Extra Space Storage Inc. annual report, FY2018

Extra Space Storage Inc. 2018 Form 10-K Summary

Business context and reporting period

Extra Space Storage Inc. is a self-administered and self-managed REIT focused on owning, operating, acquiring, developing, redeveloping and managing self-storage properties. It also operates a tenant reinsurance business. This filing covers the fiscal year ended December 31, 2018, with comparative information for 2017 and 2016. The filing was signed February 26, 2019.

At year-end, the company owned or operated 1,647 stores in 39 states, Washington, D.C. and Puerto Rico, totaling approximately 125.7 million rentable square feet and 1.2 million units.
The portfolio included 1,111 owned or partially owned stores and 536 stores managed for third parties.
The company operated through an UPREIT structure and reported 3,624 employees.

Financial performance and key metrics

Metric	2018	2017	Change
Total revenue	$1,196.6 million	$1,105.0 million	8.3%
Income from operations	$619.7 million	$654.4 million	(5.3%)
Net income	$447.1 million	$514.2 million	(13.1%)
Net income attributable to common stockholders	$415.3 million	$479.0 million	(13.3%)
Diluted EPS	$3.27	$3.76	(13.0%)
FFO attributable to common stockholders and unit holders	$623.0 million	$590.2 million	5.6%
Cash flow from operations	$677.8 million	$597.4 million	13.5%
Dividends paid per common share	$3.36	$3.12	7.7%

Revenue consisted of $1,039.3 million of property rental revenue, $115.5 million of tenant reinsurance revenue and $41.8 million of management fees and other income.
Revenue increased primarily from acquisitions, new development stores, higher rental rates and growth in the managed-store base.
Approximate margins were 51.8% for income from operations, 37.4% for net income and 34.7% for net income attributable to common stockholders, based on total revenue.
Same-store rental revenue increased 4.1%, same-store NOI increased 4.0% to $696.2 million and same-store quarter-end occupancy was 91.8%, compared with 91.9% in 2017.
Average annual rent per square foot for existing customers at stabilized stores rose to $16.16 from $15.58; average rent for new leases rose to $17.65 from $16.58.

Cash flow, debt and liquidity

Operating cash flow was $677.8 million. Investing cash flow used $443.9 million, including $426.4 million for real estate acquisitions, $60.7 million for development and redevelopment, and $65.5 million invested in unconsolidated ventures.
Financing cash flow used $247.3 million, including $424.9 million of common-stock dividends. The company issued 933,789 shares through its ATM program and received approximately $90.2 million of net proceeds.
Cash and cash equivalents were $57.5 million, with total cash, cash equivalents and restricted cash of $72.7 million at year-end.
Face-value debt was approximately $4.85 billion, compared with $4.60 billion at year-end 2017. Debt to total enterprise value was 28.4%.
Debt consisted primarily of $2.9 billion of secured notes and $1.9 billion of unsecured notes. Approximately 74.1% of total debt and other instruments was fixed-rate or effectively fixed-rate through interest-rate swaps.
The weighted-average interest rate was 3.5%, compared with 3.3% in 2017. Approximately $1.3 billion, or 25.9% of debt, was exposed to variable rates excluding swaps.
Revolving credit capacity was $790.0 million, of which $709.0 million was undrawn at year-end. The company stated that it was in compliance with all financial covenants.
Management believes operating cash flow, cash on hand, available credit and capital-market access will fund reasonably anticipated needs over the next twelve months, including debt service, recurring capital expenditures, acquisitions and REIT distributions.

Material changes versus the prior comparable period

The company acquired 34 stores and opened three development stores in 2018, compared with 46 acquired stores in 2017. Total acquisition spending declined to $521.3 million from $642.6 million.
The store base increased to 1,647 from 1,483, while owned or partially owned stores increased to 1,111 from 1,061.
Property rental revenue increased 7.5%, tenant reinsurance revenue increased 17.4% and management fees and other income increased 6.0%.
Operating expenses increased 7.9%, including a 16.2% increase in interest expense to $178.4 million, driven by higher debt balances and higher LIBOR.
Income from operations and GAAP earnings declined despite revenue growth, primarily because 2017 included a $118.8 million gain on the sale of 36 stores to a joint venture, whereas 2018 included a $30.7 million gain on the sale of one store.
FFO increased 5.6%, reflecting growth in the operating portfolio and excluding the effect of real estate depreciation and disposition gains.
The company repaid all remaining 2013 exchangeable senior notes, including $49.3 million of principal, for total cash consideration of $80.3 million.
Total assets increased to $7.85 billion from $7.46 billion, while stockholders’ equity increased to $2.41 billion from $2.35 billion.

Outlook, commentary, risks and unusual items

Management expected positive operating cash flow in 2019 and anticipated continuing to acquire certificate-of-occupancy stores. These assets may dilute earnings during their two-to-four-year lease-up period.
At year-end, the company was under agreement to acquire 18 stores for $271.5 million and 13 stores with joint venture partners for a total company investment of $73.9 million. Most were scheduled to close in 2019.
Subsequent to year-end, the company acquired its partners’ interests in 12 stores in two joint ventures, paying $172.5 million in cash and assuming a $17.2 million loan.
The business is seasonal, with a greater portion of revenue and profit generally generated from May through September.
Key risks include competition and potential declines in occupancy or rental rates, economic and real estate-market conditions, acquisition execution, access to credit, interest-rate increases, refinancing risk, variable-rate debt, asset impairment, uninsured losses, environmental liabilities, legal claims, cybersecurity, joint-venture decision rights, tenant reinsurance regulation and continued qualification as a REIT.
A 100-basis-point change in rates on variable-rate debt was estimated to affect annual earnings and cash flow by approximately $12.6 million.
The company recorded no material real estate impairments in 2018. Litigation outcomes were described as uncertain, although management did not expect existing matters to have a material adverse effect.
The company adopted revenue-recognition and hedging standards without a material financial statement impact. It expected adoption of the new lease standard in 2019 to add approximately $90 million to $110 million of lease assets and liabilities.
Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting.

Most important facts for investors to verify

Confirm the sustainability of same-store NOI growth and occupancy, particularly given the slight year-over-year occupancy decline and increasing competition.
Reconcile the improvement in FFO and operating cash flow with the decline in GAAP net income and EPS, including the effect of 2017 disposition gains.
Review debt maturities, refinancing requirements and exposure to variable interest rates, including the $208.7 million principal due within one year and $915.6 million due in 2023.
Assess whether acquisition and development activity can generate acceptable returns without excessive lease-up dilution or additional leverage.
Evaluate liquidity after dividends, acquisitions, joint-venture investments and the subsequent acquisition of 12 stores.
Review REIT qualification, tenant reinsurance regulation, joint-venture obligations, environmental matters and unresolved litigation contingencies.
Verify the impact of the 2019 lease-accounting adoption and the company’s stated expectation of $90 million to $110 million in new lease assets and liabilities.