Seeking Alpha

3 High-Flying REITs We're Buying On Cyber Monday

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Includes: MAC, SKT, SPG
by: Brad Thomas
Brad Thomas
Dividend growth investing, REITs, newsletter provider, value
Summary

It seems ironic that today, on Cyber Monday, we’re going to provide you with a list of the best bargains in the retail sector.

The common denominator for all of these high-flying REITs is that they are well-capitalized, and capable of paying out a growing dividend through good times or bad.

When we go shopping for REITs, it’s critical that the company generate a satisfactory quality score and that the company is trading with a wide margin of safety.

Today is Cyber Monday, the best time to look for deep discounts on the internet as millions of shoppers will be scouring websites to get significant savings. Since 2009 Cyber Monday sales have increased more than eightfold, according to Adobe Digital Insights, which tracks and publishes research into online marketing and sales.

Chart by iREIT: Source

As technology has improved, so have internet speeds, allowing online shoppers to scan the universe at light speed. Who would have imagined that we would be living in a world much like Star Trek? You can now order your new laptop computer almost as fast as you can say, “Beam Me Up Scotty”.

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But technology has also helped investors research at light speed, thanks to websites like Seeking Alpha. Who would have ever imagined that writers could move markets by publishing articles on Seeking Alpha?

For me it’s surreal to think about the fact that technology has become such a significant means for investors to research stocks. I remember when I was in college many moons ago, and my economics professor suggested buying a subscription to Value Line.

But technology also has its disadvantages, especially for certain retailers. In 2018, former J.C. Penney (NYSE:JCP) CEO Mike Ullman said that only 25% of America's 1,200 shopping malls will survive over the next five years. Those that do will serve the highest-earning 20% and Ullman said that only malls that can attract an Apple (NASDAQ:AAPL) or Tesla (NASDAQ:TSLA) store would survive.

According to Financial Times,

US retailers have announced 9,270 store closures so far in 2019, including Gap, Payless ShoeSource and Gymboree” and “that is more than double the number of openings and follows 5,840 closures last year.

Our research seems to mirror Ulman’s prediction as

...we decided to dig deeper into the mall apocalypse story to determine whether sucker-yielding Washington Prime (WPG) could survive… and whether investors can reap the returns they're expecting for the outsized risk they're taking right now.

I explained,

The department store sector is going to get hit the hardest over the next few quarters. And we believe that additional store closures will put enhanced risk on the REITs that have tight payout ratios.

It seems ironic that today, on Cyber Monday, we’re going to provide you with a list of the best bargains in the retail sector, and the common denominator for all of these high-flying REITs is that they are well-capitalized, and capable of paying out a growing dividend through good times or bad.

Assessing a company’s overall quality should not only be based upon the condition of the real estate, but also on the quality of the dividend itself. We have no doubt that Macerich’s (MAC) sales per square foot (average $776 in Q2-19) is above average, but we’re cognizant of the fact that the payout ratio is dangerous (nearly 100% based on AFFO).

So, when we go shopping for REITs, it’s critical that the company generate a satisfactory quality score (using our R.I.N.O. scoring model) and that the company is trading with a satisfactory margin of safety. As Spock reminds us,

Insufficient facts always invite danger.

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3 High-Flying REITs We’re Buying

As illustrated below, we scanned the entire retail REIT sector (including shopping centers and malls) in a quest to find the best companies to buy on Cyber Monday. We first screened the list of REITs based upon their overall quality rating and we then filtered based upon valuation. As you can see below, Simon Property (SPG), Federal Realty (FRT), and Tanger Outlets (SKT) provide the best overall value based on their potential for price appreciation and dividend safety.

Source: FAST Graphs

Simon Property Group (SPG) is the strongest mall REIT based upon the company’s fortress A-rated balance sheet and exceptional liquidity ($7 billion). Simon has some of the best fundamental stats, including retailer sales per square foot of $680, occupancy of 94.7%, and base rent of $54.55 per square foot. Funds from operations (FFO) were $3.05 per share in Q3-19 and $9.09 per share year to date, a 5.2% increase over the same period last year.

Buying Simon today not only means locking in a very safe 5.56% yield that's likely to keep growing even through a future recession, but also being offered the realistic potential for 15% to 20% CAGR total returns, which is above the REIT's 25-year track record. The company declared a quarterly dividend of $2.10 per share, that was a 5% increase year over year. The dividend is well covered (69% payout ratio) and we believe Simon is one of the best opportunities today on our Strong Buy list.

Source: FAST Graphs

Price: $151.21

Dividend Yield: 5.56%

Payout Ratio: 69.1%

P/FFO: 12.5x

YTD TR: -5.5%

P/FFO Variance: -23.1%

RINO Score: 4.318

Source: FAST Graphs

Tanger Outlets (SKT) is the only pure play outlet REIT and is one of the most misunderstood REITs in our coverage spectrum. What differentiates Tanger from the traditional mall REITs is the fact that (a) Tanger has no department store exposure, (b) Tanger has the lowest occupancy cost in the mall REIT sector, (c) Tanger is the only mall REIT that increased its dividend during the last recession and has a record of 25 annual dividend increases in a row, (d) Tanger has the lowest payout ratio in the mall REIT sector.

With these facts aside, Tanger has also done an excellent job managing the store closures. In Q3-19 the consolidated portfolio occupancy rate was 95.9% (compared with 96% in Q2-19) and even during the ongoing retail store closure environment, Tanger has been able to maintain strong occupancy (never dropped below 95% in more than 25 years). Also the company’s average consolidated portfolio tenant sales productivity was $395 per square foot for the 12 months ended Sept. 30, up from $383 per square foot in the comparable prior-year period.

Based on “exceeded expectations” in the latest quarter Tanger decided to boost guidance slightly for 2019 FFO per share to $2.27 - $2.31 from $2.25 - $2.31. The balance sheet is in the best shape ever with just $16 million of floating rate debt outstanding and around $600 million available on the line of credit. Shares have returned -18.3% year to date and the P/FFO of 6.7x is around 44% below its normal five-year range. We maintain a Strong Buy.

Source: FAST Graphs

Price: $15.22

Dividend Yield: 9.33%

Payout Ratio: 64.0%

P/FFO: 6.7x

YTD TR: -18.3%

P/FFO Variance: -44.1%

RINO Score: 3.873

Source: FAST Graphs

Federal Realty (FRT) has the highest R.I.N.O. score in our retail REIT coverage spectrum. The company has a strong balance sheet that allows it to borrow at an average interest rate of 3.8% for 11 years, locking in the profitability of its redevelopment projects. More recently the company sold $100 million in 10-year bonds at an interest rate of around 2.7%, driving down the company’s cost of capital to generate impressive investment spreads.

The catalyst for growth is obvious as Federal has a backlog of around $1.4 billion in redevelopment projects (~$700 million underway now) and the company is looking to maintain around $400 million to $450 million per year of redevelopment. Considering the targeted cash yields of 7.5% and low cost of capital, Federal anticipates it can grow by around 6% CAGR, which translates into similar dividend growth.

Remember that Federal is also diversifying into categories such as apartments, office, and hotels. All are complementary categories that make Federal the perfect mixed-use landlord. While the 3.2% dividend yield may not get you excited, remember that it’s possible to double your money over the next five years. We have a Buy rating on the company now, which means that we expect shares to return in the low double-digits in 2020 and if shares drop again, we’ll likely upgrade the stock to a Strong Buy.

Source: FAST Graphs

Price: $132.07

Dividend Yield: 3.18%

Payout Ratio: 65.8%

P/FFO: 20.8x

YTD TR: +15.1%

P/FFO Variance: -11.8%

RINO Score: 4.558

Source: FAST Graphs

In closing, we believe that these three REITs represent some very attractive buying opportunities for Cyber Monday. While the threat of e-commerce remains one of the biggest risks for retail landlords, we believe that there’s opportunity in purchasing shares of beaten-down REITs that have superior scale and cost of capital advantages.

Logic is the beginning of wisdom, not the end. - Spock

Keep in mind, we consider CBL (CBL), Washington Prime (WPG), and Macerich to be higher-risk alternatives based upon the fact that their dividend payouts are under intense pressure. We aren’t optimistic that Forever 21 and J.C. Penney will generate impressive results over the holiday season, and that could result in further store closings.

While many of the bulls view these REITs under the “glass is half full” scenario, we must maintain caution during one of the most challenging retail cycles in modern history. Cyber Monday should hit record sales today, and this validates the argument that weaker retailers will not survive.

In our quest for “survival of the fittest” retail REITs we are standing by the names that are best capitalized, and that includes their dividend payouts. Now is not the time to be the hero when it comes to picking retail REITs, especially mall REITs. Cyber Monday is an indication that e-commerce is critical to the omnichannel and the retailers that are not performing well are likely because that are being disrupted by the ultimate retail disruptor.

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We wish everyone a safe and happy holiday season, and as Spock reminds us,

Live long, and prosper. - Spock

Author's Note: Brad Thomas is a Wall Street writer, which 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: Written and distributed only to assist in research while providing a forum for second-level thinking.

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