Kimco (NYSE:KIM) claims to provide stability, and management is delivering. The company is focusing on its core business of leasing to stable retailers in North America. For 2011, lease rates are up, and the company continues to acquire property in its core markets (2011 Annual Report). But, beneath this image of a stalwart cash cow lies a financing structure that calls the risk assessment of this company into question.
The company's clients are among the most reliable of the retail giants. In order of rents, the largest clients are: Home Depot (NYSE:HD), TJX Companies, Wal-Mart (NYSE:WMT), Sears Holdings (NASDAQ:SHLD), and Kohl's (NYSE:KSS) [2011 Annual Report]. Even in a recession, these stalwart stores have customers that rely on them for basic goods. Wal-Mart and TJX even thrive on cash-strapped shoppers looking for bargains. But just because the company's tenants are stable does not mean that Kimco will necessarily accrue those benefits.
There is substantial reason for caution as well. The basic structure of a REIT requires management to pay out at least 90% of earnings as dividends, meaning that the natural tendency of a REIT is to be a cash cow, not a high flyer. But, when times are tough, this payment policy means that the company will have few retained earnings to fall back on. In 2009, the company was forced to issue nearly 150m shares of new equity, dramatically diluting its existing shareholders' equity (Valueline). As a result, the effective dividend yield fell sharply, leaving income-oriented investors with an unfortunate situation.
Indeed, there is more hidden risk, as the company has nearly $4B in outstanding debt, $2.5B of which is due in the next five years (Valueline). The company's financing strategy requires it to roll this debt over every year, but this requires that markets put credibility in Kimco's ability to pay. The company's B++ rating could be called into question if tough economic times threaten its asset base.
For example, the company is also subject to swings in the real estate market. In addition to the lost equity that a fall in commercial real estate prices would cause, the company would also have financing issues. As part of its borrowing terms, the company has covenants in place with its lenders who require that certain standards of financial strength be met. For many of its borrowings, the company is required to maintain a ratio of total debt / assets of 60% or better. In 2011 this figure was approximately 40% (2011 Annual Report). If the value of Kimco's commercial real estate fell close to 30% in value, its entire financing base would be in jeopardy.
What we then have here is more of a contradiction than stability. Management is pursuing a policy of safety while financing with risky debt. In good times, advances will be moderate, and in bad times, pullbacks will be large. The company is low reward and high risk. Neither one is intolerable. The risk is not exceptionally large, and the reward is not unreasonably small. But taken together, they constitute a poor investment.