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Why Duke Realty Thinks Its Stock Is Cheap

If you ask people if they are above average, almost everyone will say yes. So it shouldn’t be too shocking to hear that real estate investment trust (REIT) Duke Realty (NYSE: DRE), which is run by human beings, thinks it is being underpriced by Wall Street. Only it may just have a reason to complain. Here’s a quick look at why Duke Realty thinks its stock is too cheap today.

An interesting industrial play

The core of Duke Realty’s business is industrial properties. At the end of 2020, Duke owned 534 U.S. properties focused on the logistics market. This is a sector that has been fairly hot of late because of the coronavirus pandemic, which has increased the use of online shopping and, thus, the need for things like warehouse space. That said, this was a longer-term trend already taking shape, so it isn’t exactly a new thing. The pace of change was simply sped up.

Last year was a pretty good year for the REIT, with Duke’s adjusted funds from operations, a REIT-specific metric that’s similar to earnings for an industrial company, up 6.2{77ce8f5c13f5afba9075485d3cf7c497b0ab33a4437bbe9a3594fe3360863398}. It increased its dividend a generous 9.1{77ce8f5c13f5afba9075485d3cf7c497b0ab33a4437bbe9a3594fe3360863398}. That dividend, meanwhile, is backed by an adjusted FFO payout ratio of around 70{77ce8f5c13f5afba9075485d3cf7c497b0ab33a4437bbe9a3594fe3360863398}, which is a very reasonable figure.

Duke’s stock is even up 12{77ce8f5c13f5afba9075485d3cf7c497b0ab33a4437bbe9a3594fe3360863398} since the start of 2020, before the coronavirus pandemic really got underway. That compares quite favorably to the average REIT, using Vanguard Real Estate Index ETF (NYSEMKT: VNQ) as a proxy, which is down nearly 6{77ce8f5c13f5afba9075485d3cf7c497b0ab33a4437bbe9a3594fe3360863398} over that span. And yet, Duke thinks it isn’t getting a fair shake from Wall Street.

What’s the beef?

For example, Duke’s balance sheet has earned it a credit rating of BBB. That’s investment grade and certainly not bad. However, it believes it should be rated at A, which would lower its cost of capital and give it better bragging rights. It happily puts itself up against peers, looking at some key metrics, including net debt plus preferred to market cap, net debt-to-EBITDA, and fixed-charge coverage — all of which are in line with REITs that have credit ratings of A.

But Duke Realty’s issues don’t stop there. When it released its fourth-quarter 2020 earnings, management highlighted that the REIT’s price to adjusted FFO multiple (as of Feb. 17) was 28 times, which was at the low end of its peers. Industry giant Prologis (NYSE: PLD), for comparison, had a price to adjusted FFO multiple of 32 times. Duke reported its NAV premium at the time as 14{77ce8f5c13f5afba9075485d3cf7c497b0ab33a4437bbe9a3594fe3360863398}, compared to 26{77ce8f5c13f5afba9075485d3cf7c497b0ab33a4437bbe9a3594fe3360863398} for bellwether Prologis.

Meanwhile, Duke believes it has more development opportunities than any of its peers, including twice the level of Prologis. That suggests that future growth will be relatively robust. And it has been able to grow its rents at the top end of the group, with a 29{77ce8f5c13f5afba9075485d3cf7c497b0ab33a4437bbe9a3594fe3360863398} average in 2020 and an annualized increase of 28{77ce8f5c13f5afba9075485d3cf7c497b0ab33a4437bbe9a3594fe3360863398} over the trailing three years. Both of those metrics are better than what Prologis has achieved.

Now what?

For value-conscious investors, it would be hard to suggest that a REIT with a price to adjusted FFO multiple of 28 times is cheap, even if that ratio is lower than its peers. But Duke does appear to have a valid gripe about Wall Street’s relatively dour view when it starts to compare itself to its peers for balance-sheet strength, growth, and valuation. Of course you need to take the REIT’s assertions with a grain of salt; after all, there are more accurate measures of value than a company’s own opinion of itself. But if you’re looking at industrial REITs today, Duke is probably worth a pretty close look.