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EastGroup Properties (EGP) - Thesis

EastGroup Properties (EGP)
Current Price: $55.63 per share
Price Target: $62.34 per share
Rating: BUY


EastGroup Properties (EGP) is an industrial Real Estate Investment Trust (REIT), and we like it despite its negative 8.4% total return in 2015.  It declined in 2015 for a variety of reasons including lackluster overall market performance, slightly lower occupancy rates, lower year-over-year third-quarter earnings, fear that company’s Houston area properties will suffer from a challenged local energy market, and fear that rising interest rates will pressure the business. However, we believe EGP’s poor 2015 performance is temporary, and it provides an excellent buying opportunity for long-term value investors that seek above average dividends. 

About EGP:
EastGroup Properties, Inc. (EastGroup) is an industrial equity REIT focused on the development, acquisition and operation of industrial properties in Sunbelt markets throughout the United States. EastGroup holds its properties as long-term investments. The Company owns approximately 307 industrial properties and one office building. These properties are located in the states of Florida, Texas, Arizona, California and North Carolina. The Company has developed approximately 37% of its total portfolio (on a square foot basis), including real estate properties and development properties in lease-up and under construction. The Company's focus is the ownership of business distribution space (80% of the total portfolio) with the remainder in bulk distribution space (16%) and business service space (4%).  EastGroup competes on location (not rent), and clusters properties around a variety of transportation features.

EGP’s business is healthy and growing: 
EGP’s business is strong for a variety of reasons.  For example, occupancy rates remain high.  Specifically, properties were 96.6% leased and 95.8% occupied as of September 30, 2015 (this is down very slightly from 96.7% leased and 96.3% occupied on December 31, 2014).  Additionally, EGP’s balance sheet remains strong and flexible.  Its debt-to-total market capitalization is low especially compared to peers:

As of the end of the last quarter, ESG had both interest and fixed charge coverage ratios of 4.6x and a debt to earnings before interest, taxes, depreciation and amortization (EBITDA) ratio of 6.30x.  Further, EastGroup’s customer base is large and diverse.  At year-end 2014, EGP had over 1,400 customers with an average size of 23,000 square feet and a weighted average lease term of 5.6 years. (2014 Annual Report)

Addtionally, EastGroup is growing.  For example, EGP’s development program consists of 21 projects (2.1 Million Square Feet) at September 30, 2015 with a projected total investment of $157 million.  Additionally, Funds from Operations (FFO) attributable to common stockholders were $.94 per share at the end of the third quarter up from $.89 per share for the same quarter of 2014, an increase of 5.6%.  Also, same property net operating income increased 1.3% for the quarter ended September 30, 2015, compared to the same quarter in 2014.

EGP’s dividend is attractive and safe:
EastGroup has increased or maintained its dividend for 23 consecutive years.  This is important for dividend investors, especially considering many of EGP peers had to cut their dividends during the recession of 2007-2009.  EGP’s dividend to FFO ratio (over the last 12 month) is also relatively low compared to peers (this is a sign of safety).

Further, the dividend has increased in each of the last four years.  For reference, EGP historical dividend to FFO ratio is included in the following chart:

What is EGP Worth?
On a price-to-earnings basis, EGP looks expensive (36.6 times), but a more relevant REIT valuation metric is price-to-FFO.  FFO stands for Funds from Operations, and it is calculated as Net Income adjusted for Depreciation, Amortization, and Property Sales.  Depreciation has a big impact on REITs considering their business is real estate.  On a price to FFO ratio, EGP is trading around 15.4 times, a much more reasonable metric than the PE ratio.  This price to FFO ratio is below EGP’s recent historical multiple indicating the stock is priced attractively based on this metric.

If EGP FFO multiple were to return to the 17.1 average from 2011-2014, then the stock would trade around $62.34, 11.3% higher than its current stock price.  And 11.3% capital appreciation combined with a 4.3% dividend yield is an attractive proposition for a relatively lower risk REIT.  And while full-year 2015 results won’t be released until February 1st, management expects FFO between $3.66 and $3.68 per share.  Applying the same 17.1 multiple suggests a stock price of $62.75.

Further, industrial REITS will grow as the economy grows.  No one has a crystal ball, but we believe the economy will continue to grow over the long-term.  Plus, EGP’s properties are highly valuable as they’re located in primary industrial locations relative to transportation features that are important to industrial companies.  We believe the combination of lower debt, lower dividend payout ratios (meaning more safety and growth potential), and primary industrial locations makes EGP a lower risk investment with more upside compared to many of its peers.

Real Estate Sector:
Worth noting, we may see some additional demand and volatility for REITs later in 2016 as Real Estate is set to get its own official sector classification after market close on August 31, 2016. 

We believe EastGroup Properties is an attractively priced industrial REIT with an above average (and growing) dividend.  The stock adds important diversification to our long-term investment portfolio.  The company obviously faces many of the industry specific risks that other REITs face (such as general economic and real estate market risks), but this is why we own EGP as only one part of our diversified long-term portfolio.  Most importantly, relative to other REIT options, we believe EastGroup Properties provides a very attractive risk-reward tradeoff.  We rate EGP a BUY, and we own shares of the stock.

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