A brief glance at a stat sheet is enough to spark interest in Inland Real Estate Corporation (IRC). With -2.6% total returns over the last year, compared with the average returns from the REIT retail sector of 18.1%, and an estimated FFO multiple under 60% of the sector average, the numbers demonstrably show that IRC is deeply discounted relative to its peers. Let us delve deeper to ascertain the nature of this discount; is it weakness or value?
To answer this question, we shall examine some investor's concerns which may be the root of its low market valuation:
Large exposure to troubled tenants
Some of IRC's tenants include Best Buy, Barnes and Noble, Radioshack, and various office supply stores. These companies are struggling a bit so there is concern of the hardship being passed on to IRC through either failed rent payments or the lack of lease renewal. During the second-quarter conference call, IRC management acknowledged these as potential problem tenants and detailed a risk mitigating proactive approach: Instead of waiting for lease expiry, IRC is preemptively negotiating to refit some of these tenants. For example, among the six stores leased to Best Buy, Scott Carr indicated a need for refitting one of them. With a greater awareness of future vacancies, IRC has more opportunity to line-up a new tenant.
Gap between financial and leased occupancies
A year ago, 6/30/11, IRC's financial occupancy was 89.8%, compared with 94.7% leased occupancy. This gap of nearly 500 basis points was indicative of poor tenant performance and impending reduced renewal. In fact, it did manifest in a slightly lower leasing occupancy in 2012 of 92.9%, but the financial occupancy improved to 90.4%. The current 250 basis point spread is much healthier and reflective of the aforementioned management of tenant exposure, along with a slowly improving economy.
History as an untraded REIT
Inland Real Estate was founded in 1994 and became an untraded REIT in 1995. Many investors (including myself) are leery of untraded REITs so a lingering sentiment from its untraded beginnings may be partially responsible for its continued discounted price. However, it should be noted that management internalization took place in 2000 and IRC began trading on the NYSE in 2004. As such, the damage of the company's questionable start has mostly been absorbed, so IRC can be viewed as a fully independent company.
While these concerns remain valid, IRC has made great progress in handling them. Additionally, the results of its earnings report are strong, even surpassing analyst's estimates.
- AFFO increased to $0.22/share in 2Q12, compared with $0.20/share in 2Q11. Keep in mind that over the same period, leasing occupancy went down. Therefore, much of the increase was derived from increased tenant compliance, as well as superior rental rates. In fact, rates on renewed leases across the portfolio went up an average of 8.2% during the quarter.
- Same store NOI of H1 2012 increased 4.7%, compared with H1 2011.
- EBITDA coverage of interest expense increased to 2.8, compared with 2.4 the year prior. For a company with a high debt/equity, coverage is especially important. This bolstered coverage provides much needed protection from interest rate increases as a significant portion of IRC's debt is variable rate. In exchange for taking on the extra risk of the variable rate debt, IRC has reduced its overall weighted average cost of debt to 4.25%. If the low interest environment persists, IRC may prove to be a very strong performer.
Recent Market Price
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In summary, it seems as though the market discount of IRC is not a sign of company weakness, but rather an opportunity for value. In a previous article, Remaining Opportunities in REITs, I suggested under $8 as a good entry point for IRC. It just so happens that its market price has dropped below $8 despite a quarter of excellent performance. The underlying assets and relative weakness of tenants make IRC a riskier investment, but for investors who are willing and able to tolerate risk, it remains an excellent value play with a superb dividend to boot.
Disclosure: 2nd Market Capital and its affiliated accounts are long IRC. This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer.
Disclosure: I am long IRC.