SF Leasing And AI Expansion Will Spur Opportunities Amid Risks

Key Takeaways

• Expanding AI industry and return-to-office mandates are expected to boost leasing activity and revenue, especially in key markets like San Francisco and Seattle.
  
• Strategic asset disposals and sustainability focus may improve balance sheet strength and net margins, potentially enhancing Kilroy Realty's corporate appeal.
  
• Exposure to San Francisco's slow market recovery and early-stage political improvements in cities like Los Angeles challenge Kilroy's occupancy rate and revenue growth.

Catalysts

Kilroy Realty Corporation (NYSE: KRC, the “Company”, “Kilroy”) is a leading U.S.

• The rapid expansion of the AI industry in San Francisco, combined with improved safety and increased return-to-office mandates, is likely to boost leasing activity and potentially increase revenue for Kilroy Realty.
  
• The growth in tenant engagement in Kilroy's KOP Phase 2 life science development project in South San Francisco is encouraging, potentially impacting future revenue positively as negotiations advance.
  
• Kilroy's strategy of capitalizing on the disposal of land and non-core assets is expected to generate significant proceeds, which could be redeployed into acquisitions, leverage reductions, or stock buybacks, potentially impacting earnings and balance sheet strength positively.
  
• The rebound in office demand and leasing activity across key markets like Seattle and San Francisco, partly driven by AI sector expansion and improvements in safety, is expected to improve occupancy rates and revenue growth.
  
• Kilroy's focus on sustainability and ambitious environmental goals by 2030 may enhance its corporate appeal and potentially lead to cost efficiencies, positively impacting net margins in the long term.

Kilroy Realty Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Kilroy Realty's revenue will grow by 1.8% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 17.6% today to 12.9% in 3 years time.
• Analysts expect earnings to reach $153.9 million (and earnings per share of $1.44) by about May 2028, down from $198.1 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $118.9 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 39.1x on those 2028 earnings, up from 18.4x today. This future PE is lower than the current PE for the US Office REITs industry at 46.8x.
• Analysts expect the number of shares outstanding to grow by 0.77% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.79%, as per the Simply Wall St company report.

Kilroy Realty Future Earnings Per Share Growth

Risks

• The leasing spreads in the quarter were negative, driven by a significant lease with minimal capital investment and a short-term duration, which can pressure average realized rent and net operating income (NOI) in the short term.
  
• The City of San Francisco's leasing market, where Kilroy has significant exposure, is still recovering, and any delays in recovery could impact occupancy rates and revenue.
  
• The office demand recovery faces challenges, as political and safety improvements in various cities, including Los Angeles, are still in early stages, potentially affecting Kilroy's ability to increase occupancy and revenue in these markets.
  
• Interest capitalization at the Flower Mart site is expected to cease if development plans do not progress, possibly leading to higher interest expenses that could reduce funds from operations (FFO) if not offset by income growth.
  
• Changes in regulatory and policy outlooks pose a risk to life science leasing momentum, potentially affecting Kilroy’s future pipeline and revenue stability from this sector.

Valuation

• The analysts have a consensus price target of $39.333 for Kilroy Realty 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 $59.0, and the most bearish reporting a price target of just $31.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $1.2 billion, earnings will come to $153.9 million, and it would be trading on a PE ratio of 39.1x, assuming you use a discount rate of 7.8%.
  
• Given the current share price of $30.81, the analyst price target of $39.33 is 21.7% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
  
• 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.