Neutral Stance on AvalonBay

On Feb 20, 2013, we reiterated our long-term recommendation on AvalonBay Communities Inc. ( AVB - Analyst Report ) at Neutral. This reflects the company’s successful execution of strategic efforts to enhance its portfolio and its healthy balance sheet with adequate liquidity. However, short-term revenue headwinds arising from acquisitions and huge development pipeline, which will lead to an increase in operational risks, remain the matters of concern.

Why Neutral?

AvalonBay’s expert local operating teams and strategically located Class A properties helped it realize superior performances in 2012. It achieved same-store quarterly improvement in rental revenues of 5.8% year over year attributable to a 5.6% rise in average rental rates and a 0.2% increase in Economic occupancy.

Northern California and Seattle regions remained the major revenue growth drivers due to leasing of new units and portfolio expansions. Going forward, we believe that its efficient operating platform will help it keep posting better results and this, in turn, will boost its financial results.

Moreover, in 2012, according to its repositioning strategy, the company, along with Equity Residential ( EQR - Analyst Report ) , entered into an agreement with Lehman Brothers Holdings Inc. to acquire the entire ownership stake of Archstone Enterprise LP. The deal is slated to close by the first quarter of this year. The acquisition is expected generate decent revenue for AvalonBay in the long run.

Also, management projected to continue its expansion spree with estimated acquisitions worth $300 million of in-service communities in the current year apart from the purchase of Archstone portfolio. We believe that this portfolio repositioning activity will improve the internal growth metrics, enabling the company to emerge stronger once the real estate markets fully recover.

In addition, AvalonBay has a reasonably strong balance sheet with moderate near-term debt maturities and adequate liquidity. At the end of 2012, the company had no amounts outstanding under its $1.3 billion unsecured credit facility. Moreover, the company enhanced its shareholders’ value in the fourth quarter with a 10.3% hike in its dividend payout.

However, AvalonBay’s fourth quarter 2012 FFO of $1.27 per share missed the Zacks Consensus Estimate of $1.40. The results were hurt by higher expenses related to the Archstone acquisition and Superstorm Sandy.

However, on a year-over-year basis, FFO increased 6.7%, reflecting incremental contribution from newly developed and acquired properties and a decrease in net interest expense. We believe that the short-term revenue headwinds will limit the stock’s upside potential to some extent.

Also, the company provided negative guidance for the first quarter of 2013. AvalonBay expects FFO per share to be a loss of $0.66–$0.62 in the upcoming quarter. The modest guidance reflected the negative impact of Archstone acquisition charges.

Following the release of the fourth quarter and full year 2012 results, the Zacks Consensus Estimate for full year 2013 has inched down 1.0% to $6.03 per share with 2 estimates moving north and 3 moving south.

Also, the Zacks Consensus Estimate for full year 2014 fell 3.9% to $6.91 per share as 2 estimates were revised downward. With the Zacks Consensus Estimates going down for both full year 2013 and 2014, the company now has a Zacks Rank #3 (Hold).

Other Stocks to Consider

REITs that are currently performing well include Simon Property Group Inc ( SPG - Analyst Report ) and Ventas Inc ( VTR - Analyst Report ) . Both having a Zacks Rank #2 (Buy).

Note: FFO, a widely used metric to gauge the performance of REITs, is obtained after adding depreciation and amortization and other non-cash expenses to net income.