Alexandria Real Estate Stock: This Quality Dividend Grower Is Still A Buy (NYSE:ARE)

To me, investing is all about analyzing trends and discerning where the economy and the world is heading. It’s compatible with my calculating temperament and personality, so that’s probably why I enjoy it so much.

One trend that I still believe is showing no signs of slowing down is the need for breakthrough treatments and advances in existing treatments. As many advances have been made in recent years, more than 90% of rare diseases still have no U.S. Food and Drug Administration-approved treatment.

This is exactly why Statista believes total global pharmaceutical research and development spending will rise from $262 billion in 2023 to $302 billion by 2028.

As the landlord to many big pharma companies, this is great news for Alexandria Real Estate (NYSE:ARE). At first glance, ARE’s status as an office REIT may spell doom and gloom. So many more people are now working from home versus just five years ago, right?

Luckily, research and development is so different from all other aspects of running a business. Many functions in a business can work from home. There is no phoning it in with research and development, however. Researchers must be present most of the time at a research campus to make needed breakthroughs.

That’s why big pharma companies can’t just do away with their leases to these specialized buildings like they can with other office buildings. They are mission-critical, so to speak.

When I last covered ARE with a buy rating in February, I appreciated the differentiated office REIT business model. I also liked the company’s moderate growth prospects. Not to mention the BBB+ credit rating from S&P. Lastly, shares were a tremendous bargain.

Today, I am just as convinced that ARE is a buy as I was three months ago. That’s because the first-quarter results shared on April 22 were solid. The company’s growth outlook appears to be intact. The balance sheet remains strong. Finally, shares still look to be very discounted.

Growth Is Holding Steady

When ARE shared its first-quarter results last month, my investment thesis was arguably once again proven to be on the money. The company’s total revenue grew by 9.7% year-over-year to $769.1 million in the first quarter. For perspective, that was $4.8 million above and beyond Seeking Alpha’s analyst consensus.

Additionally, ARE’s total share count only grew by just 0.7%. This shows that the company’s business model and the moves it is making are quite accretive to shareholders.

The same factors that played a role in the Q4 2023 results were also catalysts during the first quarter. Thanks to the healthy demand for ARE’s portfolio of life sciences office properties, its occupancy held at 94.6% for the first quarter.

The vast majority of the company’s net leases (96%) as of March 31, 2024, contained contractual annual rent escalations of roughly 3%. Right off the bat, that was a nice lift to revenue.

Another tailwind for ARE was leasing volume. The company leased 100K RSF of development/redevelopment space in the first quarter. ARE also renewed/released almost 1 million RSF of properties at an average rental rate increase of 33% during the quarter. That tenants are comfortable renewing on these terms speaks to the mission-critical aspect of ARE’s real estate portfolio.

The REIT’s portfolio of rentable square footage also grew 0.7% year-over-year to 42.2 million for the first quarter.

That was helped by ARE delivering nearly 500K RSF of projects to the market in the quarter, including a couple of development properties in Boston, one redevelopment in the San Francisco Bay Area, one redevelopment in Seattle, and a redevelopment in Canada. Collectively, these projects were a $26 million lift to the company’s incremental annual net operating income.

ARE’s funds from operations per share climbed 7.3% year-over-year to $2.35 during the quarter. For context, that was $0.02 higher than Seeking Alpha’s consensus.

For 2024, CFO Marc Binda reiterated ARE’s full-year 2024 midpoint guidance for FFO per share of $9.47. According to Binda’s opening remarks during the Q1 2024 Earnings Call, that would be a 5.6% year-over-year growth rate over 2023.

As ARE benefits from higher contractual rent, more properties coming into service throughout the year, and releasing at higher rental rates, this makes sense. That’s why the FAST Graphs consensus is forecasting $9.48 in FFO per share for 2024 – – a 5.7% growth rate over the 2023 base.

Between Q2 2024 and Q4 2027, management anticipates that another 5.5 million RSF will be placed into service, with an estimated $480 million benefit to annual net operating income. Combined with the organic growth factors that I already discussed, this should sustain healthy growth for the foreseeable future.

That explains how the FAST Graphs consensus is also predicting that ARE’s FFO per share will grow by 3.3% to $9.79 in 2025 and another 4.5% to $10.23 in 2026.

If ARE’s stable growth prospects weren’t enough, its financial position fundamentally sealed the deal for me. The company enjoys a BBB+ credit rating from S&P on a stable outlook, which is among the top 10% of all publicly traded U.S. REITs. This is for good reason as well.

The company had $6 billion of liquidity as of March 31, 2024. That provides it with plenty of dry powder to opportunistically execute acquisitions to further juice its growth. ARE is also well-hedged against higher rates, with 98.9% of its debt at fixed rates and a weighted average interest rate below 4% (unless otherwise sourced or hyperlinked, all details in this subhead were according to ARE’s Q1 2024 Earnings Press Release and ARE’s Q1 2024 Supplemental Information).

Shares Could Be Worth $150+ Each

As the S&P 500 index (SP500) has delivered total returns of 7% in the last three months, ARE has posted 3% total returns. These relatively muted total returns mean the company remains a great value in my view.

ARE’s current-year P/FFO ratio of 12.5 is markedly below its 10-year normal P/FFO ratio of 19.6. Now, to be clear, I don’t think shares will revert to the 10-year normal P/FFO again. If they do, I think that would represent at least a moderate overvaluation.

This is because, even with interest rate cuts potentially coming soon, rates will likely remain higher than the aggregate of what they have been over the past decade.

Additionally, ARE’s growth prospects have cooled off a bit in the past decade. The average in the past 10 years was 7% annually per FAST Graphs. The forward consensus for 2024 through 2026 is 4.3%. It is true that as interest rates eventually stabilize, this will provide clarity to ARE and other REITs. That could help acquisition volumes to rebound closer to pre-rate hike levels, which could partially reinvigorate growth.

Thus, I believe that a valuation multiple that also builds in a margin of safety would be two standard deviations below the 10-year average. That would be approximately 15.7.

This year is 40.4% complete, which means 59.6% of 2024 is left, with 40.4% of 2025 to also come in the next 12 months. That is how I’m weighing the 2024 and 2025 analyst growth forecasts that I have already discussed. These weightings give me a $9.61 12-month FFO per share input.

Incorporating this input with my 15.7 fair value multiple, I get a fair value of $151 a share. Compared to the $120 share price (as of May 24, 2024), this would equate to a 21% discount to fair value. If ARE returned to this valuation multiple and grew as predicted, nearly 50% cumulative total returns could be generated through 2026.

Expect More Mid-Single-Digit Dividend Growth

ARE’s 4.2% forward dividend yield is below the real estate sector median forward dividend yield of 4.7%. This is probably why Seeking Alpha’s Quant System gives it a C grade for forward dividend yield.

ARE’s 10-year compound annual dividend growth rate of 6.4% registers much greater than the real estate sector median of 2.9%, though. That’s enough for an A- grade from Seeking Alpha’s Quant System for 10-year dividend growth. I don’t expect such dividend growth to quite persist in the years to come, but it doesn’t have to for ARE to be interesting.

ARE’s 54% FFO payout ratio comes in comfortably better than the 90% FFO payout ratio that rating agencies prefer from the industry. The company’s 29% debt-to-capital ratio is also about half of the 60% that rating agencies desire from the industry.

This means that ARE has the means to keep delivering dividend growth in line with or slightly ahead of FFO per share growth. That’s why I believe that ARE’s annual dividend growth will come in around 5% in the years to come.

If ARE ups its quarterly dividend per share by 2.4% to $1.30 in June (ARE raises its dividend in June and December), $5.14 in dividends per share could be paid in 2024. Against the $9.48 FFO per share consensus, that would be a 54.2% payout ratio.

Risks To Consider

ARE is a great REIT in my opinion, but there are still risks to the investment thesis.

A newer risk that ARE took the liberty of bringing up in the Risk Factors section of its most recent 10-Q filing was that which is posed by artificial intelligence.

As AI and machine learning are increasingly adopted by ARE, the possibility of inaccurate and biased information, as well as intellectual property infringement are a couple of risks. I think the benefits outweigh the risks, but it’s at least worth knowing.

Additionally, tenants are also leaning into AI and machine learning. The adoption of AI by tenants could require upgrades to the infrastructure of existing properties, which could mean significant capital expenditures in the future.

Just as I noted in my prior article, another risk to ARE would be the possibility of ongoing projects being delayed and encountering cost overages. If this happened, the company’s growth could experience a setback.

Summary: A Deep Value Dividend Pick

ARE is an all-around great business, which I believe is part of what makes it appealing. The REIT is steadily growing. The balance sheet is vigorous. The dividend is easily covered.

The cherry on top is that the valuation could be low enough to have a substantial upside in the next few years. That’s why I am maintaining my buy rating.