Despite having a reputation for growth, the FTSE 250 is home to a lot of exciting dividend-paying stocks. And among these, Safestore Holdings (LSE:SAFE) stands out as one of my favourites. Why? Because it’s a highly cash-generative enterprise that could be on the verge of surging.
In fact, shares of the self-storage operator just jumped by over 10% last month as private equity groups began circling the big discounts within this sector. Yet even with this new momentum, the price-to-earnings ratio is still at just 5.3. That’s 60% lower than the FTSE 250’s 13.7 earnings multiple.
So, what’s behind this massive discount? And is this a massive buying opportunity for investors?
What’s going on with Safestore?
Since their peak in 2022, Safestore shares have seemingly been stuck on a downward trajectory, wiping out their historical premium and sending its dividend yield above 4% for the first time in over a decade.
There were a few catalysts for this downturn. However, the primary culprit is interest rates. As a quick reminder, Safestore owns and operates one of the largest networks of self-storage facilities in the UK. But building out this asset portfolio hasn’t been cheap, and the group has subsequently also racked up quite a lot of debt.
Following a rapid increase in interest rates, combined with a larger-than-expected drop in occupancy, the firm’s cash flow growth slowed to a crawl. And unsurprisingly, investor sentiment took a massive hit.
This shift in opinions isn’t entirely unjustified. However, it seems that investors may have grown too pessimistic by being overly focused on short-term challenges. And subsequently, one of its key competitors has recently been targeted for acquisition by private equity investors capitalising on dirt-cheap valuations.
A massive growth opportunity
With potential takeover deals circulating among self-storage operators, interest in this sector seems to be ticking back up again. And this is one of the main reasons why Safestore shares jumped by double-digits in October. However, the prospect of a buyout is not why I’m keen to increase my existing position.
The firm’s latest results contained a long-awaited reversal in the downward trend of occupancy. Now that interest rates are getting steadily cut, home buying and renovation activity is heating back up. As a result, demand for self-storage is starting to recover as well.
This all points towards a potential cyclical rebound that could trigger a sudden acceleration of free cash flow. Even more so, given that despite the headwinds, Safestore has actually been busy expanding its network of locations over the last three years – not just in the UK, but across Europe as well.
Risk versus reward
While the potential for a cyclical rebound is exciting, there are still some important risks to consider. Stubborn inflation and continued economic weakness could prolong the expected recovery, especially if interest rate cuts are delayed or potentially even reversed.
Similarly, with relatively low barriers to entry, Safestore is increasingly having to compete on price, which could offset the tailwinds of rising occupancy. Nevertheless, with the stock trading at one of the cheapest valuations in the FTSE 250, these risks are worth taking in my opinion.
That’s why I’m planning on increasing my position in Safestore shares. But it’s not the only business I’ve got my eye on right now.
