Pursuing The Elusive Long-Tailed Mall RAT

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Includes: KIM, MAC, O, OHI, PEI, SKT, SPG, TCO, WPG
by: FlowPoint Capital Partners, LP
Summary

The Amazon Effect on retail shopping is real-Kevin Smith’s 1995 classic comedy “Mall Rats” wouldn’t make sense to millennial moviegoers. But some "A" mall operators are successfully managing "Retailmageddon".

Select mall REITs are compelling buys now (SPG, KIM, TCO, MAC).

B and C operators will continue to suffer; further headline risk is expected.

By now it is well known that the shopping mall industry faces a difficult, generational transition. Changing consumer preferences and the Amazon effect are profound. Many malls face existential crises; we even witnessed the launch of two Death-of-the-Mall ETFs earlier this year (EMTY and CLIX), which are long e-tailers and short mall-based retailers. However, some mall operators will not only survive, but actually offer compelling investment opportunities.

In our view, the equity risk/reward is favorable for several top mall REIT operators – our basket of mall-based Real Estate Investment Trusts (“Mall RATs”), and we are investing on a long-term basis for total return in Simon (SPG), Kimco (KIM), Macerich (MAC), Taubman (TCO), and Tanger (SKT). Valuation multiples discount many challenges, and are at the lower end of historic ranges. We see 20% upside even without M&A activity, and downside risk as manageable, based on P/AFFO multiples, yield support and opportunities for operational improvements.

From the fundamental data herein, it is evident the better operators are navigating the transition more successfully than others. Certain “A” mall operators successfully pivoted, and modified long-term strategies. We believe these trends will persist due to stronger management, higher quality assets and deeper financial resources than peers.

The following chart illustrates how top-performers like SPG, MAC and Ralty (O) have been less affected by department store challenges given their exposure to smaller-box tenants, and occupancy rates have risen to mid-90% levels. Given the extensive share price increases in O, we see better current entry points among the Mall RATs, including SPG, KIM and TCO which we’ve purchased recently.

Source: Bloomberg

Meanwhile however, B and C malls are likely to continue to post depressing numbers. Unlike our mall rats, CBL & Assoc. (NYSE:CBL) and Penn RE (PEI) haven’t seen improvements in occupancy rates in years. Long/short strategies have promise.

Source: Bloomberg

Outlet center operator SKT stands out from the group on several fronts. Occupancy is a very high 97%, but SKT is weaker than the group in sales per foot at less than $400 (chart below). Re-leasing spreads have been challenged, and management is pursuing a disciplined strategy of writing shorter leases so they can benefit when rents begin to firm up – not unlike a smart bond fund manager when they hold shorter duration in an adverse tape.

Source: Bloomberg

SKT’s tenant issues are also different in that outlet centers such as theirs are more easily and cheaply converted to new tenants. The company’s management skills, financial resources, low payout ratio and Americans’ long-term interest in bargain-shopping offer attractive long-term total-return potential, and the stock offers a compelling entry point.

The premier mall operator - Simon (SPG) has some of America’s premier mall locations, experienced management and significant financial resources. The company has consistently re-developed vacating properties such as Sears into more productive assets. Re-development in new tenants and densification can produce rents with better economics than traditional anchor tenants.

SPG has exposure to troubled department stores such as the now-bankrupt Sears and its peer JC Penney we consider very manageable, and the company’s plan is well into execution phase. In all, mall “anchor” department stores comprise less than 2% of SPG’s U.S. rental revenue, as most department stores pay only nominal rent to the REITs (rent comes from smaller “inline” stores in the mall adjacent to the anchors). Besides JCP and Sears, the SPG client base is quite healthy. including Macy’s, Nordstrom, Dillard’s, and Dick’s Sporting Goods, which are comping positive.

Top Ten “Anchor Store” Tenants Simon Property Group (NYSE:SPG)

Source: SPG

The Gap, Victoria’s Secret, The Limited, Foot Locker, Abercrombie & Fitch and other healthy, branded retailers comprise the core of SPG diversified rents.

Top Ten Inline Store Tenants - Simon Property Group (SPG)

Source: SPG

Source: Bloomberg

Today’s changes are profound; the vacating big box stores are not bring replaced by other big boxes, which means the landlords have to be creative and wisely deploy capital as they re-invent the space to best use. “Densification” projects see SPG replace an exited department store with multiple, smaller tenants in its place. See table below for examples. We believe SPG is in the middle-innings of department store closures, but early innings of the positive results of densification, including the SPG projects below.

Source: SPG

Redevelopment projects include for example repurposing a closed Sports Authority into a new Dick’s Sporting Goods. The company has earmarked several billion in redevelopment costs the next several years to upgrade facilities. See table below.

Source: SPG

Each of our select holdings among the mall rats have key attributes for success:

  • the three Ls (location^3)
  • strong management and
  • deep financial resources

Current market multiples discount many of the challenges facing the sector, and we like SPG, TCO and SKT here near the lower end of their respective historical valuation ranges. We see downside risk as manageable based on P/AFFO multiples and yield support.

Source: Bloomberg

We expect top tier operators in the space to return to high-teens P/AFFO over the next several years as the pig moves through the python, and growth returns. We also expect yields to tighten as investors receive more signals that these companies are successful in their transition strategies and that this is once again a safe place to harvest dividends.

We still see meaningful downside risk for the B and C operators, which face the risk of more permanent impairments on more poorly positioned assets. With the stocks down considerably, we are not shorting at the moment but will look to capitalize on potential catalysts such as dividend cuts on a more tactical basis.

Source: Bloomberg

This space is ripe for mergers and acquisitions. Opportunities exist to combine portfolios to achieve greater scale, operating leverage and deeper resources to execute the industry’s transition. SPG has enormous resources to execute such a transaction and has made attempts in recent years. Potential sellers should be more motivated now that the landscape has become more challenging. We expect SPG to potentially take a run at either TCO, MAC or SKT. Leveraged buyouts are another potential path that would enable an operator to do what needs to be done to pivot the portfolio for success without worrying about quarterly guidance. We see an LBO as a compelling path for SKT.

M&A is in fact a consistent theme in the space. In recent years SPG acquired Prime Outlets (2010), took a 28.7% stake in Klepierre (OTCPK:KLPEF) in 2012, shed exposure to strip centers and small malls through the spinout of Washington Prime (WPG) in 2014 and attempted to acquire GGP (2010), MAC (2015) and Intu Properties PLC (INTU in London) in 2010. Other acquirers have been active as well: Brookfield (NYSE:BPY) completed the acquisition of GGP in August 2018; Unibail (URW in Netherlands) paid A$21 billion for Westfield in December 2017.

Our Mall Rats offer capital allocation opportunities with a margin of safety. Broadly, high yields on offer but there is a real threat of further dividend cuts. We see dividends as safe in our select group with dividend growth set to improve once the vacancies wind down.

For example, we see upside to $200 for SPG and $28 for SKT, assuming no M&A. Including dividends, and a willingness to add to positions lower should prices decline, we can achieve attractive 20%+ total returns over the next 18-24 months. If M&A occurs we could see additional upside to 30% IRR.

Recent

Target

Total

AFFO

Consensus Dividend Est.

Ticker

Price

Price

Return

2018

2019

Growth

Current

2020

SPG

$163

$200

28%

$12.13

$13.18

9%

$7.80

$7.73

MAC

$41

$55

40%

$3.77

$4.09

9%

$2.99

$3.12

TCO

$44

$60

42%

$3.77

$4.21

12%

$2.62

$2.75

KIM

$15

$18

34%

$1.47

$1.53

4%

$1.13

$1.15

SKT

$20

$28

42%

$2.45

$2.46

1%

$1.39

$1.47

WPG

$5

$5

10%

$1.52

$1.28

-16%

$1.00

$1.00

PEI

$6

N/A

N/A

$1.55

$1.59

3%

$0.84

$0.86

CBL

$2

N/A

N/A

$1.73

$1.56

-10%

$0.63

$0.26

Yield

P/AFFO

Target P/AFFO

Target Yield

Ticker

Current

2020

2018

2019

2018

2019

Current

2020

SPG

4.8%

4.6%

13.4

12.4

16.5

15.2

4.3%

4.3%

MAC

6.8%

7.0%

11.0

10.1

14.6

13.4

5.7%

5.7%

TCO

5.7%

5.9%

11.8

10.5

15.9

14.3

4.6%

4.6%

KIM

7.6%

7.7%

9.9

9.5

12.3

11.8

8.2%

8.2%

SKT

6.7%

7.0%

8.3

8.3

11.4

11.4

3.6%

3.6%

WPG

19.4%

19.1%

3.1

3.7

PEI

12.8%

13.1%

3.7

3.6

CBL

13.7%

11.8%

1.1

1.2

Source: Bloomberg, FlowPoint

Today our basket of Mall Rat holdings includes starter positions in SPG, KIM, TCO, SKT and MAC. Each has upside to valuation, growing dividends and emerging opportunities for margin improvement. Long-term total return upside is attractive and the stocks represent solid replacement candidates for our earlier picks O and Omega Healthcare (OHI) which have now reached full valuations.

Risks to 2019 guidance could be revealed on EPS reports during Q1 2019, and we manage risk carefully around such announcements. We expect the transition in the business to take time; in fact time itself is chief among challenges of contrarian investing. The key is to capture the return while controlling volatility via position sizing, portfolio diversification, short selling and options strategies.

The FlowPoint Financial Advantage strategy follows a disciplined fundamental and thematic long/short strategy based on the creative destruction in the global financial sector. Our value-oriented value positions such as the Mall Rats are currently barbelled with short positions in Canadian and Aussie bank stocks, and long positions in growth stocks throughout the financial sector, primarily payments, exchanges, fintech stocks and Texas-based banks. More on those holdings in the accompanying pieces here.

Disclosure: I am/we are long TCO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We are long TCO, KIM, SKT, MAC, SPG, O and OHI