Why You Shouldn’t Look At Equity Residential’s (NYSE:EQR) Bottom Line
Equity Residential is a US$24.8b large-cap, real estate investment trust (REIT) based in Chicago, United States. REITs are basically a portfolio of income-producing real estate investments, which are owned and operated by management of that trust company. They have to meet certain requirements in order to become a REIT, meaning they should be analyzed a different way. In this commentary, I’ll take you through some of the things I look at when assessing EQR.
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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 EQR’s daily operations. For EQR, its FFO of US$1.3b makes up 77% of its gross profit, which means the majority of its earnings are high-quality and recurring.
EQR’s financial stability can be gauged by seeing how much its FFO generated each year can cover its total amount of debt. The higher the coverage, the less risky EQR is, broadly speaking, to have debt on its books. The metric I’ll be using, FFO-to-debt, also estimates the time it will take for the company to repay its debt with its FFO. With a ratio of 14%, the credit rating agency Standard & Poor would consider this as significantly high risk. This would take EQR 7.08 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.
Next, interest coverage ratio shows how many times EQR’s earnings can cover its annual interest payments. Usually the ratio is calculated using EBIT, but for REITs, it’s better to use FFO divided by net interest. This is similar to the above concept, but looks at the nearer-term obligations. With an interest coverage ratio of 3.23x, it’s safe to say EQR is generating an appropriate amount of cash from its borrowings.
I also use FFO to look at EQR’s valuation relative to other REITs in United States by using the price-to-FFO metric. This is conceptually the same as the price-to-earnings (PE) ratio, but as previously mentioned, FFO is more suitable. In EQR’s case its P/FFO is 19.19x, compared to the long-term industry average of 16.5x, meaning that it is slightly overvalued.
Next Steps:
Equity Residential 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 EQR:
Future Outlook: What are well-informed industry analysts predicting for EQR’s future growth? Take a look at our free research report of analyst consensus for EQR’s outlook.
Valuation: What is EQR 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 EQR 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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
