Extra Space Storage Inc.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Extra Space Storage Inc. is a self-administered and self-managed REIT, primarily engaged in the business of owning, managing, developing, and acquiring self-storage properties across the United States.

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.

Extra Space Storage (EXR) operates as a self-managed REIT, focusing on the acquisition, development, and operation of self-storage facilities across the U.S. They are one of the largest players in this space, benefiting from significant economies of scale and a robust management infrastructure. While not as glamorous as other real estate sectors, the self-storage business has proven remarkably resilient, especially during times of economic uncertainty.

Business Overview and Revenue Distribution:

EXR’s revenue stream is fundamentally driven by rental income from its self-storage properties. This income depends on occupancy rates, which are the percentage of units that are rented out to customers and the rental rates that are charged for these units. Demand for self-storage is generally thought to be correlated with economic growth and housing turnover, though this does fluctuate. They also have a third-party management platform which generates management fee revenue.

  • Self-Storage Operations: This segment comprises the largest portion of EXR’s revenues. Revenue is generated from rental income on storage units, late fees, sales of merchandise, and tenant protection plans.
  • Tenant Reinsurance Program (TRP): This program offers insurance or protection plans to tenants, acting as a form of fee income for EXR.
  • Property Management Operations: EXR generates fees by managing properties owned by other operators.
  • Other Income: This category includes other fees, interest income, and gains.
  • Acquisition and Development: This includes income or losses incurred by acquiring and developing new properties.
  • EXR does NOT generate income through trading property and that’s mostly kept for stable revenue through time.

Industry Trends and Competitive Landscape

  • Demand: The self-storage industry benefits from life events that require temporary storage (moving, downsizing, death, or divorce), along with growing consumerism trends and greater focus on space efficiency within homes. The pandemic led to an increase in demand, largely due to factors like people moving more due to job changes, college students having to move out, and more people moving in together. While demand has cooled down somewhat from those highs, these are not going to affect companies ability to generate revenue at a profitable level, it’s only the growth.
  • Competition: While a fragmented market, EXR and its peers, Public Storage (PSA) and CubeSmart (CUBE), control a large portion of the self-storage market, leaving smaller operators struggling to compete on price or quality of units. This has helped them build economies of scale. Even though it’s fragmented there are certain barriers to entry, and that’s what creates a moat for the bigger players, that will be discussed in the next point.
  • Technology Adoption: Companies are using data analysis, digital booking and customer service, and more digital marketing to improve efficiency and better manage yield.
  • M&A: There are increasing consolidations among the larger operators and more private equity involvement in acquisitions.

Moat Analysis: 3/5

EXR has a Narrow Moat with good justification, though. Here is why and why it’s rated 3/5:

  • Scale and Brand Advantage: EXR is one of the largest operators in the self-storage sector. Scale has several advantages:
    • Pricing Power: More locations give them more visibility and allows them to attract customers, also giving more location choice for their existing customers. Also the more they are present, the more ability to increase rental prices since people will not have many options.
    • Economies of Scale: EXR can spread out corporate and overhead costs across a larger revenue base. They have standardized practices and an integrated operating platform which adds to further efficiency. All of this also is due to their ability to acquire smaller operators, which helps increase density in existing areas and also reduce competition.
    • Brand Recognition: They have created a level of reputation that attracts customers and also increases their occupancy rates.
  • Barriers to Entry: Even though it’s a fragmented market, there is a reasonable barrier to entry and the biggest players like EXR are able to benefit from that due to strong positioning. These barriers are:
    • Physical space: Physical properties are needed to establish a storage facility. So, a lot of effort is put by these companies in choosing the place. There will need zoning permissions, and permits to be approved, which are not always easy. Also, some of the times, finding suitable real estate at a suitable price may be challenging.
    • Local Economies: Even though the business seems fairly simple on the surface, to do it well is extremely hard. Understanding local demographics, what are the requirements of the market and knowing the competition are all essential requirements. Companies must have this level of local knowledge to thrive.
    • Brand Recognition: Having a brand name does help in attracting customers. Creating a recognizable brand, which implies stability, quality, and trust in the services is very difficult for new players. This brand recognition and the trust that comes with it helps in capturing more revenue.
  • Mistaken Moats:
    • Operational Excellence - As a public REIT, EXR has to be at a certain level of efficiency, or they will not get a lot of investors. Management is under pressure to perform. This is needed just to survive, which makes it an “efficiency moat”, that every single company should strive for. It’s not really a structural moat.

Risks to the Moat and Business Resilience

  • Economic Sensitivity: While the self-storage sector is generally resilient, a sharp economic downturn could reduce housing turnover and demand for self-storage units. Recessionary periods may also make it more difficult for tenants to pay their bills.
  • Supply: Overbuilding in certain markets is a consistent problem. New construction of supply is what erodes all pricing power. And though the market is currently under supplied and that situation may persist for sometime, the company will need to continue to control the supply.
  • Competition: Although industry is consolidated, there are still more competitors, which will compete with them in attracting new customers. Competitors with large pockets, or companies that have unique ways to drive customers could become a threat for EXR and it’s earnings power.
  • Interest Rate Risk: As a REIT, EXR is sensitive to rising interest rates. Such increases increase their borrowing costs and reduce the amount of money that’s available for investors. Changes in interest rates can cause their stock to trade at lower valuations, which may also cause issues in acquiring new businesses.
  • Geopolitical Risk: Anything causing a global financial crisis could hurt the stock and performance of EXR, even if they might be able to sustain themselves.

Financial Analysis:

The following is a summary of EXR’s financials, utilizing both historical and forward-looking estimates based on recent reports and earnings call information.

  • Revenue Growth: Revenue has been increasing at a fast rate, especially from 2021 onwards due to the pandemic boom and a general increase in the storage industry. Revenue growth may slightly decrease from those high rates but continue to grow. In 2022 and 2023 the company grew revenues at 16.3% and 17.1% respectively. Although, they are not forecasting a significant increase in sales for 2024 due to an expectation of “more normalized” growth.
  • Margins: The operating margin seems to have come down slightly in the last couple of years, from 53.2% in 2020 to 48.4% in 2023. This decline is due to increase in property operating expenses and bad debt, because of the current macro economic environment. Their focus is now on operational efficiencies to help increase margins back to more historical levels.
  • Profitability The company has shown a decrease in profitability due to increased operation costs, but still has a high return on equity over time. As of the last quarter, they have reported ROE of 13.2%
  • EXR earns revenue on rent and other fees but because of the way accounting is done for REIT’s they also incur significant expenses for amortization and depreciation. Their ability to manage cash flow for shareholders is important since it’s a good measure on their profitability.
  • Capital Allocation: Their capital allocation is important to understand and see where the cash goes. A significant amount of cash is spent on growth through acquisitions, but they also pay significant dividends to their share holders. Since they have a high level of leverage, their management of debt is also equally important.
  • Leverage: They have an average amount of leverage, which does not cause immediate worry. If rates increase then they will try to improve the amount of leverage they use in order to achieve same profitability for the companies. Currently the total debt to total capitalization sits at 39.7%.
  • Cash: The company has decent cash on hand, but is reliant on continuous access to debt and equity markets. As of 2023, cash and equivalents sit at $52 million.

Although it is a large company and faces the same market forces that the rest do, one things that sets them apart from others is their strategy. As a REIT company, it should theoretically benefit their investors by having a good capital return policy and by paying dividends. But, EXR is very unique in this segment, that they have been focused on reinvesting cash into growth. This growth strategy has allowed them to grow at a much faster pace than their peers. That doesn’t mean they are ignoring dividend payouts, it’s just that they want to improve growth first and then dividends, which they also intend on doing.

Understandability: 3/5 The self-storage business model itself is very simple to understand. However, the technicalities and financial statements are still very complex for someone not used to analyzing REITS. Here’s why I have assigned a 3/5:

  • Simple Business: The core business of renting out storage units is easy to grasp.
  • REIT Structure: REITS are complex for people to understand. The nuances of real estate, the need for certain levels of equity to debt, are complex and may need significant knowledge to understand.
  • Financial Complexity: The company has complex financial statements with lots of jargon and numbers, and a thorough understanding is needed to make investment decision.

Balance Sheet Health: 4/5 The company seems to be at an okay position, not great, but not bad either. With a good mix of debt and equity and a focus on increasing their profitability, their balance sheet is healthy. Though, there are some risks:

  • Adequate Liquidity: They have a decent amount of cash, but not a lot of surplus cash. However, they are able to generate cash from operations, and have continuous access to debt and equity market if needed.
  • Manageable Leverage: They have a good mix of debt and equity on their balance sheet. They have been consistently increasing equity which is good for the long-term success of the company. They seem to be focused on debt management going forward and that is a good thing.
  • Good coverage ratios: They have a good interest coverage ratio, which also helps in decreasing their interest expense and also makes it more probable that their debts will be paid back.

Recent Concerns and Management’s Stance:

  • Rising Interest Rates: During their recent calls, management has recognized the potential risks of rising interest rates. They’ve stressed on their plan to deleverage and also mentioned that a large portion of their debt is fixed, therefore making them more resilient against the rate increases. They also look at interest rate increases as something that is temporary, with a possible rate cut in late 2024 or 2025, so they remain bullish about their longer term prospects.
  • Slower Growth: The pandemic had created an unsustainable boom that had caused a lot of increase in both revenues and margins. It has come down over the last year or so and that has caused some unease, which resulted in declining stock prices. Management has said that they were expecting a much slower growth rate in the future, and that means that a more normalized growth should be expected.
  • Acquisition premium: The company has been in a state of acquisition for a long time. Although that has helped them grow revenues, the cost of acquiring them has increased as a result, which has negatively impacted ROIC. In that sense, investors are looking for more organic growth than what has been offered in the past.

In summary, Extra Space Storage Inc. is a company with a narrow moat, which benefits from its scale, brand, and some barrier to entry. Though, due to their leverage they can be sensitive to interest rate increases and also supply side problems. They are a reasonably understandable company with a healthy balance sheet, that’s focused on organic growth rather than acquisition based growth.