CBL Vs. Seritage: Hopes And Dreams Of 'Sears-Free' Income Streams
Summary
- Seritage trades at 20X 2017 AFFO.
- The bull rationale is that deep value resides in its portfolio.
- We examine a scenario where Sears continues paying rent long enough for the portfolio to develop.
- CBL still outperforms, even if Seritage maintains a 4X multiple premium.
Seritage Growth Properties (NYSE:SRG) has a large portfolio of prime real estate which it intends to develop over time. It has been touted as one of the best real estate stocks and is one of the few that trades at a large premium to NAV. From an investment standpoint we prefer CBL & Associates Properties Inc. (NYSE:CBL) to SRG. We wrote about the Long CBL/Short Seritage case earlier. The comments we got at the time suggested that the Seritage portfolio when fully developed will be a fantastic return on investment. We decided to examine how the 2 stocks would perform if Seritage was successful in doing so.
At the heart of the bull case is SRG's ability to develop Sears (SHLD) properties over time and lease them at much higher rates per Sq Ft. The total wholly owned portfolio is about 36.66 million Sq Ft. It also has 3 joint venture sets of properties totally about 2.7 million Sq Ft. Since 2015 approximately 3 million sq. ft. of the wholly owned portfolio has been developed. This resulted in a huge uplift in rents as can be seen in the details below.
Source: SRG Q1-2017
As with any portfolio, Seritage is targeting its best opportunities first. Beyond the time-value of money concept, they are in a rush to develop as Sears their largest tenant is in extreme distress and still pays the bulk of their gross rent.
While it would be hard to extrapolate the final rents on the entire portfolio, the to-date achieved returns are a good and perhaps a slightly optimistic guess.
To model the end point returns on Seritage, we assumed the following.
1) SRG is able to develop about 3 million sq. ft. of Sears rented space annually. This is quite fast and double the historic pace over the last 2 years.
2) Capex is $350.00 million annually. We did this by using the higher end of the return assumption in the management guidance of 12%. Hence if management is developing 3.0 million sq. ft. annually and their increased rent on this sq. ft. is $14 a sq. ft. , or $42.0 million annually, this should cost $350.00 million ($42.0 million/0.12).
3) Access to additional debt is at same interest rate.
4) Dividends are held constant.
5) Sears does not declare bankruptcy at any point.
6) Real Estate Taxes increase about in line with overall rents.
7) Property expenses increase at 10% a year and G&A expenses increase at 5% a year. Property expenses can be debated but the way Sears was handling its stores is not how any sensible tenant will want the property looked after. Also I am applying the jump in rents to both base rent and tenant reimbusements, so if property expenses are overstated, so are probably tenant reimbursements.
2017 Results based on Q1-2017 annualized look like this.
Source: Author's estimates and calculations
From 2018-2022 it would like this.
And finally from 2023-2027, these would be the numbers.
Assuming the stock then (2027) trades at a 14X multiple, not unreasonable since all "growth" is gone, the stock will trade at $90.64. I am not assigning any value here to the JVs. They are about 2.7 million sq. ft. out of a total portfolio of about 40 million sq ft. If you feel they are worth a lot you can add another 10% to $90.64 stock price.
The total return for all of this hard work is 11.5% compounded including dividends. The assumptions above are pretty optimistic as I am assuming very little new stock will be issued and Sears will live on right until the end. No dilutive equity raise will be done and the whole portfolio can target 12% returns on capex. The capex required is pretty huge and SRG's internally generated funds flow will not cover this in any year during development. If all of this happens...SRG will turn out to be a decent investment.
For those touting the lack of Sears dependency, please consider the revenue distribution over time.
Even in 2021, Sears will comprise 24% of the total revenue, so the idea that the vulnerability to a Sears Bankruptcy exists only in the short term is incorrect. Even if Sears declared bankruptcy on December 31, 2020, 2021 funds flow would drop below 2017 levels and SRG's ability to develop its portfolio would be highly compromised.
CBL:
From an investment standpoint if CBL continued to pay its dividends and used the remaining self generated cash-flow of about $170 million annually to keep its portfolio performance flat, it would outperform Seritage just based on the dividend. The 12.8% dividend is just 50% of its payout and should be easily maintained. Redeveloping the limited Sears locations via its own cash flow over time, would be the icing on the cake. If SRG can develop 30 million plus sq. ft. by borrowing over 2 billion dollars, certainly CBL can develop 12.5 million sq. ft. (counting both J.C. Penney (JCP) and Sears spaces) with its 1.7 billion excess cash flow over ten years.
Source: CBL 2016 Annual Report
Conclusion:
At a 20X AFFO multiple the SRG bulls better hope everything goes right. Ultimately SRG is redeveloping retail space and there is no ultra magic formula. Washington Prime Group (WPG), Pennsylvania REIT (PEI) and of course CBL among many others are doing the same thing. Except all the above are doing it from a position of extreme strength while SRG is doing it from extreme vulnerability. Darren McCammon had a wonderful piece showing the deep value in CBL and suggested that perhaps Warren Buffett had picked the wrong retail REIT. At current valuations, if he had to choose again, I am sure he would choose CBL.
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Analyst’s Disclosure: I am/we are long WPG, PEI, CBL. 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.
The author is long SRG Dec 2018 puts.
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