Kimco Realty Has All The Ingredients Of Something Special

Summary

• I knew my uncle was a savvy investor, but I never imagined that he would teach me the concept of being a patient value investor.
• I know what you’re thinking. where is the "my oh my, Kimco is a strong buy" performance?
• After all, my strong buy picks are supposed to generate impressive 25% annualized returns.
• This idea was discussed in more depth with members of my private investing community, Rhino Real Estate Advisors. Get started today »

Yesterday, I commenced a series of articles aimed to "provide deep-level research on REITs that have the widest moats". In my quest to find the best moat-worthy REITs, I decided to focus on the concept of "competitive advantages" as explained by Heather Brilliant and Elizabeth Collins, co-authors of Why Moats Matter:

"…economic moats generally stem from at least one of five sources of competitive advantage - cost advantage, intangible assets, switching costs, efficient scale, and network effect".

The key to my year-ending research (on wide moat REITs) has two primary purposes: (1) uncover REITs that "can fend off competition and earn high returns on capital", and (2) uncover REITs that are trading at a discount with the potential to compound over times.

Around thirty years ago (in 1988), I found out that I had inherited shares in a blue-chip utility known as Consolidated Edison (ED). Up until I graduated from college, I had no clue that my uncle had gifted 100 shares (with a cost basis of ~$2.00 per share). Now, over 43 years later, the return on investment is over ~$7,500 (~90% annualized price appreciation, excluding dividend reinvestment). (Note: my uncle gifted the shares to me in 1974 when I was in the third grade).

I knew my uncle was a savvy investor, but I never imagined that he would teach me the concept of being a patient value investor. Over the years, I have become increasingly skilled at selecting sound real estate securities, as Benjamin Graham explained (in The Intelligent Investor):

"The security analyst deals with the past, the present, and the future of any given security issue. He describes the business, he summarizes its operating results and financial position, he sets forth its strong and weak points, its possibilities and risks; he estimates future earning power under various assumptions, or as a 'best guess'. He makes elaborate comparisons of various companies, or of the same company at various times. Finally, he expresses an opinion as to the safety of the issue…"

Much like my Uncle (Lee) taught me over thirty years ago, I will commence my second article in the "wide-moat" investing series by focusing on Kimco Realty (NYSE:KIM).

Photo Source

The Business Model

Kimco is a shopping center REIT that owns 450 shopping centers comprised of 78 million sq. ft. of leasable space primarily concentrated in the top major metropolitan markets. The company is headquartered in New Hyde Park, N.Y., and is one of North America's largest publicly-traded owners and operators of open-air shopping centers.

Source: KIM Investor Presentation

In 2018, the company celebrated its 60th year in business, a testament to the successful navigation of various market cycles, including the current cycle that some have referred to as the "retail apocalypse". In the 2018 Annual Report, Kimco's CEO, Conor Flynn, explained:

" ...in a year when the term "retail apocalypse" earned its own Wikipedia page, it's important to note that it is the rapid rate of change occurring today, and not the change itself, that has fooled the media into sounding the alarm.

In reality, this industry is no stranger to transformation. Brick-and-mortar retail has weathered the rise of mail-order catalogs, the birth of the Home Shopping Network and the dawn of the internet.

The retailers that have managed to succeed through these periods of intense transformation share one essential characteristic - adaptability. And now, in an environment where change is taking place faster than ever before, we must all pick up the pace. Among retailers, we've seen several standouts emerge, who have been swift in recognizing and acting on signals of change, and are now reaping the rewards of those efforts."

Source: KIM Investor Presentation

Flynn explained that "within the strategies and operating results of these standout retailers in our portfolio, one unwavering constant becomes clear amid the disruption: There will always be demand for high-quality real estate. These companies are successfully adapting while harnessing the power of the physical store."

Source: KIM Investor Presentation

There is not a single name from Kimco's top ten tenant list when the company went public over 25 years ago that remains on the top ten list today. Over Kimco's 60-year history, the company has seen consumer preferences change and retailers come and go.

And like the retailers that have persevered, Kimco's success, too, has stemmed from its ability to embrace change. Adaptability will continue to be the foundation of Kimco's competitive advantage going forward, as the company positions the portfolio to stand the test of time.

Source: KIM Investor Presentation

There are three key elements of Kimco's business model that will enable the company to thrive amidst rapid change in the years to come: (1) the quality and location of the portfolio, (2) the many sources of untapped value creation embedded in the portfolio, (3) and the strength and security of the balance sheet.

The Quality and Location of Kimco's Portfolio

Kimco is nearing the completion of its 2020 plan (5-year plan). As it refines the plan to adapt to the changing retail landscape, it's clear that the company's efforts are succeeding. Take a look at Kimco's portfolio in 2010 (8 years ago) that included 816 properties scattered across the U.S.

Source: KIM Investor Presentation

Now, as viewed below, Kimco's portfolio consists of 437 properties focused geographically in the top 20 markets in the U.S. Kimco continues with its recycling initiatives, as the company sold (in Q3-18) 10 shopping centers for $154 million (KIM share). Kimco has now sold 49 centers year-to-date with total share proceeds of approximately $722 million, exceeding the bottom end of the guidance range of $700 million to $900 million provided at the beginning of the year.

As such, Kimco raised the low end of the dispositions guidance for a new range of $800 million to $900 million. The blended cap rate through the third quarter remains within the target range of 7.5% to 8%, and KIM anticipates ending the year firmly within set range.

Source: KIM Investor Presentation

Kimco's portfolio generates 80% of ABR (annual base rent) from these major metro markets (76% are coastal and sunbelt markets). Most of these centers are located in coastal markets (represented in the shaded light blue area below). Population growth of 6.3 million is projected in these 20 markets within the next 5 years.

Source: KIM Investor Presentation

Kimco's property-level fundamentals are also improving:

• Pro-rata occupancy was 95.8% in Q3-18 (was 96% in Q2-18) despite the slight impact from the Toys "R" Us vacates. KIM's small shop occupancy has reached an all-time high of 98.8%.
• The company generated new leasing spreads of 12.1% in Q3-18, representing the nineteenth consecutive quarter that the rental rate for new leases over the prior rent for the comparable space increased by more than 10%.
• Pro-rata rental-rate leasing spreads increased 8.9% during Q3-18, with rental rates for new leases up 12.1% and renewals/options up 7.9%.

Source: KIM Investor Presentation

Many Sources of Untapped Value

As illustrated below, Kimco has completed 72 projects with a gross investment of $355.7 million. The company expects to generate an average of 9.9% return on investment.

Source: KIM Investor Presentation

The company has around $800 million of redevelopment projects underway that are expected to generate around $60 million of net operating income (or NOI). Kimco's sites are substantially pre-leased, creating positive leasing momentum for these rare high-quality opportunities, which are poised to deliver on time. The signature series redevelopments are now all over 90% pre-leased and are set to deliver significant growth for KIM in 2019 and beyond.

Source: KIM Investor Presentation

Future mixed-use opportunities include the following:

Source: KIM Investor Presentation

Kimco still owns a 9.74% stake in Albertsons, a private grocer, which planned to go public a few years ago, but given weak industry conditions pulled back its IPO. Due to the failed IPO attempt, Kimco was unable to monetize its initial investment and capital gains from its original 2006 investment and subsequent investments in Albertsons (in 2018, Albertsons tried to merge with publicly traded Rite Aid (RAD), but this failed). We estimate there is around $500 million in "untapped" value associated with Kimco's stake in Albertsons.

The Strength and Security of the Balance Sheet

A strong balance sheet is the foundation that will support Kimco's future growth initiatives, and the company's 2018 efforts have been nothing short of impressive. Its consolidation weighted average debt maturity profile is now 10.7 years, one of the longest in the REIT industry.

Source: KIM Investor Presentation

As you can see, Kimco has no unsecured debt maturing until May of 2021, and only $120 million of mortgage debt maturing during the same time frame. It has over $2 billion available on its unsecured revolving credit facility, which provides a significant liquidity for any opportunistic funding refinements.

Source: KIM Investor Presentation

As you can see, Kimco has all of the ingredients for a credit upgrade that could put the company in the elite A-rated club (like Federal Realty (FRT)). Going forward, Kimco expects debt metrics will continue to improve as NOI growth accelerates.

Source: KIM Investor Presentation

Earnings Power

In Q3-18, Kimco's FFO (funds from operations) was $0.34 per diluted share, which includes a $0.03 per share charge from the early extinguishment of about $300 million, 6.875% bonds and $0.01 per share from transactional income, primarily from gains on land sales.

FFO adjusted, which excludes transactional income and charges and non-operating impairments, was $0.36 per diluted share as compared to $0.38 per diluted share for the same quarter last year.

The decrease is a direct result of Kimco's aggressive disposition program, which resulted in the sale of $922 million of assets during the past 15 months and a corresponding reduction of NOI of approximately $16 million during the quarter.

Source: KIM Investor Presentation

Based on the year-to-date same-site NOI results, Kimco said it was increasing the same-site NOI growth guidance for the full year 2018 from 2% to 2.5% to a new range of 2.3% to 2.7%.

The company also increased the full-year NAREIT FFO per share guidance range from $1.43 to $1.46 per share to a new range of $1.45 to $1.47, and lifted the FFO as adjusted per share guidance range from $1.43 to $1.46 to a new range of $1.44 to $1.46.

Kimco's goal long-term is "to be the best shopping center REIT in the entire sector," and the company believes that in order to do that, it will "have to have same site NOI growth that's really north of 2.5% on a long-term run rate and an FFO growth rate that's in that 4% to 5% or higher."

The CEO said:

"We obviously have our work cut out across '19 where we're committed to make it a growth year. And that's why we have repositioned the portfolio to where we see now we can really run a top quality and top-flight portfolio, going forward."

Source: 2018 Annual Report

On December 28, 2017, Kimco Realty declared $0.28/share quarterly dividend, which was a 3.7% increase from the prior dividend of $0.27/share. Given the modest FFO/share growth in 2018, we suspect that Kimco will grow the dividend modestly, but enough to maintain the 10-year streak (of rising dividends). As you may recall, the company sliced its dividend substantially in 2009, but so did most REITs (all but a dozen REITs cut or suspended their dividend during the "dark days").

Source: FAST Graphs

All The Ingredients Of Something Special

Now it's time for a peer comparison, but first let's take a look at Kimco's forecasted FFO/share growth (data, as per FAST Graphs):

Source: Rhino Real Estate Advisors

As you can see (above), Kimco is forecasted to begin positive FFO/share in 2019 as the company begins to put disposition proceeds to work through acquisitions, redevelopment, and development. Specifically, Dania Pointe's Phase I and II are expected to generate meaningful new income….

Source: KIM Investor Presentation

Also, Kimco's Pentagon Center mixed use tower called the Witmer is now topped off and will begin pre-leasing apartments in 2019. Notably, the mixed-use redevelopment is located diagonally across Amazon's (AMZN) proposed headquarters, and Phase I will be completed just in time to meet the oncoming demand anticipated in Northern Virginia and its neighborhood.

Source: KIM Investor Presentation

Now let's compare Kimco's dividend yield with the industry peers:

Source: Rhino Real Estate Advisors

Now let's compare Kimco's P/FFO multiple with the industry peers (Note: I highlighted FRT and REG in green because they have comparable balance sheets):

Source: Rhino Real Estate Advisors

Keep in mind that Kimco's FFO payout ratio is higher than FRT and REG, but I don't consider it dangerous at all. As referenced above, Kimco has ample cushion with its ongoing development and Albertsons' likely monetization. By 2020 we suspect Kimco's payout ratio could be closer to 72%.

Source: Rhino Real Estate Advisors

Now let's compare Kimco's year-to-date performance (based on total return):

Source: Rhino Real Estate Advisors

Yes, I know what you're thinking... where is the "my oh my, Kimco is a strong buy" performance? After all, my strong buy picks are supposed to generate impressive 25% annualized returns…

Source: FAST Graphs

As I alluded in my previous article, Warren Buffett said, "your premium brand had better be delivering something special, or it's not going to get the business."

The biggest risk for Kimco, in my opinion, has to do with "execution risk". In order for the company to generate impressive returns, it must prove that it can continue to evolve and manage its capital wisely. Since the "2020 plan" was commenced, Kimco has delivered on its promises, which include recycling capital into more productive assets and fortifying its balance sheet.

We are maintaining our STRONG BUY recommendation as we believe the company's continued " focus on high-quality assets in top markets" will pay more than dividends " no matter how the retail landscape may transform over the next 25 years", which "is a clear path to creating additional shareholder value in the years to come".

Source: FAST Graphs

Note: I purchased shares in Kimco for all of my children, hoping that one day they will learn the benefits of being a value investor, as my Uncle Lee taught me decades ago.

Source: Rhino Real Estate Advisors

Author's note: Brad Thomas is a Wall Street writer and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos and be assured that he will do his best to correct any errors if they are overlooked.

Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking.

Disclosure: I am/we are long KIM, ED. 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.