Shares of American Tower have fallen more than 8% the last couple of weeks.

This weakness has piqued the interest of many investors looking to enter this industry space.

They want to know if the recent sell-off justifies a buy rating or not.

This idea was discussed in more depth with members of my private investing community, iREIT on Alpha. Get started today »

This article was coproduced with Nicholas Ward.

In recent quarters, we’ve seen nearly every stock that’s somehow attached to the 5G revolution experience strong price appreciation. From popular handset players like Apple (AAPL), to semiconductor names like Qualcomm (QCOM) and Broadcom (AVGO), to infrastructure names like Ericsson (ERIC)…

Investors who got in at the right times have made out well in recent years.

The notable exceptions to this trend would be the largest wireless carriers themselves, AT&T (T) and Verizon (VZ). That’s largely due to the low multiples the market gives them for their high debt loads and low growth prospects.

Put simply, many income-oriented investors have decided to play this megatrend elsewhere. That includes through the cell tower real estate investment trusts (REITs) we cover at iREIT:

American Tower Corporation (AMT)
Crown Castle International (CCI)
SBA Communications (SBA).

Shares of all three continue to be in high demand, with each producing strong double-digit returns year to date. But does that make them good buys?

Today, we answer that question for just one of those entries: The one our new iREIT IQ quality scoring system gives the highest rating of its peers.

That would be American Tower, whose shares have fallen more than 8% during the last couple weeks.

This weakness has piqued the interest of many investors who’ve been hoping to get into the larger industry. And while we’re still very bullish on where this story can go, bullish stories don’t make for automatically appropriate investments.

Let’s explore how and why.

A Cell Tower REIT Industry Overview

The cell tower REIT industry can be easily explained through a graphic American Tower provided in a recent shareholder presentation.

As you can see below, it and its peers typically own and/or operate cell towers and the land beneath them, then lease space on both to their tenants, which provide wireless communications services to their customers.

(Source: AMT Q2 Investor presentation)

We appreciate this business model quite a bit, and with good reason. Once the land is purchased and the tower infrastructure is in place, revenue is easily scalable at relatively low costs.

Plus, as more tenants sign contracts for the same towers, cell tower REITs see dramatic rises in:

Gross margins
Returns on investments.

Again, that’s without the need for additional investments.

On the fixed-cost side of the equation are ground rent, utilities, tower maintenance, taxes, and insurance. But those remain fairly stable and predictable.

All of this is fairly unique and therefore makes cell tower REITs fairly, if not very, attractive to investors. They have relatively easy access to solid growth, which shows in the strong returns they’ve produced in recent decades.

(Source: AMT Q2 Investor presentation)

Sector Growth Remains Attractive Too

As a whole, the cell tower REIT industry continues to experience strong secular tailwinds – both in the U.S and international markets – thanks to the ever-increasing rise of mobile devices and increased data demands.

(Source: AMT Q2 5G Update)

We certainly don’t expect to see an 80% data usage compound annual growth rate moving forward. The wireless market is maturing, after all.

Even so, companies operating in this space still expect strong, double-digit growth in mobile traffic, and therefore continued tailwinds for their properties and profits.

(Source: AMT Q2 Investor presentation)

The combination of increased devices and usage per device equates to very strong total demand growth. Right now, mobile data usage is growing at a 30%-40% rate in the U.S. And we expect international growth to stay strong as well, as Internet penetration continues to proliferate in developing markets.

(Source: AMT Q2 Investor presentation)

One negative trend to be aware of comes from the improvements made to the technology that drives mobile networks. These have pushed the cost per gigabyte (GB) of data down dramatically in the U.S.

Since 2006, American Tower estimates that tower leasing costs in this regard have declined at about 35% CAGR – a negative trend that will likely continue into the future.

To some degree, that is. Judging by more recent data, it’s likely to be less pronounced going forward.

For instance, in 2018 and 2019, the estimated leasing cost per GB rate fell by less than 20%. So data demand is outpacing lowered leasing costs…

In which case, AMT’s operating metrics remain solidly profitable.

(Source: AMT Q2 5G Update)

American Tower, the Business Model

The names of the two highest-quality companies that we track in the cell tower REIT space are actually somewhat ironic.

Crown Castle International, for one, has staked much of its future growth plans on small-cell growth within the United States, whereas American Tower appears to be the better international growth play.

Founded in 1995, AMT now runs a portfolio of more than 181,000 communications sites, with only 41,000 located in the U.S. Roughly 140,000 are in international markets.

Looking at the graphic above, it’s clear AMT has been focusing on international growth opportunities in recent years. Over the last 10, it’s deployed roughly $46 billion in capital toward this end.

The majority of this has come in the form of mergers and acquisitions.

(Source: Q2 ER Slide Show Presentation)

The company’s investment rate has stayed fairly consistent over the last decade or two, highlighted in the presentation above. While COVID-19 concerns have caused management to pull back a bit, return on invested capital continues to trend in the right direction.

That’s what sets AMT apart from CCI: Its willingness to maintain a focus on high-margin tower sites by expanding into new markets. While margins might not be as high as they could be in the exact markets it’s been targeting, AMT’s current demand metrics are somewhat similar to those that we see in the U.S.

In short, we prefer its lower-risk expansionary efforts compared to CCI’s recent dive into fiber and small cell infrastructure.

(Source: AMT Q2 Investor presentation)

AMT Just Continues to Impress

With all those strong mobile demand metrics, it seems safe to assume that AMT’s operating metrics are equally impressive.

And so they are.

Over the long term, AMT’s revenue, adjusted funds from operations (AFFO), and dividend growth performances have been stellar.

(Source: AMT Q2 Investor presentation)

Admittedly, that exact pace of growth has slowed in recent years. AMT reported its second quarter earnings in late July, which showed a continuation of those low single-digit increases.

Specifically, total revenue rose 1.2%, net income by 3.2%, and consolidated AFFO by 1.6%.

To be sure, foreign exchange rates played a role in this. There was a significant forex headwind during the quarter, counteracting the almost 10% uptick in total tenant billings.

(Source: Q2 ER Slide Show Presentation)

Until we see a weaker dollar, that kind of downplaying force will continue – another potential downside to AMT’s international growth plans. At the same time, increased tenant billings do show its revenue stream to be well diversified. And management continues to believe it’s setting itself up for reliable long-term growth.

That’s why it continues to invest, spending $128 million during Q2 to acquire 350 communication sites. Once again, these were primarily located in international markets.

AMT did update its full-year 2020 guidance, calling for:

Revenue growth of 3.4%
Net income growth of -6.6%
Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) growth of 3.9%
Consolidated midpoint AFFO growth of 4.2%.

And, yes, these full-year estimates factor in negative forex concerns.

Valuation Matters…

As stated in the intro, quality isn’t – or shouldn’t be – everything when it comes to making investment decisions. There’s also valuation to consider.

The COVID-19 pandemic and consequential shutdowns have fueled the already manic love for 5G investments. And, before that, the trade war with China prompted concerns that shifted investor attention from semi-conductors to other options.

Like cell towers.

In terms of bottom-line resiliency and reliability, it just doesn’t get much better. Hence the reason why investors have flocked into blue-chip stocks.

Like AMT.

Starting in early 2019, its price-to-AFFO multiple rose above its long-term historical average. And it’s stayed there consistently since – for the first time since 2014.

(Source: FAST Graphs)

If you were to extrapolate the double-digit AFFO growth trend from 2012-2018 into the 2019-2020 areas, the premium shown in the chart above would appear to make sense. However, that didn’t happen last year or this year.

The growth rate of the orange and blue lines represent AFFO growth multiples. And they’ve clearly stagnated compared to the black line, which represents price.

The result is an irrational disconnect between market sentiment and the stock’s underlying fundamentals.

Looking ahead, analysts don’t expect AMT to re-establish double digit bottom line growth. That’s something the markets seem willing to wave away for now, especially due to the forex factors.

It admittedly is hard to blame AMT’s management team for the strong dollar. However, from a valuation standpoint, it doesn’t make sense to be buying in at current prices.

Even factoring in future growth through 2023, investors are buying AMT shares at $245, or around 30x AFFO. In so doing, they’re setting themselves up for lackluster performance, assuming we see mean reversion back toward the company’s long-term average of around 22x.

That’s highlighted by the yellow 2.34% annual return figure below. The larger FAST graph indicates it will take roughly three years of strong growth for AMT’s bottom line to catch back up to its current premium.

(Source: FAST Graphs)

In Conclusion…

Even though American Tower shares have fallen roughly 8.2% since their Sept. 16 highs, shares still appear to be overvalued. That’s why we maintain our Hold rating.

While the recent selloff has gotten investors excited – particularly those who’ve been sitting on the sidelines for years, waiting for weakness in the cell tower space – we still think it’s too early to jump into AMT.

Shares still have to fall another 18% or so before they’d hit our buy range around $195. That should give investors an adequate margin of safety and attractive future return prospects.

Unfortunately, that simply isn’t the case here at $245. And wishing doesn’t make it otherwise.

Author: Brad Thomas

Source: Seeking Alpha: American Tower: A Moat-Worthy REIT To Own When The Price Is Right

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