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Standard & Poor's


08/18/14 10:29:37 AM



This week's Focus Stock of the Week is Public Storage (PSA: $175.08), which carries S&P Capital IQ's highest investment recommendation of 5-STARS, or Strong Buy.

Public Storage is an equity real estate investment trust, organized as a corporation under the laws of California. PSA operates three business segments: domestic self-storage, Europe self-storage, and commercial. In the U.S., PSA is the largest owner and operator of storage space, with direct and indirect equity investments in 2,200 self-storage facilities located in 38 states within the U.S. operating under the Public Storage name. The facilities contain a total of about 141 million net rentable square feet of space. PSA's self-storage facilities generally consist of three to seven buildings containing an aggregate of between 350 and 750 storage spaces, most of which have between 25 and 400 square feet and an interior height of approximately eight to 12 feet.

The Europe self-storage business comprises PSA's 49% equity interest in Shurgard Europe, which owns 187 self-storage facilities (10 million net rentable square feet of space) located in seven countries in Europe that operate under the "Shurgard Storage Centers" brand name and manages one facility located in the United Kingdom that was wholly owned by PSA at the end of 2013.

PSA also has direct and indirect equity interests in approximately 30 million net rentable square feet of commercial space located in 11 states in the U.S. operated under the PS Business Parks and Public Storage, Inc. brands. PSA has a 42% ownership interest in PS Business Parks, Inc. (PSB).

We see three company- specific positive catalysts which may boost PSA's revenues, profitability, and share price in the next 12 months. They are: our expectations of positive macro trends for storage companies, industry consolidation, and economies of scale.

First, storage companies benefit from increasing demand for storage. We think occupancy levels in the self-storage industry are approaching historical highs, driven by steady job growth, an improving housing market, and increased household formations. PSA has industry-leading occupancy levels, in part due to its name recognition. For PSA, we forecast that year-end 2014 domestic occupancy (on a same-store basis) will reach 95.0%, up from an average of 93.3% in 2013, and 91.9% in 2012. PSA thinks that a 96% maximum system-wide occupancy rate, which is well above peers, is possible.

Second, the self-storage sector is highly fragmented, offering significant opportunities for consolidation. The top five players in the industry control just 11% of the total US market. We believe a large number of smaller, private competitors may present attractive acquisition prospects. We estimate that there are about 40 operators owning between 2.0 million and 10.0 million square feet of space. According to Inside Self Storage, there are 75 operators that own at least 1.0 million square feet of space.

We think a lack of construction activity has limited new competition over the last five years. We think this reflects a tough environment for local developers to obtain new financing. In addition, local zoning regulations can present a significant hurdle to operators that want to locate close to residential customers. Often, in our view, a "not in my back yard" mindset may slow down or block the local approval process.

Third, PSA's size, in our view, gives it the edge in marketing, costs, and name recognition. The effective use of Internet marketing tools and company websites has allowed owners to better manage upcoming vacancies. PSA estimates that 70% of new business comes from its website, and that 70% of its web traffic comes on its own, unsolicited. This saves on marketing costs, and we see this as a competitive advantage for PSA. We also believe the use of market promotions, including offers of a month's free rent, are easing as the economy recovers.

We expect PSA's total revenues to rise 5.6% in 2014, and 5.9% in 2015, following an acquisition-driven 8.5% surge in 2013. PSA is steadily limiting discounts to entice new customers, and discounts currently run at about $20 million per quarter.

We expect 2014 average rental rates to rise nearly 4.0%, in-line with the 3.8% same-store increase in 2013, and the 4.2% increase in 2012.

PSA generated $8.78 FFO per share in 2013, and we expect $7.80 in 2014 and $8.50 in 2015. Our 12-month target price of $203 is 24.5X our forward four quarters FFO per share estimate of $8.30, a significant premium to the 18.0X that two smaller, publicly-traded storage peers trade at. We think PSA will maintain its premium valuation, driven by organic growth and contributions from acquisitions.

Risks to our recommendation and target price include rising short-term interest rates, slower than-expected growth in rental rates and occupancy levels, a drop in moving activity, higher than expected regulatory costs, and a lower availability of properties to acquire.

S&P Capital IQ's views on stocks are constantly re-evaluated. Please refer to our most recent publication on this stock to see our current view.


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