Investors in SL Green Realty Corp., a leading Manhattan office building owner (NYSE:SLG), its stock has recovered significantly since my last update (Buy rating) in January 2023.I have assessed its price action and valuation Constructive as the market reflects significant pessimism in the office market.
Office REITs like SLG were already badly hit by the market in early 2023. However, when the regional banking crisis broke out in March, markets had other ideas.
As a result, SLG fell further to lows not seen since early 2009, signaling a massive capitulation in March 2023. So, SLG quickly recovered from its pessimistic peak as SLG buyers piled in given its “extremely cheap” valuation. Then. As a result, SLG has recouped all of its March losses and more, with its recent price action retesting levels in early February 2023.
Therefore, I think now is the time to evaluate whether buyers who missed out on SLG’s capitulation in March should jump on the bandwagon now. Before that, let’s discuss whether SLG’s recovery makes sense.
While the regional banking crisis remains under pressure, it has not worsened. Howard Marks, co-chairman and co-founder of Oaktree Capital Management, warned that he “expects more companies to default on their debts as interest rates rise.”
However, SL Green’s second-quarter earnings call in July suggested the company remains well-positioned to weather current challenges. Its occupancy rate remains well above the market average and is expected to improve further. Since the U.S. economy is unlikely to hit a hard landing, I don’t expect things to be worse than the first half of 2023. Still, the Fed’s longer-term higher positioning is expected to further boost economic growth. Highly leveraged REITs such as SL Green are under pressure. Analysts estimate that SL Green’s adjusted EBITDA leverage is expected to rise to 10.8x in fiscal 2024.
As a result, the company may not have the firepower to execute a generous stock repurchase program. Instead, I expect the company to use asset disposals to pay down debt and improve its balance sheet.
The company remains committed to maintaining its per-share dividend, emphasizing that it manages its distribution based on net income rather than adjusted FFO or AFFO. However, I believe the forward dividend yield of 8.3% still reflects the risk of a rate cut, even though it has yet to materialize. Therefore, given the pressure on SL Green’s ability to maintain its dividend, the market is likely to continue to price in a significant discount to its average valuation. Additionally, with the 10-year Treasury yield still at 4.2%, it would be unrealistic to expect the market to re-rate SLG to its 10-year forward dividend yield average of 4.46%.
Still, analyst estimates suggest the worst may be over, suggesting SL Green should perform more favorably in fiscal 2024. As a result, SL Green expects FFO per share to decline by nearly 30% in fiscal 2023. However, growth is expected to resume in fiscal 2024, with an increase of 1.6%. While the impact is modest, it suggests that things are unlikely to get worse for investors who bought at SLG’s March 2023 lows.
So if the Fed cuts rates sooner than expected (a potential upside surprise), it should provide a clear path for SLG to normalize its battered valuation. However, the recent recovery appears to have hit a roadblock, suggesting investors should consider waiting for the next pullback before adding further holdings. let’s see.
SLG formed the August lows during the recent pullback before surging higher and retesting the $40 level. However, its upward momentum has stalled, suggesting caution is needed. Furthermore, it has approached the key resistance zone at the $44 level, which may attract more selling pressure. I expect short sellers to use this level to reload their positions, intensifying the selling pressure.
Therefore, I assess that buyers looking to participate in SLG’s mid-term recovery would consider waiting on the sidelines while watching for the resolution of near-term resistance levels. If the next pullback can find support above the $31 level, buyers may consider adding to their holdings.
Rating: Downgraded to Hold. Note that a Hold rating is equivalent to a Neutral or Market Perform rating.
IMPORTANT NOTE: Investors are reminded to conduct due diligence and not to rely on the information presented as financial advice. Please always think independently and note that ratings are not intended to pinpoint specific entry/exit times at the time of writing unless otherwise stated.
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