Kimco: Models Show This Undervalued REIT Is A Long-Term Buy

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About: Kimco Realty Corporation (KIM), Includes: AMC, AVB, COST, DCF, EQR, FCF, FF, LOW, O, RAD, SFM, TGT, X
by: Harrison Caplan
Summary

Kimco's deleveraging is opening up new growth avenues.

The redevelopment projects are resulting in positive returns that can be sustained, leading to long-term dividend growth.

Discounted FFO and Dividend Discount models point to an undervalued REIT that deserves long-term holding.

Kimco is a Buy at current prices.

Long-term ownership and dividend growth will certainly reward investors who wait.

Introduction

Hello all, typically I would start out with some fancy introduction discussing a macroeconomic trend and building suspense in an effort to schmooze you. For this piece, I am just going to keep it simple because, frankly, this article doesn't need it.

To summarize, this piece will go in-depth on Kimco Realty (KIM), utilizing a few valuation methods such as Discounted FFO model and Supernormal Dividend Discount model. This exercise would also project future dividends payments. Furthermore, I will address the under-appreciated growth endeavors the firm is taking that will surely create additional shareholder value over time.

Kimco is a shopping center REIT that owns 437 open-air shopping centers with a total of 78 million square feet of leasable space. The company has set its priority on owning properties in the top metropolitan cities in the country.

Balance Sheet

Just to be blunt, Kimco (KIM) does have a strong balance sheet, and I do not expect you to take that at face value. Let me show you how they do. First off, the old Kimco had accumulated a lot of debt as you can see below. The company realized that leverage was an issue and started shedding what they considered were non-core assets. Assets in the "non-core" category were either in areas that the company felt were not in their long-term views or subpar rent growth opportunities or unfavorable demographics, the list continues. Naturally, these dispositions gradually decreased long-term debt, while simultaneously strengthening their portfolio. Subsequently, KIM's debt only stands at 45.17% of their assets, according to YCharts.

Chart KIM Total Long Term Debt (Quarterly) data by YCharts

Management's stressing of debt-reduction can be taken to heart as this year the company has been very active. For example, YTD through Q3 of 2018, the company paid off ~$215M of mortgage debt with an average rate of 4.1%. Then on August 23rd, it was announced that the company was redeeming $300M of their 6.875% Senior Notes that were due in October 2019. Such a measure reduced their interest by $20.625M on a yearly basis or about $5.16M per quarter.

To add on to the topic of interest expense, an often-overlooked result of the dispositions was the decrease in quarterly interest expense, which has been a way that management has shored up some of their costs. In Q1 of 2016, the company was paying nearly $57 million a quarter in interest on that debt, which has dwindled down to $44 million in the latest quarter. The effects of this reduction have been felt like the capital that would have otherwise been allocated in the budgets for interest can be put to work elsewhere like their redevelopment program. More on the redevelopments coming up.

Chart KIM Total Interest Expense (Quarterly) data by YCharts

With these debt reduction measures are logically ensued with a reduction in leverage ratios, meaning they are more favorable. As it stands now, Kimco has a favorable maturity profile with debt on average maturing in 10.7 years. As it stands now, the company has a $2.25B unsecured line of credit (see how much is left on it) that is there as a cushion for the company should something unforeseen event arise. Furthermore, the company boasts strong credit metrics that have been awarded due to the management's strategical and financial execution of their master plan. Kimco currently has a Net Debt + Preferred-to-EBITDA ratio of around 7.07x.

Kimco Ratio Excel; Data via Presentation/Financials

This improved figure has the company on the doorstep of a rating upgrade from Moody's, who affirmed their rating and outlook for the company October. Moody's outlined that in order to receive an upgrade, the agency wants to see their Net Debt + Preferred to EBITDA approach 5.5x, a Fixed Charge Ratio of around 4.0x and an unencumbered asset pool in the realm of 90%. To put that into perspective, Kimco has a Fixed Charge Coverage ratio of 3.2x, and a 75% unencumbered asset pool. These metrics are have grown stronger as the company tightens down on their debt, which I expect to continue.

In addition to all that, Kimco's debt profile is very favorable due to their long maturity durations and rates. The company has no debt maturing until 2020, on a consolidated basis, of which the amount only makes up a meager 2% of their debt. To top that, KIM has an average fixed rate of 3.62% and an average floating rate of 3.25%. Both of these rates are incredibly low, even with the rates where they are. However, as I see it, the less debt you have, the less you have, the less you have to worry about. With this fantastic schedule, I am optimistic based on recent developments that the company will strategically to continue to pre-pay debt when it sees fit compared to alternative financial opportunities.

Kimco Debt Maturity Schedule Kimco Investor Presentation

Overall, one can be impressed by the way that management at Kimco has prioritized their financial position by executing their strategy to reduce debt and improve leverage ratios in an effort to optimize their long-term growth potential. Lastly, such measures also prove to investors that the company is limiting any doubt that their intentions of long-term dividend growth are fake. It tells investors that, the company will continue to have the financial capability and flexibility to sustain and grow their dividend.

Strong Operations?

The key to any company's success is their operations. If operations are running well then the rest can be managed, most of the time. Kimco has a resilient that has only gotten stronger as of recent, which will be elaborated more coming up. However, when it comes to growing FFO per share, the standard metric that shows the profitability strength for REITs, there is no doubt that KIM has struggled to consistently grow it over the past few years. On the flip side, the key underlying component besides share count, Funds From Operation (FFO), has grown consistently in the low to mid-single digits since 2011.

Kimco FFO per Share Excel; Data via Financials

Above, you can see the struggle to which KIM has had trying to grow FFO per share. The last three years have been rougher as the e-commerce trend started to take a toll and the company began executing their master plan. KIM has guided for FFO per share of between $1.45 - $1.47, giving us a midpoint of $1.46. On that premise, we would see a decline in FFO per share of 5.81%. As you will see later on, I do in fact see the company being able to get back on track and return to growth as redevelopments and developments start to kick in starting in 2019 adding to FFO which should outweigh any drastic increase in shares outstanding.

The failure to grow the company's FFO per share closer to the rate of FFO growth can be attributed to the rise in shares outstanding, as you can see below. Since 2011, Kimco's weighted average shares outstanding on a diluted basis has risen 3.84%. The trend of rising share counts has buckled as improvements in Kimco's Balance Sheet has yielded the company the opportunity to repurchase stock. During the first 9 months of 2018, Kimco repurchased 5.1M shares for a total of $75.1M spent. That is not the only good part about it. The average cost basis per share bought back was only $14.72, according to their latest 10-Q (pg. 21). I will say that Kimco did a fantastic job of unintentionally timing the market you might say. With the $75.1M spent thus far, Kimco has a remaining $224.9 in their two year Share Repurchase Program.

Kimco Shares Outstanding

Excel; Data via Financials

Although share count has risen, the underlying principle that really speaks on the strength of the business is Kimco's FFO. As you can see, Kimco has steadily grown this important metric even as growth rates have decelerated due to their pivoting. The company has forecasted FFO between $613 - $621M, giving us a midpoint of $617M. FFO at the midpoint would portray a -4.22% drop in FFO for FY2018 compared to FY2017. By the looks of this, the drop in FFO is a short-term hiccup as the company continues executing their strategy... which is working well. Over the long-term, Kimco has shown their operational prowess to continually grow FFO and I foresee no change to that happening in the long-term.

Kimco FFO Excel; Data via financials

I am not worried about the drop in FFO as the company gets further entrenched and closer to the finished product of their plan. Several Redevelopments and Developments are coming online this year which are located in high-traffic areas with favorable demographics and are pre-leased to strong tenants like Costco (COST), AMC (AMC), Lowe's (LOW), Target (TGT), Sprouts (SFM), among others. These projects will definitely add a needed boost to the company's top-line while trickling down to FFO as well.

The company may have had some trouble keeping growth rates intact, however, their ability to still grow FFO through all the focus on the projects is a big deal. As these projects come online you will start to see some nice growth in the FFO which should trickle down to the per share data. The projects are set to come on-line in the next few years, boosting revenue and FFO figures for the medium-term and long-term as annual rent escalators kick in.

Before moving on, I would like to address Kimco's ownership in privately held grocer giant, Albertsons. Kimco's stake in Albertsons is 9.74%, which in dollars is about $140.2M. It is known that Albertsons attempted to go public through the attempted, then failed merger with Riteaid (RAD). Yes, I know what your thinking, Riteaid just cannot catch a break with all these failed attempted mergers. It's widely known that the company backed by Cerberus Capital Management, has its eyes set on eventually going public, but when is the real question.

Growth Through Redevelopments

As I said earlier that we would get to their growth ambitions and strategy... it's time. The company has decided to keep their growth organic via redeveloping properties that were outdated or by developing empty land under their flagship. To add to that, the disposition of non-core properties provides an avenue of growth as proceeds are recycled back into other projects. The company boasts a 9.9% blended ROI thus far on their 72 completed projects.

Furthermore, with these redevelopments/developments, the company is pivoting into a new type of real estate, apartments. The entrance into this industry is one that I am quite fond of. It not only would diversify them away from retail, but also help them build another stream of cash flow. As an investor in the company, the thought of owning apartments is very appealing, especially in the manner at which it's being done and where said apartments are being constructed.

Source: Kimco Investor PresentationKimco sees an opportunity to build at least 6,000 residential units. This figure may not be significant compared to the 85,000 units owned by Avalon Bay (AVB) or the 79,000 units owned by Equity Residential (EQR), however, it is a stepping stone for the company that shall help to boost Kimco's top-line and FFO numbers in the years to come.

With Kimco's strategy of owning properties in top MSA's, the company is able to bank off the better demographics of the area. To put that into dollar signs, it means the company is able to charge higher rents in those areas. For example, the company owns the Pentagon Centre, which is right across the street from Amazon's new HQ's. Kimco's Phase I of the Pentagon Centre's redevelopment is set to be completed this year, where the finished product will a contain a lavish 25 story tower totaling 440 units. The Phase I also means the construction of another 10 story building containing a subsequent 253 residential units, bringing the total to 693 units. The entrance of Amazon will only boost the possible rents in the area, especially when its located directly across the street. It's logic that rents and home prices will increase as the same this happened in Seattle. Below is the document of the details of the project from the architect and planner of the project, WDG.

pentagon-centre-.pdf

Additionally, Kimco's Lincoln Square property, in Philadelphia, is set to be completed this year and will encompass 322 units. The apartments are located above the retail space. To add on, this building is located in a nicer area of Philly where the company will be able to charge juicy rates for their conveniently located and lavish apartments.

Source: Kimco Investor Presentation

If you look at the graphic below, you may notice where the company sees future opportunities to either add office space, hotel space, or residential space. What should catch your eye are the locations of said projects. The projects are located in regions of higher income and favorable demographics, which are directly in-line with the management's vision for the company. To someone who is long-term oriented like me, this should be a very exciting development for the company as they discover new channels to generate rental income and FFO. My readers know how I feel about millennials and I do not affiliate with them, however, the entrance into an industry, like residential, that is doing well and will continue as sadly my fellow millennials are not interested in or financially capable (generally speaking) to take out mortgages.

Valuing Kimco

Now that we are at the valuing portion of the piece, I will present you with a few ways that one may seem fit to value the company. The methods I will present are Discounted FFO model, Non-Constant Dividend Discount model, and the simple Net Asset Value. The purpose is to present a well-rounded view of the different outcomes and how they vary based on the model. As I go through each segment, I will explain to you the method and how it works. Not all readers understand these methods, thus I would like to take some time and help them out via explaining and providing links to where they can learn more.

#1 Discounted FFO

First up is the Discounted FFO mode and to start I will elaborate briefly on the model. The model is based on the Discounted Cash Flow model (DCF), which I am replacing typically used Free Cash Flow (FCF) with Funds from Operation (FFO). The idea here is to predict what future values are and then discounting those figures back to current values. You discount the figures back to present times by using what's called a Discount Date which can be a number of things. Often times the Discount Rate is a company's Weighted Average Cost of Capital or WACC. In the end, you sum up the discounted values, including the terminal value to give you the enterprise value, which then you subtract the amount of debt and add back cash to achieve a FV. Finally, you divide that by the number of shares to receive the FV per share or its intrinsic value... according to your projections.

My model is based on 6-year projections excluding the terminal value that also incorporates Cash and Debt into the equation. The dependent variable [outcome] is the Annual FFO. The independent variable, the one I am manipulating, is the Delta or the change YoY. Before I get to the numbers I used for the growth rates and how I got to them, let me talk about the Discount Rate. For the Discount Rate, I used the company's WACC according to Gurufocus.

Kimco Discounted FFO Excel; Data via Gurufocus, Financials

Ok, let us get into it. For Yr. 0, I used the midpoint of the guidance for FY2018. For Yr. 1, the 3.10% is based on trends and should be a nice bounce-back after a negative rate this year, given that the above projects come online and help buoy that year's number. Next, Yr. 2's -4% growth rate is based on the assumption of the beginning of a recession. With that economic situation comes some rough times. Yet the quality and strength of the portfolio due to location, demographics, and anchors shall help to hemorrhage the bleeding. Their concentration of 76% ABR on grocers is a lot but no matter what people must eat. Furthermore, their strong base of omnichannel and service-oriented clients is a plus as well. As for Yr. 3, the -3% growth comes as the second year of the recession is in full swing. Just as for Yr. 2, the same reasons for the hemorrhaging are still in place. In addition, more projects that were under development and redevelopment are coming online, helping to counteract the effects of the recession as well. Yr. 2 also was buoyed with a couple of new properties.

At Yr. 4, I proposed a 3.75% growth rate as I am trying to give some conservative estimates. The 3.75% is reasonable in my opinion as all the work and dispositions that have happened over the past while are putting the company in a highly competitive position. I think a rate like that is suitable for a company coming out of a recession as we get spending and begin out next economic expansion. For Yr. 5 the growth rate of 3.50% seems appropriate as the effects from the new projects might fade slightly, however, the growth from the expansion should be a boon, hence these numbers are more on the conservative side of the spectrum. Growth could easily be more than 4% for all the years following the recession. For the last year prior to the terminal value, I further decrease the growth rate more as we approach the terminal value. Again this could easily be above 4% due to the deep pipeline of projects of developing land, this should be a boon for their growth. Also before I forget, in post-recession numbers, by then Kimco should start to feel some healthier numbers thanks to properties located near Amazon's new HQ in Crystal City. Lastly, for the terminal value, I intended to use a very conservative number so I felt as if the 2.3% was adequate as it is a low target to hit making it on the more conservative end of the spectrum. When all is said and done, accounting for Cash and debt, you get a FV per share of $19.94.

#2 Supernormal Dividend Discount Model

For my next trick, I will use to Supernormal Dividend Discount model to value Kimco. Just like before, I will provide some background on the method being used.

The Supernormal Dividend Discount Model is an approach to value a stock by predicting future dividend growth and discounting those back to present value or P0. This specific model achieves this through splitting dividend growth into two periods: a period of higher growth, and constant growth. By applying this method, an investor is able to account for a company's period of higher growth before maturing to a stage where the growth of earnings or FFO is not what it use to be, thus the company would not be able to sustain that higher growth so it would turn to an indefinite growth rate.

As you can see, there are a lot of numbers so to help you out, I have color-coded the model. Starting out on the far left of the model are the dividends and growth rates from 2011 to present. On the far right, I forecasted Kimco's dividend growth rates for the next 6 yrs. excluding a terminal figure (indefinite growth rate). For the indefinite rate, I applied a 2.0% rate as I feel that is justified, yet a conservative estimate for long-term dividend growth that is an achievable target for the company to hit based on Kimco's operational strength through the above-mentioned growth avenues. Turning to the Required Return, I applied 9% based on the fact that KIM's dividend yield is 7.45%, thus that last 2.55% would be price appreciation which does not equate to very much, a more conservative figure.

For the first 6 years of dividend growth, the forecasted growth rates have real meaning behind them. What I did was I graphed the last 5 years of dividends and their growth rates. I applied a power-based trendline to the graph placed on the growth rate. When you take that equation, representing the growth rates, of y=-0.022ln(X)+0.0764 and you plug in the numbers 6,7,8,9,10, and 11 into it you receive those percentages on the far right. You plug in the numbers starting with 6 because I charted the previous five years of dividends thus D0 would be Yr. 5, making D1 Yr.6 and so on.

Kimco Dividend Discount Model Excel; Data via Financials

Once you have found all the dividends, including D7, you take D7 which is the terminal growth and find the price of the stock for the year-earlier P6. Once P6is found, you take that number and D1- D6 and divide [discount] them by (1+R)t [Required Return] all back to P0. People often screw this last part up about how to discount P6, you do so by 6 because it is not D7 anymore. After you sum all those discounted figures together you are left with your price, which was $17.31.

Income Investor's Dream

Well folks, we are now at an income investor's favorite topic: dividends. Currently, the company pays a quarterly dividend of $0.28, totaling $1.12/year. In the previous segment, I portrayed how the company has grown dividends since 2011. Over the past three years, the company has raised their dividend on average 5.56%.

In Excel, I have created my own Dividend Compounding spreadsheet. I plugged in the growth rates of dividends that I had forecasted in the previous segment and starting out with 100 shares with a cost basis of $14.92, and keeping all else equal overtime for 30 years. For a long-term investor, you love the concept of DRIP as it truly is the eighth wonder of the world. On that note, I have this gift for you.

Excel: Data via Financials

Based on that I was able to compile the information to generate this chart of how an original 100 share investment in Kimco will grow over time if left in DRIP. Keep in mind that a major limitation of this calculation is that the price at which dividends are reinvested at is $14.92. The chart is in intervals of quarters not yearly, so by the end of that 30 years, you would be collecting $1,298.82 in dividends per quarter and have a total of 2,482.53 shares. It is undoubtedly noticeable that long-term investing will reap substantial rewards when investing in the right company, and believe that Kimco will certainly withstand the test of time as they have for 60 years now.

Conclusion

For long-term investors looking for a stock with good income, dividend growth, and outstanding growth endeavors, you cannot go wrong with Kimco Realty. I have owned it since last summer and have the puppy in DRIP. When I look at the company now and the changes management is implementing and executing on, in addition to their projects, I know 30 years from now that my value in Kimco will be significantly higher than I started out with as will yours. At current prices, I certainly find value in the shares of this phenomenal REIT. Kimco's interest in entering the apartment industry is certainly a positive one that is sure to bring substantial shareholder value as time goes on.

Disclosure: I am/we are long KIM. 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.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.