Essex Property Trust, Inc. is a US$22b large-cap, real estate investment trust (REIT) based in San Mateo, United States. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how ESS’s business operates and also how we should analyse its stock. In this commentary, I'll take you through some of the things I look at when assessing ESS.
Funds from Operations (FFO) is a higher quality measure of ESS's earnings compared to net income. This term is very common in the REIT investing world as it provides a cleaner look at its cash flow from daily operations by excluding impact of one-off activities or non-cash items such as depreciation. For ESS, its FFO of US$827m makes up 80% of its gross profit, which means the majority of its earnings are high-quality and recurring.
Robust financial health can be measured using a common metric in the REIT investing world, FFO-to-debt. The calculation roughly estimates how long it will take for ESS to repay debt on its balance sheet, which gives us insight into how much risk is associated with having that level of debt on its books. With a ratio of 15%, the credit rating agency Standard & Poor would consider this as significantly high risk. This would take ESS 6.78 years to pay off using operating income alone. Given that long-term debt is a multi-year commitment this is not unusual, however, the longer it takes for a company to pay back debt, the higher the risk associated with that company.
I also look at ESS'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 3.75x, it’s safe to say ESS is generating an appropriate amount of cash from its borrowings.
In terms of valuing ESS, 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. In ESS’s case its P/FFO is 26.55x, compared to the long-term industry average of 16.5x, meaning that it is overvalued.
As a REIT, Essex Property Trust offers some unique characteristics which could help diversify your portfolio. However, before you decide on whether or not to invest in ESS, I highly recommend taking a look at other aspects of the stock to consider:
- Future Outlook: What are well-informed industry analysts predicting for ESS’s future growth? Take a look at our free research report of analyst consensus for ESS’s outlook.
- Valuation: What is ESS 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 ESS 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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