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CBL & Associates: High-Risk, High-Reward Dividend Opportunity

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About: CBL & Associates Properties, Inc (CBL), Includes: CBL.PD, CBL.PE
by: Brant Munro CFA
Brant Munro CFA
Value, growth at reasonable price, long-term horizon, event-driven
Summary

CBL shares are priced for bankruptcy as management and analyst guidance would suggest a forward 2020 P/FFO of ~1.1x.

The preferred series D and E shares have stripped yields in excess of 17%, which I believe make more sense for income-oriented investors.

The common shares will only be suitable for high-risk tolerant investors due to the very high Net Debt/FFO ratio.

Background

CBL & Associates Properties, Inc. (CBL) was a stock I bought in 2016 that I considered a deep-value stock with a 10% yield on common stock. It was priced at only 4.5x FFO at around $10/share which I thought was fairly cheap for a company that was still increasing same-store center sales and maintaining a stabilized mall occupancy rate above 90%. Granted, there has been some survivorship bias as lower-quality assets with deteriorating financials have been sold. The fact that it traded at ~50% of NAV was also a plus.

September 2019 Presentation

I figured that the market was just overreacting to the rise of Amazon (NASDAQ:AMZN) and it cannibalizing retail shopping, but I still saw a place for malls to fulfill social needs which could be provided through entertainment and events such as theatre establishments, restaurants and the experience of boutique stores that even Amazon cannot quite replace and that CBL has tilted its portfolio of assets towards recently.September 2019 Presentation

Fast forward one year and the bleeding began, both in CBL's portfolio and mine, as revenue per share and FFO have been on a steady downward trend ever since and is currently priced for bankruptcy. As of December 31, 2015, the company's credit ratings were Baa3 from Moody's and BBB- from S&P and Fitch. As of December 31, 2018, it had credit ratings of Ba1 from Moody's, BB+ from Standard & Poor's Ratings Services ("S&P") and BB- from Fitch Ratings ("Fitch"). The company's debt has essentially been downgraded by all ratings agencies.

ChartData by YCharts

ChartData by YCharts

The reasons for the bleeding were rental revenues from comparable properties declining primarily due to store closures and rent concessions for tenants with high occupancy cost levels, including tenants that declared bankruptcy in 2018 and 2019. 2018 was challenging as the bankruptcy filings of Bon-Ton (OTCPK:BONTQ) and Sears (OTCPK:SHLDQ) contributed to over 40 announced anchor closures. In the long term, these closures could provide the opportunity to repurpose the space and provide more dynamic and vibrant uses, such as entertainment, dining and other non-apparel tenants, which tend to attract today's consumers. In 2018, over 67% of total new leasing was executed with non-apparel tenants.

A common share dividend cut was announced in November 2017 from $0.2650/share to $0.2000/share and in October 2018 it was further reduced to $0.0750/share. In March 2019, CBL suspended its quarterly common dividend for the next two quarters. Prior to year-end, CBL will complete its review of taxable income projections and announce its common dividend policy for 2020. Consistent with CBL's strategy of maximizing internal cash flow available for investing and debt reduction, CBL intends to pay the minimum common dividend required, if any, to distribute taxable income. This is definitely not good news for speculative investors who bought in about a year ago, hoping that if the company just survived another couple of years they would have all of their money back in that time.

The company recorded an accrued liability and corresponding litigation settlement expense of $88 million in March 2019 related to a settlement agreement, which was the reason for suspending the dividend.

ChartData by YCharts
ChartData by YCharts

The Light at the End of the Tunnel

Now despite the sheer terror I just presented above and before you close your internet browser, there may be a light at the end of the tunnel. As of November 1, 2019, CBL Properties announced it had entered into an agreement with Exeter Capital Investors, who bought 5.97% of the CBL’s common stock.

This is not too surprising as about a year ago despite the deteriorating financials, I saw this company as a prime candidate for a "turnaround" situation as the company's cumulative annualized Q2 FFO was only ~2.5x and has since compressed to ~1.25x. CBL anticipates achieving 2019 Adjusted FFO in the range of $1.30-1.35 per diluted share, which includes a reserve in the range of $5.0-15.0 million for potential future non-budgeted losses in rent from tenant bankruptcies, store closures or lease modifications that may occur throughout the rest of 2019. This indicates a further compression of the P/FFO multiple to at least 1.18x.

As part of the company’s ongoing commitment to board refreshment, Michael Ashner and Carolyn Tiffany have been appointed to CBL’s Board of Directors, effective November 1, 2019. With these additions, the CBL board now comprises nine directors, seven of whom are independent.

Mr. Ashner has over 40 years of experience owning and operating real estate companies, many of which were NYSE-listed. Most recently, Ashner served as the Chairman and Chief Executive Officer of Winthrop Realty Trust, an NYSE-listed real estate investment trust. Winthrop Realty Trust held a portfolio of approximately $2.4 billion of real estate and real estate-related assets.

Carolyn Tiffany has been active in commercial real estate investment, operations and management for over 25 years. Tiffany was a member of the Board of Trustees and President of Winthrop Realty Trust from 2009 until her retirement in June 2017 and currently serves as a trustee to its successor, Winthrop Realty Liquidating Trust.

As we can see, this may be the first step towards stopping the bleeding and reversing the downward FFO trend.

The market is definitely pricing the company for bankruptcy; however, analysts are projecting EBITDA to increase by 11% for 2019 YE (about in line with management) and another 2% for 2020. If we assume FFO increases another 13% from its 2019 Q2 annualized level of $1.28 by 2020, in line with EBITDA, this would indicate a 2020 forward P/FFO of 1.1x with FFO being $1.45 and would almost equal the current share price. This looks very cheap for a floundering company that might be seeing a reversal in its negative trends.

ChartData by YCharts

When the company resumes paying its quarterly dividend which was at $0.075/share, the previous two quarters prior to suspension, that would imply a favourable forward dividend yield of ~19%, and even if it resumes the dividend at half that amount, which would be the lowest dividend per common unit ever paid by the company, the common shares would still pay a respectable 9% per share dividend yield with plenty of upside in the share price with the Exeter partnership.

Since the bleeding began the company has seen a rise in its cost of funds, which is not surprising due to downgrades on its debt, but has been able to stabilize this by "kicking tires" through asset dispositions and refinancing at lower rates and extending maturities to lower its debt repayment obligations as it was able to extend the weighted average maturity on debt from 4 years at 2018 YE to 4.5 years at Q2 2019.

September 2019 Presentation

In April 2019, the loan secured by Volusia Mall was refinanced to increase the principal balance to $50.0 million. In addition, the maturity date was extended to April 2024 and the fixed interest rate was reduced from 8.00% to 4.56%. The net proceeds from the new loan were used to retire the $41.0 million existing loan. During the three months ended June 30, 2019, CBL sold three properties for a total gross sales price of $32.2 million. The excess sales proceeds were used to reduce the outstanding balance on the secured line of credit, and the portion of those proceeds from the Honey Creek Mall sale was combined with the net proceeds from the refinancing of the loan secured by Volusia Mall to retire the $23.5 million loan secured by Honey Creek Mall.

In May 2019, CBL exercised an option to extend the loan secured by The Outlet Shoppes at Laredo to May 2021. In conjunction with the amendment, a payment of $10.8 million was made to reduce the outstanding balance of the loan to $43.0 million. Subsequent to June 30, 2019, CBL sold the 850 Greenbrier Circle office building, the Barnes & Noble parcel in High Point, North Carolina, the Kroger parcel at Foothills Plaza and the Forum at Grandview in Madison, Mississippi, for a total gross price of $46.6 million.

Liquidity and Debt

Typically CBL has had strong FFO/distribution coverage as shown below, but there is currently little risk for the preferred shareholders to see a cut.

Figures in thousands. Source: Author's Table and Company Filings

What remains a grave concern about the viability of paying even the $0.075/share common dividend is the leverage on a Net Debt/FFO basis as shown below.

Source: Author's Tables, Company Filings

Given that as of Q2 2019 net debt is about $4.1 billion, using management guidance of $1.35/share for 2019 YE would imply Net Debt/FFO of over 17x which is high even for a REIT. This does not even include the value of the preferred shares. With a weighted average term to maturity of only 4.5 years, CBL will likely have to resort to unsustainable measures if the negative trend in FFO persists. This may include more dispositions and/or continual refinancing of current debt.

Preferred Shares

CBL's authorized preferred stock consists of 15,000,000 depository Series D and E shares at $0.01 par value per share. Both are cumulative and accrue from the date of issuance and are paid quarterly. They are non-convertible and each has a $250 liquidation preference. Only the Series E is callable. The two classes are summarized below:

Series D (CBL.PD) Series E (CBL.PE)
Price $10.41 $9.93
Par $25.00 $25.00
Amount Outstanding 1,815,000 690,000
Discount to Par Value 58% 60%
Liquidation Preference $250.00 $250.00
Dividend $1.84 $1.66
Last Dividend Date 13-Sep-19 30-Sep-19
Stripped Price $10.14 $9.48
Stripped Yield 18.18% 17.46%
Callable No Yes

Both options look like fantastic options as the yields are very strong for preferred shares and trade well back of par value. The fact that the company trades at a discount to NAV gives some comfort in getting your capital back in the event of a bankruptcy if the preferred shares are purchased vs. the common which have a comparable yield.

The Series D would be my preference due to the slightly better-stripped yield and the higher liquidity.

Conclusion

CBL's very low valuation makes it an investment with potential for outperformance, provided the Exeter partnership can stop the bleeding. The company looks like a high-risk, high-reward kind of investment, which is especially the case for the common shares. The preferred shares may still be suitable for income-oriented investors who have below-average risk aversion as the stripped yields are very high for preferred stock. If the Exeter partnership can successfully turn the company around and get back to growing FFO, the preferred stock should begin to trade closer to par value, which would result in some capital appreciation on top of the generous dividend yield. If things go south, the likelihood of permanent loss of capital and a dividend cut is lower compared to the common. The preferred shares, however, do not have the yield and capital appreciation potential of the common shares in a best-case scenario, which would make this investment attractive for very risk-tolerant investors.

Disclosure: I am/we are long CBL. 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.