Sun Communities Inc (NYSE:SUI) may be cheap for a reason. The company has been on my radar for a while, and I’ve been consistently disappointed in its investment thesis. The biggest risks I see are around the sustainability of its future growth, the opportunity cost of investing in the stock accounting for the returns I could have gotten in other peers, and its cash-to-debt management. It’s crucial to understand if a company has a strong future based on its current operations and financial status.
First, a short introduction to the company is in order. Sun Communities, Inc. is a REIT that, as of March 31, 2018, owned, operated, or had an interest in a portfolio of 350 communities comprising approximately 122,000 developed sites in 29 states and Ontario, Canada. Started in 1975, it operates in United States and is recently valued at US$7.61B.
The first thing that struck me was the pessimistic outlook for SUI. A consensus of US equity real estate investment trusts (reits) analysts covering the stock indicates that its revenue level is expected to decline by -5.64% in the upcoming year, however, future earnings are expected to grow. On average, SUI’s bottom-line should see an annual growth rate of 30.42% going forward, leading to an unsustainable margin expansion driven by a mix of falling sales from core activities and possibly cost-cutting. In addition to this, at its existing earnings level, SUI produces worse returns to shareholders (3.36%) compared to its industry peers (7.70%), which isn’t a good sign. If a company were going through a reinvestment period, it may produce lower returns during that time period, and gains will be factored into the future outlook. Though this is not the case for SUI, which makes me wonder about the sustainability of its business.
SUI’s financial status is a key element to determine whether or not it is a risky investment – a key aspect most investors overlook when they focus too much on growth. Alarm bells rang in my head when I saw SUI’s debt level exceeds equity on its balance sheet, and its cash from its core activities is only enough to cover a mere 8.74% of this large debt amount. Furthermore, its EBIT was not able to sufficiently cover its interest payment, with a cover of 1.72x. This does lower my conviction around the sustainability of the business going forward. SUI has high near term liquidity, with short term assets (cash and other liquid assets) amply covering upcoming one-year liabilities. SUI has managed its cash well at a current level of US$15.15M. However, more than a fifth of its total assets are physical assets and inventory, which means that in the worst case scenario, such as a downturn or bankruptcy, a significant portion of assets will be hard to liquidate and redistribute back to investors.
SUI is now trading at US$91.50 per share. With 82.83 million shares, that’s a US$7.61B market cap – which is low for a firm with a 5-year free cash flow cumulative average growth rate (CAGR) of 20.58% (source: analyst consensus). Given the consensus 2018 FCF level of US$363.30M, the target price for SUI is US$109. Therefore, the stock is trading at a 15.96% discount. Although, comparing SUI’s current share price to its peers based on its industry and earnings level, it’s overvalued by 395.59%, with a PE ratio of 95.59x vs. the industry average of 19.29x.
SUI is a fast-fail research for me. Good companies should have good financials to match, which isn’t the case here. Given investors have limited time to analyze a universe of stocks, SUI doesn’t make the cut for a deeper dive. For all the charts illustrating this analysis, take a look at the Simply Wall St platform, which is where I’ve taken my data from.