by Will Ashworth | August 23, 2011 8:57 am
If you’re looking to rent a high-end apartment in New York, Boston, Washington, D.C., or San Francisco, AvalonBay Communities (NYSE:AVB) probably has something available from its inventory of 46,000 units. However, if you are looking for a good real estate stock to own, I’d pass. Here’s why:
AvalonBay is selling up to 5.9 million of its shares to investors willing to part with $128.25 per share. That’s a 6.6% dilution to existing stockholders. With maximum net proceeds of $754 million, it will likely buy additional buildings and/or develop new properties in its four existing markets.
There’s certainly nothing wrong with the plan. These buildings cost a great deal of money. In the second quarter, for example, it started construction on three separate projects that will be home to 506 apartments at a capitalized cost of $406,000 per unit. It’s no wonder a two-bedroom apartment in Brooklyn rents for $3,700 a month. Even at nosebleed prices, it’s an eight- or nine-year timeframe to get your dime back.
None of this bothers me. Real estate is a long-term game. What does concern me is the simple fact that stock offerings usually happen because the company’s top executives believe its shares are trading at a particularly high price and they want to maximize financing. Smart move in the short term, but it usually ends up hurting shareholders.
Besides the tip-off from management, one needs only to look at its current valuation versus the past as well as its peers. AvalonBay’s Graham number, a calculation that value-investing master Benjamin Graham used to estimate the current fair value of a stock, is $35.76. Going back in time to 2008 when its earnings per share were $5.19 — the highest AvalonBay had experienced in a decade — the fair value was $65.80, approximately 13.3% below the average of the high and low that year. The current fair value is 71.5% below the average of the high and low so far in 2011. In this instance, below is bad.
Another quick way to judge a stock is to look at its enterprise value to EBITDA. AvalonBay’s is 27.5, while its four largest peers — Equity Residential (NYSE:EQR), UDR (NYSE:UDR), Essex Property Trust (NYSE:ESS) and Camden Property Trust (NYSE:CPT) — are all lower than that, with an average of 22.7. Any way you slice it, no matter the metric, I think you’ll find its stock is pricey.
Its second-quarter results were reasonably good, as revenues increased 11% to $244.9 million and funds from operations rose 8.7% to $1.13 per share, thanks in part to a 4.8% increase in average rental rates. Unfortunately, its third-quarter estimate of $1.15 to $1.18 per share in funds from operations was eight cents lower than analyst expectations, sending its stock on a downward spiral that it has yet to recover from.
As a direct result of this guidance shortfall, KeyBanc downgraded AvalonBay’s stock from “buy” to “hold” and withdrew its $138 price target. This follows an earlier downgrade by Jefferies Group from “hold” to “underperform.” I’ve never been a big follower of analyst upgrades or downgrades, but some investors find them helpful in their decision-making. I think the important point to understand about these downgrades is they weren’t issued because of a problem in the business; rather, they were a reflection of a stock price that got ahead of itself.
AvalonBay owns properties in some of the strongest residential real estate markets in the country. It’s not a bad company, but I wouldn’t buy the stock.
As of this writing, Will Ashworth did not own a position in any of the stocks named here.
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