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LXP Industrial Trust: Don’t Expect Share Price Movement in the Near Future

LXP Industrial Trust: Don’t Expect Share Price Movement in the Near Future

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An Overview of LXP Industrial Trust

LXP Industrial Trust (NYSE:LXP) is primarily focused on single-tenant warehouse and distribution properties, which are leased out on a net lease basis. The company owns a portfolio of 116 properties in 20 states, with a strong presence in the Sunbelt and Midwest regions. LXP also provides construction financing to merchant builders for speculative properties.

Given the current elevated interest rate environment, it’s important to review the performance of the Industrial REIT sector and assess how LXP is positioned. In this article, we will analyze the relationship between interest rates and the industrial REIT sector, estimate LXP’s capitalization rate, and explore the cost of capital. These factors will help us understand the investment potential of LXP and whether the stock price is likely to move in the near future.

The Impact of Interest Rates on the Industrial REIT Sector

When evaluating investments, it’s crucial to consider the balance between risk and return. One way to assess this balance is by comparing dividend yield (equity return) with the yield on fixed-income instruments like corporate bonds. In Table 1, we compare the five-year total return from investing in LXP with the five-year median yield on Corporate Baa/BBB rated bonds.

Table 1: Comparison Between Equity and Fixed Income Return

  • Dividend Yield: 6.00%
  • 5-Year Dividend Growth Rate: -6.77%
  • Total Return: -0.77%

Based on this comparison, it’s evident that the dividend yield of LXP is not competitive with the yield on fixed-income instruments. This suggests that equity investors may consider reallocating their investment from LXP to bonds, potentially limiting the stock’s appreciation potential.

However, for investors interested in buying the entire business rather than just shares, it’s important to analyze the cash flows generated by the business, which we will discuss further.

The Cap Rates and Cost of Capital for LXP

The cap rate is a key measure for evaluating real estate assets and can provide insights into the relative valuation of a REIT sector. By analyzing LXP’s cap rate and cost of capital, we can assess the profitability of investing in the company.

Table 2 presents the historic relationship between the industrial REIT sector’s implied cap rate and the 10-year US Treasury from 2000 to 2019. The average cap rate for the sector during this period was 6.65%, with a spread of 328 basis points over the average 10-year Treasury rate of 3.37%. However, as of Q2 2023, the spread has narrowed significantly to just 9 basis points.

To estimate LXP’s cap rate, we consider the net operating income (NOI) divided by the value of the assets. Based on our calculations (Table 3), LXP’s cap rate stands at 6.59%, aligning closely with the historic average for the sector. This implies that LXP’s assets are priced in line with market expectations.

In order to assess the profitability of investing in LXP, we analyze the cost of capital, which consists of the cost of debt, cost of equity, and cost of preferred equity. By weighing each component by its proportion in the capital structure, we arrive at the weighted average cost of capital (WACC). For LXP, the WACC is calculated to be 7.44% (Table 7).

When comparing the cap rate (6.59%) with the WACC (7.44%), there is a negative spread of -0.86% (Table 8). A negative spread indicates an imbalance in the marketplace, suggesting that LXP’s cost of capital exceeds the return generated by its assets. This poses a risk to investors considering an investment in LXP.

Factors Influencing LXP’s Future Outlook

In order to restore a positive spread between the cap rate and the cost of capital, several factors need to be considered. One way to increase the cap rate is through higher net operating income (NOI). LXP has opportunities for NOI growth through re-leasing properties at higher rates and potential rent escalation.

On the other hand, to decrease the denominator in the cap rate calculation, either long-term debt or equity values need to decrease. A standout concern is the increase in LXP’s net debt to adjusted EBITDA ratio from 2020 to 2022, prompting a negative outlook from Moody’s (Table 9). Sustained high levels of debt could further increase the cost of equity and worsen the negative spread.

Conclusion: Hold Recommendation

Given the negative spread between LXP’s cap rate and cost of capital, it is difficult to recommend investing in the company at this time. However, it is important to note that the stock price is already at its 52-week low and LXP’s cap rate is in line with the sector average. There are potential opportunities for NOI growth through re-leasing and rent escalation. Additionally, management’s commitment to reducing net debt to adjusted EBITDA may provide stability to the stock price.

In summary, LXP’s share price is unlikely to experience significant movement in the near future. Investors should carefully consider factors such as the negative spread, current interest rate environment, and LXP’s financial metrics before making any investment decisions.