Yesterday I was putting the finishing touches on my upcoming newsletter, the Forbes Real Estate Investor. I decided to focus the entire March newsletter on "sleeping well at night" and specifically the 23 SWANs in the Intelligent REIT Lab.
As I was researching the SWANs, I could not help to be impressed by the 13 SWANs that I own (in my Durable Income Portfolio).
Since January 31, 2016, my SWAN holdings have returned over 16% and they are backed by overweight powerhouses like STAG Industrial (NYSE:STAG) +48% YTD and Digital Realty (NYSE:DLR) +32% YTD. I recently added Simon Property Group (NYSE:SPG), another rock star, expected to grow earnings by over 10% in 2017. (See my recent SPG article HERE).
Owning SWANs is an important part of my business plan as these stocks represent a majority of my REIT portfolio. Accordingly, I have designed my Durable Income Portfolio such that the SWANs represent the anchor component and the other REITs (called SALSA) are essentially yield-enhancers.
This tactical "anchor and buoy" model has served me well (since 2013) and I believe that the success is primarily related to the fundamental research and analysis. It takes significant time to weed out the "best from the rest," but the hard work is validated when I begin to see the results.
As I was reviewing the list of SWANs, yesterday I spotted a REIT that had fallen out of favor. I'm always looking to own more SWANs, if possible, and this particular company is on my watch list. Let's take a closer look.
The # REIT In The World
Federal Realty is a blue chip that any intelligent REIT investor would like to own; however, I have been trained to steer away from securities that cannot be purchased with a margin of safety.
My #1 in the world REIT pick is based on the premise that dividend-paying stocks have a long history of outperforming nonpayers, and their high-yielding stocks usually outperform low-yielding ones.
To recap this REIT, Federal Realty is a recognized leader in the ownership, operation and redevelopment of high-quality retail based properties located primarily in major coastal markets from Washington, D.C. to Boston as well as San Francisco and Los Angeles.
Founded in 1962, FRT's mission is to deliver long-term, sustainable growth through investing in densely-populated, affluent communities where retail demand exceeds supply. FRT's expertise includes creating urban, mixed-use neighborhoods like Santana Row in San Jose, California, Pike & Rose in North Bethesda, Maryland and Assembly Row in Somerville, Massachusetts.
These unique and vibrant environments that combine shopping, dining, living and working provide a destination experience valued by their respective communities. FRT's 96 properties include over 2,800 tenants in approximately 22 million square feet and over 1,800 residential units.
Although FRT does enjoy a diverse revenue stream, the company has not "cracked the secret code" based on size alone. By favoring quality over quantity, FRT has the greatest concentration (77.1%) of assets in the nation's top 20 markets, which comprise 37% of US retail expenditures.
There's no question that FRT's demographics are unequaled with incomes that exceed the peer group by 32% and the national average by 50%. FRT has the highest concentration of "SuperZips" (zip codes representing the 95th percentile and above in income and education). Clearly, this unmatched combination of density and affluence sets FRT centers apart from the competition.
Density is directly correlated to Federal's durability metrics. The company's premier operating portfolio has about 50% greater household density than the peer group average and 124% greater than the national average. As you can view below, FRT's portfolio achieves the highest cash rents in the sector, ~60% higher than the peer group average.
FRT has a highly diversified portfolio with no one tenant that represents more than 3.5% of ABR. Also, many of the retail tenants are necessity-based:
The Fortress Balance Sheet
FRT is one of just a handful of REITs with an A-rated balance sheet. In October, Fitch Ratings affirmed FRT's ratings, including its A- long-term issuer default rating with a stable. The ratings and outlook reflect FRT's "consistent and steady" cash flow growth generated from its community shopping centers, as well as the prudent management of its balance sheet and its creative redevelopment and mixed-use development, Fitch said in a note.
Fitch also affirmed the company's unsecured revolving credit facility, senior unsecured term loan and senior unsecured note ratings at A-, and its redeemable preferred share rating at BBB.
FRT has a strong liquidity position with the $800 million credit facility completely undrawn. The company's debt-to-EBITDA ratio is at 5.25x for Q4-16 and the fixed charge ratio is 4.5x. From a capital standpoint, during 2017, FRT projects to spend approximately $400 million to $450 million in development, redevelopment and releasing and $30 million for the recently completed Pasadena acquisition.
Over a five-year period, FRT has maintained debt-to-EBITDA steadily in the 5.2 to 5.4x range. Also, the company has reduced fixed charge coverage from 3.2 to 4.5x, achieved an A- rating (from all three major credit rating agencies) and has lengthened its weighted average debt maturity to a current 10.5 years.
The Development Machine
FRT has a few crown jewel properties including Assembly Row that continues to perform extremely well really, cementing itself as a substantial live-work property. Construction of Phase 2 remains on time and budget: 66 of the 107 market rate condos are under binding contracts.
In Maryland, Pike & Rose continues to progress. FRT is "confident of its long-term value creation by year-end" as the residential product is over 96% leased, but only 90% occupied. And office and retail is now 100% leased and occupied.
Here's a snapshot of FRT's redevelopment pipeline:
Here's a snapshot of FRT's mixed-use pipeline:
The Latest Earnings Results
FRT had a solid quarter with FFO per share of $1.45, the highest quarterly earnings ever reported and 6% better than last year's Q4-15 results. FRT ended the year with FFO per share of $5.65, 6% better than 2015.
FRT reaffirmed the 2017 FFO per share guidance range of $5.83 to $5.93:
Also in Q4-16 FRT's same-store property operating income rose 3% and total property income rose 7.4%, reflecting the progress made on the income generation side of new profits. FRT ended the year at 94.4% leased. FRT continues to deliver on its October 2013 plan to double NOI in 10 years.
There aren't many shopping center REITs who can boast about 7% annualized NOI growth, especially the larger cap names. However, FRT has a long history of outperformance as evidenced by the snapshot below - FRT has paid and increased annual dividends for 49 consecutive years in a row - the longest record in the REIT industry.
A SWAN on Sale?
As I was studying over the SWANs (for my upcoming newsletter), I stumbled across the growth forecast for FRT, and specifically the earnings projection. As my newsletter subscribers will recognize, I developed a model to rank each SWAN based on forward-looking durability metrics. FRT is projected to grow FFO by around 4.5% in 2017 and over 7% in 2018. Here's the FFO and dividend forecast:
As you can see, the average dividend growth in 2017 and 2018 is estimated at over 5%.
As I explained in November:
My #1 in the world REIT pick is based on the premise that dividend-paying stocks have a long history of outperforming nonpayers, and their high-yielding stocks usually outperform low-yielding ones. As the chart below illustrates, dividends aren't just for over-the-hill companies or investors - dividends are for anyone interested in total return.
While FRT's FFO and dividend are rising, the shares have been falling:
In a research paper, Boenning & Scattergood explains:
With the longest weighted average maturity profile in the strip sector at 10.5 years and no meaningful debt maturity until 2019, FRT has a fortress balance sheet and significant cost of capital advantages. Over the past five
years, FRT invested close to $350 million in capital expenditures annually including development, redevelopment, and other investments, implying a total spending of $1.7 billion. These investments were approximately 40% debt funded and priced at around 4%.
B&S estimates that FRT's current active pipeline could contribute over $629 million in incremental value and boost NAV by over 6% (see table below). Other remerchandising efforts are ongoing at 'A' rated Pentagon Row in Arlington, VA and 'A++' rated Santana Row in San Jose, CA with medium-term redevelopments planned at 'A' rated Coco Walk and 'B+' rated Shops at Sunset, both in Miami, FL.
The Bottom Line: Most all shopping center REITs sold off in Q4-16 and although shares in FRT are cheaper, we consider the valuation to be on the upper end of sound value. In other words, we don't view the pricing as a "nose bleed" anymore, but we prefer to wait for a better entry price.
In my upcoming newsletter, I will provide details of SWANs priced with a wider margin of safety. Remember that buying stocks when they are cheap is the best way to create wealth - stocks of high-quality SWANs on sale reap the highest returns.
Check out The REIT Beat: I plan to publish a weekly Nothing-But-Net REIT Guide that will include WACC metrics and valuation tools. If you'd like to get more of my ideas, including early access to my highest-conviction REIT plays, access to Q&As with management teams, weekend REIT reports and more. We'd love to have you on board, so have a look.
Author Note: Brad Thomas is a Wall Street writer and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors, if they are overlooked.
Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking. If you have not followed him, please take five seconds and click his name above (top of the page).
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 APT, ARI, BXMT, CONE, CORR, CCP, CCI, CHCT, CLDT, CUBE, DLR, DOC, EXR, FPI, GPT, HTA, HASI, KIM, LADR, LTC, LXP, O, OHI, QTS, ROIC, STWD, SNR, STAG, SKT, SPG, STOR, TCO, UBA, VTR, WPC, PEI, EQR, DEA, MVEN.
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.