MIZUHO SECURITIES USA INC. | US EQUITY RESEARCH
Summary
We are wrapping up 4Q15 multifamily earnings with this report, including several price target changes and one rating change -- ESS goes to Buy from Neutral (Exhibit 1 shows all the detail). We believe sentiment has overwhelmed multifamily stock performance, most notably in technology. Our call is that the reality of ESS's still very strong growth profile and solid organization will set in during 2016. We are also maintaining our Buy ratings on MAA and UDR, resulting in a 3-pronged approach to owning multifamily during 2016.
Key Points
Full Multifamily Update: More than any other property type, we believe multifamily earnings is best analyzed after all the companies report, rather than a silo approach that doesn't capture the inter-relationships between companies. This earnings season was marked by significant downward volatility as investors attempt to distinguish between sentiment and reality on various issues including concerns surrounding a tech slowdown and the overall risk of another recession in the US. Our conclusion is that it is right to be concerned, and management do not appear to have their heads in the sand. On the other hand, base-case housing in the form of renting apartments is itself a necessity item that we view to have natural defensive qualities on its own. So as long as the REITs make appropriate adjustments, there is still reason to own a sector that is likely to produce some of the best organic growth in the US REIT industry this year.
Same Store the Driver: As we wrote in December 2015, same store growth tends to be an overwhelming determinant of stock performance for the multifamily sector, with bottom line earnings often a distant secondary consideration. We saw evidence of this during earnings season, with direction of internal growth mattering much more than absolute levels. This second derivative of growth is one consideration in our investment thought process, but unlike how the stock market behave sometimes, its not the only one.
Stock Calls: We believe the nearly 16% year-to-date decline in ESS stock is overdone. Understanding that continued negative sentiment could delay the effectiveness of the call, we think the time is right to push back against these forces. And we do so with the benefit of a high quality organization in ESS, with a great track record and a portfolio that is expected to generate industry-leading internal growth during 2016. Separately, we reiterate our Buy rating on MAA and UDR, and consider them compelling stocks during highly uncertain times.
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