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It’s easy to get hyped up about general artificial intelligence right now.
Bill Gates is quoted saying that, "the development of AI is as fundamental as the creation of the microprocessor, the personal computer, the Internet, and the mobile phone.”
Promise and vision.
A lot of technology investments are heavily romanticized in today’s media. We live in a world where all the most valuable companies in the world are technology companies – and by a substantial margin.
While I too get excited about the prospects of these investments, sometimes you have to keep it as simple as possible.
While Gates has certainly done alright for himself, there is someone else equally as famous with a notable quote:
As soon as I learn what the hell general artificial intelligence is, I’ll write about it. But for now, let’s KISS (keep it simple stupid).
Back by popular demand, this week’s free newsletter is a deep dive into one of my portfolio companies.
This week, in <5 minutes, we’ll cover Storage Vault:
Why Self-Storage? 👉 Market Characteristics
Overview 👉 Business Units & Corporate Structure
Key Metrics 👉 High Rent PSF, High Margins, Low Capex, NOI, AFFO
Debt Load 👉 High Portion of Fixed Rate
Valuation 👉 A Well-Deserved Premium
Let’s get started!
1. Why Self-Storage? 👉 Market Characteristics
With populations moving towards high urban densities, people nowadays just have too much stuff, and at these house prices, nowhere to put it. Whether it’s moving for a life event or storing excess goods, your friend/mom only has so much room in their garage.
US self-storage REITs, which have a longer public history than Canada over many cycles, have delivered 14% CAGR over 15 years, the highest return of all US REIT sub-sectors based on NAREIT indices.
Key defining characteristics include:
High rent per square foot (psf)
Short-duration leases resulting in the ability to reset rents higher to keep up with inflation
Demand is largely uncorrelated with economic cycles, with low price sensitivity once customers are locked-in
Low Capex intensity and largely supply-restricted
Efficient low-touch operations
Bad debt is a profit centre with items auctioned off to recuperate loss rent (yeah that’s right, everyone’s favourite TV show – Storage Wars)
Demand drivers are driven by what those in the storage biz call the 6 D’s: Death, Divorce, Dislocation, Density, Disaster, and Downsizing. These trends (unfortunately) are all pointing up. At a broader level, the business is driven by population growth and migration trends, somewhat similar to the multi-residential sector. The elevated immigration target to Canada is a tailwind.
All these life events typically occur during down economic cycles, which provides resiliency to the business model.
Think about how the pandemic changed this too. Everyone was upsizing because they were sitting on cash not spent on experiences. Now, with interest rates at all-time highs (especially in Canada) housing carrying costs on mortgages as a percentage of disposal incomes have skyrocketed.
Downsizing is on the horizon.
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2. Overview 👉 Business Units & Corporate Structure
StorageVault (SV) is Canada’s largest storage provider, owning and operating over 238 storage locations across the country. SV owns 206 locations plus over 4,500 portable storage units representing over 11.4 million rentable square feet on over 665 acres of land.
SV is represented regionally under the following brands: Access Storage, Sentinel Storage, Depotium Mini-Entrepôt, and Cubeit Portable Storage.
They also provide last-mile storage and logistics solutions through FlexSpace Logistics and professional records management services, such as document and media storage, imaging, and shredding services through RecordXpress.
Although it may look like it at first glance, SV is not structured as a REIT, but as a corporation. Given the operating nature of the real estate, its assets can be depreciated on a more accelerated basis than typical commercial real estate.
This allows prior tax loss carryforwards, as SV has not been in a current cash tax position. Moreover, SV intentionally has a low payout ratio which is a structural advantage that allows the company to compound earnings growth given its ability to use internal cash flow to grow the asset base.
If you pull up their cap table, at the top you’ll find an entity called Access Self Storage. Access is a private-held company and is owned by CEO Steven Scott, and otherinvestors, including the CFO. Access owns ~35% of SV. In late 2014, Access took control over SV by vending in ~$51M of assets and taking back stock, effectively owning 50%+ of SV at the time.
Access reconstituted the board in April 2015 and SV became the primary vehicle for Access to consolidate the sector. Until 2017, Access managed SV under an external management contract with fees below market rates. In 2017, SV internalized the Access team at no cost, and SV paid $16M for managing the non-SV-owned stores (then 55 stores).
Today, Access owns, operates, and manages industrial, multi-residential, other commercial real estate in Canada, and ~30 self-storage stores which could get rolled into SV in the future.
3. Key Metrics 👉 High Rent PSF, High Margins, Low Capex, NOI, AFFO
To understand what levers to pull for growth, and how the company ticks, we look to understand what key operating metrics drive the business. We’ll start at the top with revenue
SV revenue is made up of renting the storage units to customers, information and records management, managing storage facilities on behalf of third parties (percentage fee of gross rent), and sale of merchandise including locks, boxes, packing supplies, and equipment.
For reporting segments, from their annual report, they bucket the categories as follows:
The key metric here to look at in terms of monetization is rent psf. Currently, the rent in SV’s portfolio is ~$25 psf across the entire portfolio, obviously with variances around locations. Since the lease duration is short (month to month), SV is able to scale its pricing up with inflation – which is especially important in today’s economic environment.
Limited supply due to zoning challenges helps keep psf prices stable/steadily increasing. Since self-store facilities can technically be built on “employment lands” but they don’t actually employ a lot of people, governments don’t like that it’s not a huge tax revenue driver so are less willing to push development projects through.
Also, development is speculative in nature, which greatly limits development partner options that will take on the project. The 6 D’s combined with these supply constraints help keep revenue stable.
On the cost side, there are several things that stand out. The first is the efficiency of operations. SV only needs 3 employees for every 100k sf. This allows them to achieve gross profit margins in the 65-70% range.
On the capex front – this is a very low Capex business that only requires around 5% of revenue with very low turnover costs.
Now getting to the metrics from which many derive the valuation: AFFO and NOI.
Adjusted Funds From Operations (AFFO) measures a real estate company's recurring/normalized FFO after deducting capital improvement funding.
Investors use AFFO as a better indicator of the REIT’s ability to pay dividends from its net earnings. Though FFO is commonly used, it does not deduct for capital expenditures required to maintain the existing portfolio of properties or the rent increases, so it doesn't quite measure the true residual cash flow.
AFFO is a great indicator of cash flow that can be reinvested back into the business, and SV has been growing it like clockwork.
Another metric is Net Operating Income (NOI).
Real estate investors often use this figure to calculate a “cap rate” or capitalization rate:
Using this equation you can calculate the cap rate, or you can use cap rates that are present in market comps in order to back into an estimated market value of the real estate investment. Bottom line is that as NOI grows, so does the value of the asset.
SV is also a rockstar at growing this:
Everything more or less comes down to increasing these two key levers in order for equity value to accrue over a long period of time.
In order to grow the business and for M&A opportunities, the funding source outside of organic operating income also has to be considered. This is where the capital structure and debt piece come in.
4. Capital Structure 👉 High Portion of Fixed Rate Debt
When it comes to a lot of these more capital-intensive businesses, they take on debt to fund acquisitions. The idea behind this is that your cost of capital is lower than what you can return on the asset.
The recent cause for concern amongst heavily levered companies is a rising rate environment. When rates increase, the bar you have to jump over gets higher and generally slows down deals. However, what you have to pay attention to in times when rates are rising is the portion of fixed-rate debt – because this element of borrowing cost won’t rise with the rest of the market.
As you can see, 80% of the debt load at SV is fixed-rate, which makes them much more secure in a rising rate environment.
5. Valuation 👉 A Well-Deserved Premium
When it comes to valuation, growthier assets always trade at a premium because they can “grow into their valuation.” So when looking at comps, you first need to start with the growth component.
As we can see, SV is a premium growth asset. This leads to the name trading at a premium to peers.
To arrive at a target price, I’ll pull from this excellent analyst report from RBC where they back into a valuation using the NOI, as I mentioned above.
This is how RBC arrives at a price target of $8.50, which is a 10% premium to forward NAV, with the premium well deserved due to a more rapid growth rate.
Wrapping Up…
In a world with shiny object syndrome, sometimes it’s best to stick to long-term compounders.
We’ve all heard about the magic of compound interest. There are a couple of companies that do this on an operational basis and investors can participate in this wealth-creation strategy.
SV is one of those companies and deserves at least a starter position in your portfolio.
Until next time. Always Yours. Incessantly Chasing ROI,
-Genevieve Roch-Decter, CFA
