Plymouth Industrial (NYSE:PLYM) owns 151 industrial logistics and manufacturing properties, mostly located in the middle section of the country stretching from Chicago to Jacksonville.

This article will discuss its fundamental outlook and valuation taking into account major recent events.

The buy thesis

Plymouth is well positioned for the current macro environment as domestic manufacturing ramps up to meet the supply shortages that are prevalent across so many verticals. Its class B focus is better positioned than the fancy class A new builds as tenants tighten purse strings as inflation increases costs. I see a catalyst for new shareholders buying the stock as a complex financial overhang is removed. We calculate the new FFO/share run rate for the freshly simplified balance sheet and it is clear that PLYM is substantially undervalued relative to peers.

Portfolio fit in macro environment

Industrial REITs have been fundamentally booming for the better part of a decade. As e-commerce took off seemingly every retailer was clamoring to get enough logistics space to operate their online sales channels.

The stock market was rewarding companies for revenue growth to an even greater extent than earnings growth, so building these channels was a top priority with cost only a back-burner concern. The push for online logistics channels accelerated even further when COVID hit, pulling a substantial portion of brick and mortar traffic into online sales.

During this time, the class A industrial REITs were handsomely rewarded as rental rates on coastal big city warehouses jumped hundreds of percent in less than a decade.

Today, however, a few things have changed which I think will tilt the balance in favor of lower cost, middle America industrial space.

1. The market now demands earnings rather than revenues. This causes companies to actually care about cost structure. It will cause an increasing number to choose to rent a well-located class B warehouse for $4 per square foot rather than a perfectly located class A warehouse at $16 per foot.
2. The cessation of COVID as a dominating force in our lives has led to a massive shift back toward brick and mortar sales. This brings back the hub and spoke model as the dominant logistics pathway rather than the last-mile delivery. Class B warehouses are a great fit for hub and spoke as it does not require warehouses to be located in extremely population-dense areas.
3. Supply chain shortages are financially incenting a surge in domestic manufacturing. Capacity utilization increased sharply in April.

This indicates the industrial real estate is being more fully utilized and will increase demand for industrial real estate going forward.

PLYM’s portfolio of assets is particularly well equipped to service the more cost-conscious tenant and its locations in the more manufacturing heavy areas of the U.S. will see greater benefit from the increased manufacturing activity.

Cost effective rather than cheap

PLYM’s property acquisitions have been at remarkably low prices with a weighted average cost per square foot of $53.69.

Most industrial properties are closer to $100 or even $300 in some of the more contested MSAs. So this leads one to question, are these just undervalued or are they junky?

My research leads me to conclude that they were purchased at well below property value. These are quality industrial properties in high demand that simply slipped through the acquisition nets of larger peers who are looking for certain check boxes. There are four key data points that tell me these are strong properties.

1. Site Visits
2. Current rent relative to market rents
3. Replacement cost
4. Property Performance

A few years back, Jeff Witherell was kind enough to facilitate a few property tours where I got to examine three of PLYM’s warehouses in the Chicago area. At these site visits, it became clear to me that PLYM understands the core aspects that make an industrial property valuable. So, while they are buying these properties at just over $50 a foot, they are specifically only selecting properties that have strong workforce numbers, workforce access, and ingress/egress.

Each facility was proximal to an ample workforce, had conveniently located public transportation and strong access pathways with either railway access, highway access or both.

The theory behind such acquisitions is that if the tenants have a reliable workforce and can move their product, they will be highly incented to stay at that location rather than moving.

Further, there would be chances to increase rent over time as PLYM has both short lease terms remaining and its current rents are far below market rates. Mark-to-market for PLYM’s total portfolio is 12.5% as per the 1Q22 conference call.

The ability to increase rent is protected by the difficulty of building replacement products. In fact, replacement cost of their portfolio is $2.95B, or nearly double the purchase price of $1.51B

This makes renting from PLYM a far more economic choice than building.

Leasing results

All of the above culminates in favorable leasing activity.

In 1Q22, PLYM retained 73% of expiring leases and increased rent by an average of 12.6%. The other 27% of leases to new tenants saw rent increases of 29.7% on average.

The high renewal contingent kept TI and LC to just $0.33 and $0.18 per square foot per year, respectively.

Over the next few years, a substantial portion of PLYM’s lease will roll.

This provides the opportunity for a similar marking up of rental rates. As such, I anticipate substantial organic growth ahead.

So far, this article has been quite positive as the fundamentals are legitimately very strong. Now, I want to discuss the somewhat uglier issue of the share overhang.

I have consistently been impressed by PLYM’s property acquisition skills, but substantially less impressed by the way in which these acquisitions are financed.

Share dilution from Madison conversion is not in the consensus numbers

For years, PLYM has traded at an enormous FFO multiple discount to industrial REIT peers and the reason for this is that they have an outstanding preferred issue that will eventually convert to common shares. The magnitude of dilution upon conversion will depend on the share price at the time of conversion so it hasn’t really been possible to factor it into the numbers.

The opacity has left the market with a general sense that the FFO multiple is not real because everyone knows that at some point a large number of shares will be issued in exchange for the preferred B and when that happens FFO/share will drop.

So people see the 11.5X P/FFO shown below.

They know that is ridiculously cheap for an industrial REIT as its peers trade closer to 30X, but they also know that the real multiple on PLYM is significantly higher due to the share overhang.

Sell-side analysts are supposed to make their forward estimates match what gets reported in the future. This means that they naturally use the same metrics and same calculation methodologies as the company on which they are reporting.

That way when the earnings release comes out, the analyst is very close to the reported number. Thus, the consensus estimates shown below do not reflect the impact of the overhang since the overhang is not yet fully in guidance.

As a buyside analyst, I don’t care about matching my estimates to the reported number. My goal is to understand the value of the business, so I like to distill the reported FFO down to a clean FFO number inclusive of the overhang dilution and any other items that affect true earnings.

• The consensus estimate for 2022 is $1.85
• PLYM guides for 2022 Core FFO of $1.80-$1.85
• I calculate clean FFO/share run rate at $1.57

Here’s how I get there.

Let us start with guidance as presented in the 1Q22 report.

The weighted average share count has a note on it which is parsed below.

The Preferred B was issued when PLYM was a very small company and did not have access to the kind of capital they have access to today. As such, it came with terms that were more favorable to the counterparty than they were to PLYM. Madison, the counterparty, gets the better of a 12% IRR or $21.89 plus accrued and unpaid dividends.

In 2022, the Preferred B pays a 4% dividend yield on the initial liquidation value of $75 million which equates to $3 million in preferred dividends.

While the Preferred is active the expense recorded in Core FFO is the 4% dividend yield, so the accrual portion will hit later in the form of dilution when this thing gets converted.

Well, in 2022, Madison began the conversion process by redeeming half of the preferred for common on a 1-to-1 basis. As such, the shares outstanding were 40,609,640 as of May 2. The rest is expected to be converted in 2022 indicating another 2.2 million shares will be issued.

Thus, I spot the total shares outstanding net of accounting for the overhang at 42,815,522. In 1Q22 PLYM got $0.47 of FFO indicating a run rate of $1.88 annually. The half conversion that already took place is in guidance which knocked the guidance down to $1.80-$1.85. Note that this actually wasn’t lower than previous guidance because the operational outperformance largely netted out the financial overhang dilution.

We adjust this guidance to include the fully diluted share count as well as the slight savings from the cessation of the preferred B dividend. The net result is an FFO/share run rate of $1.72.

I also believe that maintenance capex is a real expense, so I further adjust this number by an estimated $6.692 million of annual recurring capex.

This takes clean FFO/share to $1.57.

Note on accounting practices

PLYM’s accounting is proper. It is done in accordance with GAAP with respect to the Preferred B and NAREIT defined FFO does not factor in maintenance capex.

As such the guidance being so much higher than clean FFO is not a trick of any sort. Nobody is trying to deceive. The accounting is clean.

This is just one of those things that an analyst has to do with any company they look at. The standard accounting procedures will rarely provide a true earnings number.

Valuation using clean FFO/share

After discounting FFO/share for the factors discussed above, PLYM is trading at 13.64X clean FFO. It may not be as cheap as it looks today before the dilution of the preferred B hits, but it is still extremely cheap relative to peers.

Once the preferred B is a thing of the past, the portion of investors that had previously avoided PLYM due to the opacity of the overhang will be more likely to consider it. Given the strong organic growth, I find 13.64X to be opportunistically cheap.

PLYM is also substantially undervalued on an NAV basis with NAV/share of about $29.

I believe this makes it a potential M&A target. There is no cheaper way to get these assets than to buy PLYM.

On a stand-alone basis, I also think PLYM can perform well as an investment. Once they get past the overhang dip, the FFO/share growth rate should be quite strong. Fundamentals remain excellent for its properties.