CBL & Associates Properties: Yikes - I Am Buying What The Good Analysts Are Selling

| About: CBL & (CBL)


Brad Thomas, Ian Bezek and Colorado Wealth have all come out with articles, critical of an investment in CBL & Associates Properties to varying degrees.

Simultaneously, I have been buying CBL, having added 25% to my portfolio earlier in this week, even as it "goes against" the advice of authors I respect.

The difference appears to be (to varying degrees) their emphasis on the dividend while I am focused on the cash flow and price-to-book value as key drivers of investment success.

One of the difficulties of being a value investor is inevitably going against the grain of mainstream investment advice; if you are not doing this, you are likely not a value investor in the first place.

The Seeking Alpha community is blessed with many excellent authors, with Brad Thomas, Ian Bezek and Colorado Wealth numbered among them. Indeed, I follow all of these authors to know what they are doing and their state of mind at any given time. Thus, I happened to notice that all of them wrote articles critical, to varying degrees, of CBL & Associates Properties (CBL) as an investment, contemporaneous to my adding 25% to my current CBL position (with plans to add more as I pull in more cash from income investments in my account). Having read their articles closely, some of those items justifying their more negative views discussed in their articles actually are key elements of my thesis to buy, as we will discuss. Sometimes, it depends upon your point of view.

Mr. Thomas, one of the most (if not the most) prominent analysts and commentators in real estate, has been consistent in being negative on this name and has not wavered in expressing his concern about CBL (and WPG). He gets high marks from me for a very consistent, disciplined approach, even if it's just not my approach. In a recent article "Holy Cow, My Local Sears Store is Closing", he made this comment in wrapping up:

"To be perfectly clear, I consider WPG and CBL highly speculative, and these Sears closures validate the fact they are dangerous stocks to own. I will continue to pound the table about their "sucker yield" status regardless of their "cheapness". The fundamentals are continuing to deteriorate, as viewed below (the emboldened comments are Mr. Thomas' emphasis):

A screenshot of a cell phone Description generated with very high confidence

(Quote and table from Seeking Alpha article by Mr. Brad Thomas, "Holy Cow, My Local Sears Store is Closing")

Earlier, he had offered a view within that same article:

"The real question, however, boils down to whether or not CBL and WPG have adequate capital to redevelop and pay out dividends. The game is all about balancing the rental income (or NOI) with operating expenses, capital expenditures, and dividends."

I could not agree more. This is indeed the quandary that some of the more financially pressed mall REITs will face and why Mr. Thomas expresses a concern about the "sucker yield" about which we will discuss later. Even as I agree about the "sucker yield" being too high, we arrive at two very different places around an investment of CBL based upon that discussion.

Mr. Bezek, making his view clear in the title of his recent article, "Why I Sold CBL & Associates on Thursday" (two days before I bought my additional 25%), is generally discouraged by the retail scene, stated that he was not expecting a turnaround, was concerned about rampant bankruptcies of tenants in the less positively viewed names including CBL and was concerned about a previous cut to the dividend (and I inferred also worried about the next dividend cut).

Colorado Wealth wrote recently "Retiring with Higher Yields", which I read because it was written by Colorado Wealth (hereafter CW) and I would love to retire with higher yields, but I was not necessarily looking for yet other commentary on CBL. However, nowhere to run and nowhere to hide, as commentary on CBL was included here, too. In this article, CW focuses potential investors on FFO multiples rather than strictly on dividend yields, a very thoughtful, useful approach and one that will also incorporate into this article. He points out, and we will return to this point, that CBL has the lowest FFO multiple of Mall REITs, to which he ascribes the following causes:

a. Excessive leverage, increasing interest costs,

b. Declining NOI from their properties, and

c. Requirement for an enormous amount of cash flow for redeveloping properties.

Parenthetically, I will say that, while I am not taking CW's advice on the name to sell it (I am buying it), I am not buying it in my retirement income fund, so I am taking his advice in part to keep it out of risk-sensitive funds. I appreciate CW's advice very much and was one of the first authors that I followed as I joined the SA community.

All three of these articles were excellent articles and I don't disagree with the facts offered (with a couple of exceptions). However, looking at what is presented in a different way may lead to a different conclusion and, in my case, it did. I have a couple of viewpoints, perhaps different than other financially driven investors, which may cause a difference in investing approach:

  • I view any equity purchase as buying a fractional part of a business, so I want to maximize the income back on each $1 that I invest. This is not simply a general aspiration but a financial metric that I use against earnings and cash flow to determine the relative attractiveness of any investment.
  • I do not view the dividend yield as a fundamental aspect of any investment. Dividends are one method, but only one, for the board to distribute the wealth that is created by the business; however, other approaches can include investment in existing assets to improve performance, purchase of new assets to grow income, repurchase of shares to shrink the share count (dividing existing assets by fewer shares to increase asset value) or deleveraging. Which is best? It depends upon the circumstances, and any one of these approaches can be good answers or bad choices.
  • The ability of any corporate board to do any of these things are critically dependent upon cash flow of the entity, not how the distribution takes place. The operational cash flow is the fundamental aspect that enables the ability to do any of these; therefore, my measure of the ability of any entity to create wealth for me is through measuring cash flow as well as how much cash flow am I buying with my investment. How that wealth is funneled back to me is a separate and subordinate question. As such, the obsession with dividends and whether they will be sustained, reduced or eliminated is significantly less important to me than the capacity of any entity to create wealth through cash flow, and we can argue about how to distribute it later.

How Does CBL Compare to SPG?

Simon Property Group (SPG) is arguably the industry darling of mall REITS. Everyone loves them. Why not? They are arguably the best-run Mall REIT, respected by a majority of market participants, including me. I do not buy SPG because of how it is managed as it is superbly managed; rather, I avoid SPG (and many other REITS as well as other equities) because I believe them to be massively overvalued.

There are a very few securities that I don't believe are overvalued, CBL being one of them. So let's compare the CBL with the best in the business (SPG) by comparing the assets owned by each as well as what one buys for each $1 of investment in each:

Compare Balance Sheets The first thing that jumps out of this table is that CBL is actually less levered than SPG. Strictly speaking, CW's claim that CBL is more levered is not correct. However, I understand that CW meant to include the preferred shares in the "leverage" category (which I do not) nor was he necessarily comparing CBL to SPG but to mall REITs more broadly, for which many (like FRT) are indeed less levered than CBL.

Even including the preferred shares, CBL would be only slightly more levered than SPG, again the gold standard of the mall REIT universe. Would l like to see CBL delever a bit? Yes, but I don't consider them to be dangerously overlevered and they can use some of their cash flow over the intermediate future to accomplish this in a measured manner.

While some analysts consider preferred shares as "the equivalent of debt", I do not. I do understand the position of some common shareholders having a view that preferreds look like debt as both the preferreds and debt are senior to the common.

However, preferred shares have other attributes that make them different from debt. While the preferred shares are cumulative, payments on those securities can be suspended (even if cumulative which CBL's preferreds are) while a suspension on interest payments for a debt instrument probably leads to a restructuring process very rapidly, with less margin of error. In addition, REITs need to pay out 90% of their income to maintain their REIT status, so payments to the preferred shares can be used to discharge some of that requirement.

Confirming CW's claim, CBL's interest expense is measurably higher than SPG's, with CBL paying 5.1% annually on its aggregate indebtedness while SPG pays about 3.5% on its aggregate indebtedness (both as measured by total interest expense divided by total non-current liabilities).

At the same time, buyers of CBL at current prices are buying substantially more book assets and real estate than buyers of SPG (eight times more at $0.66 per $1 for CBL and $0.08 per $1 for SPG). This demonstrates the exceptionally high value placed by market participants on Simon's ability to manage their assets, a compliment to SPG management that they are priced so expensively relative to other REITs. This obvious compliment to their management prowess, however, is a compliment that I am unwilling to pay (pardon the pun). I will not pay the very high "comfort" premium to own SPG; rather, I will spend my money purchasing real estate and real assets rather than paying up for reputation.

In the next table, you can also see that one is paying a very high price for SPG earnings as well:

FFO Comp One is buying 30 cents of FFO for each $1 of investment in CBL while one is getting only 7 cents of FFO for each $1 of investment in SPG. CW rightly pointed out that CBL is being valued by the market with the smallest FFO multiple for mall REITs as well as articulating why this is a reasonable valuation. This precipitous decline in market price, due to the concerns cited by CW, has resulted in the so-called "sucker yield" about which Mr. Thomas writes so frequently. Both have expressed concern about the need for CBL to redevelop and questioning whether they can and from what source the money could come from, honestly a concern with which I agree wholeheartedly.

CBL has now had its value so compressed because of a fear of an additional cut (and WPG for fear of a dividend cut as well). But what if they do cut? A dividend is not a fundamental attribute of a security, but rather a board decision and more focus should be put on the cash flow to value the security rather than the dividend paid. In the long run, CBL investors would be better off with some of that dividend being reinvested into specific properties to improve NOI while also leaving some additional cash to trim leverage and interest expense.

I have estimated that CBL probably needs to pay out 30-40 cents per common share (after preferred dividends) to maintain their REIT status based upon their imputed income. Using as a basis that they would retain a 40 cent dividend (still delivering an attractive 7.1% yield, 50% higher than SPG AFTER the cut), this would mean that CBL has about 40 cents per share in upside spending for capex, redevelopment or delevering through repurposing of the higher dividend payment. Forty cents per share on 173M shares yields another $69M in additional capacity beyond the substantial capacity that they have already set aside for these purposes, without resorting to external financing.

Mr. Thomas views the so-called "sucker yield" as a threat to CBL investors or "suckers", pulled in then disappointed when the exceptionally high income evaporates. Indeed, I don't necessarily disagree with his sentiment that the dividend is probably unsustainably high and needs to be reduced to address other issues as we agree on that. What appears to be lost in this conversation is that the money set aside in a dividend cut is not burned nor disappears; as such, I don't view this as a threat but as an opportunity. The money can then be redirected into more effective wealth-creating purposes of reducing leverage or improving existing facilities to make them more competitive (and more profitable in the long run). What the other three analysts view as a threat, I view as an opportunity to provide substantial, additional internal funding without the need for external borrowing to accelerate the recovery process to create a more attractive security over the long-term for which I plan to hold this security.

Finally, as the "threat" of the dividend cut (with other issues as well) is driving down the market price of CBL to very low levels, the "price" of taking advantage of the opportunity of the dividend cut is resulting in pricing of CBL at "fire sale" levels, and I am now taking full advantage of these "fire sales' by adding positions. Mr. Thomas has promised to continue to pound the table about CBL's sucker yield status. I hope he continues to do so as it is resulting in market prices that are very attractive. At some point, however, the focus will move to fundamental measures of financial strength rather than a "red herring" like the dividend yield; at that point, I suspect that these bargains will begin to dissipate and move to higher market prices.

Finally, both CW and Mr. Thomas have discussed deteriorating fundamentals, with CW discussing declining NOI and Mr. Thomas referring to deterioration in Sales per Square Foot (SpSF) based upon the chart provided above and here as he said, "The fundamentals are continuing to deteriorate, as viewed below":

A screenshot of a cell phone Description generated with very high confidence

Actually, this chart does not prove or even illustrate deterioration of a trend; rather, it shows that CBL, as well as the merchants in their facilities, are not yet capable of generating a competitive level of sales per square foot relative to other providers of space. To demonstrate whether there is a deteriorating trend, one would need to look at SpSF over time for CBL, and here it is for the past five years (from Citi 2018 Global Property CEO Conference, presented on March 5th, 2018):

Year: Sales per Square Foot:
2013 $356


2015 $374
2016 $376
2017 $372

I will leave it to the reader to decide whether this can be reasonably called a deteriorating trend and whether this trend should justify the massive discount of CBL versus other retail Malls. I do not and am acting on that view.

Just one more point on SpSF: most securities move in price because they are showing some degree of improvement or deterioration in a key metric. Look back up at the SpSF chart and ask yourself who has the most opportunity for improvement and who is most at risk for a small slip, even an insignificant one, that could result in a significant drop in a very highly priced security (to me very overvalued). This would be but one example of SPG priced for perfection and CBL priced for extinction.

As for NOI, CW is absolutely correct that NOI has declined very recently. Here are the NOIs for CBL over the past five years, as reported in a presentation to the Citi 2018 Global Property CEO Conference on March 5th, 2018:

Year: NOI ($M)
2013 $756
2014 $784
2015 $787
2016 $775
2017 $714

So, NOI dropped significantly in 2017, which was a very difficult year for retail, and I expect it to drop again this year. Yes, you expect a difference of value for CBL, with negative NOI growth over the past couple of years, relative to SPG, which continues to grow NOI. However, does that difference explain the extreme difference in valuation? Does this recent drop justify the massive valuation difference between CBL and other "better" mall REITs? Again, this will be a question left to the reader.

Summary and Conclusions:

So, consistent with my earlier article on comparing CBL with SPG (and FRT at that time) titled "Retail REITs: Would You Rather Buy Overpriced Good News or Discounted Bad News", I am swimming against the tide by buying CBL & Associates Properties while shunning the other retail/mall REITs. I do agree with Colorado Wealth that CBL may not be the right security for a retirement income fund; however, I believe that other REITs are also not right for a retirement fund due to overvaluation, but that is a conversation for another time.

I am buying CBL:

  1. Because the valuation is compelling with the ability to buy Real Estate at bargain prices,
  2. Which is delivering very high FFO earnings per dollar of investment,
  3. Taking into account that the dividend may well be cut (and am even hoping for a dividend cut to fund other redevelopment and deleveraging),
  4. Providing additional cash to upgrade current real estate and help reduce leverage,
  5. With the expectations that such a strategy would pay off in the long run, even as it may well be very unpopular in the short run.

My holding period will be until CBL reaches a high fair value to overvalued status, which can represent weeks, months, years or decades. This is not a trade; rather, it is a long-term investment to take advantage of an evolving view of CBL over a longer time.

Experienced value investors may want to take a second look at CBL. Should you decide to invest, sip don't gulp, buy a bit and see how things develop, don't overcommit and don't be a hero. Investing in deep value or distressed securities is likely to be very "bumpy" and one is likely to see lower values before higher values.

In the long run, however, the valuation will reflect the underlying value of the security rather than the fear of the worst case scenario. "In the short run, the market is a voting machine, but in the long run, it is a weighing machine" says Warren Buffett. I agree, but prior to that point, it can be very bumpy machine, so anyone buying this name should be ready for the turbulence.

Disclaimer: No guarantees or representations are made. The Owl is not a registered investment adviser and does not provide specific investment advice. The information is for informational purposes only. You should always consult an investment adviser.

Disclosure: I am/we are long CBL, CBL.PD.

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.