Public Storage Downgraded, But Analyst Says 'We Could Be Wrong'

Public Storage PSA is likely to underperform given an unattractive valuation and persisting supply pressures, and yet there's a variable that a Bank of America Merrill Lynch analyst said could make the firm more bullish on the self-storage company.

The Analyst

BofA Merrill Lynch analyst Jeffrey Spector downgraded Public Storage from Neutral to Underperform and lowered the price target for the shares from $214 to $212.

The Thesis

Supply is the key risk for Public Storage, with pressures expected to intensify in 2018, Spector said in a Monday morning note, citing a BofA Merrill Lynch proprietary analysis. (See Spector's track record here.)

The analyst said he expects growth to slow across a number of key markets, including Atlanta, Miami, New York and Texas — excluding Houston.

Spector expects supply to be kept elevated due to development yields remaining attractive at 8-9 percent. But access to financing has become more challenging, with construction costs increasing and rent growth moderating, the analyst said.

"Visibility into '19 deliveries remains low with the impact & quantum of delivery delays uncertain," BofA Merrill Lynch said. This, along with the outperformance of Public Storage relative to the broader REIT group following Hurricane Harvey, prompted the downgrade.

If Public Storage closes its performance gap with peers, questions about its revenue management system could fade, Spector said. The company's "standout" balance sheet, with 13 percent leverage, could drive relative performance if macroeconomic confidence and/or capital markets become constrained, according to Barclays.

Public Storage "could also use its balance sheet to drive accretive, external growth," Spector said.