Extra Space Storage (NYSE:EXR) and VEREIT (NYSE:VER) are two of the most attractive dividend stocks, but like an ill-fitting suit, something about these companies feels a little off. However, with some minor alterations, they could be a perfect fit and are well worth keeping an eye on.
1. Extra Space Storage
Most Americans have more stuff than they know what to do with, and the runaway success of the self-storage industry is proof. That's why I like this segment of the real estate investment trust, or REIT, universe.
As of June 30, Extra Space Storage either owned, had an ownership interest in, or managed 1,147 self-storage facilities across 35 states plus Washington, D.C. and Puerto Rico. A quick glance at its results shows the company growing like gangbusters: Funds from operations, or FFO -- a key cash-flow measure in the REIT industry -- nearly tripled between 2011 and the 12 months ending this June. Throw in a steadily growing dividend, and you can see why I've got this name on my watchlist.
But here's the problem: The success of the self-storage industry is no secret. For a REIT like Extra Space Storage, we'd want to look at valuation on the basis of its price versus FFO -- or, stock price divided by annual FFO per share. Currently that figure stands at more than 25, which is at the high end of Extra Space's historical average, rich compared with other self-storage REITs -- which are trading about 22 times FFO on average -- and considerably more expensive than many of the top self-storage REITs in other industries, which are trading closer to 20 times FFO.
Extra Space's hot growth does justify a higher-than-average multiple, but it's far from a bargain at today's price, so I'd need it to get a bit cheaper before I jump in. For instance, if Extra Space's FFO multiple were to fall in line with its peers -- which can happen through earnings growth or a falling stock price -- because of the company's significantly better performance than its peers, I would view that as a very attractive valuation and a great time to buy.
On the other side of that coin is VEREIT, which is currently trading at a much cheaper valuation of 10 times FFO.
Formerly American Realty Capital Properties, the $7.3 billion company owns a portfolio 4,645 single-tenant retail properties spread across 49 states, Washington, D.C., Puerto Rico, and Canada. And although bricks-and-mortar retail isn't a booming industry, VEREIT's simple business model has proved wildly successful for peer companies National Retail Properties and Realty Income, which have each increased their dividend for more than 20 consecutive years.
One important piece of this business model is using sale-leaseback transactions. Essentially, VEREIT buys properties such as convenience stores, gyms, and quick-service restaurants and then leases the space back to the seller. Everyone wins: The seller frees up capital, and VEREIT gets a property with a tenant already in place and willing to sign a long-term lease -- which, in general, averages 10 to 20 years. This model is an important reason VEREIT is able to keep its occupancy rate over 98%, and it helps to generate more consistent cash flows.
The catch is that VEREIT is the midst of a turnaround story. Under former management, the company aggressively grew assets from $2.5 billion in 2013 to a whopping $22.8 billion by October 2014, done in part by aggressively taking on debt. This situation isn't unheard of for REITs, but the business came to a screeching halt when the company released a statement on Oct. 29 that it had falsely reported earnings during that time period. The fallout included the ousting of top executives and board members, and newly appointed CEO Glenn Rufrano was left with a big mess to clean up.
Rufrano has been a steadying force since he took over this past April, but the combination of the accounting scandal and a huge debt pile has led to the stripping of VEREIT's investment-grade credit rating. In an industry where competitive advantage is hard to come by, a good credit rating is crucial for getting better access to capital at lower costs. VEREIT is planning to sell off $1 billion in assets over the next year in an effort to pay down a portion of its $9 billion in debt and earn back its credit rating. I'll be watching and waiting until that plan becomes reality. However, if all goes according to plan over the next year, this is a large and diverse company that has the potential to generate a reliable dividend, and it could be a great buy.
Dave Koppenheffer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.