Interest in Americold Heats Up

Americold Realty Trust COLD is the only publicly traded real estate investment trust in the United States that is focused on owning and managing cold storage real estate. The company, which is the second-largest owner of cold storage assets in the U.S., has received heightened interest as a result of increased scrutiny on global supply chains due to the coronavirus pandemic. We consider the cold storage industry to be the best positioned in the existing environment and expect significant short-term growth. Our $32 fair value estimate suggests that investors already recognize the opportunity that it represents. Despite our favorable outlook, we do not think Americold possesses a material advantage.

Americold has built its business by owning and operating cold storage facilities as well as providing ancillary services to attract and retain tenants. More than 80% of revenue derives from the U.S., where Americold is the second-largest player by market share behind Lineage Logistics. Although cold storage shares similarities with traditional industrial real estate, it is a unique space that contributes less than 3% of total industrial square footage in the U.S. While industrial real estate typically features multiyear commitments for space, much of cold storage space is rented on an as-needed basis, adding some risk but also allowing pricing to recalibrate more quickly.

Americold’s primary business is its warehouse segment, which generates around just over three fourths of companywide revenue. This is where the company rents various forms of temperature-controlled warehouses to customers across the supply chain. In the third-party managed segment, Americold operates facilities on behalf of customers that own cold storage space but do not have expertise in operating it. The transportation segment provides services to customers to help them effectively manage the transportation of their perishable goods.

Although cold storage has been in existence for decades, institutional interest in the space has just begun to heat up. Whereas the relative complexity involved in developing a facility had served as a deterrent, an increased focus on supply chains due to the rise of e-commerce and the coronavirus outbreak has eroded this prior source of hesitation. Although the rise of online grocery, hastened in part by the coronavirus crisis, certainly has some positive implications for the industry, it is unlikely to cause demand to explode like e-commerce did for traditional industrial space. The existence of well-located grocery stores means they will remain the preferable last touch point before food is ultimately delivered to consumers, tempering expectations for demand growth.

No Signs of Competitive Advantage We don't believe Americold has an economic moat. The primary moat source for REITs is efficient scale, where the company operates in a market of limited size that is effectively and efficiently served by only one or a small number of companies. Despite Americold's significant global presence, the industry is fragmented and littered with competitors, and we do not see any indicators of competitive advantages for the company.

To analyze its competitive position, we look to Americold’s operations in the rent, storage, and warehouse services segment, which represents over 80% of revenue. Although the company has a global presence, it derives around 85% of its revenue in the U.S., with smaller operations in Australia, New Zealand, Canada, and Argentina. In addition to its core business, Americold runs a third-party management business and provides transportation services to various customers. We do not view these segments as moaty, given the razor-thin margins and the fact that these businesses largely operate as complementary services to the core business of leasing temperature-controlled warehouses.

The U.S. contains around 214 million square feet, or 3.65 billion cubic feet, of temperature-controlled warehouse space. Of that space, Americold accounts for 992 million cubic feet, or 27%. Unlike most real estate subsectors, cold storage space is largely measured by cubic feet since space is used vertically, with newer facilities boasting ceiling heights as tall as 140 feet. Although cold storage operates in a separate sphere, we consider it to be a part of the broader industrial real estate industry, with cold storage facilities representing only around 2%-3% of the total industrial market.

We think Americold’s market share is elevated compared with other real estate subsectors, but we do not see any evidence that this position confers the ability to command above-market rents. The market share figure must also be taken within the context of the cold storage industry representing only a sliver of a much larger industrial real estate market.

Although there are certainly costs associated with ensuring that cold storage facilities are temperature-controlled, it is not inconceivable for traditional warehouse facilities to be converted to cold storage facilities if market conditions would support such a conversion. Research by Jones Lang LaSalle indicates that capitalization rates for cold storage have been compressing to converge with those of dry warehouses, decreasing from a historical spread of around 150-200 basis points to as little as 75 basis points for Class A product more recently.

Although demand for space has increased and is expected to increase significantly, so has institutional money and the new construction that has been coming onto the market. Institutional private equity players like Blackstone and Bay Grove Capital have shown an increased appetite to invest in the market because of favorable growth prospects. Development costs for cold storage are higher than industrial real estate at $250 per square foot versus $80-$120 per square foot for a traditional warehouse facility. This, combined with the sophisticated equipment needed to develop the product, had previously kept institutional players uninterested in truly entering the space. However, the additional opportunity that the industry now represents ensures that new supply will be added commensurate with the added demand.

We view Americold’s facilities as among the best in terms of quality and location, with a concentrated presence that closely aligns with regions representing the most attractive markets in the country, such as Chicago, Los Angeles, Dallas, Seattle, and coastal California. However, while Americold’s facilities may be newer and well located, nothing in them is impossible for competitors to replicate. We expect future new developments to remain concentrated in key warehouse locations across the country, especially on the outskirts of densely populated cities.

While location plays a key role in the strength of a portfolio, the massive size of most facilities is such that they are typically located near densely populated areas instead of in them. This makes it difficult for any cold storage facility to differentiate itself because of the abundance of unutilized or underutilized land surrounding large population centers. Additionally, temperature-controlled warehouses are a commoditized real estate asset class to develop, supporting our view that any outsider with financing can enter the market and participate in new construction whenever demand outpaces supply. We traditionally view the ability to effectively rebalance short-term differences in supply and demand as supportive of a no-moat rating in the REIT sector.

Unlike traditional industrial real estate, where tenants sign three- to five-year leases, much of cold storage space is leased on an as-needed basis, with some tenants signing for space on a month-to-month basis. Americold receives only around 40% of its annual rental revenue from tenants that have committed to a fixed-length contract, with month-to-month contracts representing around 5% of total rental revenue (and as-needed accounting for the rest). Among fixed-length contracts, the weighted average length of the term is around six years.

Given that our time horizon for a narrow moat is 10 years, we do not think the structure of contracts in this industry supports a switching cost moat source. The short length of stay is further complicated by the commoditization of these facilities and the numerous substitutes available in key metropolitan distribution hubs. Although demand is poised to increase significantly, a commensurate increase in supply should ensure that market conditions return to midcycle conditions over the next 5-10 years. Indeed, Americold itself maintains an active development pipeline, with ground-up development representing a core element of the company’s growth strategy.

We attempt to approximate Americold’s economic returns through analyzing its adjusted returns on invested capital. We accomplish this by adjusting our traditional return on invested capital calculation to include only an estimate of economic depreciation, which we approximate as annual operations capital expenditures, instead of accounting depreciation. By these steps, we calculate that Americold has earned an adjusted ROIC below its 8.4% weighted average cost of capital in recent years. While the company’s historical results might be obscured by a significant level of acquisition activity, we expect adjusted ROIC levels to fall short of its weighted average cost of capital over the next 10 years.

Industry Holds Comparatively Fewer Risks The cold storage industry's fortunes are directly tied to changes in overall demand for food, since it supports the supply chain that allows food to move from agricultural farms and food processing factories to endpoints of food consumption, such as grocery stores. As such, this industry is subject to comparatively fewer risks. Demand for food is relatively inelastic, which ensures that cold storage operators perform well even in the worst economic times.

However, there are a few risks we are monitoring. Much as with the traditional industrial REITs, we view additional supply and overbuilding as a threat to Americold. Although it is somewhat more difficult to build a temperature-controlled warehouse than a traditional warehouse, there remain low barriers to entry such that new construction could be harmful.

On the demand side, macroeconomic conditions affecting global trade present a concern. The new administration has exhibited a desire to rearrange some key trade agreements that could affect domestic relationships with important trade partners. Although Americold’s presence is international, it is relatively insulated, with about 85% of revenue coming from the United States. Nevertheless, major disruptions to global supply chains would affect Americold customers’ appetite for cold storage space.

The rise in e-commerce and online grocery has the potential to increase demand for temperature-controlled warehouse space, although vertical integration among some of Americold’s largest customers is a concern. Notable investments in distribution and logistics have been made by the likes of Amazon and FedEx, so tenants taking distribution efforts in-house could result in higher vacancies industrywide. The current industry structure is such that many food producers already own their adjacent cold storage facilities. If more of these food processors choose to manage and own these facilities in-house, it could reduce demand for a player like Americold.

Americold’s balance sheet has improved over the past several years, as the company has made a concerted attempt to reduce leverage following a highly acquisitive growth period. We now consider the company’s financial position to be much improved and more in line with peer industrial REITs. We forecast 2020 debt/EBITDA to be 4.9 times, with EBITDA/interest of 4.1 times. We see these levels as reasonably sustainable, with the company planning to continue growing through a combination of development and acquisitions. Additionally, strong operating performance should help Americold maintain or even improve these metrics.

As a REIT, Americold is required to pay out at least 90% of its income as dividends to shareholders. The current dividend of $0.84 per share represents around 75% of the company’s 2019 funds from operations. It’s likely that Americold will continue to tap into the debt markets as its main source of financing, given its continued appetite for growth in an industry that represents significant opportunity. Management has relied on a combination of acquisitions and strategic developments to continue to push for further growth. We estimate that this appetite for growth will eventually slow in the long term as economically attractive opportunities become scarcer.