Crown Castle: This 6%-Yielding REIT Is No Sucker Yield (NYSE:CCI)

Introduction

As most of my readers may know, I am very careful when it comes to elevated dividend yields. Most of the high-yield stocks I discuss are in the energy space, which is an industry filled with companies that currently benefit from subdued CapEx growth and strong income tailwinds.

In other words, it makes sense for these stocks to have elevated yields.

In fact, it’s the industry with the biggest difference between current CapEx (as a share of total S&P 500 CapEx) and 10-year average CapEx.

Another area with low CapEx requirements is real estate, which has – by far – the lowest CapEx requirements of the entire S&P 500.

Real estate is also the sector with the highest dividend yield in the S&P 500.

Using the data below (lowest row), we see the dividend yield of S&P 500 real estate stocks is 4.2%, 40 basis points above its 20-year average.

A 4.2% yield is good. However, it competes with elevated rates on risk-free government bonds.

Using the overview below, we see that investors can make more than 5% on short-term bonds!

This means companies that offer a high yield need to bring real value to the table, as the risk-free alternative is quite attractive. The problem is that the higher the yield, the higher the risk that a given yield is not sustainable.

After all, most dividend yields are part of a stock’s valuation.

Let’s assume Company A pays $0.50 in dividends each year. That’s the part it can control.

What it cannot control is its stock price.

If the stock trades at $50, investors receive a 1% annual payout. If the stock trades at $10, the stock yields 10%. The market decides the yield.

That’s why so many stocks with elevated dividend growth still do not provide an elevated yield for new investors.

Carlisle Companies (CSL), for example, has a ten-year dividend CAGR of 14.5%(!). However, its current yield is just 0.8%. That’s because consistent capital gains have more than offset dividend growth.

Then, there are companies that have grown their dividend consistently.

However, due to poor stock price performance, their yields have become quite “high.”

Crown Castle (NYSE:CCI) is one of these companies.

It has a current dividend yield of 6.1% and a five-year CAGR of 7.6%. Its most recent hike was 6.5% on October 20, 2022.

In this article, I want to spend some time focusing on the quality of this business and dividend yield, as the company’s stock price is having a 50% off sale, which does not suggest a lot of confidence.

Since I wrote my most recent article on January 13, titled “Small Cells, Big Gains: 5.5%-Yielding Crown Castle’s Blueprint For Success,” shares are down another 8%, excluding dividends.

In other words, we need to figure out if this 6%-yielding stock is a fantastic deep-value opportunity or a “sucker yield.”

So, let’s dive into the details!

The Deep Value Behind The CCI Ticker

What’s interesting is that despite its current stock market crash, Crown Castle has still delivered a lot of long-term value.

Don’t believe me?

The chart below shows that since its IPO in 2012, CCI has returned more than 10% annually, including dividends.

The time series starts in 2012. Back then, the U.S. economy rose from the ashes. There was (almost) no better time to buy real estate.

With that said, I can understand people who are (somewhat) bearish on the stock, as CCI is dealing with some issues.

• Growth is gone. Using the FactSet data in the chart above, after 2% adjusted funds from operations (“AFFO”) growth in 2023, this year is expected to see an 8% contraction, potentially followed by a 3% contraction in 2025.
• The dividend payout ratio is elevated. Using the aforementioned growth expectations, CCI is expected to generate $6.92 in AFFO this year. It pays a $6.26 dividend. That’s a 90% payout ratio. The payout ratio is 93% using 2025E AFFO.
• Its debt is elevated. The company went into this year with $22.8 billion in net debt. That’s 5.2x EBITDA. The good news is that over the past five to seven years, it decreased the percentage of secured debt from 47% to 6% and increased the fixed-rate portion of its debt to 90%. Moreover, the company has roughly $6 billion in available liquidity and just $2 billion of debt maturities through 2025. It has a BBB investment-grade credit rating from Standard & Poor’s.

While none of this screams “trainwreck,” it makes sense that investors opt for other investments with lower payout ratios, higher (expected) growth, and better balance sheets.

Especially after rates started to increase after 2021, a lot of high-quality REITs have suffered, allowing investors to buy quality at discounted prices.

As we can see above, the decline in CCI’s stock price was mainly triggered due to macroeconomic issues. It was only amplified by other issues like inconsistent growth.

It also needs to be said that there is a lot to be upbeat about.

For example, the company has a new CEO, Steven Moskowitz, who has 25 years of experience in the industry, mainly with American Tower (AMT) and Centennial Towers.

The company also initiated a strategic and operating review of its fiber business, aiming to enhance shareholder value.

This process started in January and includes an assessment from advisors like Morgan Stanley, Bank of America, and consulting firms to assess the company’s assets, market position, and overall structure.

Essentially, this review confirmed the company’s value in attractive U.S. markets and identified opportunities to optimize the enterprise fiber and small cell business.

The next step was to determine the optimal path to maximizing the value of these assets both within and/or outside of Crown Castle. To help assess the potential value creation opportunities, we have recently engaged with multiple parties who have expressed interest in a potential transaction involving all or part of our fiber business. These discussions are ongoing. While we will not comment further on these discussions during the call, we are excited to have Steven onboard to help us think through our strategic alternatives. – CCI 1Q24 Earnings Call

As we can see below, the small cell business is a huge part of its portfolio, as it had roughly 115 thousand small cells at the end of 2023. These assets are great for markets with concentrated data demand, including major cities.

Due to the Internet of Things (an all-connected world), data demand has exploded, requiring billions in new infrastructure. Despite carriers’ focus on profitability, Crown Castle noted that the annual CapEx of major carriers has remained close to $30 billion per year, with 2023 CapEx coming in at $36 billion.

We continue to invest in our wireless networks, high-speed fiber and other advanced technologies to position ourselves at the center of growth trends for the future. During the year ended December 31, 2023, these investments included $18.8 billion for capital expenditures.

[…] Capital expenditures continue to relate primarily to the use of capital resources to enhance the operating efficiency and productivity of our networks, maintain our existing infrastructure, facilitate the introduction of new products and services and enhance responsiveness to competitive challenges. – VZ 2023 10-K

This is what I wrote in my prior article:

The small cell business segment is emerging as a particularly promising source for growth.

As the limitations of traditional towers become more obvious due to interference and regulatory constraints, the deployment of small cells becomes crucial for addressing the escalating data demands in urban areas.

They are also much more profitable, as we can see in the overview above!

In light of these opportunities, the new CEO plans both short-term and long-term measures to improve employee effectiveness and customer service.

Essentially, by focusing on these areas, he aims to improve the company’s operating margins and position it to capture a larger share of new leasing business and site development opportunities.

As customer spending on network expansion increases, these efforts are expected to significantly improve Crown Castle’s performance and competitive position in the market!

With that said, the company’s results continue to reflect strong demand.

In the first quarter, this demand translated into a 5% organic growth rate, excluding the impact of the Sprint cancellations.

The breakdown of this growth includes a 4.6% increase in towers, a significant 16% rise in small cells—which included $5 million of unexpected nonrecurring revenue, and a 2% growth rate in fiber solutions.

Unfortunately, despite strong organic growth, Crown Castle faced several offsetting headwinds that led to a year-over-year decline in the financial metrics seen above, including site rental revenues, adjusted EBITDA, and AFFO.

• The first major factor was a $50 million reduction in site rental revenues due to Sprint cancellations, which had a major impact on the company’s overall financial performance.
• Additionally, two significant noncash items contributed to a combined $54 million reduction. These were related to straight-line revenue and prepaid rent amortization.
• The company saw a $26 million decrease in services margin contribution. This was primarily due to lower tower activity and the strategic decision made last year to discontinue offering construction and installation services.

Nonetheless, the company kept its full-year guidance unchanged.

The company expects a year-over-year decrease in site rental revenues, adjusted EBITDA, and AFFO, largely due to the aforementioned factors.

However, the company’s expected organic growth rate also remains unchanged, which includes at least 2% organic growth.

To add some color here, expectations include 4.5% growth from towers. That’s slightly lower than the 5% growth rate the company saw in 2023.

Small cells are expected to see 13% growth, with 16,000 new billable nodes projected for 2024, which is a significant increase from the 6% growth and 8,000 nodes in 2023.

Meanwhile, fiber solutions are expected to grow by 3%, which would be a positive shift from the flat growth the company saw last year.

So, what does this mean for its valuation?

Valuation

One major benefit is that the market has priced in a lot of weakness.

Using the FactSet data in the chart below, CCI trades at a blended P/AFFO ratio of 14.1x, which is well below its long-term normalized multiple of 20.5x.

In order for CCI to go back to that valuation, (at least) two things need to happen:

• We need interest rates and inflation to come down again, which is the biggest reason why the market is giving REITs lower valuations.
• The company needs to win back the market’s confidence and prove it can go back to sustainable growth.

If the company succeeds in doing that, there’s a high likelihood it works its way back to $140 (36% above the current price).

This means my price target remains roughly unchanged compared to my January article.

While I do not expect CCI to take off anytime soon, I believe it offers good value, as I do not consider CCI to be a dumpster fire.

Although there is no doubt that CCI needs to improve its operations and find ways to unlock more value, I believe the odds of a longer-term rebound are great, which should come with a return of dividend growth in the next few years.

For now, investors can enjoy an elevated yield while waiting for growth to return.

According to the company, we can assume the dividend is safe unless its earnings take a turn for the worse.

We believe our balance sheet is strong and that our earnings and our balance sheet will support the dividend. So we’re going to have to, as we go through — and the strategic review and everything else, we’re going to have to go through that. But I want to just reiterate our support for the dividend, and it’s a key part of our capital and our philosophy as a Board. – CCI 1Q24 Earnings Call

Takeaway

In summary, Crown Castle presents an interesting investment opportunity despite ongoing challenges.

Its 6.1% dividend yield is appealing, particularly for those seeking high-yield stocks, but it’s essential to understand the underlying risks and potential rewards.

The company’s recent performance has been impacted by macroeconomic conditions and internal issues, yet its long-term value remains strong, with a strategic review underway to optimize assets.

While mid-term growth may be limited, the company’s efforts to enhance efficiency and explore new opportunities could pave the way for a solid rebound.

Pros & Cons

Pros:

• Attractive Dividend Yield: With a current yield of 6.1%, CCI offers a juicy payout.
• Long-Term Value: Despite recent setbacks, CCI has historically delivered over 10% annual returns since its 2012 IPO.
• Strategic Review: The ongoing strategic and operating review, supported by experienced advisors, aims to unlock shareholder value, mainly in the fiber and small cell businesses.
• Experienced Leadership: New CEO Steven Moskowitz brings 25 years of industry experience. Given his background, he has seen some of the industry’s best practices that may be helpful for the CCI turnaround.

Cons:

• High Debt Levels: With $22.8 billion in net debt and a 5.2x EBITDA ratio, CCI’s financial leverage is significant, yet not putting the business at risk.
• Stagnant Growth: Projected declines in AFFO and a high payout ratio indicate growth challenges ahead.
• Macro Headwinds: Broader economic issues and higher interest rates have negatively impacted REIT valuations.
• Operational Uncertainty: While the strategic review is promising, its outcomes remain uncertain.