Preferred Apartment Communities, Inc. is a US$638m small-cap, real estate investment trust (REIT) based in Atlanta, United States. REIT shares give you ownership of the company than owns and manages various income-producing property, whether it be commercial, industrial or residential. The structure of APTS is unique and it has to adhere to different requirements compared to other non-REIT stocks. In this commentary, I’ll take you through some of the things I look at when assessing APTS.
REIT investors should be familiar with the term Fund from Operations (FFO) – a REIT’s main source of cash flow from its day-to-day business activities. FFO is a higher quality measure of earnings because it takes out the impact of non-recurring sales and non-cash items such as depreciation. These items can distort the bottom line and not necessarily reflective of APTS’s daily operations. For APTS, its FFO of US$145m makes up 58% of its gross profit, which means the majority of its earnings are high-quality and recurring.
APTS’s financial stability can be gauged by seeing how much its FFO generated each year can cover its total amount of debt. The higher the coverage, the less risky APTS is, broadly speaking, to have debt on its books. The metric I’ll be using, FFO-to-debt, also estimates the time it will take for the company to repay its debt with its FFO. With a ratio of 5.5%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take APTS 18 years to pay off using just operating income, which is a long time, and risk increases with time. But realistically, companies have many levers to pull in order to pay back their debt, beyond operating income alone.
Next, interest coverage ratio shows how many times APTS’s earnings can cover its annual interest payments. Usually the ratio is calculated using EBIT, but for REITs, it’s better to use FFO divided by net interest. This is similar to the above concept, but looks at the nearer-term obligations. With an interest coverage ratio of 1.52x, APTS is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.
In terms of valuing APTS, FFO can also be used as a form of relative valuation. Instead of the P/E ratio, P/FFO is used instead, which is very common for REIT stocks. In APTS’s case its P/FFO is 4.46x, compared to the long-term industry average of 16.5x, meaning that it is highly undervalued
Preferred Apartment Communities can bring diversification into your portfolio due to its unique REIT characteristics. Before you make a decision on the stock today, keep in mind I’ve only covered one metric in this article, the FFO, which is by no means comprehensive. I’d strongly recommend continuing your research on the following areas I believe are key fundamentals for APTS:
- Future Outlook: What are well-informed industry analysts predicting for APTS’s future growth? Take a look at our free research report of analyst consensus for APTS’s outlook.
- Valuation: What is APTS worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether APTS is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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