Equity LifeStyle: Buy-The-Dip Opportunity Near 52-Week Low (NYSE:ELS)

It pays to be a contrarian when the chips are down for certain stocks and sectors. While some investors may try to overthink it, value investors may be better served to layer into quality companies when they are out of favor with the market.

In the words of Buffett, the market is a voting machine in the short run, and is a weighing machine in the long run. This brings me to Equity LifeStyle Properties (NYSE:ELS), which I last covered in July of last year, noting its quality locations and strong balance sheet, but with a valuation that seemed a bit high.

Since then, ELS has seen bottom-line growth and its share price dipped by 7%, due in large part to market fears around a higher-for-longer interest rate environment. Both of these factors have helped to drive down its P/FFO valuation. As shown below, ELS stock now sits at a 52-week low!

In this article, I revisit ELS including its operating fundamentals, and discuss what makes now a better time to buy into this quality stock, so let’s get started!

Why ELS?

Equity LifeStyle Properties is one of the largest manufactured housing REITs in North America, with 451 properties spread across 35 U.S. states and 1 Canadian province. It was founded in 1969 by Sam Zell, who passed away last year, and is a member of the S&P MidCap 400.

Similar to peer Sun Communities (SUI), ELS also owns RV (recreational vehicle) resorts, campgrounds, and marinas in desirable locations across North America. As shown below, ELS’s properties are located in densely populated regions with above average population growth in the Age 55+ category, particularly in the warmer states of Florida, Arizona, and California.

Manufactured Housing REITs are well known for the economic resiliency and for their responsiveness to inflation. This is reflected by ELS’s closing of a strong 2023, during which Core MH base rental income grew by 6.8% YoY. In addition, ELS has made meaningful progress towards addressing the lack of housing supply in the U.S., by adding 994 expansion sites and new home sales of 905 units last year.

Also encouraging, total core income from property operations rose by 5.2% YoY during Q4’23, which is not too far off from 5.7% YoY growth in Q1’23, when I last visited the stock. This translated into robust NFFO per share growth of 11% YoY during the fourth quarter, from $0.64 in the prior year period to $0.71.

This enabled ELS to continue its strong track record of bottom-line growth. As shown below, ELS has seen a NFFO per share CAGR of 9% and Dividend per share CAGR of 21% over the past 18 years (11% Dividend CAGR over the past 10 years)

Looking ahead, ELS is well positioned to capture favorable demand trends, on back of 13% mark-to-market rental increase in 2023. This is reflected by ELS’s 2024 guidance for 5.6% NOI growth and 4.7% NFFO per share growth at their respective midpoints of range. Management also seeks to pursue external growth opportunities in the strategic Sunbelt markets of Florida, California, Arizona and Texas, a region that has represented two-thirds of ELS’s new property acquisitions and developments over the past five years.

I view this focus as being a good move, considering that it sets up ELS for anticipated future demand from generations currently in the workforce. This is supported by management’s comments during the last conference call on expected growth in the senior population over the next 20 years.

I’d also point out that subsequent generational cohorts, Gen X, Millennials and Gen Z follow similar aging trends as the baby boomers. Note that millennials will start to retire in 20 years, and they represent a population of 74 million, or 5 million more than the baby boom generation.

Overall, the U.S. population, 55 plus, is projected to increase 6.4% over the next 5 years. While our Sunbelt properties in Florida, California, Arizona and Texas are projected to increase 8.5%, outpacing the national growth rate by 200 basis points.

The leader in our Sunbelt states is Florida, our largest state, with strong 55-plus population growth of 9.4% over the next 5 years, outpacing the national average by approximately 300 basis points. Our second largest state is California with a 55 population projected to grow in line with the nation at 6.4% over the next 5 years.

In addition, the national housing shortage is expected to be a growth driver for the manufactured housing segment, with the MH market size expected to grow at a 6.5% CAGR between now and 2027. In addition, MH remains quite affordable compared to apartment and single family units. This is particularly in true in California, one of ELS’s top markets, where supply of housing has lagged behind job growth. By some estimates, California will need to build 180,000 units annually by 2025 to keep up with demand, and this pairs fairly well with ELS’s plans for external growth.

Meanwhile, ELS maintains a strong balance sheet, as reflected by its 5.3x net debt-to-EBITDA ratio, sitting below the 6.0x level generally considered to be safe for REITs by ratings agencies. It also has a strong interest coverage ratio of 5.2x and $435 million in available capacity on its revolving line of credit.

This lends support to the dividend, which comes with a safe 66% payout ratio and a 10% 5-year CAGR. This year, management raised the dividend by 6.7%. At present, ELS yields 3.1%, which as shown below, sits at its highest level over at least the past 10 years.

(Note: The following chart shows TTM yield. Forward yield is 3.1%)

Risks to ELS include potential for higher-for-longer interest rates, which would raise the cost of debt on maturing debt and also raise the cost of capital for new property acquisitions and development. Other risks include macroeconomic factors such as inflation, which could put pressure on household budgets’ ability to absorb rent increases, and a slowdown in travel could negatively impact ELS’s RV business.

Turning to valuation, I now see value in ELS at the current price of $62.73 with forward P/FFO of 21.7, sitting below the P/FFO of 23.3 from when I last visited the stock. This sits close to its normal historical valuation of 21.2 P/FFO over the past 20 years, as shown below.

While ELS is by no means cheap by trading at its historical valuation, I believe it’s deserving of a ‘Buy’ rating considering its accelerating growth over the past decade, thereby a higher valuation. Analysts expect 6% annual FFO/share growth in the 2025-2026 timeframe, which I believe is a reasonable estimate considering the recent demand trends and expansion opportunities across the Sunbelt region.

Compared to peers, ELS is more expensive than Sun Communities, which carries a P/FFO of 16.5, and UMH Properties’ (UMH) P/FFO of 16.0. However, I believe ELS is deserving of a higher multiple due to its stronger balance sheet (lower leverage ratio) compared to its peers as well as its better geographic diversification and exposure to in-demand markets compared to UMH.

With a 3% dividend yield and a 6%, ELS could produce a 9% annual total return, which closely resembles the long-term return of the S&P 500 but with the benefit of an easy-to-understand business with a far higher dividend yield. As such, I believe ELS could be a reasonable buy up to a P/FFO of 22.

Investor Takeaway

ELS is well positioned to benefit from the growing demand for affordable housing among the aging populations in the U.S. With a strong track record of bottom-line growth and a focus on strategic Sunbelt markets, ELS has shown resilience and consistency in its operating performance.

While there are risks to consider, such as interest rates and macroeconomic factors, ELS’s strong balance sheet and track record of dividend growth make it an attractive investment opportunity for those seeking long-term stability. Lastly, with the stock price and valuation being materially down since I last visited the stock, I find it to be appealing enough to warrant an upgrade from a ‘Hold’ to a ‘Buy’ rating.