like Big Yellow to capitalize.

As of 30 September 2023, the net debt stood at £495.3 million. Following the placing, it was reduced to £388.3 million. This reduction provides the Group with undrawn facilities of £159 million and an additional $225 million bilateral shelf. Approximately 50% of the debt is fixed, in alignment with the hedging policy, and the current average cost of debt is 5.6%.

Rental Growth

As previously mentioned, the company is achieving rental growth broadly aligned with inflation rates. It's noteworthy that 60% to 70% of customers vacate within 6 months. In my view, this factor assists the company during periods of higher inflation. They are capable of reletting space to new customers at higher prices compared to REITs that are bound by long-term fixed contracts on space. Even among their long-term customers, who constitute 52% of the customer base, the average length of stay is only 52 months. This duration, for long-term property tenants, is relatively short.

Supply

Big Yellow maintains a focus on London and its surrounding commuter towns, areas characterized by high competition for land and challenges in obtaining planning permission. Over the past five years, the growth in new self-storage centre openings, excluding container operators, has averaged about 3% of total capacity annually. Despite this, I feel that the strength of the “Big Yellow” brand may not be particularly significant. The crucial factors are the location and price of the storage space. The company's advantage in this area is likely attributable to their capital, enabling them to fund the expansion of new locations easily and quickly.

Operating Costs

Store operating costs experienced a rise of £0.9 million, amounting to a 4% increase. This increment encompasses non-recurring items, primarily consisting of the release of a provision for property rates from the 2017 rating list and a reassessment of the Group's bad debt provision. When these non-recurring items are excluded, the store operating costs witnessed an increase of £2.0 million, which is an 8% rise compared to the same period in the previous year.

Property rates saw an increase of £1.6 million, a 22% rise, following the Rating Revaluation published in November 2022. The like-for-like increase is 19%, with the addition of four months' worth of rates payable on Kings Cross.

Property Portfolio

There are concerns regarding the method REITs, including Big Yellow and other listed REITs, use to value their portfolios. These valuations are heavily based on a multiple of the yield achieved. While this method has its merits, especially under normal trading conditions, it can be misleading during periods of market volatility, such as rapidly rising interest rates. I think the real prices that companies might attain if they were to actually sell property on the market may not match up to their carrying values in the accounts. This issue is not exclusive to Big Yellow but is prevalent among most listed REITs.

Share Price

The share price experienced a general downward trend from January 2022 to November 2023. I consider it possible, and even likely, that this trend has now been broken with the potential of peak inflation.

Valuation

Historically, Big Yellow has maintained a substantial premium over their Net Asset Value, as detailed in previous research on REITs. However, I don’t believe it's reasonable to assume they should attain the same level of valuation at this point in time, especially considering the significant shocks experienced in the property market and economy in recent years. In fairness to Big Yellow, they have managed to navigate through a challenging period without much negative impact on their actual operating business. They continue to expand, moving forward during a time when other REITs are looking backward, focusing on reducing debt and selling parts of their portfolio. I think Big Yellow is adopting the right strategy by pursuing property opportunities. While they do face a rising vacancy issue that needs monitoring, they have been successful in swiftly passing rising rent prices onto their tenants.

BUY

Valuation: 1461p