Self-storage provider Safestore (LSE:SAFE) has recently seen its valuation decline. In fact, over the last 12 months, the FTSE 250 stock is down more than 20%, despite delivering seemingly solid results. As such, shares now trade at a P/E ratio of just 6.7.
For a company that has delivered an average annualised total shareholder return of 27.3% over the last nine years, this valuation seems absurdly cheap. So am I looking at a buying opportunity? Or is there a fundamental problem with this business?
Real estate is cyclical
Safestore’s business model is pretty straightforward. It owns and operates a network of self-storage facilities across the UK and Europe, collecting rent and fees for additional services such as content insurance. However, in the six months leading up to April, despite sales growing by 9% to £110.1m, pre-tax profits collapsed by more than 60%!
Suddenly, a double-digit drop in the share price makes sense. However, as horrific as this number sounds, it’s a bit misleading. That’s because it also includes the effects of changes in the fair value of its properties worldwide.
With interest rates on the rise, mortgages are getting more expensive. And, subsequently, the price of real estate has started to drop. Given Safestore’s results, this impact is obviously significant. However, it’s essential to note that shifts in property valuations don’t actually affect cash flow.
As an investor, cash flow is ultimately what matters, especially when it comes to covering the cost of dividends. And after eliminating this non-cash impact on performance, underlying profits were actually up by 6.5%, hitting £62.5m. That’s more than enough to cover dividends, interest on mortgages, and other operating expenses.
In other words, while growth has undoubtedly slowed due to the weaker real estate sector, Safestore is still chugging along nicely, in my opinion.
Every investment has its risks
Even though this income stock looks like a bargain, investors must consider potential threats. Rising interest rates may not be that problematic for Safestore’s existing loan obligations. However, to continue its expansion across international markets, a lot more money will be needed.
That means taking on new loans at higher rates. And since the current strategy is focused on the Benelux and German regions of Europe, this only amplifies the financial risk. Why? Because these markets are currently underdeveloped in regards to self-storage.
On the one hand, that means Safestore has little competition to fend off. On the other, it means the group will also have to help build interest in its storage solutions for these populations. And apart from being expensive, this may be far easier said than done.
Nevertheless, the group’s existing track record of defying expectations gives me optimism. And that’s why, despite the risks, I’m planning to add Safestore to my income portfolio in the near future.
