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Pennsylvania REIT - On Track For Earnings Growth

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About: Pennsylvania Real Estate Investment Trust (PEI), Includes: MAC
by: Marel.
Marel.
Value, Deep Value, long only, contrarian
Summary

Q3 2019 results were not exciting, but the Company remains well on track for reaching the inflection point in terms of FFO and earnings growth. The thesis remains intact.

Core mall sales increased by 5.5%, reaching $536 PSF (getting deeper into A-Mall territory), and core mall leased space increased to 95.5%.

More than 1M people visited Fashion District Philadelphia since the grand opening a few weeks ago in September. Reviews on Fashion District are overwhelmingly positive.

Traffic is up significantly in other redeveloped projects: 40% up at Woodland Mall and 23% up at Plymouth Meeting.

Progress is also being made on the densification front. The Company received offers from twelve bidders on its multifamily land parcels and expects to provide more information before the end of 2019.

Pennsylvania REIT (PEI), often referred to as PREIT, is getting closer to the inflection point in terms of FFO and earnings growth. However, Q3 2019 results were not appealing. In particular, the Company cut its guidance for adjusted FFO per share to $1.08-$1.14 (from $1.16-$1.27) as it expects 2019 same-store NOI to decline between 2.5% and 1.5%. The headlines seem spooky:PEI Q3 2019 headlines

There is no way to spin this positively.

  • "misses on revenue"
  • "FFO misses"
  • "PREIT slumps"
  • "bankruptcies eat into Q3, guidance"

The market doesn't like lower guidance revisions, the market doesn't like same-store NOI declines, and the market doesn't like earnings misses. That said, if one digs deeper beneath the surface, nothing has really changed. In fact, the Company is well on track to deliver earnings growth, especially in 2021 and beyond, when the full impact of all major redevelopment projects will be incorporated into the financials. These things take time, especially in real estate. First you build, then you earn. For example, Fashion District is a ~$420M redevelopment of The Gallery in downtown Philadelphia (50/50 JV between PEI and Macerich (MAC) i.e. ~$210M at PEI's share). After almost 4 years of construction, Fashion District finally opened on 19 September 2019. In other words, for ~4 years PEI was not generating any income on the ~$210M invested capital. To put things into perspective, $210M represents ~50% of PEI's current market cap! It is fair to say, this was a very big project for PEI, and is capable of moving the needle.

Traffic and sales are strong

Redevelopments are working in terms of higher sales and traffic. Note, PEI has no unleased department stores in its core portfolio - perhaps the only listed mall REIT to claim such a milestone.

PEISource: PEI Q3 2019 Supplemental

Fashion District:

More than 1M people visited Fashion District since the grand opening on 19 September 2019. CEO Joe Coradino mentioned during the Q&A session of the Q3 2019 conference call:

...traffic's been great. Retailers are reporting strong results. During the opening week, 87% of the retailers reported sales ahead of expectations, with some retailers reporting results that were triple and double their initial projections. So all things considered, the property is doing phenomenal business. I am not sure how some of the food operators actually keep enough food inventory to sell to the crowds that are there on, and I'm not joking about that. So businesses -- business at Fashion District always could be better, but it's great.

In addition, it was announced that international fast fashion retailer Primark will anchor the west end of Fashion District with a high-profile location at the corner of 11th and Market, along with Sephora and Kate Spade New York Outlet. Commenting on this and future occupancy trends:

In light of our early success, the project is oversubscribed with prospects. We’re being extremely deliberate and curating the remaining 15% of the space with brands and experiences that will solidify the project as a truly iconic destination in retail real estate, and a must-see for our 43 million people visiting the region each year.

In other words, PEI and JV partner MAC are cherry picking the best and most sought-after tenants.

Woodland Mall:

Woodland Mall recently unveiled its expansion and traffic is up 40% since opening. The $100M redevelopment features 19 new retailers, including several new-to-market tenants. Tenants include Von Maur, REI, Urban Outfitters, Tricho Salon and Mobile Station, as well as the newly renovated and expanded Bath & Body Works/White Barn Candle and Williams-Sonoma. What's more, Black Rock Bar & Grill, an award-winning steakhouse and first-to-market experiential dining offering, has recently joined the roster and The Cheesecake Factory will open its second location in Michigan (and its only location in over 50 miles).

Plymouth Meeting Mall:

Traffic is up 23% since opening. PEI is welcoming over 200,000 SF of new retail, dining and experiential concepts, including Burlington, Dick's Sporting Goods and Miller’s Ale House. Edge Fitness open this Fall and Michael’s is set to open in 2020. In addition, there is strong focus on health and well-being, with tenants including Red Rose Spa, Sola Salon and Restore Hyperwellness & Cryotherapy.

Moorestown Mall:

The rent generated in the former Macy's store is 19 times higher versus the prior revenue. Traffic has improved by ~5.7% through June 30, 2019, compared to H1 2018.

Capital City Mall:

PEI replaced Sears with Dick's Sporting Goods, PA Fine Wine and Premium Spirits, Primanti Brothers and also added the only Dave & Buster's in the region. Comparable sales are up ~8% and traffic is up ~9.5% on a YTD basis.

Mall at Prince Georges:

PEI overhauled the inline tenant mix to be better aligned with the customer base. New tenants include ULTA Beauty, DSW, Five Guys, &pizza, Chipotle and H&M. Comparable sales are up over 23% and NOI is up over 20%.

Top 6 Properties now generate over 50% of company-wide Mall NOI

In the previous quarter, PEI's Top 6 properties produced sales of $633 PSF and 48.8% of Mall NOI. In Q3 2019, PEI's Top 6 properties produced sales of $642 PSF and 50.3% of Mall NOI.

Q3 2019 top 6 mallsSource: Q3 2019 Supplemental, pg 24

In other words, the Top 6 Properties, which are well into A-Mall category, generate more than half of company-wide NOI. That's substantial and deserves attention amongst investors. Many might remember PEI as a low productivity mall company, but that is clearly not the case any more. As the CEO stated, "PREIT is a different company than we were seven years ago".

In addition, Fashion District is anticipated to generate strong sales, in excess of $700 PSF. It is therefore a matter of time until it forms part of PEI's 'Top 7 Malls' list, something I expect to see in future quarterly supplementals (especially once we have proper comparable data for Fashion District).

It is important to note, on a pro-forma basis, the Top 7 malls are expected to produce ~2/3 of company-wide NOI, in the not-so-distant future. In other words, PEI's Top 7 malls are well into A-Mall land and I expect them to deliver ~2/3 of company-wide NOI. An interesting exercise is for one to determine what these properties would be worth as things stand, or if they were spun off into a separate company. Management has provided some numbers for us:

PEI top 6 propertiesSource: September 2019 Investor Update Presentation, slide 5

Note the current share price is ~$6 versus estimated NAV for the Top 6 Properties of $8-$12 per share. Add into the mix the projections for the multifamily land value (more on this below) and the situation becomes really interesting.

One might wonder, what's the deal with the remaining core malls? Excluding Fashion District, below is list of PEI's 18 core malls, including the aforementioned Top 6 Malls.

core portfolioSource: Q3 2019 Supplemental, pg 24

Some interesting points are that Malls 7-12, are also close to A-Mall territory (average sales PSF of $471 with strong occupancy of 97.4%), producing 24.7% of NOI. So The Top 12 Properties produce 75% of NOI (again excluding Fashion District which is expected to improve average results).

Another interesting observation is that Plymouth Meeting Mall is the lowest in terms of sales PSF ($342) out of the core malls, but it has substantial upside potential given the significant redevelopments taking place. As mentioned above, Plymouth Meeting Mall is attracting tenants like Burlington, Dick’s Sporting Goods, Miller’s Ale House, Edge Fitness and Michael’s. Other tenants include one of 9 LEGOLAND Discovery Center locations in the U.S., Whole Foods, Dave & Buster’s, Cyclebar (indoor cycling studio) and a renovated AMC Movie Theatre. In addition, Plymouth Meeting Mall is turning into a hub for health, wellness, nutrition, and recovery by bringing in tenants like Red Rose Spa, Sola Salon and Restore Hyperwellness & Cryotherapy, among others. As the CEO mentioned:

Plymouth Meeting Mall sets the standard for the new era of mall experiences that are sweeping the industry. Having integrated entertainment, dining, grocery and fitness segment within our portfolio, we’re driving new customers to the mall regularly,” said PREIT CEO Joseph F. Coradino. “Our proactive and strategic remerchandising efforts, including the redevelopment of the mall’s anchor space, along with our drive to create a diverse tenant mix, are crucial ingredients to elevating the consumer experience and providing local shoppers with more reasons to visit the mall.

Photos of the improved Plymouth Meeting Mall:

plymouth meeting mallplymouth meeting mallplymouth meeting mallSource: PEI website

Regarding the remaining non-core NOI, Wyoming Valley Mall was transitioned out of the portfolio in September, and PEI recorded a gain on debt extinguishment of $29.6M ($0.38 per share of gain). Note, PEI had previously recognized an asset impairment loss of ~$32.2M.

The remaining two non-core malls represent 4.5% of mall NOI:

  • Valley View Mall (1.9% of Mall NOI, average sales PSF of $351, total occupancy of 69%)
  • Exton Square Mall (2.6% of mall NOI, average sales PSF of $325, total occupancy of 76.2%)

Progress on densification initiatives

PEI has identified significant opportunities to add over 5,000 multifamily units and over 2,000 hotel rooms to its properties. This is aided by PEI's presence in densely populated markets. In Q3 2019, PEI announced that it has received offers from twelve bidders on its multifamily land parcels. The Company is calling for best and final offers and expects to move to Agreements of Sale within 2019. So we should have an update fairly soon.

As Mario Ventresca, incoming CFO commented during the Q3 2019 earnings call:

On the multifamily land sale front, our significant presence in the Philadelphia and Washington D.C. markets with their strong economic fundamentals and strengthening demographics provide our properties in these markets with several distinct advantages that are being recognized by multifamily developers.

As a result, we are currently engaged in a bid process with over a dozen qualified participants through the sale of multifamily land at seven of our properties. We’re encouraged by the robust interest in the properties and expect to document transactions with successful bidders by year-end.

PEI's densification program is an important initiative, as it provides a clear deleveraging plan since land sales can fetch up to $300M (around 3/4 of PREIT's current market cap!). For example, $200M in proceeds will reduce Debt/EBITDA by 1x, and this will also lower interest payments. Importantly, these multifamily land sales are non-dilutive given that these land plots (think land adjacent to existing malls / excess parking lots) do not produce income!. What's more, this extensive multifamily (and hotel) opportunity allows for enhancing PEI's mixed-use platform, driving additional traffic to the properties in question (e.g. more residents living next to the mall should translate to more visits).

PEI has mentioned in the past that it expects land sale proceeds to fetch $150M to $300M. When asked about this during the Q3 2019 Q&A session by analyst Christy McElroy from Citi, the CEO mentioned:

Well, again, Christy, much as I'd like to give you specificity, we are literally going to document -- going to pick horses in the next week or two and are pretty deep into negotiation. So I wouldn't want to specify an amount. We expect to execute documents this year and move to closing next year.

The analyst pushed on this matter by asking a following up: "Is it fair to say that it's kind of coming in, in line with your prior expectations?"

The CEO replied:

Again, I'd rather not get into a specific discussion with you, but we are not unhappy.

I am not sure what "not unhappy" means, but it is a hint that we are within the projected range. In any event, even if it is not within the target range, every little helps. I believe that these land sales have not been properly taken into account by the investment community.

densification PEISource: September 2019 Investor Update Presentation, slide 19

Conclusion

In closing, even though I am not thrilled about Q3 2019 results, including the headline optics, nothing has really changed. Patience is required until all high-impact redelopments start generating NOI, which will also enable the Company to deleverage on a Debt/EBITDA basis. In addition, I also look forward to a positive outcome on the multifamily land sales (hopefully within 2019), which will also help deleverage on a Debt/EBITDA basis, and reduce interest payments. I am pleased with the performance of Fashion District thus far, with more than 1M visits since the grand opening in September. I believe it is important to reiterate that PEI is now well into A-Mall territory, and acknowledge that it is a very different company compared to when the current CEO took over. In fact, in the not-so-distant future, on a pro-forma basis (including Fashion District) the 'Top 7' properties, with average sales well in excess of $600 PSF, are expected to produce ~2/3 of company-wide NOI. That is substantial and deserves attention. The inflection point will arrive one way or another. There might be setbacks along the way, but I think we have turned the corner, and it is a function of time. To be clear, 2021 is the catalyst, but improved results should start being reflected in 2020 financials.

Disclosure: I am/we are long 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.

Additional disclosure: I am also long MAC, PEI's JV partner in Fashion District.