You May Have Been Looking At Empire State Realty Trust, Inc. (NYSE:ESRT) All Wrong

Empire State Realty Trust, Inc. is a US$4.1b mid-cap, real estate investment trust (REIT) based in New York, United States. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how ESRT’s business operates and also how we should analyse its stock. In this commentary, I'll take you through some of the things I look at when assessing ESRT.

Check out our latest analysis for Empire State Realty Trust

A common financial term REIT investors should know is Funds from Operations, or FFO for short, which is a REIT's main source of income from its portfolio of property, such as rent. FFO is a cleaner and more representative figure of how much ESRT actually makes from its day-to-day operations, compared to net income, which can be affected by one-off activities or non-cash items such as depreciation. For ESRT, its FFO of US$279m makes up 72% of its gross profit, which means the majority of its earnings are high-quality and recurring.

ESRT'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 ESRT 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 15%, the credit rating agency Standard & Poor would consider this as significantly high risk. This would take ESRT 6.9 years to pay off using operating income alone. Given that long-term debt is a multi-year commitment this is not unusual, however, the longer it takes for a company to pay back debt, the higher the risk associated with that company.

I also look at ESRT's interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it's better to use FFO divided by net interest. With an interest coverage ratio of 3.5x, it’s safe to say ESRT is generating an appropriate amount of cash from its borrowings.

In terms of valuing ESRT, 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. ESRT's price-to-FFO is 14.79x, compared to the long-term industry average of 16.5x, meaning that it is slightly undervalued.

Next Steps:

As a REIT, Empire State Realty Trust offers some unique characteristics which could help diversify your portfolio. However, before you decide on whether or not to invest in ESRT, I highly recommend taking a look at other aspects of the stock to consider:

1. Future Outlook: What are well-informed industry analysts predicting for ESRT’s future growth? Take a look at our free research report of analyst consensus for ESRT’s outlook.
2. Valuation: What is ESRT 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 ESRT is currently mispriced by the market.
3. 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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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.