Is Wheeler Real Estate Investment Trust Inc., Growing Too Fast?

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About: Wheeler Real Estate Investment Trust (WHLR)
by: Long Player
Summary

Management has guided to full distribution coverage beginning with the fourth quarter, 2016 for the first time in company history..

The long term debt to value ratio is currently about 59% but will only increase to about 64% after the next deal..

As the company grows, the acquisition costs are slowing and becoming a smaller part of the expense picture. Continuing rental management expenses have decreased sharply even as revenue as increased..

BI-LO is too large a customer, so future diversification away from this customer is indicated.

Probably the concerns on a lot of shareholder agendas was best summarized by the following comments:

  • "Directors owe a duty to both preferred and common holders.
  • We recommend a new common stock dividend policy tied to actual cash flow as opposed to projections.
  • We note that additional preferred B dividends and new preferred D dividends will lead to short-term dilution in AFFO available to common shareholders.
  • We caution management against hurrying acquisitions or due diligence to mitigate short-term diminution of AFFO from additional preferred dividends.

We continue to believe that Wheeler is undervalued by the market based on the potential for growth of AFFO, and we hope that the Board will further consider our recommendations so that this potential is no longer obscured.

Following is the text of the September 30, 2016 Letter from SLKW to Jon Wheeler and the Wheeler Board"

Rather than reprint the whole letter, I will reference that letter so any reader of the article can review it at their leisure. Basically Wheeler Real Estate Investment Trust Inc. (NASDAQ:WHLR), has never covered the distribution in its entire history as a public company. Since the distribution has been already cut in half once, that lack of coverage has given shorts an unparalleled field day about the future of this company. Plus Mr. Market gets really nervous whenever a distribution is not covered for a length of time.

Source: Wheeler Real Estate Investment Trust Inc., September, 2016, Investor Presentation

These slides should help ease some investor concerns. First, management is making material progress towards covering the distribution. This is not the kind of progress posted by a company in a financial straight jacket that is about to cause investors a lot of pain.

"Earlier this year we set forth our strategic plan internally to reduce the Company's cash, general and administrative expenses and cover our $0.21 dividend with AFFO on a run rate basis by year-end 2016. We communicated those goals to the market and we feel we've been able to execute.

For the third quarter cash, general and administrative costs the four acquisitions in capital costs was $1.1 million or $4.4 million annualized versus $5.9 million run rate in the first half of 2016. This is in line with our most recent guidance for the second half of 2016 of cash, general and administrative costs runway of the below $4.5 million."

So the company reaffirms its guidance (to the chagrin of the shorts) that the distribution will be covered in fourth quarter for the first time in company history. This quarter the company claimed to hit the higher end of the guidance before a few items. All this growth and the financial adjustments needed to present the progress made cause a lot of confusion. But one thing is abundantly clear, as the acquisitions costs become a smaller part of the quarterly expenses because the company is now larger, the recurring property management costs and income that management breaks out as shown above (and elsewhere) are under tight cost control. Plus management has indicated that there will be no need to expand the senior ranks as the expansion continues.

In the meantime, the ratios above appear quite healthy for a company that is supposedly having a near-death experience or worse. Plus management mentioned that the long term debt (primarily mortgages) to property value ratio is currently 59%. It will increase to about 64% or so after the next acquisition valued at more than $90 million. That is a ratio that comfortably meets the bank covenants.

The debt cost averages a little more than 4%, so as long as the amount on the credit line remains minimal, there is ample opportunity to make some shareholder profits between the rental income and the debt cost spread.

Source: Wheeler Real Estate Investment Trust Inc., Third Quarter, 2016, Supplemental Information Packet

The actual AFFO reported was $.14 per unit annualized. Not too far from the $.17 management reported before removing a few costs. But the big news is the progress made. The AFFO is about double the figure from the previous year. Reported losses have decreased sharply as the rental income has increased to cover expenses and provide more cash.

The preferred stock issued and outstanding has increased quite a bit again. This provides some leverage for the common unit holders. Maybe more than they want. However, some of that preferred stock is convertible and management needs to execute in such a way as to assure that conversion and provide a less expensive way to acquire capital in the future.

Future sources of growth include notching the occupancy rate up to about 95% on acquired properties, enhancing occupied properties, expanding occupied properties, and other opportunities. But Wheeler is primarily a growth vehicle that pays a decent distribution. So far Mr. Market has not liked the results because the dividend was cut and the distribution has never been covered throughout the history as a public company. But that may be about to change.

Source: NASDAQ Website Company Specific Information

One thought about the company's future is being voiced by the purchases by insiders. Any distribution cut worries should vanish at the sight of all those insider purchases. Even John Wheeler, Chairman has purchased some more shares to add to his already significant holdings. Clearly the officers of the company are bullish on this REIT's future. Their inside information is far more accurate than any information a shareholder has. Plus the stock has recently retreated into the upper range of a fair number of the purchases.

Source: NASDAQ Website Company Specific Information

Likewise some decent value hunters have taken a significant position in this company. Michael Price, who had sold his mutual funds to Franklin Templeton is a noted value hunter. Bulldog Investors is another. But the big news is that by and large the institutions have increased their positions. They are not running away screaming from this investment, which may happen if the company had some serious financial problems.

The rapid growth makes this company riskier than a typical REIT. Plus it is small and there is not that much of a track record. But there is a long list of insiders and professional investors that think this company is a bargain right now.

So for an investor willing to assume above average risk the company is a deal that offers an above average distribution combined with significant capital appreciation. If management executes their plan, and there are enough independent directors to keep management focused, then shareholders could see the common unit price double as the investment quality of the units rise. Given Wheeler's past history that is a big "IF". But activist investors are part of the board, and the institutional shareholders clearly have the votes to oust Jon Wheeler, Chairman if that is deemed necessary.

Jon Wheeler mentioned during the conference call that the latest preferred stock sales will be used for the latest acquisition deal. He also mentioned that there would only be about $15 million left on the credit line after the latest acquisition. The bank, however, did increase the credit line recently to $75 million, so there could be more increases down the road as needed if the company continues to progress satisfactorily. Jon Wheeler seems determined to keep growing the REIT. The key is to make sure it does not grow at any cost.

Source: Wheeler Real Estate Investment Trust Inc., September, 2016, Investor Presentation

The company emphasizes necessity based shopping as a way to deter online competition. This should also stabilize the business of the tenants occupying the properties making them less sensitive to economic downturns. Plus these small towns are often insulated from economic downturns more so than the big cities. The geographic diversification of this REIT should result in some very stable earnings.

But management also emphasizes small markets to increase returns on investment. Many of these markets are growing markets in the Southeast, as there is a general migration to many of these states. The populations in the targeted markets tend to grow at a higher than average rate. So there is the possibility of "market upgrade" to add additional long term valuation increases to these properties. But currently, these are less liquid properties that are offered to sellers at a higher capitalization rate than properties in larger markets.

The numbers to analyze are very different in these smaller towns. Costs are usually far lower but traffic is also lower because there are less households nearby. But that usually means less competition for the retailer in what is usually a brutally competitive industry. So profits margins are usually a little higher. These small town locations can be very profitable despite the lower numbers. One just has to examine the total picture.

Source: Wheeler Real Estate Investment Trust Inc., September, 2016, Investor Presentation

The company is fairly dependent upon BI-LO. There needs to be some diversification away from that customer. The next few deals could solve that problem. The second slide shows a significant project underway that the company has contributed land to, and also has loaned money to. This project is also an exception in that it is located in the Charleston metropolitan area. That is a far larger market than the company usually owns properties in. The management company does have some performance goals to meet, but the project appears to be a significant profit enhancer when completed.

Risks

Rapid growth carries its own risks. Maintaining the quality of deals during a period of rapid growth is far more challenging. Making sure the proper management infrastructure is there to support the acquired properties is exponentially harder during times of rapid growth. Failure on either of these or other execution type challenges could lead to some serious losses.

Like all REITs this company is very sensitive to interest rates. A period of high interest rates could depress profits as well as the value of the portfolio. This would diminish the long term prospects of the investment.

The credit line will be almost used up. Management may need to "take a breather" to assimilate the latest acquisitions. This would allow proper supporting company infrastructure growth as well as time for the bank to determine if an increased credit line is warranted. Much of the newly issued preferred stock is convertible, but only if the conversion price is exceeded. Management needs to execute in a way that assures that conversion so the cost of capital does not become prohibitive.

Summary

Wheeler Real Estate is a rapidly growing REIT that may finally be achieving the operational size and goals set by the chairman some time ago. This has come at a considerable cost to the original shareholder and the chairman because the stock is trading at less than half of the original $6 offering price noted in several previous articles. Plus the original distribution was cut in half to attract institutional money for the rapid growth. All of that has left a lot of "burned" investors.

Now the credit line is a little strained, but the debt ratio is fairly conservative for real estate loans. Although that low ratio may be due to the lack of track record of the company, and the illiquid assets purchased in smaller markets. Still the bank has increased the credit line to enable the next set of deals to close and the company is acquiring mortgages at very reasonable costs.

Management has guided to distribution coverage in the fourth quarter. That would be a first for this company in its entire public history. However, a demonstration that over time the coverage can be maintained and increased to the market's liking would indicate a sharply higher price.

Currently management increases the distribution coverage by making acquisitions. There are other, slower distribution coverages also in progress. But a material increase in the cost of capital or credit may slow the progress currently envisioned. Capital markets rarely close, they just increase costs until the company cannot afford it. That result needs to be avoided by this company.

Investors such as Michael Price generally invest for fairly sizeable capital gains. The purchases by insiders is clearly bullish for the future of the company. Still the current lack of distribution coverage indicates that the common units are speculative.

The preferred stock has much better distribution coverage and is therefore safer. But the small size of the company and the lack of a long term track record could well make the preferred issues a speculative investment for most investors.

Disclaimer: I am not an investment advisor and this is not a recommendation to buy or sell a security. Investors are recommended to read all of the company's filings and press releases as well as do their own research to determine if the company fits their own investment objectives and risk portfolios.

Disclosure: I am/we are long WHLR. 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.