Certainty during rocky macroeconomic times deserves a premium. Predictable and dependable profits are exactly what cell-tower real estate investment trusts provide, and yet their stocks are selling at steep discounts right now.
The major wireless companies—Verizon Communications (ticker: VZ), AT&T (T), and T-Mobile US (TMUS) in the U.S.—couldn't function without the communication towers that three REITs own and operate. American Tower (AMT), Crown Castle (CCI), and SBA Communications (SBAC) lease space to the wireless companies, essentially acting as landlords for antennas.
These are massive companies: Even after suffering sharp declines this year, the big three tower REITs have a combined enterprise value of about $285 billion, reflecting some 300,000 towers in their portfolios across several continents.
The stocks have been serial compounders over the past two decades, supported by growing cellphone use and periodic upgrades to network technology. Profit margins are wide, recurring revenue is high, and future visibility is clear, given long-term contracts that often have annual rent increases. Importantly, the tower REITs will come out ahead no matter which wireless company—AT&T, Verizon, or T-Mobile—snags the most customers; they rent space on the same tower to multiple carriers.
The broader REIT sector has been clobbered in 2022's bear market. Higher interest rates mean greater costs for the borrowing-dependent industry—plus, REIT dividend yields are less attractive when bond yields rise. Tower REITs are a different breed: Ample free cash flow gives them the ability to internally finance growth, and the stocks should offer significant capital appreciation on top of their quarterly dividend payout.
To be sure, the Federal Reserve isn't done hiking interest rates, and valuations for tower REITs could contract further. But unlike other real estate owners that could see rents slump in a downturn, tower REITs' fundamentals should remain intact through a potential 2023 recession and beyond.
Wireless carriers continue to expand their subscriber bases, and smartphone users consume more data each year. The arrival of 5G networks using higher-frequency wireless spectrum bands creates a tailwind for tower REITs. Service is faster, but signals don't reach as far. That means more towers are needed to blanket an area with effective 5G coverage, relative to older generations like 3G or 4G.
Verizon and AT&T are in the process of deploying antennas that support newly acquired wireless spectrum, while T-Mobile is further ahead in its 5G network rollout, helped by assets it scooped up via its 2020 acquisition of Sprint. Dish Network (DISH) is also an emerging player, with ambitions to become a fourth nationwide carrier in the U.S.
The outlook is for several more years of new lease growth for the REITs, despite rising interest rates and gloomy economic forecasts. "Tower fundamentals weren't affected by the global financial crisis; they never cut numbers because of Covid-19," says RBC Capital Markets analyst Jonathan Atkin. "That's because that next wireless milestone from a technology standpoint is table stakes."
Valuations have dropped sharply, nonetheless. Since last fall, American Tower's ratio of price to adjusted funds from operations, a key measure of REITs, has fallen from about 28 times to below 20 times. SBA and Crown Castle's multiples have compressed even more.
American Tower stock has lost 23% after dividends this year, versus losses of 33% for Crown Castle, 23% for SBA, 25% for the Real Estate Select Sector SPDR exchange-traded fund (XLRE), and 15% for the S&P 500 index.
Tower REIT fundamentals, as evidenced by strong third-quarter results over recent weeks, aren't showing signs of a collapse commensurate with their share performance. The group's leverage does tend to be high. But interest expenses are manageable—with a low proportion of floating-rate loans—and won't take a meaningful bite out of profits.
There are nuances among the big three tower REITs. American Tower is the largest. Revenue was $10.3 billion, and adjusted funds from operations, or AFFO, was $4.5 billion over the past year. Both measures have compounded at about 10% annually over the past half-decade. Analysts expect sales of over $12 billion by 2025.
American Tower is also the most international of the group, with about 45% of its revenue coming from outside North America, including from several faster-growth but lower-margin emerging markets, such as India and Brazil. American Tower stock, at a recent $220, yields 2.6% in dividends annually and has 12% upside to analysts' average price target of $246.
Crown Castle is the least exposed to non-U.S. markets, which helped shield its results from a strong-dollar headwind in 2022. The REIT generates about a third of its revenue from leasing its more than 80,000 miles of fiberoptic cable. Crown Castle is also placing more of an emphasis than peers on small cells, or compact sites for antennas that may be attached to a lamppost or on the roof of a building. That's a newer and less proven business model than the big towers.
Separately, Crown Castle management gave guidance for 2023 with its latest quarterly results that implied slowing growth next year, as T-Mobile allows former Sprint leases to expire.
Crown Castle stock has a dividend yield of 4.6%. Wall Street analysts' average price target is $156, or 15% above the stock's recent $136.
SBA Communications is the smallest of the group. It is the purest play on U.S. macro towers. As at Crown Castle, Sprint churn will probably be a headwind in 2023.
At a recent $296, SBA shares have a dividend yield of 1.0%. The average price target is $328—a potential upside of 11%.
All three tower REITs are selling at compelling prices. "Very few times—I'd say about twice a decade—do you get to buy it at a level that's going to generate above-average returns." says John Neff, a portfolio manager of the $12.8 billion Akre Focus fund (AKREX), which counts American Tower as an 11% holding. "There's no question that you're getting such an opportunity today."