CCI: Q2 2023. Concerns Priced In

Executive Summary

The tower REIT sector had a rough week. It started with the lead-sheathed cables and moved into a weaker-than-expected report from Crown Castle International (CCI).

AFFO guidance is down 1.1% at the midpoint (from $7.64 to $7.54). 

Site rental revenue guidance is unchanged. Revenue from services (not rent) is projected to decline. Lower expenses partially offset the revenue dip. That would be more concerning if the projections were for lower site rental revenue. The hit to services should be a smaller factor. Services is a much more volatile category, so lower projected services revenue shouldn’t be extrapolated out the way rent growth can be extrapolated.

It seems like service revenue would be a good tool for forecasting rental revenue growth, but that wasn’t the case. The correlation wasn’t there.

There’s also a bump higher in net interest expense as interest paid will increase more than interest earned. The big year-over-year factor is still interest expense, but the story for this quarter was the guidance swinging from services revenue. 

When interest rates jump up or down, it can distort the AFFO growth rate for that one year. Hikes seen in 2023 should create a modest headwind for 2024, but not on the magnitude seen in 2023. After the rest of the tower REITs report, I’ll run some models to create my estimates and share the results with members. 

From a valuation perspective, CCI’s dividend yield is too high (recently 5.8%), and its AFFO multiple is too low (recently a bit over 16x) for a growth REIT. Most of the headwinds to growth are temporary, so valuation should eventually recover. Until then, investors are getting paid a nice dividend for waiting.

Updated Guidance

This slide has some nice features, but the midpoint changes (bottom boxes) don’t stand out. I suspect it isn’t intuitive enough for most investors:

The graphic part demonstrates the year-over-year factors driving AFFO growth. The very bottom line reflects how much those values changed compared to prior guidance:

• Positive numbers improve AFFO.

• Negative numbers reduce AFFO.

Expenses were expected to increase by $120 to $90 million. Instead, they are projected to increase by $80 to $50 million. That is favorable by $40 million. 

However, the reduction in expenses is more than offset by a reduction in “services” revenue. Those two should be strongly related. 

Then we have unrelated items. Net interest expense projections are up because the forward curve shows more hikes. However, the “other” line item includes $10 million of additional interest income and a $15 million reduction in maintenance costs. Per management, this reflects improved execution rather than delaying costs.

Towers

This is where things get interesting to me. 

On the Q2 2023 earnings call, CCI said tower activity slowed, reducing the demand for services. However, tower site rental revenue guidance is unchanged as much of the leasing is already done. Further, contracts with major carriers require minimum levels of additional growth each year:

CCI targets and projects 5% annualized organic growth in tower revenue. 75% of that amount through 2027 is already contracted. That creates a bit of a floor for the tower's revenue growth rate.

Can We Use Service Revenue to Foreshadow Rental Revenue?

No. 

This doesn’t work. Intuitively, it seems like it would work. If “service” revenue drops when activity drops, the lower “service” revenue foreshadows weaker growth, right? No. Does more “service” revenue mean more rental revenue growth? No.

Seems intuitive. Doesn’t work. A good chunk of the delay in preparing this article was the result of searching for that intuitive connection.

Note: I’ll have an extended part at the bottom for investors who want to see the data since I already spent time creating the charts to see if there was any predictive value.

Organic Growth Rates