The Macerich Mousetrap

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About: Macerich Company (MAC)
by: Brad Thomas
Summary

Recognizing that capital allocation is the key for retail REITs, we’ve maintained strict discipline with our mall REITs.

Our optimism for high yield has been tempered with REITs that offer low payout ratios and flat-to-positive NOI (net operating income) growth.

We believe that retail has “shelf space” left (pun intended), and the focus for my article today is on this beaten-down name known as Macerich.

Last week, I attended REITweek in New York City, where I met with more than 24 REIT management teams. Over these “fast and furious” three days, I was able to spend valuable time with CEOs and CFOs to discuss their business model and growth strategies.

In particular, I made sure to attend the Macerich (MAC) presentation because I wanted to obtain a better understanding of the so-called “mousetrap” business model. I’ve written on the company before, but it’s been almost two years since then (previous article here), and a lot has changed.

When I began thinking about Macerich’s mousetrap, it became clear that there was plenty of cheese in the trap. The shares now yield 8.5%, and the price has seen a rapid decline – returning 51% since July 2016 (when shares were trading at $89).

To be clear, up until now, Macerich has been a Hold for us, as we opted three years ago, in the early innings, to focus on Simon Property (SPG), Taubman Centers (TCO), and Brookfield Property Partners (BPY). In addition, we’ve maintained a speculative, or “spec,” Buy rating on Pennsylvania REIT (PEI) and, of course, a Strong Buy on the outlier known as Tanger Factory Outlet Centers (SKT).

Recognizing that capital allocation is the key for retail REITs, we’ve maintained strict discipline as it relates to mall REITs. And, our optimism for high yield has been tempered with REITs that offer low payout ratios and flat-to-positive NOI (net operating income) growth.

As I’ve often explained, “There’s absolutely no need to be too cute when it comes to investing.” Our temptation for chasing yield has become much less enthusiastic given the continued stress in retail… thanks to all of those store closures, bankruptcies, and the exponential growth of the almighty Amazon (AMZN).

Nonetheless, we believe that retail has “shelf space” left (pun intended), and the focus for my article today is on this beaten-down name known as Macerich. By the time you finish reading this article, you will know whether or not this S&P 500 participant is a premium brand that can deliver something special…

Because if it doesn’t, as Warren Buffett explains, “it’s not going to get the business.”

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Photo Source

The Macerich Mousetrap

Macerich is one of nine REITs on our coverage spectrum, ranking fourth-worst in performance year to date at -17%. It’s followed by CBL Properties (CBL), which is down 54%, Tanger Factory Outlet Centers, down 18.3%, and Washington Prime (WPG), down 17.9%.

Macerich has a total market capitalization of more than $14 billion, and the company is a leading owner, operator, and developer of dominant A-quality domestic regional malls located in the “last mile” of some of the most densely populated U.S. markets.

As viewed below, it owns 48 trophy properties, located in top U.S. markets:

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Source: MAC Investor Presentation

Macerich began as the MaceRich Real Estate Company in New York in 1964 by Mace Siegel and Richard Cohen. After years of buying and owning shopping centers privately, they went public in 1994 as The Macerich Company. And, in 2006, the company name was rebranded to just plain old Macerich.

In the 1990s, as the retail market began to soar, Macerich announced a number of strategic acquisitions in key markets. This included the purchase of Queens Center in New York City. And, it also reached into markets such as Santa Monica, CA, Modesto, CA, Downey, CA, Los Angeles, Portland, OR, and Lubbock, TX.

In 2002, Macerich added another 14.1 million square feet in Arizona by acquiring premier shopping center-developer Westcor. Just like that, it added a top collection of Arizona malls to its portfolio. Among these were:

  • The iconic Scottsdale Fashion Square
  • Arrowhead Towne Center
  • Chandler Fashion Center in Metropolitan Phoenix
  • FlatIron Crossing in Broomfield, CO.

Leading up to the recession, Macerich scored another round of new acquisitions. There was the Biltmore Fashion Park in Phoenix and Victory Valley Mall in California. And, a number of new deals went down on the East Coast too, such as Tyson's Corner Center, Freehold Raceway Mall, and Danbury Fair Mall.

Like most REITs, Macerich was forced to cut its dividend in 2009. (Tanger was the only mall REIT that actually grew its dividend during that time, whereas Taubman should be mentioned as maintaining it during that period.) As you can see below, though, Macerich cut its payout from an annual $3.20 per share to $2.05 in 2011.

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Source: FAST Graphs

With that said, the company went on the offensive after the last recession and began to introduce outlet concepts in the Niagara Falls and Chicago areas. In 2012, it expanded its New York City footprint with the acquisition of Kings Plaza and Green Acres and also opened the country's second Eataly in Chicago at The Shops at North Bridge. Macerich also announced strategic partnerships with Taubman Centers (Country Club Plaza in Kansas City) and PREIT (The Gallery in the heart of Philadelphia) since then.

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Source: FAST Graphs

Quality Matters

One of the key differentiators for Macerich is that it derives a majority of NOI (net operating income) from market-dominant centers. As viewed below, as of Q1 2019, Macerich sales per square foot (PSF) is $774 vs. $513 for average U.S. malls.

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Source: MAC Investor Presentation

Here’s a breakdown of PSF sales for its mall REIT peers:

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Source: TCO Investor Presentation (June 2018)

As you can see, Macerich’s come second to only Taubman. In addition, it has other key metrics that are impressive, as illustrated below:

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Source: MAC Investor Presentation

Overall, the A-mall REIT’s performance has held up very well in spite of the secular challenges the industry is facing. The positive direction in PSF sales is certainly a positive sign… as Macerich’s portfolio sales ended Q1 2019 at $746 per square foot. This represents an 8.7% increase on a year-over-year basis.

The company’s economic PSF sales (weighted based on NOI) were $869 in Q1-19 – up 8.6% from $800 a year ago. As you can see below, the consistency of these operating metrics validates the strength of the overall portfolio:

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Source: MAC Investor Presentation

The company’s quarter-end occupancy was 94.7%, a 70 basis point (bps) increase vs. a year ago and a 70 bps decline as compared to year-end 2018. This decline is due to store closures from the early 2019 bankruptcies.

Despite these headwinds, occupancy has remained high – increasing 80 bps from 94.6% on Dec. 31, 2013, to 95.4% as of December 31, 2018.

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Source: MAC Investor Presentation

Also, the company’s average rent for the portfolio was $60.74 PSF, up 3.9% from $58.44 in Q1-18. Collectively, these metrics illustrate the strength of Macerich’s “mousetrap,” in which the company owns some of the highest quality retail properties in the U.S.A screenshot of a cell phoneDescription automatically generated

Source: TCO Investor Presentation

Betting on Development

To fund redevelopment, Macerich has raised around $1.8 billion over the past five years, as viewed below:

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Source: MAC Investor Presentation

By recycling lower-quality properties, Macerich has utilized the funds for accretive acquisitions, share repurchases, and the development/redevelopment pipeline.

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Source: MAC Investor Presentation

In January, it closed on a $300 million, 12-year financing for Fashion Outlets of Chicago at a fixed rate of 4.58%. As viewed above, this asset generates sales of more than $800 PSF. And, Macerich was able to pull out roughly $100 million to repay a portion of its revolving line of credit.

On its latest earnings call, the company said it’s “in market to source financing opportunities on the recently developed office and residential components of Tyson's Corner,” which are currently unencumbered. And, if you look at the data-filled image above one more time, you’ll see that the retail component generates PSF sales in excess of $1,000.

Then, if you turn your attention below, you’ll find that Macerich expects to spend roughly $200-300 million per year on development/redevelopment.

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Source: MAC Investor Presentation

At the end of Q1 2019, Macerich said it “had a total of 21 Sears stores broken into three different ownership groups.”

  • Group 1: A 50-50 partnership with Seritage (NYSE:SRG) that includes nine stores with average sales PSF of over $800. These locations represent some of the best-situated Sears parcels in the portfolio.
  • Group 2: Seven Sears (OTCPK:SHLDQ) locations that are owned by Macerich and leased to Sears for a very nominal rent. The company said it's “actively exploring various alternatives" for redeveloping four of those locations and assumes those leases will be rejected in mid-May.
  • Group 3: Five Sears stores (four of those are owned by Seritage and one is owned by Sears).

Out of the 21, Macerich anticipates total spending of “$250 million to $300 million of incremental capital to redevelop the Sears boxes. That could vary depending on the scope of these projects, as well as the underlying ownership structure. The redevelopments are expected to be completed starting in 2020 and run through 2024.”

The Latest Quarter

For Q1-19, Macerich’s same-center growth in NOI was 1.7% and funds from operations (FFO) per share was $0.81. The latter beat guidance and consensus estimates by $0.01. The company reaffirmed its 2019 guidance for both FFO per diluted share and same-center NOI, predicting 0.5% to 1% same-center NOI growth.

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Source

At REITweek, Macerich management said that “there’s another $600 million of liquidity… debt maturities are well laddered, and it’s financing 55% LTV (loan to value ratio) and $200 to $300 million per year from those sources.” And, it added it was “considering an opportunity for JVs (joint ventures) that could yield $550 to $700 million.”

With that said, one of my concerns here is its elevated payout ratio based on adjusted funds from operations (AFFO). The company acknowledged last week that the payout ratio “is tight” and how it will “evaluate the dividend in Q4 2019.”

My gut feeling is that they won’t increase it from here, but we shall see. Regardless, here’s the payout ratio on an FFO basis:

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Source: F.A.S.T. Graphs

Here’s the payout ratio on an AFFO basis:

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Source: F.A.S.T. Graphs

As you can see, there’s no room for error on an AFFO basis. Macerich must manage the retail cycle without fumbling, or it will be forced to cut its dividend. Fortunately, the balance sheet appears to be in good shape to easily manage the redevelopment pipeline. Just so long as…

Did You Say China Tariffs?

Nobody knows when the Chinese tariffs will unwind, and this cartoon sums it up…

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Source: Bill Bramhall – New York Daily Post

The biggest retail-sector group to feel the impact of tariffs, in our view, will be department stores. Out of those, J.C. Penney (NYSE:JCP) appears to be one of the most volatile names.

In a recent Seeking Alpha article, WYCO Research explained:

“Putting 25% tariffs on a wide variety of products that J.C. Penney Company sells could be the final straw that forces the company to file for Chapter 11 bankruptcy in order to deleverage and reorganize into potentially new profitable retailer.”

The analyst added that “the latest quarterly results were poor, and the company only had $171 million cash as of May 4.”

Even though J.C. Penney is not on Macerich’s top 10 list in terms of rental percentages, the exposure it does have could still force the REIT to cut its dividend. After all, it still does have 27 such locations on its hands…

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Source: Annual Report

And, that’s not there the problematic news ends either, considering its more significant exposure to Forever 21. This is Macerich’s second-largest tenant, with 30 locations that amount to 2.5% of its total rent.A screenshot of a cell phoneDescription automatically generated

Source: Annual Report

According to Bloomberg, Forever 21 is “in talks with potential lenders and restructuring advisers as it explores options for turning around its ailing business.” It’s also “exploring financing that would shore up its liquidity and ensure founder Do Won Chang maintains control.”

Now, you can see why Macerich has so much cheese (i.e., its high dividend) in the mousetrap. Investors should maintain caution until the dust settles.

We’re maintaining a Hold for now, un-tempted by the notion of making a quick buck. For that matter, that’s also why we’re avoiding Washington Prime.

As previously mentioned, PREIT is still a “spec buy,” and we have to remind you that the tariff tantrum is weighing heavily on it, making it even more speculative than before.

Given what we know today, there are simply too many unknowns out there. And, the potential for a dividend cut is up. So, regardless of the tempting yield, it’s just not worth the chance.

We’re maintaining a Hold here

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Source: Yahoo Finance

Author's note: Brad Thomas is a Wall Street writer, and that means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free, and its only purposes are to assist with research while providing a forum for second-level thinking.

Disclosure: I am/we are long SPG, SKT, TCO, BPY. 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.

Disclosure: I am/we are long SPG, SKT, TCO, PEI. 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.