1 Dividend Stock With Fabulous Growth

By Markets Fool.com

If you're looking for stocks that give both juicy dividends and huge growth, I've got an interesting one for you. It's in a big, growing industry, its dividend yields 3.6%, and it just grew revenue by 25% year over year.

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Interested yet?

Searching for extra space

OK, that subhead was kinda cutesy -- but I just can't help myself. The stock is Extra Space Storage (NYSE: EXR), a real estate investment trust (or REIT, for short) that invests in self-storage buildings. It's an industry that has seen explosive growth as more and more Americans have too much stuff for their homes: Roughly 10% of Americans use self-storage.

Image source: Getty Images.

Extra Space Storage has been growing like a weed; in Q2 of 2016, the stock saw revenue grow by 31% year over year. Adjusted funds from operations (or adjusted FFO -- a non-GAAP measure that many REITs report in addition to the more traditional earnings per share) rose 25.3% compared to the year-ago quarter. The stock has been turning in impressive growth like that for years. For example, Extra Space's revenue grew by 24% from 2013 to 2014 and by 21% between 2014 and 2015.

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That revenue growth comes from a mix of organic growth (same-store revenue grew by 8.3% year over year last quarter, for example) and real estate purchases -- Extra Space has roughly doubled its store footprint since 2008. Let's break each of those down into their component parts.

Pricing power

The same-store growth is due in large part to Extra Space Storage's aggressive rent increase schedule. As CEO Spencer Kirk noted on the Q1 2016 call, "It's five months for the first rate increase. It's nine months thereafter, nine months thereafter, nine months thereafter." (All quotes courtesy of S&P Market Intelligence.) Extra Space maintains that pricing power for two reasons: The self-storage market is supply constrained (meaning that occupancy will likely remain high, as space is at a premium), and there's a big hassle factor for moving out. I'll quote Spencer Kirk again:

If you're renting a unit and you get a rate increase letter that says your rent is going up $15, you are not likely to go get a U-Haul truck, take a Saturday morning, pack up your stuff, go down the street, unpack your stuff, return the U-Haul truck to save $15. People just won't go through the effort to do that.

Lather, raise rents, repeat. It's as simple as that.

Buying growth

The picture is a bit more complex on the acquisitions side. Real estate is capital intensive -- and REITs are required to return 90% of their profits to shareholders in the form of dividends -- so you should always look into how a fast-growing REIT is financing its growth. The major choices are by issuing new debt or shares. Both have their pros and cons, although given that we're in a low interest rate environment, I definitely have a preference for debt (a preference that will likely change when interest rates begin to move meaningfully).

Extra Space has kept share dilution to a minimum, only growing its share count by 12% between 2013 and 2015. Management has financed its growth through debt, by roughly doubling Extra Space's long-term debt from $1.8 billion at the end of 2013 to $3.8 billion as of the end of June. Given that Extra Space is bringing in roughly $3 of earnings before interest and taxes for every $1 of interest expense, the company still has plenty of room to make more acquisitions, and plenty of safety margin on its balance sheet.

Extra Space has also been carving out an increasing niche managing others' self-storage properties -- 378 for third parties, and 252 in joint ventures as of the last quarter. This is an attractive business for two reasons: It's less capital intensive than owning the properties outright, and it enables Extra Space to get a clear sense of a property's performance potential before making an offer. It's a nice chance for Extra Space to leverage its expertise, both for immediate income (management fees) and to strengthen its acquisition pipeline.

Dividends are growing nicely, too

Extra Space Storage's management is expecting adjusted FFO of $3.71 to $3.78 for full-year 2016. Given its current quarterly dividend (which is up 32.2% from a year ago, by the way) of $0.78, that means Extra Space is paying out roughly 83% of its adjusted FFO in dividends. Anything higher than 90% would have me nervous, as it would imply relatively little margin of safety for the dividend, in case AFFO slips (everyone has a bad quarter from time to time). But 83% should establish a nice margin of safety. Another thing that adds to that perception: Extra Space has grown its dividend by a whopping 680% over the past five years. And with a yield of over 3.5%, it's attractive for income investors, too.

Threats seem manageable

Extra Space, like most REITs, has some floating-rate debt that could grow more expensive as interest rates eventually rise. (As of the end of 2015, about $1.1 billion of its $2.8 billion in debt was floating-rate.) But management estimated at the end of 2015 that a shift in interest rates of a full 1 percentage point would only affect annual interest payments on that variable debt -- not including variable debt with a floor to its interest rates -- by around $7.3 million annually. It's just not that big of a threat.

On the flip side, acquisitions would become more expensive in a rising interest rate environment. That would likely slow Extra Space Storage's acquisitions pipeline...but I expect the company would compensate by taking more management contracts and doing more joint ventures. Extra Space's model allows for a lot of flexibility.

Now, the stock trades at a real premium -- about 23 times estimated 2016 AFFO -- but that's the price you pay for growth. It's a little expensive for my taste, but you can bet it's high on my watch list. This one could be a solid long-term winner.

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Michael Douglass has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.