Washington Prime Group: Let The Herd Run Away

Summary

• The current fiscal year features a forecast of declining funds flow from operations.
• This bargain is now priced so that the recovery potential outweighs current risks.
• Secondary malls primarily service the roughly 70% of the country that tier 1 malls cannot service.
• Management has a plan and has reserved for the most likely scenario involving the problem retailers.
• This partnership features a projected $1.46 funds flow from operations.  The funds flow could decrease materially and still offer a bargain to investors.

Mr. Market can get very distracted by short term events. Recently Washington Prime Group (WPG) forecast another year of declining funds from operations. That was good enough for Mr. Market to hit the ignore button and sell whatever remaining position was left. After all, common knowledge included a high risk of a dividend cut and maybe more disappointing guidance in the future. Bargains are typically bargains for a reason. Investors need to decide if that bargain fits their risk portfolio and the time frame needed to adequately recover. Recoveries are often delayed or load up with additional challenges along the way. But if the main story is still intact, then maybe hitting the sell button could cost an investors some big profits.

Washington Prime Group has significant exposure to "B" malls. Mr. Market appears to assume that "B" malls will soon be a thing of the past.

Global Mizuho Investor Conference Presentation, December, 2017

Despite the common wisdom (click on presentation) the second and third tier malls appear to fill a need that the first tier malls cannot fill. More than half of the country does not appear to have the population centers needed for a tier one mall to succeed. To signal the extinction of the only mall that services some of these lower population areas appear to border on irrational panic. Some of these malls are the major attraction to shoppers for miles around. Therefore if these malls can adapt to changing consumer needs, they should be fine in the future.

Global Mizuho Investor Conference Presentation, December, 2017

Despite the presentation above, there are clearly competitors that have below average exposure to the current retail bankruptcy cycle. Those competitors probably deserve a higher current price or higher relatively current value. But Washington Prime offers a fair amount of recovery potential provided the problems do not pile on too quickly. There is every possibility that the worst outcome of this group of challenges will not happen every single time. Mr. Market may not want to hear that right now.

The fact is that companies do not all go bankrupt at the same time. If there is a bankruptcy, then there are plenty of alternatives to an open space as a result of that bankruptcy. Management appears to have reserved for and planned for the most likely scenario. Deviations from that projection are to be expected. As long as those deviations do not "break the bank" then there is really no reason to panic.

Retail stores have gone through this bankruptcy cycle before. This is definitely not the first time. However, for some reason, internet sales scare enough investors to death even though many of the stores shown above now have their own internet division. Retail competition has changed a lot through the years and it will continue to change in the future. But there probably will remain a demand for brick and mortar stores because customers want to see and test some merchandise before they purchase them.

Management projects at least $.37 per unit of funds flow from operations (FFO) in the first quarter. Annualized, that makes the current share price fairly cheap when compared to the annual FFO of at least $1.48. The capital projects appear intact and management appears satisfied with the results of the capital expenditures. Therefore any threat of a distribution cut could be more than made up by the recovery potential as the redevelopment projects complete.

A long term horizon of about 5 years should yield that average investor a far above average return. In case something goes wrong, a basket of similar stocks for diversification is advised. Management claims to have about $600 million in liquidity. That should be more than enough to handle any unforeseen problems. Once the market realizes that management has a good, disciplined handle on problems, this stock will be properly re-valued. It is hard to imagine an investor sustaining a large loss at the current price. The recovery potential far exceeds any near term challenges.

Five years from now the stock should be at least $12 and may reach $20 as the new earnings power from the upgrades is unleashed. Clearly, this year will not be a banner year. But the stock appears to be enough of a bargain that the risk of extra costs, a distribution cut, and delayed recovery appear to be largely priced into the stock. The current distribution is icing on the cake.

Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.

Analyst’s Disclosure: I am/we are long WPG. 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

[1govols]

I've often wondered how many S A authors actually have had responsibility of say a 20 million dollar organization...When Macy’s announced it would close its doors at Beaver Valley Mall for good last year, the department store left behind two floors of real estate in an area that’s expecting growth as a new petrochemical plant moves into the neighborhood.

The empty store was an opportunity for the right tenant. But the new owners won’t be selling shoes, men’s suits and cookware.

Moving and storage company U-Haul bought the space in January for $1.5 million.

The location has been a department store since the mall opened in 1970. Now, the plan is to turn part of the first floor into a U-Haul showroom, with the remaining first-floor space to be leased out.

And the second floor that once held Tommy Hilfiger sweaters and Calvin Klein suits? Soon you’ll be able to store that dining set you don’t know what to do with yet.

The plan is to convert the second floor into self-storage space, according to Bob Bourgeois, president of U-Haul Co. of Pittsburgh.

Reusing vacant storefronts is happening at shopping centers over the country, and Beaver Valley Mall is no exception. In recent years, the all-retail business model has shifted to more of a mixed-use destination. The mall hosts the Beaver County Office on Aging, DCI Career Institute and a CareerLink location. Other malls have welcomed churches, community services, medical centers and escape rooms.

Right now, the 200,000-square-foot space acquired by U-Haul is unmistakable as a former Macy’s.

[Ventureshadow]

You are saying that U-Haul bought 200,000 sq ft space in a mall for $1.50 million, which is $7.50 per square foot. That is the lowest price I've ever heard of for space in a building, by far. Even if they rent it for that for a year that is so cheap I have trouble believing it.

[mattgru]

there are other equally scary high div stocks. i own wpg cbl and
gxocf
cjref
gov
snr
takes AC ideas to their logical Conclusion:
everyone will stay home, but not watch TV, won't need gas as they dont drive to work as they work from home and don't go to malls, but end up in a "home"

[Actionable Conclusion]

Ahh to live in the binary world...

Matt, your only alternative to being in a mall is staying at home?

is this your thesis for staying long mall stocks? Interesting line of reasoning?

[Eprindle]

risk/reward ratio very favorable for wpg....downside 1.5 upside 6-8

[Actionable Conclusion]

Do I get a thank you from anyone for warning to avoid WPG when it was twice the price? Nope, only vapid consternation from WPG shareholders, even tho WPG has fallen from $14 to $7.

PS. There is a dif tween being right and getting it right. In the world of investing, the latter is what counts.

[CincinnatiRick]

Perhaps the problem is that you are resting on your laurels. No matter how "right" one was about another stock or even the same stock a year ago or at a much different price than it sports currently, it is not relevant to the current situation. Mr. Market tends to overshoot in whichever direction he is going. Arguably, buying WPG at 14 was a mistake while passing it over at 7 might be forgoing a nice return.

[Actionable Conclusion]

Arguably buying WPG at $14 was a mistake? How can you argue it was not?

I have no idea where WPG goes from here, but the mall stocks have been trending pretty much as I figured they would. Going forward, malls are going to have a difficult time escalating rents. The pricing power they had in the past has vanished.

Here on this thread I am surrounded by WPG longs, I can sense the ownership bias. It is a tribal group mostly underwater on WPG, and you do not want to hear anything that might portend to even lower prices... human nature.

Here is what you want to look for to confirm the bullish take - you want to look for Moody's raising their credit rating, if they do it twice, I think going forward there is more viability than the bears (me) had predicted. If you do not see any credit raise, then figure that the best case scenario is unlikely. Maybe even 2nd best too.

Just one mans take. I may have it wrong.

PS. As for "resting on my laurels" Just because I am not actively buying this dog... I just bought O at $48, and also WPC. I visit the malls and talk to the security guards, retailers, and kiosk owners to get their perspective. Resting on my laurels? Hot air...

[Long Player]

If you hold for the whole cycle, then buying WPG at $14 may work out. But if you bail because the down cycle is still going, then you are better off waiting for better evidence of a recovery.

I still go back to my John Templeton Example. He bought Ford in the $30 range with a nice dividend at the time. But the downtrend continued, the dividend got cancelled and the stock dropped to $15. He held on for the recovery and still made about 7 times his original investment. It took a few years. Being early is not the problem as being early and getting scared.

[Breeze Block Capital]

This:

"More than half of the country does not appear to have the population centers needed for a tier one mall to succeed. To signal the extinction of the only mall that services some of these lower population areas appear to border on irrational panic. Some of these malls are the major attraction to shoppers for miles around. Therefore if these malls can adapt to changing consumer needs, they should be fine in the future."

...is exactly right.

Great analysis.

[Actionable Conclusion]

Can these malls adapt to the dearth of discretionary spending?

Most of WPG malls serve those not earning high income. A big part of the problem facing retail is that the US discretionary dollar has shrunk tremendously over the last few decades. Rent, healthcare, tuition have all gone up far faster than incomes. Folks have neither the cash nor the desire to shop for apparel like we did in the 20th century.

Malls were also a social and entertainment center, this too has diminished.

Also, the malls are getting old. When they are first built there is an architectural splendor that attracts. The bar keeps getting raised and what was once fancy is now old and stale.

And then online keeps eating more and more of the pie.

The era of extremely low interest rates seems to be coming to an end.

Credit in the industry is often being downgraded.

Add it all up and you have too many headwinds.

This has been the narrative for years. The stark reality. On the other hand you have the mall industry and REIT industry who have been feeding you a different narrative, a much brighter narrative. Don't drink the kool aide.

[Breeze Block Capital]

Malls will once again be relevant gathering places once some of the largely retail-only tenants are replaced and better mixed and better integrated (meaning the geography within the mall itself) w/ food, services and entertainment. This is a bet against people wanting to sit dormant and alone in their internet and "social"-media induced comas. I am drinking the Kool-Aid. Lots of it.

And so is Conforti:

http://bit.ly/2FZYglb

[ckarabin]

The incredibly tight labor market is pushing up incomes again, so I would not be focusing on the dearth of spendable income but instead on what these low end workers will now do with rising incomes. Unemployment claims last week were they lowest ever recorded. Unemployment is under 4% in most MSA's. Income is going to do just fine

[tkent1234]

The writer is correct when he says that many B and C malls operate in secondary markets that are many miles away from major markets and the better malls in those markets. These malls will not all close and many will continue to serve those markets and do well. Let’s look at one such mall owned by WPG in such a market that I picked randomly and may not be representative. Mesa Mall is a 873,467 square foot enclosed mall located in Grand Junction, Colorado. Grand Junction is in western Colorado on Interstate 70 and the metropolitan area has a population of around 150,000. It takes around 4 hours to drive to either Denver or Salt Lake City from Grand Junction. As far as I can tell the Mesa Mall is the only major retail project in the Grand Junction area. WPG owns roughly half of the space with the other half being owned by tenants. The mall is anchored by Cabelas, Target, Sears, JCPenney, and Herberger’s (Sports Authority closed their store in 2016 as part of the liquidation of the company). I am going to guess that Sear’s, Target and JCPenney own their stores. I am going to further guess that WPG owns the Cabelas and Herberger’s stores. The good news is that these anchor stores are open and operating and in 2017 WPG was able to buy the mall from the lender at a large discount to the mortgage loan secured by the property. The bad news is that Sears, JCPenney and Herberger’s are all struggling department stores. Sear’s has closed hundreds of stores and will likely file for bankruptcy protection this year. The situation for JCPenney is not as dire; but, this retailer is also struggling and has also closed dozens of stores. Herberger’s is owned by Bon Ton and Bon Ton filed for bankruptcy protection in February (the Mesa Mall store is not on an initial list of 42 stores to be closed). So, there is at least some risk that Mesa Mall could end up with three empty anchor stores (in addition to the Sports Authority box that appears to remain empty). These stores likely represent a small, if any, portion of the rents at Mesa Mall; but, the original premise of a mall was the idea of having two, three, four or more anchor stores that would attract shoppers. These anchors would pay little to no rent in return for generating traffic. The mall owner would then lease at higher rents smaller spaces located around and between the anchor stores. Shoppers would come to the mall because of the anchors; but, then also shop at the smaller stores. Vacant anchor stores do not attract shoppers. Unless the vacant anchor stores are replaced with new attractive anchor tenants, the small shop tenants begin to suffer and ultimately close. The downward spiral then begins. This is the risk associated with B and C malls in secondary and tertiary markets. WPG has 42 stores with Sears, 38 with JCPenney, and 15 with Bon Ton. I am sure that some of these stores are great stores in great locations that could quickly be replaced with even better anchors; but, many would sit empty forever should they be closed.

[Long Player]

You would be surprised how fast they can fill a Sears store with a fitness center and restaurants (for example). Things are very much changing.

[Breeze Block Capital]

At a probable 2-3x re-leasing multiple.

[Long Player]

Easy. Those old Sears leases were based upon an outdated model that typically netted the mall owner next to nothing.

[Actionable Conclusion]

My strategy for years has been to avoid the malls. Especially the low grade malls like WPG and CBL. One of the fallacies of the mall space is that most malls are grade A or B. What use is a grading system if there are no D or F grades given.

If one is an investor in WPG, consider that many of the malls that are bandied about as "B" malls are in fact in the bottom 30% of the scale. It's just not PC to call these malls out.

Even SPG which is touted as having top tier, some SPG malls should be rated "C" class. So you can imagine where WPG lines up on this farcical grading scale.

As I have been advising for years, avoid the mall space. If you must invest in malls, choose only SPG or TCO, and enter only near multi year lows. For instance I bought TCO a few months ago when it fell under $50. I have a limit order on SPG to start a toe dip at $120. Be a qualtiy and price nazi.

PS. Here we have been in a perfect storm for malls, all time highs on stocks and housing, low gas prices, low unemployment, low interest rates. Malls should be killing it right now, yet they have been getting hammered... why? If they cannot kill it in this environment, how do you figure they will do come the next recession?

[glenart]

You really really need to get out of that New York penthouse more often! Because if you did, you would discover that most of the USA is not a major population center and people actually DO go to their local malls and shop. AND since we are talking about killing it? You know.........You might want to look at the stocks that are killing it. Netflix, Amazon, and a very small host of others BID UP to the nosebleed levels......EXPERIENCED investors will go back to the 1970s and remember another such time and recall the NIFTY FIFTY or recently in the DOTBOMB days........The TECH WRECK......of 2000-2003. The fact is that the market has severely sold off MALL STOCKS to bid up the HIGHER FLYERS.......But if my memory suits me.........The NIFTY FIFTY came down with a massive crash...........And the CISCOS and ORACLES and LUCENTS and so many others lost 75% of their value in the LAST TECH WRECK! Eventually when interest rates rose, the cheap and easy money was gone in a flash.......and the tech darlings all collapsed....

[Actionable Conclusion]

Wow captain obvious ... what an epiphany!

For starters, I live in Santa Monica, a small town that utilizes paragraphs for more optimal reading.

Also, what is with all the large caps? Screaming? Why? Please tell me you are not one of those folks so in tune with Middle America, yet so out of touch that you loaded up on mall REITs... I suppose that explains the screaming caps.

And what is with the plethora of platitudes and vapid outbursts, and dearth of anything relevant? What a laugh, me so out of touch with America, yet so fortunate not to be holding shares in this dog. And you?

[Long Player]

I hate to break it to you but Santa Monica is definitely in a population center. It may be a "small town" but definitely not a typical small town.

[MarionPolk2017]

Both CBL & WPG should survive and provide excellent returns in the long run. At present pricing, CBL appears to be an even greater bargain than WPG.

[Long Player]

Right now, CBL has more exposure to the wrong crowd. That is really the only difference

[tyler.freeborn]

The "wrong crowd"? Meaning the people who live in Minot, ND and Hattiesburg, MS? They need someplace to shop too, and I thought your main point was that you can make money selling hamburger just as you can selling steak.

But, CBL is behind WPG in property quality and lost its investment grade rating. The discount to WPG is probably warranted, but give the deeper pit of despair CBL has fallen into, if management is correct and 2018 is the nadir, it's possible it could end up being the better bargain. So, I own a little of both, more in WPG.

[Long Player]

I meant wrong crowd retailers, not locations

[galicianova]

Please contrast the goodie with cbl