Cousins Properties Incorporated

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Cousins Properties Incorporated is a self-administered and self-managed REIT that acquires, develops, leases, and manages primarily Class A office properties in high-growth Sun Belt markets.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Cousins Properties operates as a real estate investment trust (REIT), focusing on Class A office properties primarily within the high-growth Sun Belt region of the United States. This region encompasses vibrant markets with strong employment and population growth. The company aims to deliver superior returns to its shareholders through strategic acquisitions, developments, and asset management practices.

  • Revenue Streams: Cousins derives most of its revenue from rental income generated by leasing office space in its properties. They categorize their revenue between Office and Non-Office components, with Office properties accounting for the vast majority of their revenues (e.g. in the recent quarter, the majority of the $188.9M in revenues came from Office properties, compared to $22.7M from Non-Office properties). Non-office is mainly comprised of retail, industrial and hotel operations.
  • Industry Trends: The office market in the Sun Belt has seen a mix of tailwinds and headwinds. On one hand, there has been a consistent migration trend of people and businesses to the region, driving demand for office space. On the other hand, the proliferation of hybrid and remote work has created some uncertainty on whether this demand will continue and reach its previous levels. The industry is seeing a flight to quality with companies prioritizing best-in-class, new or renovated office space.
  • Margins: Operating margins are heavily influenced by occupancy rates and lease rates, which have been facing pressure over the last few years. On one hand, many companies are reducing office footprints, on the other hand, there’s been increased operating expenses because of increased taxes and costs of maintenance and building operations. Furthermore, there may be potential write-offs related to loan impairments, or other assets. As a result, recent operating margins are below their historical norms.
  • Competitive Landscape: The office market is highly fragmented, with a number of REITs and private real estate operators participating. Competition is primarily on amenities, location, lease terms, pricing, and building class. Those with lower cost structures, better access to capital, and stronger networks are likely to perform better over the long term.
 **What makes Cousins different?**: Cousins focuses on building relationships with tenants, and is focused on Class A properties in high-growth regions of Sunbelt. They prioritize having assets in areas where business growth is expected, and therefore, they are expected to have high-quality companies leasing from them in the long term. They also seem to be trying to get rid of Non-Core Assets.
  • Recent Concerns: Cousins has recently faced challenges due to the downturn in the office market. Occupancy rates and lease rates have seen pressure, and the REIT’s growth has slowed down. These factors have been further worsened by higher interest rates.
    • In addition, Cousins has had difficulty in some joint ventures. As a result, they have been taking losses related to write-offs. On one hand, management seems to be working through some of these losses, on the other hand, these risks are present and likely to continue.
    • Cousins has been trying to shift towards a more sustainable business model. Therefore, they have been focusing on their core properties, and divesting out of less-profitable properties. However, this process will take time, and also present its own risks.
    • In Q2 2023 earnings call, Management noted that they do not expect any major new office development starts in their current cycle because they want to focus on a more sustainable and less risky portfolio.

Financial Analysis

Cousins’s financial performance can be understood through these parameters. They have been experiencing some pressure on revenue and earnings, and the debt position is something to look into.

  • Revenue: Overall revenues have increased during the last few quarters, but the margins have been impacted due to higher interest rates.
  • Net Operating Income: Net Operating Income (NOI) represents rental revenue less property operating expenses, excluding depreciation, amortization, and corporate overhead expenses. NOI was $183.1M for 3Q23, and $185.6M for the same period in 2022. Therefore, their same store NOI fell to 2.6% during this time period.
  • Return on Invested Capital (ROIC): ROIC has been under pressure due to higher cap rates. They are trying to fix this by increasing rents and improving their occupancy rates and tenant retention.
  • Free Cash Flow (FCF): There is significant volatility and change in the free cash flows. It can be difficult to predict because it is heavily reliant on non-recurring asset sales and loan reimbursements. Also affected by investments in new properties. The last quarter showed a slight decrease in their free cash flow.
  • Debt: They have been maintaining a levered capital structure. At the end of the most recent quarter their total liabilities was close to $4.5B. This results in increased risks related to leverage. Management has repeatedly tried to emphasize the high level of flexibility and liquidity that they have to manage these liabilities. Although they have been refinancing their debt at favorable interest rates over the last few quarters, that cannot go on indefinitely.

Moat Rating: 2 / 5

  • Justification: Cousins Properties possesses a narrow economic moat, limited by its location-based advantages and the difficulty of replicating its integrated operations in the Sun Belt. Although its geographic focus and the scale within its niche can contribute to some brand recognition and customer loyalty, the company faces intense competition in the real estate market. As they try to focus on a higher percentage of Class A tenants, there’s competition from other well established players. Also, REIT companies in general find it difficult to build economic moats because the tenants can move fairly easily from one property to another.
  • Limitations: Cousins does not have unique technology, a strong brand name or large switching costs that would increase moat.

Risks to the Moat and Business Resilience

  • Interest Rate Risk: Rising interest rates are a significant risk for the company, as this would increase the cost of capital and reduce the profitability of investments in new properties. This will also put downward pressure on valuations. Furthermore, higher interest rates can be a headwind for leasing as companies might scale down their operations.
  • Economic Downturn: A significant recession or economic slowdown in the Sun Belt region could severely damage the revenue generation of the company.
  • Overdevelopment: High construction activity in the Sun Belt could increase supply and pressure lease rates and occupancy.
  • Tenant Concentration Risk: Losing a major tenant could significantly impact Cousins Properties’ bottom line, leading to declines in free cash flow and occupancy rates.

  • Technological Disruption: Shifts in work from home and hybrid working may negatively affect the long-term prospects of the office market, and could hurt the business.

  • Resilience: While there are risks, Cousins does have several positive attributes to counter those. Its management has a long-standing experience in the Sun Belt area. Their strategic focus on A Class properties reduces its susceptibility to price wars. Finally, they also have reasonable liquidity and flexibility.

Understandability Rating: 2 / 5

  • Justification: The business model itself is not too hard to understand. It’s a REIT that collects money in rent, and needs to have favorable cost structure and good occupancy rates to generate revenue. But the financials are hard to understand because of all the moving parts and special non-recurring charges associated with REIT. Furthermore, a very deep understanding of the different accounting principles for real estate is needed for a good analysis.

Balance Sheet Health: 3 / 5

  • Justification: Cousins has a substantial amount of long-term debt. Given the current environment of high interest rates and uncertain economic outlook, it is not a very healthy profile. However, the management has been focusing on lowering the debt burden, and they do have adequate liquidity and access to credit markets. It is a reasonably healthy balance sheet, with a few underlying risks that need to be kept under a close watch.