Developer Diversified: Numbers Are Decent but Stay Higher in the Capital Structure

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 |  Includes: DDR, KIM, REG
by: Rubicon Associates

Developers Diversified Realty Corp. (NYSE:DDR) said funds from operations amounted to $63.2 million, or 25 cents a share. Analysts polled by Thomson Reuters expected funds from operations of 24 cents a share.

The company continues to be focused on regaining investment grade ratings by all the agencies, but there is significant work to do before this can happen. The company continues to execute on its plan to reduce leverage and increase the quality of its portfolio and is slightly ahead of expectations. NOI should continue to increase in 2011 and 2012 as space currently being negotiated and/or under LOI begins paying. At the end of the day, the story is improving and the portfolio is improving, but it will be some time before the company is investment grade.

Key Numbers and Stats:

  • FFO for 3mo 9/10 (adjusted for $26mm of charges) was $63.2MM. FFO for 9mo '10 (adjusted) was $193.4MM (adjusted for $160MM of charges).
  • FFO for 3mo 9/10 (unadjusted) was $37.1MM (excluding preferred dividends) which compares to a FFO loss of $90.1MM for the prior-year comparable period.
  • FFO for 9mo '10 (unadjusted) was $32.7MM which compares to a FFO loss of $116.6MM for the prior-year comparable period.
  • Core portfolio leased rate increased to 92.0% at September 30, 2010 from 91.6% at June 30, 2010 and 90.9% at September 30, 200;
  • Same Store Net Operating Income growth of 2.0% as compared to an increase of 1.5% in the second quarter of 2010 and a decrease of 4.1% in the third quarter of 2009;
  • Gross PP&E fell by 4.3% since EOY '09 (down 6% on a net basis); Real estate holdings fell by 6.3% during the same period
  • Total debt fell by over $240MM to $4.4B; Debt is down 15% since EOY '09, with the majority of the reduction in secured/mortgage debt;

Covenant Compliance:

  • Debt to Real-Estate Assets (<65%): 50%
  • Secured debt / Assets (<40%): 24%
  • Unencumbered assets / unsecured debt (>135%): 224%
  • Fixed Charge Coverage (1.5x): 1.7x

The company is well within their covenant levels and have enough headroom to continue managing their balance sheet.

Other Relevant Information:

  • During the quarter, the 25 assets owned by MV LLC were placed in the control of a court appointed receiver and as a result, the entity that holds the assets and nonrecourse mortgage loan was deconsolidated. Upon deconsolidation, the company recorded a gain of approximately $5.6 million because the carrying value of the nonrecourse debt exceeded the carrying value of the collateralized assets.
  • YTD, DDR has activity on 75% of the space vacated by bankrupt retailers including 43% sold or lease, 11% at-lease and 21% in LOI negotiations.
  • Brazil continues to outperform with a lease rate of 98%, same store NOI growth of 14% and positive spreads for new deals of 23% and positive spreads renewals of 16%.
  • Last week DDR closed on the refinancing of our unsecured revolving credit facilities, which now have an aggregate capacity of just over $1 billion and a 40-month term that expires in February of 2014.
  • From the call on credit ratings "our goal to the investment grade rated credit by all three rating agencies remains the top priority for this company. While we remain investment grade rated by Moody's and the requirements for an investment grade rating at Fitch and S&P are aspirational, we will continue to pursue prudent strategies that we believe will result in an eventual upgrade to our corporate credit and a continued reduction of our risk profile."

Guidance:

The company continues to estimate operating FFO for the year of $1.00-$1.05 per diluted share.

Market Reaction:

On the day of release, the equity was up, rolled over then recovered on the 26th and is currently down (with the market).

Bonds (20s) traced up about 2pts from prior trades.

Value:

  • DDR 9⅝ 16 Baa3/BB 115.00-117.00 5YR 508/468 480/439z. 5.888ytw
  • DDR 7½ 17 Baa3/BB 106.00-107.00 10YR 375/357 454/435z. 6.162ytw
  • DDR 7½ 18 Baa3 BB 104.00-105.00 10YR 423/406 471/455. 6.661
  • DDR 7⅞ 20 Baa3 BB 107.00-108.00 10YR 428/415 442/428. 6.746
  • KIM 4.3 18 Baa1 BBB+ 101.96-102.28 7YR 208/203 189/183. 3.936
  • KIM 6⅞ 19 Baa1 BBB+ 116.28-116.68 10YR 203/198 226/220. 4.576
  • REG 5⅞ 17 Baa2 BBB 109.62-109.92 10YR 160/155 229/224. 4.146
  • REG 6 20 Baa2 BBB 110.00-110.41 10YR 210/205 219/214. 4.646
  • DDR CDS: 295/315
  • KIM CDS: 140/150

I find the bonds compelling north of 450/z due to the strides the company has made in its "plan", the headroom under their covenants and the increased role their "prime" portfolio plays in the company. NOI gains in 2011 and 2012 should be further supportive of the credit.

Basis swaps are also compelling given the premium at which the CDS trade to cash.

Preferreds are interesting, but not overly compelling at these prices (although Gs have underperformed the Hs and Is and might be worth a look relative to the others).

I don't find equity all that compelling at these prices and believe the NOI gains and portfolio improvement are baked into the cake.

Bottom line: Staying higher in the capital structure.

Disclosure: Author is long DDR preferreds