Taubman Means Unrivaled Luxury At A Deep Discount

Summary

• Taubman has enhanced the footprint of new retailers throughout its portfolio by replacing formerly prominent tenants with high-productivity retailers.
• In terms of Taubman’s “terrible track record,” let me provide “proof” that management is delivering shareholder value.
• We are upgrading Taubman to a Strong Buy.
• This idea was discussed in more depth with members of my private investing community, iREIT on Alpha. Get started today »

Have you noticed? It’s very difficult, if not impossible, to haggle over the price of a luxury product.

Case in point, I bought my wife a Land Rover a few years ago. When I approached the dealer to try to negotiate, my attempts were slapped right down.

I distinctly recall attempting to knock a few hundred off the sticker price. (Just a few hundred!) But the salesman told me plainly, “We don’t negotiate on the price.”

OK then.

More recently, I was in a Rolex store in Las Vegas, where I was interested in buying a new watch. I’ve always wanted a Rolex, so I thought I would try to use my negotiating skills to chisel a few hundred dollars off the price.

Nope.

Similar to the Land Rover experience, I was stopped cold by the salesperson with the same six word. “We don’t negotiate on the price.”

Even so, I was taught growing up that you never know until you ask. That’s why I’m still more than willing to keep searching for bargains among the high and mighty.

And guess what? That fits the current situation with Taubman Centers (NYSE:TCO) to a luxury-brand T.

(photo source)

Taubman Is the Luxury Play in Retail

Taubman Centers was founded in 1950 – over 68 years ago – and is the first publicly-traded company to UPREIT as an IPO in 1992.

It may be smaller than its closest rival, Simon Property (SPG), which has a market cap of around $90 billion. But Taubman Centers, complete with its $10 billion market cap, has the highest-quality mall portfolio in the U.S. (TCO’s net equity at today’s prices including preferred is nearly $4.5 billion).

Today, the company owns, manages, and/or leases 27 regional, super-regional, and outlet shopping centers in the U.S. and Asia. Its portfolio of U.S. shopping centers are located in major markets and report trailing 12-month sales in comparable centers of $919 per square foot as of Q1 2019.

Source: TCO Investor Presentation

The evolution of Taubman’s tenant mix has contributed to its sales growth over the last decade. Its A-rated malls are expected to remain the beneficiaries of incremental demand for space. Plus, they have higher rent-negotiating power as well.

Its best-in-class sales and rent per square foot also are illustrative of the quality of its holdings. As viewed below, Taubman’s portfolio of 21 assets average between A+ and A-quality, with roughly 80% of all mall asset value being held in A malls.

Source: TCO Investor Presentation

Taubman is well versed in enhancing its new retailers’ footprints throughout its portfolio by replacing formerly prominent tenants with high-productivity retailers. This evolution has resulted in significantly more sustainable revenue and extraordinary productivity.

Source: TCO Investor Presentation

As viewed below, many luxury brands have chosen a Taubman Center as their first U.S. mall location. And many traditionally online retailers are now tenants in Taubman properties too.

Source: TCO Investor Presentation

Being a landlord to luxury retailers has proved to be a competitive advantage since the landlord has pricing power. There are a limited number of A-rated malls in the U.S. But Taubman’s tenants can showcase their brand in the best markets possible.

As viewed below, the company has the highest concentration of asset value in the top U.S. 50 markets…

Source: TCO Investor Presentation

Who Wouldn’t Want to Rent Space From Taubman?

As of year-end 2017, Taubman had grown its total market capitalization from $2.2 billion at IPO to $10.7 billion. And that’s while owning about the same number of assets as before – not to mention issuing only $50 million of common equity on a net basis.

This means it’s extremely good at recycling capital to generate superior returns on capital invested. And its IPO equity market cap of $1.3 billion has grown to $5.6 billion as of year-end 2017. This represents an increase of 4.3x.

Source: TCO Investor Presentation

But it’s not just doing well in the U.S., where it costs well over $100 million to build a new mall and there are limited opportunities for growth. Around four years ago, Taubman decided to explore opportunities in China as well, despite having limited experience there.

At first, many analysts were skeptical. In fact, some still are.

One skeptic – and ongoing activist – Land & Buildings, recently wrote an open letter on the subject. It believes that Taubman should “exit Asia.” Otherwise, it would “likely drive nearly 10% accretion to annual earnings” and “materially reduce debt and eliminate future capital commitments for development.”

Yet Blackstone (BX) very clearly disagrees with that assessment of one of the world’s hottest retail markets. That much is evidenced by it taking a 50% interest in Taubman’s Starfield Hanam, CityOn.Xi’an, and CityOn.Zhengzhou for $480 million… which feature a 4.1% cap rate.

Taubman, meanwhile, plans to earn up to an additional $50 million based on 2019 performance of the assets.

Source: TCO Asian Investor Presentation

Taubman will retain responsibility for day-to-day management of the properties, with Blackstone paying a property services fee. This deal validates Taubman’s value-creation strategies in China. Around $325 million (at share) of net value already has been created on a total project cost of about $635 million (at share).

The company will receive around $315 million after taxes, fees, and closing costs.

Taubman has gained extensive experience in China, and the Blackstone deal appears to be a smart deal. As I explained in a recent article, Blackstone also is one of the smartest real estate investors in the world.

In addition, once the deal closes, Taubman’s leverage will drop by around 50 basis points (bps) to around 8.2x. And its interest coverage ratio should improve by around 25 bps, or 3x.

In addition, the company should recollect $140 million as a result of refinancing two of its China assets. And about $455 million is expected to be retained and increase liquidity.

Source: TCO Asian Investor Presentation

Also, building upon the success of Starfield Hanam in South Korea, Taubman is again partnering with Shinsegae Group – one of South Korea’s largest retailers – to create the first super-regional shopping center in the rapidly growing area of the southern Gyeonggi province.

The project, which will cost an estimated $570-$600 million, is expected to open in late 2020. Taubman should own 24.5% of this 1.1 million square-foot project, with projected cash-on-cash return of about 6.5%.

Source: TCO Asian Investor Presentation

Now, I don’t want to try to second guess an activist. But the fact that Land & Building wants Taubman to exit China seems absurd.

Taubman has negotiated a heck of a deal in Asia it gets its 4.1% cap rate cake and eats it too thanks to continued net operating income (NOI) growth and management fees. And it has executed its operations just as beautifully in Los Angeles, specifically at Beverly Center.

This iconic shopping destination opened in 1982 and was developed on the site of a small amusement park called “Kiddieland.” For the next 20 years-plus, Beverly Center was recognized as the dominant retail asset in west L.A. And it thrived as the surrounding community prospered.

Source: Beverly Center -Investor Event–January 16, 2019

All the way into the 2000s, Beverly Center was seen as one of the U.S.’s top 10 regional mall assets. And why not? It’s located at the point where the affluent communities of Hollywood, West Hollywood, Los Angeles, and Beverly Hills come together.

That’s a trade area of nearly 4 million people.

In March 2016, Taubman announced a massive redevelopment of Beverly Center. The goal was to maintain and improve its market position while increasing its long-term viability against new, expanded, and re-energized competition.

Source: Beverly Center -Investor Event–January 16, 2019

Simply out, Beverly Center had an extreme mall makeover. And here are the before and after photos:

Source: Beverly Center – Investor Event – January 16, 2019

In other words, this wasn’t just a cosmetic makeover. Beverly Center went through a soup-to-nuts transformation, with Taubman expanding its premier collection of luxury tenants. It also added retail offerings across every price level and fashion profile.

Source: Beverly Center – Investor Event – January 16, 2019

Similar to the China expansion, Taubman had skeptics in this as well. But those skeptics should be officially silenced by now. Taubman delivered the project on schedule and on budget, and Q3-18 year to date sales per square foot were up double digits.

Source: Beverly Center – Investor Event – January 16, 2019

The company said that, following the Beverly Center investment… it’s “resumed its trajectory to re-establish itself as one of the 10 best retail assets in the country. Sales per square foot are already approaching peak historical levels and are expected to grow significantly. Beverly Center will be one of about 10 assets in the country with 20 full luxury tenants.”

What Terrible Track Record?

In the open letter from Land & Building, Jonathan Litt wrote:

“I did not stand for re-election at the 2019 annual meeting... it was clear that the company did not intend to re-nominate me for election to the board. I decided not to run a proxy contest this year in order to let [it] focus on improvements and because Bobby Taubman – who I believe bears most of the responsibility for Taubman’s terrible track record – was not up for election.

“However, shareholders are clearly disappointed with the actions the board has taken – including, in our view, the decision to not re-nominate me – as the shares are down 14% and have underperformed Class A mall peers by 7% since the announcement.”

Sour grapes much?

Take a look at Taubman’s current board, and you will see a high-quality team of finance-oriented experts. And in terms of Taubman’s “terrible track record,” let me provide “proof” that management is delivering shareholder value.

Source: TCO Investor Presentation

Taubman has never once reduced its dividend since the IPO in 1992. In fact, it was the only mall REIT that did not reduce its dividend during the Great Recession… when it maintained an all-cash dividend throughout the year.

(Editor’s Note: Tanger (SKT) did increase its dividend too, but it isn’t considered to be a “pure play” mall REIT.)

Sometimes, as investors often do, you must make capital allocation decisions. Because, sometimes, it’s worthwhile to trust management to run the business instead of being an “armchair quarterback.”

In Q1 2019, Taubman’s comp center NOI growth (excluding lease cancellation income) was up to 2.3%. And sales per square foot were up 18.6% – the company’s 11th consecutive quarter with positive sales growth.

Meanwhile, the railing 12-month tenant sales per square foot was $832, up 10.3%. And Taubman’s adjusted funds from operation (AFFO) per share was $0.95.

It expects 2019 FFO per share to be in the range of $3.62 to $3.74.

Source: Q1-19 Earnings Results

As viewed below, Taubman maintains extremely attractive, stable, high-quality assets. Better yet, they allow for financing at the best rates with extended maturities.

Source: TCO Investor Presentation

The company expects to add around $150 million of additional FFO over the nest few years. And development projects should add around $70-$75 million of NOI.

Core center growth, meanwhile, is expected to add around another $50 million. And redevelopment projects should add around $20-$30 million.

An Unrivaled Luxury Mall REIT at a Deep Discount

By now, you should have a clear understanding of Taubman’s business model. So now let’s take a look at the valuation metrics, starting with the dividend yield.

As you see, Taubman yields 6.2%, around 100 bps above Simon Property.

Now let’s review the payout ratio for each mall REIT:

Again, Taubman’s dividend coverage appears stable. This is especially true considering its low exposure to troubled department stores such as J.C. Penney and Sears.

Source: TCO Investor Presentation

Next up, let’s examine Taubman’s P/FFO multiple compared with its peers.

Again, Taubman is trading at 11.9x price to FFO, which is below both Simon and Brookfield Property (BPY). As for its growth forecast, as examined through FFO per share data obtained from F.A.S.T. Graphs…

On a forward-looking basis, Taubman has an excellent profile, averaging 6% FFO per share growth through 2021. This gives me comfort for future dividend increases.

But it does beg the question of why this high-quality, unrivaled luxury mall REIT is on sale?

As I explained at the beginning of this article, I love luxury. But I insist on buying it at a discount.

Over the last three years, the retail REIT sector has evolved. And it’s now clear to see that there will be winners and there will be losers.

In fact, I’ll make the bold prediction that there will only be a handful of – as in three or four – survivors left standing in terms of publicly-traded mall REITs.

These victors will need significant capital to get through the cycle. Any companies with high leverage and high exposure to distressed department stores will likely fade into the sunset.

But Taubman Centers will not be one of them.

In my opinion, this REIT is stronger with one less board member (i.e., Jon Litt). I trust the current management team, which has strong insider ownership and a long history of generating solid returns.

Source: F.A.S.T. Graphs

Legendary investor Benjamin Graham summed up his assessment of owning shares in superior stocks by saying, “One of the most persuasive tests of high-quality is an uninterrupted record of dividend payments going back over many years. We think that a record of continuous dividend payments for the least 20 years or more is an important plus factor in the company’s quality rating.”

That’s just one of the many reasons why we’re updating Taubman to a Strong Buy, as viewed below.

Source: F.A.S.T. Graphs

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 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 SPG, TCO, BPY, TCO, SKT. 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.