- Market sentiment is negative on KIM despite a resilient business.
- Capital Expenditures is now focused on redevelopment.
- Understanding the business will help determine if profits will continue to grow.
Kimco Realty Corporation (NYSE:KIM) is a Real Estate Investment Trust or “REIT” that focuses on owning and operating open-air shopping centers. It has been operating for over 50 years and has ownership interests in 507 centers. The market is bearish on the stock, but sentiment does not match operating performance.
Kimco buys land to develop open-air shopping centers, the type with multiple external storefronts that shoppers can access from large parking areas. Or, it purchases and refurbishes existing shopping centers. Retailers lease units in those shopping centers and pay Kimco rent. The average lease has 10 years remaining for anchor tenants and 5 years for smaller retail spaces. Therefore, rental revenue is steady and predictable. The leases lock in an annual base rent (NYSE:ABR) with contracted annual rent increases, and some of the leases also include small additional payments based on tenant sales. Kimco also makes money by selling shopping centers for more than they initially invested. There are typically one or more large anchor tenants that draw people to the shopping center. Their anchor tenants include grocers, discount retailers, home improvement, fitness, warehouse clubs, medical services, restaurants, and beauty salons.
Anchor stores do not command high rent-per-square foot—$7-$12 per square foot annually. But they are very important to the success of a shopping center. A popular anchor store can draw people to the property, which will then attract smaller retailers to rent adjacent storefronts. Those small-store spaces rent for an average of $26.70 per square foot, because anchor stores created high-value real estate.
Kimco's Real Estate Portfolio
Figure 1: Source, KIM 3Q17 Presentation, pg 15
As Figure 1 shows, their rent is spread evenly among many retail categories. No category accounts for more than 14% of annual base rent.
One trendy opinion in the investment community is that brick-and-mortar retailers will lose out to online retailers. While there have been several retail casualties from the rapid growth of online sales, there are substantially more physical retail stores being opened than there are being closed. According to an August 2017 report from IHL Group, "Debunking the Retail Apocalypse" by Holman and Buzek, there were 4,080 more store openings than closings in the first 7 months of 2017 for chains with more than 50 locations. For every company that reduced its store count, there were 2.7 companies increasing store count.
Ninety-six percent of their rent comes from retailers that are either internet resistant or participate in online retail. As a result of catering to this growing group of retailers, Kimco witnessed a net addition of store openings, similar to what was seen in the IHL Group report. In the first nine months of 2017, Kimco had a total of 38 stores close, which affected only 0.5% of total annual base rent. For reference, in just the last three months Kimco signed 60 new leases and 215 renewals/options. Their occupancy rate has increased from 95.0% to 95.8% in the last year. In addition, replacing those closed stores with new tenants resulted in a 52% increase in those rents. Not only is the number of closures manageable but also lucrative to KIM. If physical retail is truly under pressure from online stores, then KIM has not felt the effects.
The demand for high-quality retail space has also allowed their average base rent (ABR) to grow.
One important point to make is that KIM is heavily grocery dependent. At first glance, grocery stores/warehouse clubs make up only 14% of ABR. However, 73% of their rent came from shopping centers anchored by grocery stores. That means that despite the low proportion of total rent, grocers have an out sized influence on the value of other leases. Amazon.com (AMZN) put a scare into the investment community when they bought the Whole Foods grocery chain in August 2017. Amazon has a track record of radically changing the landscape for many retail sectors. I described Amazon’s business in my article “Amazon: Built For Greatness, Not Built For Profitability,” which is available to SA PRO subscribers. Therefore investors became worried that their entrance into the grocery space would mean that existing grocers would have their profits squeezed. Grocers, themselves, have not shared the dour outlook for their industry. Kroger (KR) is still gradually increasing their store count. Germany grocer, Lidl, plans to open 100 US stores during 2017 and 2018. Aldi plans to open 1,200 new US stores by 2022.
While it seems inevitable that the grocery business will make big leaps into the online world, physical grocery stores are still a critical part of the industry. Contrary to lingering sentiment, Amazon seems to have bought Whole Foods specifically for their physical presence in the community. In my opinion, existing grocery stores are currently the best way to distribute fresh food, even for online orders.
Perishable items cannot be easily delivered to individual doorsteps from just a few large national distribution centers. Imagine trying to order a week’s worth of groceries from an Amazon distribution center over 100 miles away from home. Delivery by USPS, Fedex (FDX), or UPS (UPS) would be prohibitively expensive, perhaps $20 or more per delivery. And a typical Amazon package passes through half a dozen transit points. One could build mini distribution centers near every neighborhood plus a delivery service, like Peapod which has been slow to gain traction. But the investment in land and warehouses would be very expensive, especially because there is already an existing grocery distribution network with an existing supply chain—grocery stores! Existing grocery stores are already profitable, and they are spaced efficiently throughout the population. While there would need to be some physical and logistical improvements, it makes sense to utilize the current grocery infrastructure to support online sales. Grocers would need to devise an efficient way to assemble customer orders. But adding a pick-up counter or a pizza-delivery-guy delivery system seems both easier and cheaper than building out a competing distribution network. Currently, no online retailer has significantly challenged the brick-and-mortar grocery store. Therefore, it is unlikely KIM’s grocery tenants will be going out of business in the foreseeable future.
An evaluation of Kimco’s portfolio shows that the largest customers are all stable. Plus, the off-price retailers, Home Depot (HD), and Walmart (WMT) are all increasing their store counts. The top ten tenants are described below:
1. TJX Companies (TJX): Off-price retailer that owns TJ Maxx, Marshalls, HomeGoods, Sierra Trading Post, and Homesense. Plans to open over 3000 new US stores. Steadily increasing same-store sales—sales growth of stores open for more than one year. Consistent sales and profit growth for many years.
2. The Home Depot: Home improvement retailer. Company projects 14% earnings-per-share growth in 2017, sales increase of 6.3%, increased store count by 2% through three quarters in 2017.
3. Ahold Delhaize: Grocery Retailer with stores in US and Europe. US revenue growth of 2.1%. US store count decreased 2.5%. Growing online sales from 3.2% of total sales to 3.8% compared to previous year.
4. Bed Bath & Beyond (BBBY): Annual earnings per share estimated to decrease about 34% in the last 12 months due to higher mix of online sales/shipping costs and due to increased technology investment. But net sales are expected to be flat. Store count still increased slightly. Brick and mortar stores are still very profitable.
5. Albertsons: Flat sales growth year to year. Opened or acquired 18 stores while closing 19 stores this year. Note that in 2015, Kimco made a $140 Million equity investment in Albertsons that has grown by $40 Million (KIM 3Q17 Earnings Supplement, pg 9).
6. Ross and dd’s Discounts (ROST): Sales growth 8% and EPS growth 13% year over year. Long-term plan to increase store count from 1,533 to over 2,500.
7. Walmart: Consistent quarterly increase in same-store sales and in customer traffic, increasing operating cash flow, US store count increased by 108 over the last year.
8. Petsmart: Privately-held company with over 1,500 stores, no publically available financial data. Kimco management stated in the 3Q17 presentation that the pet supply sector has added 278 stores.
9. Kohls (KSS): Revenue decreased 2.5% last year and store count decreased by 10, after several years of gradual increases. But sales turned back to a 6.9% increase in Nov/Dec 2017.
10. Whole Foods: Had been steadily increasing store count every year until purchased by Amazon.com in 2017.
No other tenant accounts for more than 1.3% of ABR. So, there do not appear to be any big time bombs in the portfolio.
Transactions & Redevelopments
In a quest to increase the quality of their real estate, Kimco has culled their portfolio from 900 properties in 2010 down to their current 507. In 2017, they expect to sell $350-$400 Million in properties at 7.5% cap rates. They expect to acquire $340-$375 Million in properties around 5.5% cap rates (3Q17 Supplement pg v). Cap rate represents the net operating income (NOI) return that a seller would get at the sale price. For instance, buying a $100 Million property at a 7% cap rate would mean that the property produces $7 Million in NOI. A lower cap rate means a higher sale price. At first glance, it appears that Kimco is selling a stream of income at one price and buying new income at a higher price. But, remember that Kimco’s skill set includes property development. The properties that they disposed had low potential for further growth. The new properties are in good locations and have below-market rents—large potential for income growth, ideal for redevelopment. The pool of investors looking for turn-key properties has increased in recent years, which has driven up asset prices and decreased returns. A much smaller pool of companies have the ability like Kimco to take on large-scale fixer-upper properties. Kimco sees better returns in redevelopment, and that is where they have focused their resources.
With a little redevelopment, management believes that they can increase rents in excess of 500% at their $123 Million Whittwood Town Center acquisition in Whittier, CA. The rent growth will take many years due to current lease durations, but it could eventually look like a 25% cap rate purchase.
Last year’s other large purchase of $131.8 Million Jantzen Beach Center in Portland, OR, is another prime real estate location. It also has substantially under-priced rents that need to catch up with local market rates. This should eventually turn into another high-return investment.
Figure 5: Data Source, KIM 2016 Annual Report pg 47
Since 2010, Kimco has had a net gain on properties that it has sold. This is a good indication that prior acquisitions have done well and that they have successfully developed those properties. Starting in 2017, they accelerated their redevelopment pipeline.
Management expects redevelopment projects to increase the returns of those properties by 8-13%. While projections must always be taken with a healthy dose of caution, Kimco has demonstrated a consistent track record of increasing property values, increasing rents, and maintaining high occupancy rates. I would caution investors to monitor how well they handle the increased volume of redevelopment.
Kimco partially funds their $11.7 Billion in assets with $5.55 Billion of long-term debt.
Consolidated Debt/EBITDA = 6.3x
Consolidated Debt + Preferred Stock/EBITDA = 7.4x
A number that stands out to me as a red flag is the debt to EBITDA ratio. EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. REITs typically do not have significant tax or depreciation & amortization; therefore EBITDA closely represents the cash flow available to pay debt. EBITDA is commonly used by the real estate industry to compare relative debt levels. A debt level of 6.3 times EBITDA is on the high end of the range for a REIT. Usually, that level of debt would lead to an unmanageable level of interest expense. Typically, I look for debt below 5.5x. Adding in preferred stock, which has many characteristics of debt, increases the ratio even further. However, after digging further into the debt, I am less worried about the total debt.
Kimco has investment grade ratings (BBB+/Baa1/BBB+) from all three ratings agencies. This is manifest in very low interest rates. Their debt is 98% fixed-rate with a weighted average interest of 3.86%. The remaining 2% is floating-rate debt with an interest rate of only 2.5% (KIM 3Q17 Supplement pg 14). Their annual interest payments project to $189 Million (KIM 3Q17 Supplement pg 4). If we include preferred dividend payments of an additional $48 Million, then Kimco pays around $237 Million each year in debt obligations. Annualized EBITDA of $914.8 Million covers debt service by 3.9 times. Therefore, while the total debt is very high, the interest payments are relatively low. Another company with 7% interest rates could have a Debt/EBITDA that is half that of Kimco but still have to pay just as much interest. This low-cost source of funding gives the company a significant advantage when competing for investments.
Ultimately, our study of Kimco’s business is to determine the likelihood of future profits. Kimco has $11.7 Billion in assets (KIM 3Q17 Supplement pg 3). Based on 3Q17 results, those assets should produce about $1.2 Billion in annual revenue.
Figure 7: Derivation of Net Income, Joshua Mou
After subtracting expenses, such as real estate taxes, operating and maintenance costs, administrative costs, depreciation and amortization, and interest expense, Kimco projects 2017 net income to be around $375 Million or $0.88 per share. For simplicity, Figure 7 left out a few minor sources of income and expense.
Figure 8: Derivation of Adjusted Funds From Operations, Joshua Mou
For real estate companies, net income is not a good measure of profitability. Remember that real estate assets are land and buildings, which can last indefinitely if they are maintained. One of Kimco’s biggest expenses is depreciation and amortization, which all publicly-traded companies are required to report. Most companies have assets that deteriorate and lose value over time. The depreciation and amortization calculation is supposed to show the eventual cost of replacing assets such as manufacturing equipment, office equipment, vehicles, and patents. Kimco’s land and well-maintained buildings typically do not need replacement. However, even though they will never have to pay for their replacement, they are still required to account for depreciation and amortization against their income.
Because this expense is not real, they can add depreciation back to their income for a more realistic profit calculation called Funds From Operations (FFO). Further adjustment for one-time charges gives a core profit number called Adjusted Funds From Operations (AFFO), projected to be about $645 Million in 2017 or $1.51 per share.
Kimco’s AFFO growth per share will be minimal in 2017. Management states that this is due to the 1) increased proportion of shopping centers in development that are not producing rent and 2) due to hurricane-related delays in rent payment at some properties. There is rent-loss insurance on storm-hit properties. Therefore, I would expect AFFO to catch up next year to the long-term growth rate. The Annual Dividend chart in Figure 9 is the kind of chart that investors love to see. KIM’s stock price has been volatile lately, but that has not been due to poor operating performance.
The stock market currently values Kimco at $6 Billion based on the current stock price of $14.18 per share (2/9/18). We can use Adjusted Funds From Operations to represent profit—money left over to reinvest and to pay shareholders. Purchased today, Kimco’s $1.51 per share of AFFO would equal a profit return of 10.6%. Kimco ‘s dividend for 2017 was $1.08 per share ($1.12/share in 2018).
That stock purchase of KIM today would deliver a 7.6% cash return, money straight into an investor’s pocket in the form of a dividend. On top of the dividend, stockholders get another 3% return in the form of AFFO reinvested in the business. That reinvested AFFO gives the company a cash cushion to handle unexpected operational difficulties such as the hurricane that hit its Puerto Rico properties last year. The retained AFFO gives the company cash to grow future AFFO and, hence, future dividends. Even though investors do not see the retained profit right away, that profit is still adding value to their investment.
Kimco has built a profitable and growing business by using their skill in shopping center acquisitions, property redevelopment, and balance sheet management. There do not appear to be any near-term threats to their business. With the current drop in stock price, an investment should yield an above average return for many years.
KIM is currently a high-yield stock. Despite its high yield, the business is stable and increasingly profitable. This is attractive candidate for income investors, who plan to use the payouts for living expenses. A dividend that grows at 7% is a great defense against inflation.
I differ from other SA members because I do not think that any stock is “must own.” Everyone has different expertise and circumstances, which change a stock’s risk profile for the individual. So, I would like to point out some obvious reasons not to buy KIM. Don’t buy KIM if you do not think there is a difference between the different types of shopping centers or if you are not willing to investigate the stability of the tenants. An investor needs to be willing to monitor occupancy rates, success of redevelopments, ABR changes, and the balance sheet. If you have knowledge that the company will not be able to fill their stores, then don’t invest—and please enlighten the rest of us! Also, Kimco’s skills in acquisitions and redevelopments may not scale up; and the volume of redevelopment projects may overwhelm their resources.
Now it is your turn to discuss points that I have missed or that I have misinterpreted. We would all benefit from anyone with a different perspective or from anyone with retail experience. I find investing to be fascinating because there are always things to learn from other investors, especially if they can steer me away from a costly mistake. So, have at it!
This article was written by
Analyst’s Disclosure: I am/we are long KIM. 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.
This article is not a recommendation to buy or sell, but rather a starting point for investment research and discussion. I am also long SKT and WPC.
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