Postal Realty Trust: Dividends From The USPS

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Postal Realty Trust, Inc (NYSE:PSTL) is a real estate investment trust (“REIT”) that has an interest in over 1,000 properties that are leased to the United States Postal Service (“USPS”) under modified double-net terms. They are the first and only publicly traded REIT with this focus on the USPS. And, with a 6% market share, they are also the largest. Combined, the next top 20 portfolios owners own just 11% of the market. At a total market size of +$278M square feet, significant expansion opportunities exist.

In the few years the company has been public, PSTL has made strong strides in capturing incremental share in this highly fragmented market. In the current year, for example, they are expected to exceed +$100M in acquisitions. If so, it would mark their third consecutive year of exceeding that milestone.

While some may be wary of these expansion plans, especially given ongoing concerns regarding the USPS, they are a reliable government-backed tenant with a high retention ratio. At less than 2% of their total operating expenses, lease payments are among their lowest commitments.

As demand for critical infrastructure supporting e-commerce and last-mile delivery continues to grow, PSTL will continue to benefit from the USPS’ retail distribution network, which is the largest in the country.

Though shares are up 7% over the past month, they are still down over 20% YTD and are currently trading at the bottom end of their yearly range. For income investors, the annual payout is yielding close to 6% after having been recently increased by 5%. As a portfolio holding, PSTL would provide investors with a niche business whose revenues are backed by the full faith and credit of the U.S. government, along with an attractive dividend yield and share price upside potential.

Accretive Contributions From Acquired Properties

In the most recent filing period ended March 31, 2022, PSTL reported total revenues of +$11.9M. This was 35% greater than the same period last year and in-line with expectations. Driving revenues during the current period were higher rents on a greater number of properties included within the comparable population.

Total operating expenses did track higher during the period, led by a 46% increase in real estate taxes and a 68% increase in property operating expenses, both of which were directly related to their volume of acquisitions during the quarter. This resulted in an overall decrease of 3% in total operating income.

Q1FY22 Form 10-Q – Summary of Operating Income

After adjusting out the outsized impact of depreciation and amortization on total operating expenses, however, funds from operations (“FFO”) came in at +$4.8M. This was slightly higher than last year but just shy of estimates.

Net operating income (“NOI”), on the other hand, has been steadily increasing due to favorable contributions from their acquired properties and adequate expense control. YOY, NOI is up 14%. Sequentially, it is up 8.2%.

Q1FY22 Investor Supplement – NOI Summary

During the quarter, PSTL acquired 50 properties for +$27M and another 24 properties subsequent to period end for a total of +$7M. In addition to +$34M in acquisitions, the company has 123 properties totaling +$40M under definitive contracts.

All in, the acquisitions were made within the company’s expected weighted cap rate of 6-8%. While management didn’t provide detailed guidance, they did note that they were on track to exceed +$100M in annual acquisitions, its third consecutive year above that level. With these acquisitions, management expects to capture significant additional market share in the years ahead, after having already captured 6% since going public.

Conservative Debt Profile And Ample Capacity

As of March 31, 2022, PSTL had total assets of +$407M and total liabilities of +$139M, comprised principally of fixed-rate debt of +$83M and floating-rate debt of +$40M bearing interest at a weighted average rate of 2.34%.

Subsequent to quarter-end, PSTL closed on a +$75M delayed draw loan facility and used the proceeds to pay down a portion of the outstanding amount of the floating rate debt on their revolver. Additionally, they also initiated a swap of +$50M on their credit facilities through February 2028. Doing so further reduced their exposure to floating rate debt.

Overall net debt as a percentage of enterprise value (“EV”) is low at just 23%. As a multiple of annualized adjusted EBITDA, it is just 3.9x. This is significantly lower than their targets of 40% and 7x, respectively. Another feature of their debt structure is their distant maturities. With a weighted average term of 5.6 years, repayment risk is limited in the near-medium term.

FY2021 Form 10-K – Summary of Debt Maturities

With contractual interest expense of just +$686K reported during the period, the company’s adjusted interest coverage ratio was 10.9x on $7,500 of quarterly adjusted EBITDA. Coverage of fixed charges were also in the upper mid-single digits at 9.6x. These high coverage ratios suggest the company’s operations are clearly unencumbered by their outstanding debt load.

Attractive Future Leasing Opportunities

Favorable leasing structures continues to support PSTL’s cash flows and NOI growth. Though the company is responsible for costs incurred on insurance, roofs, and structures, they are insulated from increases in certain operating expenses due to the modified double-net nature of the majority of their leases.

In addition, most existing leases have a weighted average term of just 4 years. For other REITs, that can pose a risk due to non-renewal risk. The USPS, however, has a retention rate of nearly 100%. With operating lease payments representing just over 2.5% of their total commitments and less than 2% of total operating expenses, lease-related outlays aren’t a significant financial consideration for the USPS.

USPS Form 10-K – Summary of Total Commitments With Emphasis on Total Lease Obligations

Furthermore, the leases are not subject to annual budget appropriations. This mitigates the risk arising from deadlocks in government bureaucracy. While the financial health of the USPS has often been called into question, the Postal Service Reform Act of 2022 was recently signed into law in April. Among other things, the bill is intended to overhaul the finances and delivery services of the USPS. This should provide a bridge for continued viability in the years ahead.

With nearly 30% of total annual rent set for expiration prior to 2025, an attractive opportunity exists for PSTL to reset rates at favorable terms that are reflective of the current inflationary environment. Near-full occupancy and retention provides a high degree of confidence that the leases will be renewed at expiration. The alternative option for the USPS would be to build-to-suit, which would be an unlikely decision due to its significantly greater capital requirements.

Q1FY22 Investor Supplement – Lease Expiration Schedule

Stable And Predictable Operating Cash Flows

Having a government-backed tenant with a high retention ratio provides predictability and stability to the company’s cash flows. It also provides them with the panache to engage in significant investment activities. For the third consecutive year, PSTL is expected to spend over +$100M in acquisitions. While this has proved accretive to growth in NOI, it is resulting in significant cash burn.

In FY2021, for example, they generated +$17.1M in operating activities but spent +$106.7M in investments. In order to cure the shortfall, PSTL relied primarily on the issuance of shares, which totaled +$138.8M. For existing shareholders, the dilution to earnings is certainly one drawback.

Q1FY22 Form 10-Q – Partial Cash Flow Statement

For income-focused investors, PSTL has increased their dividend for 11 consecutive quarters, its most recent one being a 5% increase. This brings the current annual payout to $0.92/share, which represents a yield of nearly 6% at current pricing. Though the dividend has been steadily increased in recent quarters, coverage is not the most desirable.

Though there was no remaining free cash flow (“FCF”) for the distribution during the quarter, PSTL had just enough in AFFO/share at $0.24 to cover their $0.2275/quarterly dividend. At about 96% of annualized AFFO, the payout’s runway for continued growth is limited. Though a cut is unlikely, given the current portfolio metrics, it can’t be ruled out.

A Niche REIT With Upside Potential

PSTL has interests in a geographically diverse portfolio comprised of properties leased to the USPS. As the largest such company by market share and the only publicly traded REIT to focus on the acquisition and management of these properties, PSTL is largely protected from new entrants into the competitive market environment.

The nature of their leases, which have built-in escalators on shorter duration leases, enables the company to re-lease their properties at rates that are in-line with the prevailing market. As a high retention tenant with limited cost-effective spacing alternatives, the USPS is likely to fully occupy PSTL’s properties for years to come.

Downsizing and the long-term financial health of the USPS is one concern, but a congressional bill was recently signed to bridge the near-medium term holes in their finances. Additionally, lease payments are just a fraction of their total commitments and are not subject to annual budgetary appropriations.

At current pricing, PSTL appears to be approximately 25% undervalued when utilizing a dividend discount model using an estimated discount rate of 6.9% and a long-term dividend growth rate of 2% applied against the consensus 2023 annual dividend estimate of $0.95.

Down over 20% YTD, this level of upside would bring shares to levels last seen at the beginning of the year. For investors seeking to add a niche business to their long-term portfolios, PSTL offers an attractive opportunity at a modest level of risk.

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