Seritage Growth Properties (NYSE:SRG) is one of the rare REITs that we feel is massively overpriced in this market. Q4-2017 results came out last evening and did not do much to change our minds. Here is what we saw.
Adjusted EBITDA continued to drop off sharply
We generally ignore the earnings noise from REITs and focus on Net Operating Income (NOI), Adjusted EBITDA and funds from operations (FFO). None of the three gave much cause for enthusiasm in SRG's case. Adjusted EBITDA was sharply lower.
Source: SRG Supplemental Information
For comparison this number was over $45 million in Q4 2016 and $34 million in Q3-2017. The almost 20% drop in one quarter played a role in FFO coming in much lower as well.
FFO dropped from $0.46/share in Q3-2017 to a rather abysmal $0.22/share in Q4-2017.
Sears Holdings (SHLD) still dictating the scene
While the Q4-2017 press release was filled with the company's view of accomplishments (completed redevelopments, sale to General Growth Properties (GGP), 4X uplift on rents on developments), one tiny point in Q3-2017 release essentially ran the numbers for Q4-2017.
It was not clear exactly when this happened, but unless it was on October 1st, Q4-2017 likely did to reflect the full brunt of these vacancies. So brutal has been the impact of SHLD's closings that Q4-2017 adjusted EBITDA is now 44% lower than Q4-2016 number and that is in spite of so many new projects being completed with large rent uplifts.
In January SHLD announced another 100 store closings. We compared the released list with SRG's properties in the 2016 SRG annual report and found a few matches. More keys will be handed in in the second quarter of this year making for one challenging environment.
Net debt to Adjusted EBITDA at over 9.5X
SRG has raised significant cash during 2017 and net debt stands just over $1.0 billion if you subtracted cash and restricted cash from total liabilities. If you annualize the Q4-2017 adjusted EBITDA of $27 million, which comes to $108 million and divide the net $1.036 billion of debt, you get a debt to adjusted EBITDA multiple of 9.5X. A tad high for sure.
SRG reports the annual numbers though and that takes into account adjusted EBITDA for the whole year (rather than annualizing Q4-2017). But with two more quarter of rolloffs we suspect that this will start to look extremely worrisome by the time Q2-2018 results come out. If all of that information did not inspire warm fuzzies, please remember that SRG has very high exposure to LIBOR rates, which have been on a tear recently.
The fourth quarter FFO of $0.22 would make the current multiple close to 40X. That FFO does not even cover the quarterly dividend of $0.25. SRG is a good way into this journey of redevelopment and the numbers do not exactly inspire confidence. The one offset has been the significant amount of cash raised from selling certain properties and lease termination fees. That does give SRG some breathing room, but we would feel more enthusiastic about it if we felt that things were bottoming. Instead the way we see it, FFO will be under tremendous pressure in the next two quarters and the company will be giving away $25 million in dividends which it really cannot afford.
SRG valuation has never made sense to us. We see this as a collection of mediocre and some top end properties (75-25 split) that is being valued above Net asset value. We estimated the very top end of SRG stock's potential returns previously and had concluded that it would return 11% per annum assuming SHLD did not ever declare bankruptcy and SRG could kick them out of each store as they pleased. Now, our estimate is that a good portion of the entire REIT space can deliver those same returns with much less risk. Hence it seems logical to us to SRG's price should fall to where it can deliver 15-20% returns to compensate for the extreme risk. We don't know what that price is currently but we think it is lower than the current price. However, in the past though, FFO multiples or SHLD problems have never mattered for SRG. So we wonder if this time will be any different.
Disclaimer: Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
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