Extra Space Storage Inc. annual report, FY2017

Extra Space Storage Inc. 2017 Form 10-K Summary

Business Context and Reporting Period

Extra Space Storage Inc. is a self-managed, self-administered REIT focused on owning, operating, acquiring, developing and managing self-storage properties. The filing covers the fiscal year ended December 31, 2017; it is an annual filing rather than a standalone fourth-quarter report. The company operated two reportable segments: self-storage operations and tenant reinsurance.

Owned and/or operated 1,483 stores in 39 states, Washington, D.C. and Puerto Rico.
Portfolio included approximately 112.1 million rentable square feet, approximately 1.02 million units and approximately 835,000 tenants.
Owned or held interests in 1,061 operating stores and managed 422 additional stores for third parties.

Key Financial Metrics

Metric	2017	2016	Change
Total revenues	$1.105 billion	$991.9 million	11.4%
Income from operations	$541.6 million	$449.8 million	20.4%
Net income	$514.2 million	$397.1 million	29.5%
Net income attributable to common stockholders	$479.0 million	$366.1 million	30.8%
Basic diluted EPS	$3.79 / $3.76	$2.92 / $2.91	29.8% / 29.2%
Funds from operations attributable to common stockholders and unit holders	$590.2 million	$494.7 million	19.3%
Net cash provided by operating activities	$597.4 million	$539.3 million	10.8%
Total assets	$7.455 billion	$7.091 billion	5.1%
Cash and cash equivalents	$55.7 million	$43.9 million	Increase

Income from operations represented approximately 49.0% of revenue. Common-stockholder net income represented approximately 43.3% of revenue. Quarterly fourth-quarter 2017 revenue was $281.8 million, net income attributable to common stockholders was $216.0 million and diluted EPS was $1.69.

Property rental revenue increased 11.9% to $967.2 million, driven by acquisitions and higher rental rates.
Tenant reinsurance revenue increased 12.7% to $98.4 million.
Same-store revenue increased 5.1% and same-store NOI increased 6.9% to $607.1 million across 701 stores.
Same-store year-end occupancy increased to 91.9% from 91.5%.
Dividends paid increased to $3.12 per common share from $2.93.

Debt, Liquidity and Capital Allocation

Total face-value debt, including revolving lines, was $4.601 billion at year-end, compared with $4.364 billion in 2016. Reported debt-related liabilities, net of discounts and issuance costs, were approximately $4.554 billion.
Debt consisted primarily of $2.8 billion of secured notes, $1.7 billion of unsecured notes and $604.3 million of exchangeable senior notes, together with $117.4 million of notes payable to trusts and $94.0 million drawn on revolving lines.
Revolving credit capacity was $600.0 million, of which $506.0 million was undrawn.
Debt to total enterprise value was 28.1%, compared with 29.6% in 2016. Approximately 74.7% of debt was fixed-rate or effectively fixed-rate through interest-rate swaps.
Weighted-average interest rate was 3.3%, compared with 3.0% in 2016. Approximately $1.2 billion of debt was exposed to variable rates, excluding debt hedged with swaps.
Management stated that the company was in compliance with all financial covenants and expected to fund near-term requirements through operating cash flow, cash on hand and revolving borrowings.
Contractual obligations totaled $5.321 billion, including $4.601 billion of principal and $566.9 million of estimated interest.
Operating cash flow was $597.4 million, while investing cash flow was an outflow of $369.6 million and financing cash flow was an outflow of $216.0 million.

Material Changes Versus the Prior Comparable Period

The company acquired 46 stores for total consideration of $627.5 million, compared with 99 stores acquired for $1.087 billion in 2016.
The company sold 36 stores to a new joint venture for approximately $295.0 million and recognized a gain of $118.8 million. This transaction was a significant contributor to the increase in reported earnings.
Interest expense increased 15.0% to $153.5 million, primarily because of higher debt balances and a higher average interest rate.
Acquisition-related expense declined to zero from $12.1 million because the adoption of ASU 2017-01 resulted in qualifying acquisition costs being capitalized as asset acquisition costs rather than expensed.
General and administrative expense declined 3.5%, partly because 2016 included a $4.0 million legal settlement expense.
The company adopted or implemented accounting changes affecting business-combination classification, stock compensation and derivative accounting. Comparability of earnings and acquisition-related expenses should be considered in light of these changes.
Income tax expense declined to $3.6 million from $15.8 million, including an $8.6 million benefit from remeasurement of deferred tax balances following the 2017 Tax Legislation.

Guidance, Outlook, Commentary and Risks

The filing does not provide formal quantitative earnings or revenue guidance. Management described continued focus on revenue management, cost control, acquisitions, development, redevelopment, third-party management and joint ventures. Management expects certificate-of-occupancy acquisitions to continue in 2018; these properties may dilute earnings during their two-to-four-year lease-up period.

Self-storage operations are seasonal, with higher revenue and profit generally realized from May through September.
Competition from existing and newly developed facilities may pressure occupancy, rental rates and expenses.
Month-to-month leases provide pricing flexibility but also expose the company to rapid tenant turnover and weaker re-leasing rates.
Interest-rate increases could raise expense and reduce cash available for distributions. A 100-basis-point change in variable rates was estimated to affect annual earnings and cash flow by approximately $11.6 million.
The company is exposed to refinancing and liquidity risk, particularly because significant principal maturities occur in 2018 through 2022.
Joint ventures reduce the company’s control over certain properties and expose it to partner performance, disputes and funding risks.
Uninsured losses, environmental liabilities, natural disasters, legal claims, regulatory changes and cybersecurity incidents could adversely affect results.
The company reported $2.1 million of hurricane-related property damage, net of insurance recoveries, and $2.3 million of tenant reinsurance claims related to Hurricanes Harvey, Irma and Maria.
As of year-end, the company had agreements to acquire 14 stores for $190.2 million and 17 stores with joint venture partners requiring total investment of $88.2 million.
A $400.0 million share repurchase program was authorized in November 2017, but no repurchases had occurred by year-end.
The company reported no material impairment of operating stores, although it recorded a $6.1 million impairment on undeveloped land.

Important Facts for Investors to Verify

Reconcile reported earnings growth with the $118.8 million gain on the 36-store joint-venture disposition and the $8.6 million tax benefit.
Assess recurring operating performance using same-store NOI, occupancy, rent growth and FFO rather than GAAP net income alone.
Review debt maturities, refinancing assumptions, covenant requirements and exposure to variable interest rates.
Evaluate the effect of ASU 2017-01 on acquisition expense capitalization and period-to-period comparability.
Monitor the lease-up progress and potential earnings dilution from certificate-of-occupancy acquisitions.
Review commitments for pending acquisitions, joint-venture funding and contractual obligations.
Consider REIT qualification, tax-law changes, tenant reinsurance regulation and the company’s ability to maintain required distributions.
The independent auditor, Ernst & Young LLP, issued unqualified opinions on the consolidated financial statements and internal control over financial reporting.