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Empire State Realty: Promising Signs, but Not Enough

Empire State Realty Trust (ESRT) is a self-administered and self-managed REIT that owns, runs, and purchases office and retail properties in Manhattan and the greater New York metropolitan area. The company prides itself on owning the Empire State Building, one of the world’s most famous buildings.

As a result, the company also owns and operates its signature, newly reimagined Observatory Experience, which is located on the 102nd floor of the iconic building.

As of its latest filings, Empire State Realty Trust owned 14 office properties comprising approximately 9.4 million rentable square feet of office space. I am neutral on the stock.

Emerging from COVID-19

The pandemic had a major impact on New York City, where the company’s properties are primarily located. With stiff measures to prevent the spread of COVID-19 and the emerging work-from-home economy, office and retail properties suffered substantially between 2020 and 2021.

Office and retail property owners such as Empire State Realty Trust were challenged by the lack of meaningful lease renewals, softer occupancy levels, and the inability to meaningfully raise rent rates.

The company has lately seen improvements in its performance compared to the midst of the pandemic, though its overall financials still appear rather weakened.

In late April, Empire State Realty Trust reported its Q1 results for Fiscal 2022, with the company showcasing some notable recovery signs. Total revenues came in at $164.0 million, 17% higher year-over-year. Rental revenues expanded modestly, up 5.2% compared to last year. The real growth driver, though, came from observatory revenues, which increased 408% to $13.2 million.

The massive increase in observatory revenues was attributable to visitation volumes revving from their crushed levels last year, which was the case due to COVID-19. As a result, FFO rose 19.8% to $49.2 million, further boosted by higher income from the company’s non-controlling interests. Accordingly, on a per-share basis, FFO grew by three cents to $0.17.

The company’s improving trajectory is also illustrated in its occupancy rate, which stood at 97.6% at the end of the quarter, an advance of 120 basis points sequentially. Based on the company’s Q1 results and the current market conditions, management forecasts Fiscal 2022 core FFO/share to be between $0.73 and $0.78.

Putting the Recovery into Perspective

The midpoint of management’s FFO/share outlook ($0.76) implies growth of 8.5% compared to Fiscal 2021’s $0.70 and an even more significant improvement of 22.5% compared to $0.62 in fiscal 2020. However, FFO/share still remains considerably lower from its pre-pandemic levels, when it usually exceeded $0.90.

Further, even though observatory revenues appear to have significantly recovered compared to last year, they still remain a fraction of their past levels. In fact, annual observatory revenues increased almost every year, from $25 million in 2001 to $128.8 million in 2019.

Despite last year’s recovery, they remained rather soft, grossing only $41.4 million in Fiscal 2021. Further, despite last quarter’s 408% “growth” sounding glamorous, observatory revenues were still 36% softer versus their Q1-2019 levels.

Capital Returns & Valuation 

Empire State Realty Trust had completely suspended its dividend following the second quarter of Fiscal 2020 in order to preserve liquidity in the midst of the pandemic. The dividend has now been resumed, backed by renewed confidence in New York City’s recovery as well as positive progress in the company’s results and liquidity. Yet, at a quarterly rate of $0.035, the current quarterly dividend is a fraction of its pre-pandemic levels ($0.11/quarter).

At an annualized rate of just $0.14 and the midpoint of management’s FFO/share guidance, the payout ratio presently stands at a meager 18%, which implies considerable room for the dividend to grow. Then again, with management communicating no such intention, the market may be growing tired of the underwhelming dividend.

In the current environment, investors crave real, tangible capital returns amid great levels of widespread uncertainty. This likely explains the stock’s depressed valuation. At its current price levels, Empire State Realty Trust shares are trading at just 10.5 times the midpoint of management’s outlook.

Strangely enough, management has taken advantage of the stock’s steep price drops to repurchase shares on the cheap. Since the company’s stock repurchase program was initiated in March 2020, roughly $215 million worth of stock has been bought back at a weighted average price of $8.67 per share.

Management’s buybacks could affirm that the stock is indeed undervalued. However, I doubt REIT investors are in for financial engineering in a world in which substantial dividend payouts appear to be the only safeguard behind violent stock price declines.

Wall Street’s Take

Turning to Wall Street, Empire State Realty has a Hold consensus rating based on one Buy and one Sell assigned in the past three months. At $9.50, the average Empire State Realty price target implies 18.6% upside potential.

Takeaway

Empire State Realty Trust is a truly unique REIT, with its iconic properties distinguishing it from its peers. The company’s performance has lately shown promising yet not impressive enough signs of headway. Observatory revenues remain rather depressed, and the dividend can hardly kindle investors’ appetite for the stock, which, as a result, has undergone a significant multiple compression.

On the one hand, there could be value in purchasing the stock at its current levels. However, on the other hand, with a large number of companies out there currently trading at depressed multiples while offering more substantial capital returns prospects, it may not be worth allocating capital to Empire State Realty Trust.

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