High Future PE Ratio Signals Overvaluation Risks Ahead

Key Takeaways

• Growth in leasing activity and strong development pipeline signal potential revenue and earnings increases from higher occupancy and stabilized projects.
  
• Strategic asset recycling and anticipation of lower interest rates may enhance portfolio quality, reducing costs and allowing strategic acquisitions for growth.
  
• Strong financial results and strategic asset management are driving Highwoods Properties' growth, with increased market share and promising future revenue streams.

Catalysts

Highwoods Properties, Inc., headquartered in Raleigh, is a publicly-traded (NYSE:HIW), fully-integrated office real estate investment trust (“REIT”) that owns, develops, acquires, leases and manages properties primarily in the best business districts (BBDs) of Atlanta, Charlotte, Dallas, Nashville, Orlando, Raleigh, Richmond and Tampa.

• Highwoods Properties is expected to experience significant growth in leasing activity, particularly with strong second-gen leases signed, suggesting an uptick in occupancy and revenue as these leases commence. This bodes well for future occupancy rates and revenue growth.
  
• The company is advancing its development pipeline, which is 49% leased and seeing strong interest, indicating potential for future cash flow growth and increased earnings as these projects complete and stabilize.
  
• Highwoods is actively recycling non-core assets into higher-quality prospects and reducing leverage, which could enhance future net margins through improved portfolio quality and lower borrowing costs.
  
• The office investment sales market is anticipated to open up with future interest rate cuts, paving the way for potential strategic acquisitions that could spur revenue and earnings growth.
  
• Leasing dynamics such as high net effective rents and a long weighted average lease term in prime locations suggest potential for sustained net margin improvement as competitive advantage may lead to higher rental income and longer-tenured leases.

Highwoods Properties Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Highwoods Properties's revenue will grow by 2.0% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 17.1% today to 8.1% in 3 years time.
• Analysts expect earnings to reach $71.0 million (and earnings per share of $0.63) by about December 2027, down from $141.5 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $110.2 million in earnings, and the most bearish expecting $42.9 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 62.0x on those 2027 earnings, up from 23.4x today. This future PE is greater than the current PE for the US Office REITs industry at 30.7x.
• Analysts expect the number of shares outstanding to grow by 1.14% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.39%, as per the Simply Wall St company report.

Highwoods Properties Future Earnings Per Share Growth

Risks

• Highwoods Properties reported better-than-expected financial results for the first three quarters of 2024, indicating ongoing strong cash flows and an increase in Funds from Operations (FFO), which suggests resilience in its revenue generation.
  
• The company has experienced strong new leasing volumes, with a significant amount of second-gen leases signed, which is likely to drive strong organic growth and bolster occupancy rates, positively affecting future revenue streams.
  
• Highwoods has a robust pipeline of development projects, approximately 49% leased, expected to drive significant cash flow growth as these assets deliver, indicating further revenue and earning potential.
  
• Continued asset recycling, with proceeds being invested into higher-quality buildings while reducing leverage, is indicative of proactive financial management that could support net margins and earnings stability.
  
• The company is benefiting from flight to quality trends, reflected in increased market share gains and high effective rents, which suggests strong demand for their properties and the potential for positive revenue and profitability impacts.

Valuation

• The analysts have a consensus price target of $32.0 for Highwoods Properties based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $37.0, and the most bearish reporting a price target of just $23.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $879.9 million, earnings will come to $71.0 million, and it would be trading on a PE ratio of 62.0x, assuming you use a discount rate of 7.4%.
• Given the current share price of $31.25, the analyst's price target of $32.0 is 2.3% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.