By The Valuentum Team
DDR's Investment Considerations
• DDR (NYSE:DDR) is a real estate investment trust that owns, manages and develops shopping centers and office properties in the US, Puerto Rico and Brazil. The REIT's assets are concentrated in high barrier-to-entry markets with stable populations and high growth potential. Its portfolio leased rate of ~96% in 2014 was the highest its been since 2008.
• DDR is focused on generating net operating income growth of 2.5%-3.5% and improving its portfolio leased rate. The REIT continues to optimize its portfolio via acquisitions and divestitures. We've liked the progress it has made.
• The REIT remains focused on NAV growth and reducing its risk profile via an improving balance sheet. Its dividend health, however, is dependent on future equity issuance, but this is not unlike any other REIT that pays out a large portion of earnings. Capital-market dependence is something to be aware of, in any case.
• DDR's portfolio has experienced a dramatic quality upgrade since 2010. Retailers moving out of its portfolio include Staples (NASDAQ:SPLS), Rite Aid (NYSE:RAD), Tops, and Sears (NASDAQ:SHLD), while retailers moving into its portfolio include Panera (NASDAQ:PNRA), Nordstrom (NYSE:JWN), Ulta (NASDAQ:ULTA), and Five Below (NASDAQ:FIVE). The percentage of prime NOI has advanced to 93% in 2014 from 81.6% in 2010.
• The firm's portfolio transformation can be seen in its improving operating statistics. Same-store net operating income grew more than 3% in 2015, which was above the high end of its original guidance range. This allowed DDR to grow its quarterly dividend by more than 10%.
• DDR and Blackstone (NYSE:BXMT) recently formed a joint venture to acquire shopping centers from ARCP. Though Blackstone holds most of the JV ownership, we'd be looking for DDR to benefit from this relationship.
Funds From Operations Analysis
This is the most important portion of our analysis. Below we outline our valuation assumptions and derive a fair value estimate for shares.
Our discounted cash flow model indicates that DDR's shares are worth between $11-$21 each. Shares are currently trading at ~$18 per share, just above our fair value estimate. This indicates that we feel there is slightly more downside risk than upside potential associated with shares at this time.
The margin of safety around our fair value estimate is derived from the historical volatility of key valuation drivers. The estimated fair value of $16 per share represents a price-to-earnings (P/E) ratio of about 13.6 times last year's earnings and an implied EV/EBITDA multiple of about 18 times last year's EBITDA.
Our model reflects a compound annual revenue growth rate of 2% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 11.7%. Our model reflects a 5-year projected average operating margin of 33.7%, which is above DDR's trailing 3-year average.
Beyond year 5, we assume free cash flow will grow at an annual rate of 1% for the next 15 years and 3% in perpetuity. For DDR, we use a 7% weighted average cost of capital to discount future free cash flows.
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $16 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values.
In the graph above, we show this probable range of fair values for DDR. We think the firm is attractive below $11 per share (the green line), but quite expensive above $21 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate DDR's fair value at this point in time to be about $16 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart above compares the firm's current share price with the path of DDR's expected equity value per share over the next three years, assuming our long-term projections prove accurate.
The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change.
The expected fair value of $18 per share in Year 3 represents our existing fair value per share of $16 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
Wrapping Things Up
DDR's portfolio has experienced a dramatic quality upgrade. The REIT continues to optimize its portfolio via acquisitions and divestitures. DDR remains focused on NAV growth and reducing its risk profile via an improving balance sheet. Its dividend health, however, is dependent on future equity issuance, but this is not unlike any other REIT that pays out a large portion of earnings in dividends. Capital-market dependence is something to be aware of, in any case.
Looking forward, We expect DDR to benefit from its recent joint venture with Blackstone to acquire shopping centers from ARCP. As it relates to our opinion of the investability of DDR, we think there are more attractive REITs available, Realty Income (NYSE:O) is among our favorites. We would like to see DDR trading at a material discount to our fair value estimate before altering our opinion of shares. The REIT currently registers a 7 on the Valuentum Buying Index.
This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.