Should one Consider Buying, Selling, or Holding Sun Communities Stocks?
Should one Consider Buying, Selling, or Holding Sun Communities Stocks?
Decreasing interest rates have attracted some investors back to real estate investment trusts (REITs) recently. Lower rates allow REITs to acquire more properties, while diminishing returns on CDs, bonds, and Treasuries have pushed income-focused investors towards higher-yielding dividend stocks.
However, in a successful year for REITs, Sun Communities (SUI -0.88%) has been left in the lurch, experiencing an 8% decline in stock price over the past year as the S&P 500 rose by nearly 30%. So, what's the best course of action for investors now regarding this disregarded REIT?
Comprehending Sun Communities' business model
By the end of the third quarter, Sun's portfolio consisted of 659 properties, including 288 manufactured housing properties, 179 RV properties, and 138 marina properties across North America, with 54 U.K. properties of various types. However, this represented a decrease from 670 properties a year earlier, primarily due to a reorganization of its manufactured housing portfolio facing challenges with high inventories as interest rates increased.
On the positive side, the merged occupancy rate for its North American manufactured housing and RV segments increased by 50 basis points year-over-year to 97.7% in Q3. The U.K. segment's occupancy rate rose 90 basis points to 91.5%.
From 2018 to 2023, Sun's core funds from operations (FFO) per share grew at a strong compound annual rate of 9%, even as its residential business navigated the pandemic and rising interest rates. However, for 2024, it expects its core FFO to decrease by 4% to 5% as it trims its manufactured housing business. Additionally, it intends to restructure its business to cut costs further.
Why are investors not optimistic about Sun's future?
Although Sun's business appears steady, it was faced with troubling allegations in September 2022 from Blue Orca Capital, a short-selling hedge fund based in Texas. Short-sellers make profits when a stock's price falls, so this should be a consideration for investors.
In its report, Blue Orca accused Sun President and CEO Gary Shiffman of financial misconduct. The report also criticized some of Sun's financial reporting strategies and claims it is overly leveraged, with a net-debt-to-recurring EBITDA ratio of 6.0.
However, investors should consider these bearish claims with caution. It's not uncommon for REITs to report results similarly to Sun, and it's not unusual for REITs to carry high debt loads.
In its Nov. 6 quarterly conference call with analysts, the company revealed that it had retained an independent external law firm to investigate matters following the short report's release. "There have been no alterations to our financial reporting practices, and the Audit Committee determined that the company complied with its disclosure obligations," Shiffman said.
On Nov. 6, Sun announced that Shiffman would retire in 2025 and that John McLaren, the former COO, would return to serve as the company's president. (The board has initiated a separate search for a new CEO.) The timing of this transition and Sun's uncertain earnings outlook spooked investors, and the stock dropped by approximately 14% in the past three months. However, the company mentioned that "Shiffman's retirement is not the result of any disagreement with the company on any matter relating to its operations, policies, or practices," and Shiffman himself attributed his decision to the Blue Orca report.
Trading around $124, Sun's stock appears fairly valued at 17 times last year's FFO per share, but its forward dividend yield of 3.1% appears low compared to the yields of other REITs or the 10-year Treasury's current yield of 4.1%.
Should one buy, hold, or sell Sun's stock?
Sun's future could improve as it restructures its business and interest rates further decrease, but there are more appealing REITs with higher dividend yields and lower valuations to choose from. For instance, Realty Income (NYSE: O) - a REIT giant focusing mainly on large recession-resistant retailers - offers a forward yield of 5.8% at its current price, makes payments monthly, and trades at less than 14 times last year's FFO per share.
Therefore, it would be wiser to bypass Sun's stock for the time being. It will likely recover from its current predicament, but it may not be the best use of your investment capital when there are numerous better options available in the sector.
In light of the allegations against Sun Communities and its CEO, some investors may be hesitant to invest in finance, leading them to explore alternative opportunities in the REIT market. Despite Sun's steady business model and strong historical FFO growth, the ongoing investigations and uncertainty surrounding its future earnings may cause its stock price to remain stagnant. Therefore, investors might consider diversifying their portfolio by investing in other REITs with higher dividend yields and lower valuations, such as Realty Income.