Equity One (NYSE:EQY) operates as a REIT and owns strategically-located shopping centers in high traffic urban and suburban areas. These busy shopping areas are attractive to tenants, because they are located in quality marketplaces with ample customers. Most of Equity One's shopping centers are anchored by necessity-based businesses such as supermarkets and drug stores. This allows for a steady stream of regular repeat customers which makes it likely that the tenants will experience success, thus giving Equity One some degree of confidence that it will maintain a high occupancy rate. It also gives the REIT some protection from economic downturns, as consumers still consume food and medicine during recessions. As of the end of Q1 2014, Equity One had an occupancy rate of 93.9%. Even if one of Equity One's tenants had to close its doors, the attractiveness of the shopping locations make it likely that another tenant would take its place.
Equity One has a portfolio of 138 properties, of which 116 are retail and six are non-retail. The REIT is continually working to expand its footprint for strategically-located properties, while shedding less strategic ones. Equity One is focused on investing in its target markets which include: the Northeastern United States, California, the Washington D.C. area, South Florida, and Atlanta. The REIT continues to sell non-strategic assets located in North and Central Florida and in the Southeastern United States. Improving the mix of assets in this manner will increase the REIT's net income, which will increase the chances that Equity One will raise the distribution payments going forward.
Equity One stated in its latest 10-Q report that it will acquire additional assets in its target markets through joint ventures and through the REIT's own capital resources. The REIT also stated that it will finance its development and redevelopment with its own capital or by issuing debt or equity. The balance sheet shows that the REIT has $31.5 million in cash at the end of Q1 with the cash flow statement showing about $135 million of operating cash flow for the past twelve months. This looks like enough for some property acquisitions, but the REIT has a track record of spending more in CapEx than it has in operating cash flow every year, so I think it is likely to add to its debt with future acquisitions based on its past performance. However, as Equity One sells off its non-strategic assets and acquires strategic properties, the REIT will earn more from its properties and is more likely to achieve a positive free cash flow in the future.
Equity One is active in developing and redeveloping strategic properties. The REIT is in the first phase of developing the Broadway Plaza in the Bronx, which comprises 115,000 of the 148,000 total square footage for the Broadway Plaza location. Phase 2 involves the remaining 33,000 square feet fronting Broadway. Equity One is seeing interest from food operators, health clubs, and mobile phone stores for this space. With Equity One's average base rent at $16.37 at the end of Q1 on the total of 148,000 square feet, my revenue projection for this space is about $2.4 million per year for the REIT. The Broadway Plaza is 72% leased, so Equity One will need to secure tenants for the remaining 28%. Both phases are expected to stabilize in late 2015, so Equity One will likely see the full benefit from this space in 2016.
Equity One has a number of redevelopments in the works. The Serramonte Center has added an 84,000 square foot Dick's Sporting Goods (NYSE:DKS), which opened in April with project costs below budget. My revenue projection for this site based on the REIT's average rent rate is $1.38 million per year.
The Willows has a 10,000 square foot ULTA Salon, Cometics, and Fragrances (NASDAQ:ULTA) store under construction and a permit for a 5,000 square foot expansion of the UFC Gym. There will be a new 40,000 square foot LA Fitness opening at the Kirkland shops. The REIT has also acquired a gas station site to accommodate a new Walgreen's store (WAG). I'm not sure how large the Walgreen's store will be, but they average 14,500 square feet. Taking that estimate into consideration, these stores should contribute about $1.1 million in revenue for Equity One.
Alafaya Commons was added to the REIT's portfolio and contains 126,000 square feet. Publix is being replaced with an Academy Sports at the Alafaya Commons site. At Boyton Plaza an existing 37,000 square foot plaza will be demolished for a new 54,000 square foot Publix store. Alafaya and the additional 17,000 square feet at Boyton will add about $2.3 million in revenue for Equity One.
Equity One is in the final stages of the Boca Village Square redevelopment where the relocation of a CVS Caremark (NYSE:CVS) to a standalone site will allow the REIT to lease the remaining shop space. This site includes the new 13,000 square foot CVS and about 20,000 square feet of additional shop space. The great news about the Boca Village Square site is that the rent for the reconfigured shop space runs in the mid $30 per square foot range, which is well above Equity One's average of $16.37. Therefore, the reconfigured square footage at Boca Village Square is likely to produce over $1 million in annual rent income for Equity One.
Overall, there is an abundance of productive activity in Equity One's pipeline. It is easy to see that Equity One will achieve revenue increases going forward as the developed and redeveloped sites begin earning rental income for the REIT. This revenue is in addition to the rents earned from Equity One's existing properties.
Undervaluation Relative to Peers
Equity One has an attractive valuation relative to the retail REIT industry. Equity One is trading at 17.6 times 2015's expected FFO per share of $1.34. I derived my estimate for the REIT's FFO per share from rental income from existing properties plus developed/redeveloped properties which will be captured in 2014 and 2015 for expected revenue of about $362 million in 2014 and $377 million in 2015. I then added that 4% year-over-year revenue increase to a modest 1.5% increase in gross margin for a 5.5% increase in FFO in 2015 over 2014. I factored in that Equity One will end up in the high end of its FFO per share range for 2014 of $1.23 to $1.28 to arrive at this year's expected FFO per share of $1.27. The REIT typically achieves actual FFO in the high end of its estimate range. The retail REIT industry is trading at over 41 times next year's FFO. Therefore, Equity One is attractively valued as compared to its peers. To reinforce Equity One's undervaluation, I also compared the REIT's Price/FFO divided by its expected FFO growth rate. Equity One has a figure of 3.3, while the retail REIT industry trades with a ratio of 6. This confirms my conviction that Equity One is priced attractively in relation to its industry.
I think that the primary reason for Equity One's undervaluation is because the REIT has been running a negative free cash flow. However, the negative cash flow has decreased by an average of 48% for the past two years. The REIT spends more in CapEx than it has in operating cash flow due to its expansion efforts. As Equity One sells off its non-strategic properties and replaces them with strategic properties, it will be earning more per square foot in rent income. Operating cash flow is positive and has grown at an average of 26% for the past two years. As the operating cash flow continues to grow, the REIT is likely to achieve positive free cash flow in future years. Therefore, I think that it would be wise to invest in the REIT now before the valuation goes higher as a result of the improved cash flow metrics.
Equity One looks like a solid income-producing investment going forward. The current price is a bargain in the retail REIT industry and the pipeline of developments and redevelopments should fuel growth for the future. The REIT has a 3.7% yield for income seeking investors. The risk of losing tenants is mitigated by its strategic locations which are likely to bring in replacement tenants in a relatively short period of time. If I take my 2015 FFO estimate of $1.34 for 2015 and divide that by the current price of $23.59, I think that the REIT can conservatively appreciate in price by about 5.7% within one year.
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