Extra Space Storage Inc. quarterly report, Q2 FY2016

Extra Space Storage Inc. — Q2 2016 Form 10-Q Summary

Business context and reporting period

Extra Space Storage is a fully integrated, self-managed REIT focused on owning, operating, acquiring, developing, redeveloping and managing self-storage properties. The filing covers the three and six months ended June 30, 2016, with comparative periods ended June 30, 2015.

At June 30, 2016, the company had direct or indirect ownership interests in 1,035 stores and managed an additional 377 stores, for 1,412 stores across 37 states, Washington, D.C. and Puerto Rico.
The owned or managed portfolio contained approximately 106 million rentable square feet, 945,000 units and approximately 864,000 tenants.
The company operates through rental operations, tenant reinsurance, and property management, acquisition and development.

Financial performance and key metrics

Metric	Three months ended June 30, 2016	Three months ended June 30, 2015	Six months ended June 30, 2016	Six months ended June 30, 2015
Total revenue	$244.3 million	$185.9 million	$473.7 million	$359.0 million
Income from operations	$110.3 million	$81.6 million	$203.9 million	$157.0 million
Net income	$90.0 million	$61.0 million	$179.4 million	$119.6 million
Net income attributable to common stockholders	$83.0 million	$55.3 million	$165.6 million	$109.1 million
Diluted EPS	$0.66	$0.47	$1.32	$0.92
FFO attributable to common stockholders	$120.9 million	$90.1 million	$225.8 million	$174.6 million

Second-quarter revenue increased 31.4%; six-month revenue increased 31.9%.
Second-quarter income from operations increased 35.2%; six-month income from operations increased 29.9%.
Second-quarter net income attributable to common stockholders increased 50.1%; six-month growth was 51.8%.
Approximate operating margin was 45.2% in Q2 2016 versus 43.9% in Q2 2015. Net margin attributable to common stockholders was approximately 34.0% versus 29.8%.
FFO increased approximately 34.2% in the quarter and 29.4% for the first six months.
Cash dividends paid per common share were $0.78 in Q2 and $1.37 for the first six months, compared with $0.59 and $1.06, respectively, in the prior-year periods.

Operating trends and material changes

Property rental revenue increased 31.5% in Q2 and 32.7% year to date, primarily from acquisitions, higher occupancy and higher rental rates.
Wholly owned stabilized-store occupancy increased to 93.6% at June 30, 2016 from 92.8% on a comparable prior-year basis. Total stabilized-store occupancy was 93.5% versus 92.5%.
Same-store rental and tenant-reinsurance revenue increased 7.6% in Q2 and 8.3% for the first six months. Same-store net operating income increased 9.4% and 10.8%, respectively.
Average annual rent per square foot for existing customers at stabilized stores increased to $15.33 from $14.35; new-lease rent increased to $16.61 from $15.62.
The company acquired 45 stores during the first six months for total consideration of approximately $469.9 million, including $401.9 million of cash, assumed debt and $56.2 million of Operating Partnership units.
Management expanded to 629 joint-venture and third-party stores from 532, while total owned and managed stores increased to 1,412 from 1,147.
Expenses increased 28.5% in Q2 and 33.6% year to date, with depreciation and amortization rising 39.3% and 40.1%, respectively, primarily due to acquisitions.

Cash flow, debt and liquidity

Net cash provided by operating activities was $239.7 million for the first six months, compared with $183.3 million in 2015.
Net cash used in investing activities was $406.0 million, including $435.3 million for real estate acquisitions and $14.4 million for development and redevelopment.
Net cash provided by financing activities was $131.6 million. Financing included $492.9 million of proceeds from notes payable and lines of credit, $222.9 million of principal repayments, $171.5 million of common dividends and $22.2 million for repurchases of exchangeable senior notes.
Cash and cash equivalents declined to $41.1 million from $75.8 million at December 31, 2015.
Face value of total debt, including lines of credit, was $3.856 billion. Debt to total enterprise value was 23.8%, the weighted-average interest rate was 3.1%, and 78.0% of total debt and related instruments was fixed-rate or effectively fixed-rate through swaps.
Credit facilities totaled $360.0 million, of which $88.0 million was drawn at June 30, 2016. Management reported compliance with all financial covenants.
The company expects to fund operating expenses, recurring capital expenditures, dividends, distributions and interest from operating cash flow, cash on hand and credit facilities, but stated that additional borrowing, joint ventures and equity or debt offerings will likely be needed for broader liquidity needs and acquisitions.

Guidance, outlook, risks and unusual items

The filing does not provide specific earnings or same-store operating guidance.
Management intends to maximize store performance, pursue acquisitions and expand its management platform. The company also had contracts to acquire 16 stores for approximately $190.7 million and 21 stores with joint-venture partners for approximately $409.9 million.
Q2 and year-to-date results included an $11.3 million gain on the sale of seven stores and a $93,000 gain on the exchange of one store. The first six months also included a $26.9 million non-cash gain from remeasuring an existing joint-venture interest in connection with a six-store step acquisition.
A $4.0 million litigation liability was recorded during the first six months in connection with allegations involving wrongful foreclosure, state self-storage statutes and consumer fraud laws. Management stated that litigation outcomes remain uncertain and potential exposure could exceed accrued amounts.
Interest-rate swaps had a net liability fair value of $53.1 million and a combined notional amount of $2.1 billion. The company estimated that $19.4 million would be reclassified from accumulated other comprehensive income into interest expense during the remainder of 2016.
A 100-basis-point change in rates would affect annual earnings and cash flows by approximately $7.6 million for variable-rate debt not subject to floors or caps.
Key risks include competition, economic and real estate conditions, acquisition execution and integration, access to capital, higher interest rates and operating costs, property valuation declines, joint-venture performance, regulatory changes, litigation, environmental liabilities and maintenance of REIT status.
Subsequent to quarter-end, the company acquired one Hawaii store for $31.0 million and sold 550,000 common shares under its at-the-market program for net proceeds of $50.1 million.

Most important facts for investors to verify

Whether acquisition-driven growth can continue without excessive leverage or equity dilution.
Same-store occupancy, rental-rate growth, expense inflation and performance of the growing lease-up portfolio.
Available liquidity, upcoming debt maturities, credit-facility extensions and compliance with debt covenants.
The effect of interest-rate movements and the $53.1 million net derivative liability on future earnings and liquidity.
The ultimate cost and resolution of the pending litigation and any other contingencies.
The sustainability of dividends relative to operating cash flow, FFO and required REIT distributions.
The terms, timing and closing risk of contracted acquisitions and joint-venture transactions.