Fundamentals Continue To Remain Strong for Americold 

Equity Analyst

Suryansh Sharma

Americold owns and operates cold storage warehouses that mainly store perishable food products but also other temperature-sensitive items like pharmaceuticals, florals, and chemicals. The company’s main line of business is the warehouse rent and storage segment, which accounted for 79% of the company’s revenue in 2022. While these warehouses vary in size and exact temperature, four-fifths of Americold’s warehouses are in North America and we consider Americold’s facilities as among the best in terms of quality and location. The company provides ancillary warehouse services like flash freezing and picking/packing to serve, attract, and retain customers. The company also has a transportation services segment where it brokers, manages, and operates transportation for its customers. The remainder of the revenue comes from the third-party managed segment, where it operates facilities on behalf of customers who own cold storage space but do not have expertise in operating it.

Historically, many temperature-controlled warehouses were independently owned and there was little institutional interest in the space. There was also little speculative development (i.e., development without tenants already signed up) because of the complexity of construction, high initial capital investment, unique requirements of every tenant, and the modest growth profile of the industry. Recently, though, many deep-pocketed institutions have entered the space—most prominently, Bay Grove Capital-backed Lineage Logistics.

The warehouse portfolio of the company has been materially impacted due to lower commodity stock levels in the past two years. The warehouse services segment has also been struggling partly because of the difficulties in attracting and retaining workers at cold storage facilities. We expect the occupancy to recover to prepandemic levels in the upcoming years as food manufacturers continue to ramp up production and supply chain issues and labor shortages abate. We think that the company will continue to grow its market share in a rapidly consolidating industry and should be able to achieve high-single-digit net operating income growth in the upcoming decade.

Business Strategy & Outlook

Due to the lack of switching costs and the ease of additional developments, we do not believe that Americold Realty has a maintainable competitive advantage. Therefore, we assign Americold a Morningstar economic moat rating of none, which is consistent with the other North American industrial REITs that we cover. We estimate that cold storage facilities represent around 2%-3% of the total industrial market.

In 2022, Americold derived nearly 80% of revenue and over 90% of net operating income, or NOI, from the rent, storage, and warehouse services segment. Americold’s other two business lines—third-party managed services and transportation services—operate with razor-thin margins that are in line with logistics companies, which tend to have around 5%-10% net income margins. Because of these add-on services’ pricing model of typically being sold at cost plus a fixed service fee and their low margin profile in general, we view these services as largely complementary to Americold’s core business of leasing temperature-controlled warehouses and not a major factor in the company’s moat rating.

Market Dynamics (Supply and Demand):

Compared with dry (i.e., non-temperature-controlled) warehouses, cold storage warehouses are more complicated to construct and operate—an average development takes five months long and costs 2-3 times more, and they require more operational expertise because specialized equipment and staff are required to keep the facilities at the desired temperature. Even so, the development process for cold storage warehouses is relatively simple compared with other real estate subsectors, and, at the end of the day, these buildings are essentially swathes of open space that are filled with pallets on storage shelves.

From a demand point of view, temperature-controlled warehouses are a commodity because we see little evidence that current market dynamics award firms with pricing power. Low switching costs enable Americold’s tenants to seek out other temperature-controlled warehouses with lower pricing. If Americold substantially raised rents on a tenant, and the customer determined that cost savings would exceed the all-in costs of moving (and potentially higher transportation costs moving forward), the tenant could leave for another cold storage facility. Even in an extreme hypothetical scenario where one player owned all the temperature-controlled warehouses in an area, or all players colluded on pricing, tenants are not stuck using available temperature-controlled warehouses. Most of Americold’s biggest tenants are well-established, multinational food production/distribution companies with deep pockets and ample access to capital. While it is not in their tenants’ wheelhouse of expertise, they have the ability to buy or build temperature-controlled warehouses.

While the main driver of demand growth in the dry warehouse space is the continued adoption of e-commerce—for every dollar of sales, it takes approximately 3 times the amount of warehouse space to fulfill an e-commerce order compared with traditional retail channels—that driver of demand is mostly not applicable to the temperature-controlled warehouse space. Currently, there are few perishable goods shipped via e-commerce other than at-home meal kits (like those from Blue Apron and HelloFresh). Even so, these at-home meal kit companies’ requirement for space is de minimis compared with the needs of food producers/distributors, and very few of these services have yet found mass-market adoption. If, in the future, items were delivered directly from temperature-controlled warehouses to consumers, we think this would represent a boon to the cold storage industry, since it would necessitate significantly greater demand for space. Although we intend to watch this dynamic closely, there is no evidence to indicate that this will be the case at the moment.

We also do not think online grocery ordering will affect the demand for cold storage. When a consumer places an online order for groceries (for either pick-up or delivery), their order is currently fulfilled at a brick-and-mortar grocery store, which is typically located within three to five miles of their target consumer demographic, meaning they are the best located to facilitate an efficient and speedy delivery. In contrast, Americold’s warehouses typically are on the outskirts of urban areas, enormous, and generally mixed-use. Therefore, owners of cold storage facilities are nearly agnostic as to the channel from which consumers purchase their groceries. If e-commerce demand reaches a certain threshold, some grocery stores could shift exclusively to delivering groceries to online shoppers. Such a change would have a limited impact on cold storage, which operates further upstream in the grocery procurement process.

In our view, the fundamental driver of demand for temperature-controlled warehouses is increased urbanization and general population growth. In addition, incremental demand will come from the desire of companies to build supply chain resiliency into their operations as well as greater consumer appetite for fresher, more sustainably sourced foods (which tend to have a shorter shelf life).

We believe the temperature-controlled warehouse industry is not supply-constrained in the long run. Despite how management cites how many of its warehouses are located in key logistics corridors—including strategic metropolitan statistical areas, or MSAs, like Chicago, Los Angeles, Dallas, Seattle, and coastal California—the sheer size of warehouses requires them to be on the outskirts of urban areas, where zoning laws are less stringent, and land is cheaper and more abundant. Contrast this with a central business district, where it is much more challenging to secure a plot of land (for greenfield development) or an old building (for brownfield development), in addition to zoning. Thus, players with enough capital can freely enter the industry. The temperature-controlled warehouse space may be especially attractive considering capitalization rates for cold storage have been historically higher than dry warehouses, according to research conducted by Jones Lang LaSalle. As a recent example, Bain Capital and Barber Partners formed a $500 million joint venture in May 2022 to develop 15 Class A cold storage facilities in high-demand markets across the U.S. In our view, development can and will catch up to demand in the long run, from either incumbents like Americold or institutional-backed ventures, and we traditionally view the ability to manage short-term supply/demand imbalances as supportive of a no-moat rating in the REIT sector.

Efficient Scale:

Efficient scale is the most common moat source for real estate investment trusts and refers to situations where companies are effectively serving a very limited market size and potential competitors have little incentive to enter the market because by doing so, they would lower the industry’s returns to below the cost of capital. The heart of an argument for efficient scale would go like this: Given a well-defined market that is effectively served by established players’ warehouses, the addition of another warehouse will take up market share from the pre-existing warehouses, thereby lowering economic profits across the board. At a glance, it may seem like Americold fits these criteria, due to the relatively consolidated nature of the industry and the capital intensity of building/operating a temperature-controlled warehouse. However, we have a few counterpoints.

First, the efficient scale moat source is often awarded to companies in industries like railroads, regulated utilities, communication infrastructure, midstream oil and gas, etc.—industries that require massive initial capital expenditures and also have significant maintenance needs. The cost of building a temperature-controlled warehouse, in the high tens to low hundreds of millions of dollars, is comparatively quite small. 

Second, a common characteristic of industries with efficient scale is they operate in a market that has seen little entry or exit in recent times. The industrial REIT sector, as a whole, has attracted plentiful investment over the past decade. For temperature-controlled warehouses, in particular, speculative development (i.e., development without tenants signed up) has hit a new record. There is something that institutional investors see that elicits their interest—and it seems they believe incremental supply will not lower all players’ returns below their cost of capital. 

Third, we think that the market size for warehouse space (both temperature and non-temperature controlled) in a particular submarket is poorly defined. Tenants, for the most part, are not tied to a specific locality as long as they can still effectively serve a submarket. In other words, tenants have the ability to “mix and match” warehouse locations, meaning they are free to move some or all of their operations to another warehouse and modulate the capacity accordingly. 

Lastly, in industries where the efficient scale moat source is often awarded, there is one or a handful of players that dominate an entire market. For example, in the case of a regulated utility that has a monopoly in a particular submarket, the entrance of a new player would cause these two players to split economic profits. Assuming there is no change in electricity demand, both the incumbent and the new entrant will find it difficult to meet their cost of capital. Contrast this with the dozens of temperature-controlled warehouses in a typical metropolitan area of a couple million people. The addition of another temperature-controlled warehouse will increase competition and push prices down, but the reduction in economic profits will be spread among the existing warehouses (albeit not equally). In the case of the regulated utility, economic profits were cut in half; in the case of a market with a dozen warehouses, economic profits would be cut by a single-digit percentage.

Switching Costs:

The industrial warehouse space exhibits negligible switching costs, and that is also the case for industrial cold storage. Industrial real estate typically features multiyear space commitments, but cold storage space is typically rented on an as-needed basis, adding some risk but also allowing pricing to recalibrate more quickly. For Americold specifically, 39% of revenue comes from multi-year fixed storage commitment contracts, which have an average lease length of six years. The remaining 61% of revenue comes from space that is rented out on month-to-month leases or on an as-utilized, on-demand basis. We view the mix shift toward fixed storage commitment agreements as a positive development.

It is true that, for Americold's tenants, storage costs are quite low compared with transportation costs. For food producers/distributors/retailers, however, there is a natural stocking-up and emptying-out of inventory within one season. For example, during the spring and summer, a food distributor may begin to stockpile turkeys at an Americold facility in anticipation of Thanksgiving. After November, however, most of its inventory would be depleted, leaving it with little left in the Americold facility, and thus the freedom to pick up and leave. And, as a general point, inventory throughput is quite high—in 2021, Americold reported average inventory turns of approximately 30 days, meaning an average facility saw 12 entirely different sets of inventory entering and exiting.

It should also be mentioned that, as of the end of 2021, 58 of the approximately 250 facilities that Americold operates are termed as “production advantaged,” meaning they are dedicated to one or a small number of customers and are either connected or located adjacent to customers’ processing/production facilities. In fact, many of these facilities were often built-to-suit at the time of their customers’ facility’s construction. Americold operates production advantaged facilities with companies including Unilever, KraftHeinz, and Conagra. Having facilities connected (or immediately adjacent) to the customer’s production facilities streamlines logistics for the customer. As a result, there are large incentives for Americold’s customers to continue to use the connected facility, because the efficiencies that come with connected or close-in-proximity plants vastly reduce transportation costs.

However, if Americold hiked rents enough, it would be more economical for the customer to switch to another storage plant as long as the transportation and new storage costs outweigh Americold’s rents. Specifically, for customers who have non-connected facilities (i.e., the two facilities are close in distance but pallets would still need to be transported by refrigerated semi-trucks), the marginal cost of driving further to an alternative, cheaper facility is quite low, since a customer had to load, drive, and unload regardless. Lastly, many customers’ processing/production facilities are in less logistically important and more remote areas, resulting in a larger risk of obsolesce if their customers were to no longer use the facility. Americold’s customers know this and can use it as a bargaining chip when renegotiating rents—for the customer knows it would be challenging for Americold to find a replacement tenant paying a similar amount in rent. We believe these production-advantaged facilities create slight switching costs for Americold’s tenants because it creates cost advantages for them; but, we do not believe Americold deserves a companywide moat from switching costs because production-advantaged facilities compose less than one quarter of the portfolio.

Conclusion:

The cold storage space is niche but provides a vital service for its customers—something like 96%-97% of temperature-controlled products at grocery stores have spent some time in a cold storage facility. But, any given cold storage warehouse is not too different than another, and we can point to the fact that both Lineage Logistics and Americold have been very acquisitive to show that acquired warehouses can “plug in” to the current portfolio without too much integration.

A quantitative way to assess whether a company has a moat is to compare a company’s weighted cost of capital, or WACC, to its return on invested capital, or ROIC. In the case of REITs, though, we adjust the ROIC calculation to use maintenance capital expenditures instead of accounting depreciation to arrive at adjusted ROIC. While our ROIC data is limited because Americold IPO’ed in January 2018, we calculate that the company’s ROIC only exceeded its WACC of 7.2% in 2017 and 2018, and has subsequently fallen below WACC. We expect the adjusted ROIC of the company to remain materially below its WACC over the projected period. 

To wrap up, we believe that demand for new temperature-controlled warehouse facilities is inelastic in the long run, and we forecast occupancy rates and margins to recover in our explicit forecast. However, we also believe supply will keep pace in an industry where the biggest barrier to entry is capital. Therefore, we are left with neither quantitative nor qualitative evidence to support awarding an economic moat for Americold.

None

Economic Moat

Americold Realty

Americold Realty Trust, Inc. is a real estate investment trust, which focuses on the ownership, operation, development, and acquisition of temperature-controlled warehouses. It operates through the following segments: Warehouse, Third-Party Managed, Transportation, and Other. The Warehouse segment collects rent and storage fees from customers to store frozen and perishable food and other products within the firm's real estate portfolio. The Third-Party Managed segment manages warehouses on behalf of third parties and provides warehouse management services to food retailers and manufacturers in customer-owned facilities. The Transportation segment is involved in brokering and managing transportation of frozen and perishable food and other products. The Other segment includes ownership in a limestone quarry in Carthage, Missouri. The company was founded in 1931 and is headquartered in Atlanta, GA.

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