CHUYN/iStock via Getty Images

CHUYN/iStock via Getty Images

Lamar Advertising (NASDAQ:LAMR ) is a quiet and almost unsuspecting outperformer that benefits from inflation and several industry-related secular trends.

Lamar Advertising is one of the largest outdoor advertising companies in the United States. Lamar operates three segments :

More than 90% of Lamar's revenue is from the billboards segment. The underlying land beneath Lamar's billboards is either owned or leased by the company and the billboards themselves are leased at a duration ranging from 4 to 52 weeks.

The outdoor advertising industry is a fragmented one, with Clear Channel (CCO) Outfront Media (OUT), and Lamar Advertising sporting a market share of 15%, 20%, and 25%, respectively (Billboard REITs: In Your Face, But Under The Radar). The remaining market share is owned by thousands of small owners (ibid.). As such, the big three outdoor advertising companies are constant acquirers of the smaller players.

Outdoor advertising is heavily regulated by Federal law that controls outdoor advertising along federal highways. In addition, all states have billboard control statutes and regulations at least as restrictive as federal requirements. In some cases, states have passed laws that require the removal of signs at the owner's expense without compensation from the state. However, management believes the number of their billboards subject to removal is illegal and immaterial and no state has banned billboards entirely. Also, at times billboards have been removed for beautification purposes under the power of an eminent domain, but Lamar has generally received compensation for the removal of these billboards. Given the tight regulations regarding new billboards, many existing billboards are "grandfathered" in and are fairly insulated from new competition.

Another factor impacting Lamar's business is the growth of digital billboards. Digital billboards resemble essentially a large tv screen that changes ads every 6 to 8 seconds. While the installation costs are higher, digital billboards have more attractive economics because it allows Lamar to sell ad space to multiple clients (compared to a static billboard) and easily change the content for little cost. Lamar has 3,932 digital units as of the end of Q4 2021 and plans to continue growing its digital footprint where regulations permit it.

Regulations limiting new billboards reduce the threat of entrants and new competitors and give Lamar pricing power on its existing billboards. Moreover, the growth of digital billboards provides opportunity for margin expansion due to more attractive economics compared to static billboards. The lack of new competition combined with the short-term advertising duration creates a perfect storm that allows Lamar to benefit from an inflationary environment. In fact, management's commentary on the Q4 2021 conference call summarizes some of the secular trends Lamar is experiencing:

Interestingly, even in light of the added capacity, our same unit digital yield was up 16% in Q4 and 23% for the full year of 2021. So clearly, we have pricing power with our digital unit. But one of the best stats we saw coming out of Q4 2021 is our analog posters. Our rate was up 5% and our largest product, Bulletin's rate was up 6.6% in Q4. Again, that gives us tremendous confidence, number one, that in an inflationary environment, we have pricing power. And number two, that again, as our Transit and Airport divisions continue their recovery, we should see out sized growth across the whole platform in 2022.

Considering these facts above, it's no surprise that Lamar has performed well. Compound annual returns for Lamar were of 17.28% per year from 2017-2021 and 20% per year from 2012-2021. Having owned Lamar for over five years, I decided to assess where it stands.

To value Lamar, I utilized a discounted cash flow model to account for the recovery from the effects of the COVID-19 pandemic. Since many REITs utilize FFO or AFFO as cash flow metrics, I decided to start with AFFO and make adjustments to calculate free cash flows to equity capital. AFFO is an equity-level cash flow, meaning it already includes payments to debt holders (interest payments not principal payments) and maintenance capex. Lamar is an attractive business from a capex perspective as existing billboards require little future capex.

Lamar reported AFFO of $667,744 for 2021 ($6.49 per share) and management indicated in their 2022 guidance that they expect to report AFFO of $7.18-$7.30 per share. This represents a nearly 9% growth in AFFO from 2021. This guidance does not reflect any impact from acquisitions. After 2022, I estimated AFFO increasing by 5% in 2023 and by 3% in the long-term terminal period. The 5% is somewhat arbitrary but I am fading the growth down from 9% and a little above inflation estimates of 3.4%. From AFFO I made the following adjustments to derive free cash flows to equity:

A final adjustment to make to the cash flows isn't straightforward, and that is taxes. REITs avoid corporate income taxes by distributing substantially all of their income as dividends. Accordingly, the value of Lamar (and other REITs) can differ based upon an individual's tax bracket. To account for this, I prepared a valuation matrix with differing discount rates and tax brackets so investors can consider the value of Lamar to them based upon their tax bracket. The taxes were computed assuming a full payout of AFFO in the form of dividends. Also, the tax rates utilized did not factor in Section 199A dividends which provide for a 20% deduction. It's important to note that almost all of Lamar's recent dividends were classified as Section 199A dividends so the taxes may be slightly overestimated. The example below is utilizing an as-if C-Corp rate of 21%.

The estimates above resulted in the following cash flows.

For a discount rate I included discount rates ranging from 7%-10%. The example above uses a discount rate of 8% which I deem to be a reasonable upward adjustment to the market rate of return of approximately 7% given Lamar's sensitivity to economic downturns.

The following presents the matrix based upon differing tax rates and rates of return.

A weakness in my forecast is that it fades the growth rate to 3% by 2024. While this growth rate should be lower than what Lamar may actually report since only maintenance capex was deducted in AFFO (thereby excluding growth capex and acquisitions), actual organic growth may differ from my forecast. In addition, the forecast does not include any potential margin improvement. Accordingly, I consider my forecast to be fairly conservative and remain positive on Lamar given the secular trends in the business. Said another way, I don't think I would be surprised if Lamar performed better than my forecast.

In summary, Lamar is continuing to experience beneficial industry trends and is insulated from both competition and an inflationary environment. I would consider buying or adding to Lamar at these levels as a long-term investment. Moreover, if you are in a lower tax bracket or have a tax-advantaged account such as an IRA or 401k, Lamar should definitely be considered in your portfolio.

This article was written by

Disclosure: I/we have a beneficial long position in the shares of LAMR either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not a registered financial advisor.