Back in March (2013), I wrote an article on DDR Corp. (DDR) and although I was not upgrading the Beachwood-based shopping center REIT to my SWAN (sleep well at night) list (then), I was optimistic about the "turn around" potential - so I opted to include the REIT on my research list.
Clearly DDR was one of a high flying REIT that owned significant assets ($9 billion in 2008) and, as evidenced by the FAST Graph below, the company took a nose dive in 2009. The share price fell from $67.20 in 2007 to around $1.81 in 2009.
So as I began to unfold the DDR opportunity in March (2013), I was thrilled that DDR had begun to turn the corner and I explained the opportunity as follows:
DDR has done a fine job of climbing from the bottom of the abyss to become a formidable REIT contender…I like the progress that's unfolding and the potential for more dividend increases…This bird is movin' on up! It's no Swan. It's A Phoenix From Afar Named DDR.
Since March, DDR has provided six more months of solid results and in this article I plan to determine whether or not I intend to add DDR to my SWAN or SALSA portfolios. Better yet, I will examine DDR's fundamentals to determine whether or not I plan to initiate a BUY in my SALSA portfolio (see my newsletter here). DDR's share price has dropped by 13% since I wrote my article in March (2013):
In my last article (March), I suggested an entry price of $15 - $16 and a divided yield entry price of 4% or higher. Here is a snapshot of DDR's dividend history since March:
Although Federal Realty (FRT) has the lowest paying dividend yield in the shopping center sector, DDR has the second lowest yield (of 3.48%). As noted above, I was previously looking for an entry yield of 4%; however, I will examine the latest performance to determine whether or not an entry price is warranted now.
Shopping Center Fundamentals Look Solid
In the latest (July 2013) edition of Retail First Glance (a Reis publication), Ryan Severino, CFA, Senior Economist with Reis explains:
General economic news would suggest that consumers are weathering the one-two punch of higher taxes and spending cuts relatively well. Retail sales growth, though inconsistent, has generally remained positive.
Other favorable indicators for the shopping center industry include employment growth that has averaged 190,000 per month in the last twelve months.
In addition, average hourly earnings (for all employees on private nonfarm payrolls) has increased by an average of 2% year-over-year in the last twelve months.
Also, an increase in home prices support stronger consumer spending. Here is a snapshot below that illustrates monthly year-over-year changes in existing home prices.
The demand for retail space remains strong as evidenced by these retailers (that will demand more than 150 million square feet in 2013 and 2014):
For neighborhood and community centers, both net absorption and new construction are anticipated to increase slightly during the latter half of this year. However, these increases will be modest and a significant amount of the net absorption will stem from pre-leased space in newly completed projects. Power center supply is expected to add only 80 bps to total stock in 2013, the fifth consecutive year where new supply is under 1%, well below historic norms.
While market share for conventional and national chain department stores is declining, expansion is occurring in off-price sectors such as Nordstrom Rack (JWN), Saks OFF 5th (SKS), Neiman Marcus Last Call, and Bloomingdale's Outlet. Meanwhile, retail sales continue to shift to the largest discount chain tenants.
Also, various discount, warehouse club, dollar stores, and specialty stores continue to chip away at traditional grocers.
Meanwhile, warehouse clubs, dollar stores, and supercenters are winning trips away from traditional grocers. That means shopping trips are declining.
DDR Corp. - Twenty Years as a Public REIT, and Counting
DDR, Corp. commenced operations as a publicly-listed REIT on February 3, 1993 and today the company is the owner and manager of 435 value-oriented shopping centers representing 115 million square feet in 39 states, Puerto Rico and Brazil. Here is a snapshot of the portfolio history:
DDR maintains one of the highest credit tenant portfolios with the top 10 tenants accounting for approximately 36% of annual base rent (or ABR):
Here is a snapshot of the top 25 tenants:
DDR's Top 20 MSAs account for approximately 50% of NOI:
In order to reduce debt, DDR has been actively selling off non-core properties and reinvesting back into more "critical" shopping center properties. This aggressive recycling program has improved portfolio fundamentals and enhanced overall credit quality of the company's cash flows.
As part of the asset recycling, DDR has significantly improved exposure to top domestic markets (on a pro rata basis). Boston, Washington DC, and Minneapolis are added to the Top 20 MSA list with Tucson and Charleston falling out. Denver moves into the top 5 and Chicago moves into the top 10.
Here is an illustration of DDR's geographic diversification in major MSAs and heavy overlap with other DDR assets:
DDR has been aggressively recycling assets to improve portfolio quality and enhance credit quality of cash flows. Since 2007, DDR has disposed of $3.2 billion in properties and significantly reduced exposure to tertiary markets and retailers with poor credit.
DDR has also grown the portfolio by adding around $4.7 billion in assets since 2011. By increasing the demographic quality of the portfolio, DDR has acquired properties with an average trade area population of 503,000 people and average trade area household income of $85,000.
Here is a snapshot of DDR's improved portfolio metrics:
DDR has been transitioning into "prime" portfolio assets. Here is a snapshot that summarizes the difference in "prime" and "non-prime" assets:
Here is a snapshot that breaks down DDR's "prime" assets:
Here is another snapshot that breaks down DDR's "prime" assets:
DDR's goal is to have more than 95% of total NOI generated from the "prime" portfolio. Here is a snapshot that summarizes DDR's critical mass and scalable platform:
DDR has a strong international platform with JV interests in 8 operating shopping malls and 2 new developments. Here is a snapshot of the Brazilian portfolio (owned with Sonae Sierra Brasil):
DDR: Now Let's Check Under the Hood
From the transactional and financing perspective, DDR's consistent execution of its capital recycling program has led to 16 consecutive quarters of growth in the percent of NOI generated by the prime portfolio, helped greatly by 18 consecutive quarters of nonprime assets sales and 8 consecutive quarters of prime power center acquisitions. Here is a snapshot of DDR's occupancy history (current occupancy is at 94.6%):
During the latest earnings call, Daniel B. Hurwitz, DDR's CEO, explained DDR's targeted occupancy:
With our increasing quality and control, we are confident that a full occupancy level of 96.5% is achievable, leaving almost 200 basis points of additional growth through lease up and even when that number is within sight, we will continue to proactively create growth opportunities through terminations, downsizings and consolidation of space.
DDR has also been able to provide tremendous growth by redeveloping many of its assets. Over the past 5 years, DDR has invested around $750 million with returns greater than 10% unleveraged. As Hurwitz explains during a recent earnings call, downsizing is a mark to market opportunity:
Retailer distress, no matter how limited, when combined with our quality portfolio on leasing platform continues to create value-add opportunities within prime assets that we aggressively pursue on a regular basis and add considerably to the growth story. For example, with Toys "R" Us and Babies "R" Us, over half of our contracts are ground leases with rents, typically 50% to 75% below markets. We are currently in the process of recapturing 2 Babies "R" Us locations and replacing them with Nordstrom Rack, Old Navy and Gap outlet with rental increases between 100% and 370%.
In each case, not only are the economics are attractive, they dramatically improve the tenant lineup, NOI, credit quality and obviously, the overall value of the assets. In regards to Barnes & Noble, we are currently in a position to recapture 14 of our 25 locations over the next 24 months. As you know, Barnes has great locations in our portfolio with all of them being in prime centers that average 98% leased.
The list of retailers interested in these assets includes Bed Bath & Beyond, Nordstrom Rack, T.J. Maxx and Sprouts Farmers Market to name a few, and we anticipate rental increases between 30% and 50% with very reasonable CapEx.
As evidenced by the snapshot below, DDR has made significant progress since July 2009:
DDR's Funds from Operations (or FFO) fell considerably in 2009:
However, in 2013, DDR has positioned itself for peer-leading growth:
DDR has made a strategic objective to reach consensus investment grade ratings and the company is continuing to take steps to lower debt-to-EBITDA, extend duration and improve fixed charge coverage ratio in order to further enhance its credit rating. Here is a snapshot of DDR's rating agency momentum:
Here is a snapshot of DDR's positive debt-to-EBITDA trend:
At the end of the quarter, DDR's weighted average consolidated debt maturity was 5.4 years, continued improvement from 5.2 years in the first quarter and significant expansion from the 4.3 years at the end of 2011. Looking at future capital needs, DDR has no maturities remaining in 2013 and no unsecured maturities until May 2015.
I Consider the Blackstone Deal a Tipping Point
On May 15th (2013), DDR announced that it was planning to acquire Blackstone's 95% interest in 30 open-air, value-oriented power centers for $1.46 billion. This unique opportunity for DDR to gain control of the 95% leased portfolio should provide significant value to DDR's growing pipeline of quality.
When the Blackstone acquisition of 30 power centers closes, 75% of DDR's overall portfolio GLA will be wholly owned, up from 55% just 3 years ago. With full control over a significantly larger percentage of the portfolio and the further significant improvement of quality metrics, DDR gains both additional leverage and further negotiating flexibility when dealing with its retail partners.
DDR expects to fund the $1.46 billion Blackstone investment with a combination of new common equity ($739 million), proceed from preferred equity and mezzanine loan repayments ($146 million), assumed mortgage debt ($398 million), and new 10-year unsecured debt ($300 million). At closing (Q4-13), 21 assets will be added to DDR's high quality unencumbered asset pool, increasing annualized NOI of the pool by around 15%.
In my opinion, the Blackstone deal solidifies DDR's plan to be a high-quality shopping center REIT and further validates the transformation of the once small town landlord into a dominant retail powerhouse.
So When Should I Jump?
As you know, when you touch a hot pan you don't instantly touch it again (right away). In other words, there was a lot of pain associated with DDR's loss in value and substantial dividend cut and although I like what DDR is doing today, I'm not ready to jump back in yet.
I believe that DDR's evolution is promising and it appears that management is sincere with getting back to business. Let's take another look at DDR's historical FFO per share:
Now let's take a look at DDR's historical dividends per share:
Now let's take a look at the historical dividend history:
Since the 2009 landslide, DDR's dividend has begun to climb again:
DDR's current annualized dividend is $0.54 per share, which represents an FFO payout of approximately 50% and 12.5% growth over the 2012 dividend. This means that DDR has more room to grow the dividend, which is adjusted on an annual basis. Here is a snapshot of DDR's regular dividends paid compared with several peers:
Here is a snapshot of DDR's dividends paid compared with the 10-year treasury:
DDR's Price to Funds from Operations (or P/FFO) is 14.2x and at the low-end of the peer group:
However, based on historical trends, DDR's P/FFO is still trading at the mid-point:
Based upon the FASTGraph below, I would prefer to own DDR when shares are at or below $15.00. That means that the dividend yield will be closer to 4%, a yield that I believe is in-line with the peer group and other REITs trading at the valuation range. I am warming up to DDR and I think the company has made exceptional progress with its recycling initiatives.
DDR also has a Class J perpetual preferred (the company replaced the Class I 7.5% shares last year) that yields 7.10%. The current price is $22.90 with a B rating. DDR also issued $150 million of 6.25% perpetual preferred equity in early April (2013), 25 basis points below the coupon on the preferred equity issuance (DDR-J). The DDR-K issue is trading at $22.04 and yields 7.09%.
In closing, it has been 6 months since I wrote about DDR. During that time, the company has continued to impress me with strong operating results. I believe the company is becoming more attractive and the dynamics of the shopping center sector are looking stronger. DDR has proven that it can create value and I believe that the management team has a solid track record for redeveloping assets.
My Target Entry price is $15.00 and I plan to accumulate shares in my SALSA portfolio if shares hit that target. Given DDR's solid outperformance since the Great Recession, I believe that DDR will continue to provide sound returns in a rising interest rate environment. I'm not in love with DDR, yet I'm willing to give DDR a chance for the SALSA dance!
For more information, check out my monthly newsletter HERE.
Source: SNL Financial, FAST Graphs, DDR Presentation
Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.