Seritage: Tears And Fears Of A Bankrupt Sears-II

Summary

• Seritage Growth Properties reported Q4-2017 results.
• The stock dropped 4% on the release.
• We dissect the numbers and point out why we would not buy this one.

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.

Valuation

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.

Conclusion

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.

Seeking Alpha has changed its policies. Previously "following" someone required a ritualistic commitment and an offering of not less than 4 oxen or 3 breeding horses. Now, all it takes is one click! If you enjoyed this article, please scroll up and click on the "Follow" button next to my name to not miss my future articles. If you did not like this article, please read it again, change your mind and then click on the "Follow" button next to my name to not miss my future articles.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Comments

[User 4405691]

As of December 31, 2017, the Company had originated 63 wholly-owned projects since the Company’s inception. These projects represent an estimated total investment of $1,066.9 million, of which an estimated $801.7 million remains to be spent
------estimated $801.7 million remains to be spent--------------

http://bit.ly/2FDrHcg

Company’s inception 3 years ago
$1066 - $801 = $265 Million
$265M/ 3 = $88 Million per year

$88 Million a year is all, were did rest of $$'s go ?
($241.6 million is not sounding like a lot to me considering payday loans , property sale , share offering , and that does not include previous Mezzanine Loans )

801/88= 9 more years
inflation will double that $801 M to $1.5 B in 4 years
just because SHLD is not passing out any raises...does not mean the rest of the world stopped with them
Politics are making materials cheaper to right ?
no illegal work force .........cost are going up

---------originated 63 wholly-owned projects --------is all they have done in 3 years

SRG had to borrow, sell property , and issue shares to do that , and not go under themselves

the bulk of leases SRG has , is what they were given from SHLD

lets not confuse facts with B/S

[Axius Holdings]

any thoughts on the newly issued Preferred A trading below par ? yielding 8%...

[fxfx]

They do not need 800 million within a year. They can strectch things out and finance if from the increasing cash flows over the next few years.

Both the common and the prefs look like a pretty sweet deal here.
Since I do not buy the "yields will explode from here" nonsense, I started to accumulate the prefs here between 22 and 23$. 7.5-8 % yields will be great for the coming 10 years, far higher than what you get for very risky frackers' debt or for less risky, but also less yielding treasuries

[Adam Levine-Weinberg CFA]

All of the redevelopment projects that have been announced so far are supposed to be completed by the end of 2019. So Seritage definitely needs to raise capital, probably through some combination of asset sales and incremental debt.

That said, it seems likely that as SRG increases its rent from third parties, it would be able to take on significantly more debt than what it has now, so I'm not especially worried about this issue.

[fxfx]

Adam, I know that they are "supposed to". That is different from "must be" (come hell or high water). Imho there is no contractual obligation to complete all of them until that deadline.

[Adam Levine-Weinberg CFA]

Maybe not, but it would be a terrible idea to delay construction. The biggest and longest-term projects are the ones that will create the bulk of the extra rental income needed to improve cash flow.

[Rgarga]

A lot of noise here makes reading these reported numbers very confusing. So they have enough cash for redevelopment for basically 2018. They can either sell JVs or take loan against cash flows from properties that are going to be opened for business this year which are many. I must be missing something but the more I look at this, the more I agree with Adam above.

Fundamentally thesis makes sense. Rent for 4x the amount, and since ones costs do not go up proportionally, one may end up with much more 4x ffo. Question is whether there will be enough cash to do the redevelopment. I think so from what I see. Rest seems to be noise and accounting.

Either way, I may be biased as I am long for a year or so.

[User 4405691]

Bill
a link to MAC buying shares please (SEC , not opinion)

Sraja
what are thoughts on this , think they might need a tad more than 200 to 300 M

"As of December 31, 2017, the Company had originated 63 wholly-owned projects since the Company’s inception. These projects represent an estimated total investment of $1,066.9 million, of which an estimated $801.7 million remains to be spent"

since inception they have spent $267 Million , but need $801 M more to get ghetto's that are promised done ?

http://bit.ly/2FDrHcg

[serenecapital]

As of December 31, 2017, the Company had $241.6 million of unrestricted cash and restricted cash of $175.7 million, the substantial majority of which was held in reserve accounts for redevelopment, re-leasing and operating expenses at the Company’s properties. The Company also had $55.0 million of permitted, but uncommitted, borrowing capacity under its $200.0 million unsecured term loan facility due December 31, 2018.

Series A Preferred Shares

During the fourth quarter, the Company issued 2,800,000 7.00% Series A Cumulative Redeemable Preferred Shares (the “Series A Preferred Shares”) in a public offering at $25.00 per share. The Company received net proceeds from the offering of approximately $66.7 million after deducting payment of the underwriting discount and offering expenses.

Unsecured Term Loan

During the fourth quarter, The Company refinanced its existing $200 million unsecured term loan facility with a new $200 million unsecured term loan facility (the “Unsecured Term Loan”). The previous facility was a delayed draw facility with a maturity of December 31, 2017, against which the Company had drawn $85 million against the total capacity of $200 million.

The lenders under the previous facility, which are entities controlled by ESL Investments, Inc., have maintained their funding of $85 million in the Unsecured Term Loan, and new, non-affiliated lender committed and funded an additional $60 million for a total of $145 million committed and funded at closing. Maximum total commitments under the Unsecured Term Loan are $200 million and the Company has the right to syndicate the remaining $55 million with existing or new lenders. Existing lenders are not obligated to make all or any portion of the incremental loans.

[fxfx]

They do not need 800 million within a year. They can strectch things out and finance if from the increasing cash flows over the next few years.

Both the common and the prefs look like a pretty sweet deal here.
Since I do not buy the "yields will explode from here" nonsense, I started to accumulate the prefs here between 22 and 23$. 7.5-8 % yields will be great for the coming 10 years, far higher than what you get for very risky frackers' debt or for less risky, but also less yielding treasuries

[UncleLongHair]

SRG's numbers are skewed because most of the redevelopment they did in the past 2 years was in unconsolidated joint ventures, so the increased revenues, cash flow, EBITDA, etc. from those efforts is not consolidated. This is why these numbers declined year over year even though they accomplished significant redevelopment and growth.

Some of these JV's were sold during the year ($60M of proceeds). This figure is arguably cash flow but is apples-to-oranges from FFO because it is non-recurring. But to ignore it is to ignore a major source of their profit and liquidity.

SRG was not very well capitalized by Eddie when it was spun and it has to pull itself up from its bootstraps, which means flipping its first few redevelopments to JV partners and raising more capital via preferred. Going forward they will likely retain more of their properties and we'll see FFO increasing.

There are a lot of moving parts but the way to evaluate the company is by how much they paid to acquire and redevelop each property, and what rents and sales proceeds they get, to see if they are successfully recycling capital, which I believe they are. If you think the stock is worth half of today's value you're in for a surprise.

[Trapping Value]

I did an analysis a few months back where I ran through their entire redevelopment list and used the high end of management ROI. I also assumed Sears would survive till 2027 and gently turnover properties as needed.
That produced a 11% compounded return.
I seriously doubt even that will ever happen.
I see a best case now for a 7-8% compounded return, which is really low in a market where many reits should deliver that with much less risk.

[UncleLongHair]

The thrust of your article is declining FFO, EBITDA etc with no explanation of the joint ventures and the role they play. Very misleading.

[Trapping Value]

YLH,
The quarter over quarter decline has to do with Sears Vacating and not the JV sales which were completed previous quarter.

[serenecapital]

I think I read somewhere the seritage has identified 36 such properties for mixed use. I may have misread this. so I have to go back and search again but this will be significant not to mention the 4x releasing spreads

[Bill Stoller]

Hi Sraja, yes, you are correct on WEB buying in mid-$30s.

I was being lazy... :/ I went back and found one of my early articles on Seritage, where I estimated $35.25 per share.

https://seekingalpha.c...

However, SPG, GGP, and MAC did take down a chunk of shares at a better price point as part of the JV negotiated with Seritage.

Best, Bill

[Bill Stoller]

@Sraja, from my reply to rube123, above:

"Additionally, all three mall owners agreed to purchase Seritage common shares in private placements as part of the JV arrangement. By way of example, Simon purchased 1,125,760 Seritage shares at $29.58 per share as part of its JV agreement. In hindsight, each of these "insiders" bought shares at a very attractive price."

Best, Bill

[bluescorpion0]

Reminds me of IBM. He bought, went up, then back down to and below his purchase price. Same pattern here almost. Has he lost it? If so, beware of owning Berkshire too!

[serenecapital]

Buffett's price was mid 30s. This analysis does not seem to include some of the densification potential in the portfolio.

see the following links

http://bit.ly/2FFSLrr

https://nwsdy.li/2t6KgDh
you read it correctly- 500+ apartments and then storefront.

there are many such properties within seritage. I think there are planned submissions in seattle etc.

http://bit.ly/2FHuRvE

yes we might need a 200-300M financing in the interim if (only if) sears bankrupts. but this is a gold mine.

Added more today..!

[Trapping Value]

What do you believe is the ultimate FFO/NOI potential of the whole portfolio?
Because I just don't seem them getting a self funding mode on it till maybe 2021 or later. So there is a lot of dilution between here and there.

[serenecapital]

I think you can JV these properties similar to the dallas model and get a lot of bang for your buck. Sears has 22M sqft currently which means seritage needs ~5M sqft to cover it completely. Sears will not close all stores even in bankruptcy and so my guess is another 1 year of development i.e 3M sqft. which should generate about 50M if rental income. so that will take 1 year and that should be 200M-300M at max to tide over if that. (construction opex etc)

Ultimate NOI potential is hard to say. these are just 3 properties out of the 230 total. My guess is even 10% for mixed use would be a big deal.

icing on the cake.

[bluescorpion0]

That's why it would be great if they had 2019 or 2020 leap options on this stock, alas december of this year is all you're going to get.

[Steve Ess]

Does Warren Buffett still owns SRG shares? I am pretty sure he did a couple of years ago in the high 30's.

I think it was his personal account, not Berkshire, this is the only reason I look at this.

[Trapping Value]

I think he does from what I remember. This may still work out for people, just don't see the reward as particularly enticing for so much risk.

[Bill Stoller]

Steve, as I recall Mr. Buffett's basis is in the mid-to-high $20s per share. He can afford to wait.

SPG, MAC, GGP all got shares ~$28, as part of JV deal with Seritage, as I recall SPG sold out last year.

ESL owns the largest chunk of Seritage, and he isn't going to kill the upside potential, in my view.

[User 4405691]

" mid-to-high $20s per share. "
care to explain that ?

SRG has never seen mid $20's ...........$38 Plus is magic number

[Steve Ess]

<< If you annualize the Q4-2017 adjusted EBITDA of $27 million >>

Why? There was a loss of 16.5M on a joint venture sale.

Isn't that more of a one time item?

[Trapping Value]

Steve,
Adjusted EBITDA adds the loss back, see figure 1.

[RoseNose]

I always thought this one to be a strange REIT.
SRG perhaps has only one goal -which might include the harvest of land assets and build better buildings or house better tenants within the communities.
It is one to watch...at least for me.
Thank you for your ideas-
Best :)) Rose.

[Trapping Value]

Thanks Rose.
This one baffles all, including the analysts who don't see why this is trading so high over NAV while every other REIT is below it.

[PennyPlanSupporter]

Back up the truck on the preferred shares and wait to buy SRG debt hand over fist when issued.

Inflation is coming on strong.

[Trapping Value]

Preferred's would be safer for sure and the yield is good.
Good luck.

[Stock Market Mike]

I like WPG more than SRG. They also have questionable quality assets, but they are managing to hold FFO relatively flat as they redevelop and transition, and the valuation is far lower. Debt levels have been dropping - they're closing in on < 6.0x

High leverage doesn't spook me during development - TCO also hovers close to 10x while significant developments are happening - but it does need to back off afterwards, and is something to watch.

-Mike

[Trapping Value]

SMM,
It will be a race to see whether they can get these out in time I think.
I mean if you think all Sears properties can be redeveloped for a big jump, both CBL and WPG at 2.5X and 4.5X AFFO pay you to take the risk while SRG at 40X is pricing a lot of goodness.

[Adam Levine-Weinberg CFA]

WPG is a much different animal, IMO. For one thing, it has about 10% of its rental income on expiring leases in each of the next several years. The trend has been big declines in lease rates on renewals -- or tenants simply closing up shop. That could lead to pretty rapid erosion of FFO, particularly in a downturn. SRG already has enough signed/not opened leases to drive substantial FFO growth by 2020 if SHLD shrinks slowly, or offset much of the lost income if SHLD accelerates lease terminations.

I would characterize SRG's real estate as running the gamut from junk to extremely high quality. WPG has a lot of junk without the benefit of the really top-notch properties that SRG has.

[Trapping Value]

Adam,
That is where I strongly disagree. SRG's portfolio is above average but nothing like what the bulls make it out to be. The $17/rents should be a nice clue on that front. For comparison, WPG has an average $23 rent on its malls per sq ft. Also, look at their signed on tenant list, hardly awe inspiring.
Even Bruce Berkowitz pretty much said SHLD properties are identical to SRG properties overall.
But valuation has never mattered to this stock, so it might even go to $100 if SHLD goes under.

[frommi]

I don`t know but have you looked at the tables with current redevelopments in the latest press release? Most of the buildungs have just been completed or are completed in 2018 or 2019.
I think the current EBITDA and FFO numbers are just garbage and not something to base a valuation on. There is much too much going on with the redevelopments right now to make these numbers matter.

[Trapping Value]

I have looked and that is certainly possible. My concern stems from the fact that they have completed substantial developments and Sears revenue is sub 50%, and yet the numbers don't look too good.

[Adam Levine-Weinberg CFA]

I agree that there wasn't much in the Q4 report to change anyone's opinion of Seritage.

However, I don't agree with your characterization that SRG has completed "substantial developments". Of the redevelopments budgeted at $20 million-plus, SRG has only completed 1 out of 15 at this point. In the $10 million-$20 million bucket, it has completed 4 out of 24. By and large, the redevelopments that have been completed are smaller projects that naturally bring in less incremental revenue.

Over the course of 2017, annualized rent from SHLD fell by more than $45 million. Meanwhile, rent from in-place 3rd party leases rose by a little over $6 million. So obviously, the current financials look bad. But the SNO leases rose by more than $22 million.

Bottom line: SRG lost more than 30% of its rent from SHLD and signed leases during the year to make up more than 60% of that amount. That doesn't seem like a bad showing to me. And to the best of my knowledge, Seritage hasn't even begun leasing for the three premier properties it just started to redevelop (Santa Monica, Aventura, and San Diego).

If I had to guess, I would say that there will be sequential improvement in FFO during the first half of 2018. That sequential growth could slow or even potentially reverse in the back half of the year, depending on recapture/termination activity by SRG and SHLD. But many of the best properties aren't going to be ready until very late in 2019, so I don't think it's reasonable to expect sustained improvement in the financials until 2020.

[Trapping Value]

Hey Adam,
I think where I really differ from the bulls is how i view the portfolio, i see it as above average but not superlative and the FFO multiple/NAV value, which is superlative.
Timing matters here as an accelerated SHLD bankruptcy timeline will force SRG to sell its best properties or raise capital at unattractive prices.