Sun Communities, Inc. is a US$13b large-cap, real estate investment trust (REIT) based in Southfield, United States. REIT shares give you ownership of the company than owns and manages various income-producing property, whether it be commercial, industrial or residential. The structure of SUI is unique and it has to adhere to different requirements compared to other non-REIT stocks. In this commentary, I'll take you through some of the things I look at when assessing SUI.
REIT investors should be familiar with the term Fund from Operations (FFO) – a REIT’s main source of cash flow from its day-to-day business activities. FFO is a higher quality measure of earnings because it takes out the impact of non-recurring sales and non-cash items such as depreciation. These items can distort the bottom line and not necessarily reflective of SUI’s daily operations. For SUI, its FFO of US$363m makes up 53% of its gross profit, which means over a third of its earnings are high-quality and recurring.
In order to understand whether SUI has a healthy balance sheet, we have to look at a metric called FFO-to-total debt. This tells us how long it will take SUI to pay off its debt using its income from its main business activities, and gives us an insight into SUI’s ability to service its borrowings. With a ratio of 12%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take SUI 9 years to pay off using just operating income, which is a long time, and risk increases with time. But realistically, companies have many levers to pull in order to pay back their debt, beyond operating income alone.
I also look at SUI's interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it's better to use FFO divided by net interest. With an interest coverage ratio of 2.73x, SUI is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.
In terms of valuing SUI, FFO can also be used as a form of relative valuation. Instead of the P/E ratio, P/FFO is used instead, which is very common for REIT stocks. SUI's price-to-FFO is 37.08x, compared to the long-term industry average of 16.5x, meaning that it is overvalued.
Sun Communities can bring diversification into your portfolio due to its unique REIT characteristics. Before you make a decision on the stock today, keep in mind I've only covered one metric in this article, the FFO, which is by no means comprehensive. I'd strongly recommend continuing your research on the following areas I believe are key fundamentals for SUI:
- Future Outlook: What are well-informed industry analysts predicting for SUI’s future growth? Take a look at our free research report of analyst consensus for SUI’s outlook.
- Valuation: What is SUI worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether SUI is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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