Yesterday, I wrote an article titled REITs That Have Risen From The Ashes in which I examined four companies that were hit extremely hard during the last recession. I explained that "when the storms died down in 2009, it became clear that much of the failures were due to leverage and precautionary equity issuances. Because REITs rely on bank financing, quite a few REITs opted to preserve cash in order to manage risks of the unknown."
One of the REITs that I referenced was DDR Corporation (NYSE:DDR), a dominant power center REIT with a market cap of around $6.29 billion. By definition, a power center is an unenclosed shopping center with a typical range of 250,000 square feet to 600,000 square feet of gross lease area that usually contains three or more big box retailers and various smaller retailers (usually located in strip plazas) with a common parking area shared among the retailers. (Source: Wikipedia)
When you consider the landscape of shopping center REITs today, many of them own and operate grocery-anchored centers and neighborhood centers; however, DDR has positioned itself as a leading owner of the larger, power centers. Here's how DDR and the peers compare based on overall market capitalization:
The Great Recession became the true "category killer," wiping out countless retailers and slowing growth in an industry that seemed invincible. The monstrous "power center" and most other forms of shopping came to a screeching halt, yet the retail consumer kept up - never underestimate the "kingdom of thing-dom" (as you can see below):
The Power Center REIT
While many of the so-called "category killers" were killed by tough economic times, the "power center" model survived. Much of the success of the "power" model has been driven by the evolution of the tenants (in the power centers).
While many department stores, like J.C. Penney (NYSE:JCP), and Sears (NASDAQ:SHLD) are losing market share, the value store discounters, like Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) are gaining ground.
In addition, many traditional grocery chains are continuing to fight with ultra-thin margins and the non-traditional chains (located in power centers) are gaining ground.
While demand is strong, supply of power centers per capita is declining for the first time (as illustrated below):
Also, as evidenced by the snapshot below, jobs and wages also influence the US consumer and their retail spending decisions over the long term:
…and will benefit from historically low underemployment and high consumption. Jobs and wages influence the US consumer over the long term.
In addition, new store opening plans continue to be robust:
Off-price concepts have significantly outperformed their full-price counterparts:
Traditional department stores have recognized off-price opportunities and opened new concepts such as Saks Off Fifth, Macy's Backstage, Kohl's OffAisle, and Find @ Lord & Taylor. The market share battle favors the current off-price giants which benefit from barriers to entry through scale, buying experience, optimized supply chains, and merchant relationships.
As you can see below, consumers continue to spread their grocery shopping across multiple channels:
Here is why DDR invests in Power Centers:
The Evolution of DDR
As illustrated below, DDR's (formerly Developers Diversified) value plummeted in 2009 when the company was forced to cut its dividend from $2.64 per share (in 2007) to just $.08 per share in 2010.
That was a drastic dividend cut, but the company had no choice as it was forced to almost suspend payments as a result of high leverage and no access to capital. Since the end of the recession, and in around 2011, DDR has evolved the portfolio from smaller, lower quality assets into larger format prime Power Center properties.
As you can see below, DDR's average property size now exceeds 350,000 square feet:
Also, DDR's portfolio has moved up the quality spectrum:
Capital allocation has (and is) DDR's top priority as evidenced below:
As you can see below, DDR is intensely focused on increasing its rent per square foot that has yielded attractive earnings and dividend growth:
DDR has become more focused on its US footprint as the company has completely exited Brazil and now has around 11% of revenue generated in Puerto Rico. 10 out of 14 of DDR's Puerto Rico properties are considered Prime of Prime Plus assets and 70% of the rent derived from the centers is from US based creditworthy tenants.
An Improved Balance Sheet
Also part of DDR's evolution has been its transformed balance sheet. As you can see below, DDR has reduced its debt to total cap:
But more importantly, DDR has reduced its reliance on secured debt financing:
As you can see below, the $7.2 billion unencumbered pool has improved materially in terms of size, quality and credit.
During the fourth quarter, DDR closed on the sale of nine operating assets and three land parcels for $211 million (DDR's share), bringing the full-year total to 66 operating assets and eight non-operating assets sold for $570 million. Pricing within the asset class remains at historic high levels and DDR has leveraged this environment to opportunistically sell the bottom tier of the portfolio at an average cap rate of 7.2%.
Also in the fourth quarter, DDR closed on the acquisition of seven assets for $166 million, bringing the full-year total to 10 shopping centers and three out parcels acquired for $330 million.
In October 2015, DDR issued $400 million of 10-year unsecured notes at a 4.25% coupon, marking the 10th unsecured issuance since 2009.The proceeds were used to repay the $350 million of convertible notes that were due in November which carried a GAAP interest rate of 5.25% and a cash interest rate of 1.75%.
DDR has $350 million of secured and unsecured debt maturing in 2016 at a weighted average interest rate of 7.8%, and the company intends to accretively repay all maturities with disposition proceeds (and it's likely DDR will not access the capital markets in 2016). The 2016 maturities consist of $240 million of seven-year unsecured debt that was issued in 2009 and carries an interest rate of 9 5/8% which will be fully retired in March.
As evidenced by the near-term debt refinancings, DDR has decent FFO tailwinds with regard to the high coupon refinancings.
Following the repayment of all 2016 maturities, DDR's consolidated debt tier ratio will be the longest on record since 2005.
The expected, asset sales proceeds will be used to retire maturing debt and reduce the company's consolidated debt to EBITDA by approximately 0.5 to 0.8x by year-end 2016. As you can see below, DDR has investment grade ratings from all three rating agencies.
Here's a snapshot of the recent balance sheet:
As noted above, the growing size of the unencumbered pool and exposure to floating-rate debt and ample access to liquidity through our asset sale proceeds, have dramatically reduced the risk profile and put DDR's balance sheet in a position to outperform in all market cycles.
So How Does DDR Move The Needle?
DDR's portfolio evolution was dramatic in 2015 as evidenced by the execution on $326 million of acquisitions and $569 million of dispositions. The fruits of these transactional efforts through since the end of the recession include selling nearly 500 assets and acquiring over 200 assets (since 2008).
Excluding Puerto Rico, same-store NOI growth in the wholly-owned portfolio, a pool that makes up approximately 80% of DDR's NOI, was 4.5% in the fourth quarter, highlighting the strength of the core business.
As seen below, same-store NOI growth is trending toward the high-end of shopping center REITs.
DDR grew average base rent per square foot for the portfolio by 4.1% year over year, the third consecutive year of growth above 4%. Interestingly, despite having the most aggressive transactional program in the peer group over the past few years, the nominal cap rate ascribed to DDR's portfolio by the investment community has moved in lock step with the peer group, highlighting the lack of recognition for the progress made.
For the fourth quarter, DDR's operating FFO was $114.1 million or $0.31 per share. Including non-operating items, FFO for the quarter was $116.7 million or $0.32 per share. (Non-operating items consisted primarily of transaction costs offset by asset sale gains).
For the full year, operating FFO was $446.2 million or $1.23 per share which is a 6.1% increase over the prior year. Including non-operating items, FFO for the year was $348.3 million or $0.96 per share.
In the past five years, DDR has been able to grow its FFO per share at a compound annual growth rate of more than 6% (despite selling nearly $4 billion of lower-quality assets, highlighting the ability to manage dilutive events). In 2016, DDR is projected to generate modest FFO growth:
The impact of dispositions will slow growth short term, but DDR believes that the recycling efforts will materially improve performance over the long term. Many of the lower-quality assets are being sold and that will ultimately reduce earnings risk and increase the safety of the dividend. Here's a snapshot of DDR's consensus growth for 2017.
The assets sold in 2015 were over 96% leased and DDR has underwritten to grow at less than 2% over the coming years.
DDR trades at an implied cap rate comparable to the company is selling its lowest quality assets, approximately 80 basis points outside the shopping center peers. This is the same relative bifurcation the stock experienced in 2010 and 2011 prior to DDR selling an additional 280 assets.
In other words, Mr. Market is giving DDR very little credit for its transformational acumen, especially given the fact that a large percentage of the company's value is in a small number of assets that will define performance in the years to come.
How Do The Chips Fall?
One of the most important things to consider with regard to DDR is the dividend growth record - not the chart I already provided that illustrates the massive cut in 2008, but instead the growth record since 2011: Click to enlarge
Now let's examine the growth based on annual % growth per share:
That's impressive - around 12% CAGR since 2013. Now let's examine the payout ratio over the same period:
As you can see below, DDR has a lower risk profile that allows for a higher payout ratio going forward:
Here's how DDR's current dividend yield compares with the peer group:
In terms of valuation, DDR is trading at 14x P/FFO and here's how that compares with the peer group:
When you look at DDR's price and earnings multiple (using AFFO below) over the last two years, we can see that the shares are trading at roughly the same multiple as two years ago.
Here's how DDR has performed over the last two years compared with the peer group:
So that tells me that Mr. Market is not paying attention. Let's examine the last 12 months:
Again, Mr. Market is ignoring DDR. What about year to date?
Again, not excitement. What could he be missing?
Perhaps he does not recognize DDR's powerful grocery-driven revenue stream:
….and maybe he is missing the robust development engine:
…there's also a steady path to 2.5% to 3.5% same-store growth:
The Bottom Line: DDR has evolved into a much stronger REIT and although the company has reduced risk considerably, the market is not providing credit for enhanced performance. DDR is trading at a discount of around 25% compared with the peer group AFFO multiple, a sign that there is value that is yet to be recognized.
Although growth in 2016 will be modest, the dividend payout is safe and the revenue drivers are much stronger than previous years. I am comfortable initiating a BUY at the current price point, with the potential to trade at $20.00 a year from now (shares are now trading at $17.24).
There are 20 REIT analysts covering DDR:
One of them, KeyBanc, recently upgraded DDR an overweight with a price target of $19.00 per share. Here's my FASTGraph forecast:
In May, I will be attending (May 22-25) the annual ReCon (shopping center) conference in Las Vegas and in the upcoming edition of my newsletter (Forbes Real Estate Investor), I will provide a full run down of the shopping center REITs. DDR is one of the shopping center REITs that I am recommending based upon my research of the company.
Author's Note: I'm a Wall Street writer, and that means that I am not always right with my predictions or recommendations. That also applies to my grammar. Please excuse any typos, and I assure you that I will do my best to correct any errors if they are overlooked.
Finally, this article is free, and my sole purpose for writing it is to assist with my research (I am the editor of a newsletter, Forbes Real Estate Investor) while also providing a forum for second-level thinking. If you have not followed me, please take five seconds and click my name above (top of the page).
The only guarantee that I will give you is that I will uncover each and every rock I can, in an effort to find satisfactory investments that "upon thorough analysis promises safety of principal and satisfactory return. Operations not meeting these requirements are speculative." (Ben Graham).
Sources: SNL Financial, FAST Graphs, DDR Filings.
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.
Disclosure: I am/we are long O, DLR, VTR, HTA , STAG, GPT, ROIC, HCN, OHI, LXP, KIM, WPC, DOC, EXR, MYCC, BX, TCO, SKT, UBA, STWD, CONE, BRX, CLDT, HST, APTS, FPI, CORR, NHI, CCP, WSR, CTRE, WPG, KRG, SNR, LADR, HCP, PEB.
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.