We can avoid making similar mistakes the next time such opportunities come along.
People like to say that “a dividend cut is already priced in” to such struggling stocks.
They’re not. They never are. And I’ll be sincerely surprised if they ever will be.
I know it’s only January, but right now, I find myself thinking about March.
The ides of March, to be specific.
Everyone knows – or thinks they know – about that fateful date. It’s when 23 Roman politicians told Julius Caesar in no uncertain terms that his reign was over.
He had dared to declare himself emperor, and that just couldn’t be tolerated.
While their objections may have been valid – though they might just as easily have been nothing more than self serving – what they did spawned a long stretch of utter chaos for the nation. Known and new names alike rose up to claim power in one form or another.
And known and new names alike fell.
Octavius. Mark Antony. Cleopatra. Those are only the ones we know. There were plenty of much smaller, less influential winners and losers in the resulting mess: People who sided with the forces that would come out ahead…
And those who sided with the other end of the stick.
This January, let’s commit to getting it right. Before another one bites the dust.
A Series of Elements to Analyze
While hindsight allows for the best perspectives, that doesn’t mean we’re left completely blind in the moment.
We always have a series of elements to analyze – facts, opinions, ideas, possibilities, and probabilities – and therefore to work with. Some of them are less clear than others, it’s true.
But some are fairly obvious.
“Ide” say what happened to Julius Ceasar was more along the latter line.
I know. I know. I’m speaking from hindsight. It’s easy to look back on that once revered, then unfortunate individual, and judge him.
“If he had only done A,” I can argue from the lap of luxury, far, far removed from his situation. “If he had only avoided B or considered C.”
But truly, A and B were obvious, and C should have been considered. In its piece on the ides of March,” History.com notes how, at the time:
“Caesar was scheduled to leave Rome to fight in a war on March 18 and had appointed loyal members of his army to rule the Empire in his absence. The Republican senators, already chafing at having to abide by Caesar’s decrees, were particularly angry about the prospect of taking orders from Caesar’s underlings…
“Caesar should have been well aware that many of the senators hated him, but he dismissed his security force not long before his assassination. Reportedly, Caesar was handed a warning note as he entered the Senate meeting that day but did not read it.”
A. B. And C. I rest my case…
Right after I point out that he also had plenty of time to have contemplated such a fate.
Maybe he was too arrogant to think it would happen. Maybe he was otherwise misinformed.
Either way, he suffered the consequences of that mistake, as hindsight shows.
How the Mighty (or Not-So-Mighty) Do Fall
According to another history.com article, the plot was first hatched in winter 44 B.C., months before the deed was done. It’s very important to recognize that this didn’t just happen out of the blue.
It wasn’t spontaneous. Such major moves usually aren’t, which often gives us plenty of time to read the warning signs – and get out of the way already.
Unlike the Roman emperor.
The reason why I’m picking on poor Caesar today isn’t to gloat over someone else’s demise. In the same way, I didn’t point out the fall of a certain out-of-favor REIT in “CBL & Associates: It’s No Time to Be the ‘Hero’” late last year.
I bring and brought it all up so we can avoid making similar mistakes the next time such opportunities come along.
And believe you me, they are coming along. The signs are everywhere.
I think – I hope – that everyone has learned their lesson about CBL (CBL) by now. But everyone also should take it as a harbinger of what’s in store for certain other floundering mall REITs out there.
They’re destined for dividend cuts. Probably sooner than later too.
People like to say that “a dividend cut is already priced in” to such struggling stocks. But let me tell you…
They’re not. They never are. And I’ll be sincerely surprised if they ever will be.
Regardless, I’m not going to bet on it happening anytime soon.
The way I see it, the note’s been slipped into our hands. So let’s read it while we’ve got the chance and get out already.
In case you haven’t been following the matter as closely as you should have been, let’s discuss the details down below.
These REITS Are Likely To Cut Their Dividend
As many of my loyal readers know, I maintain bullish sentiment with regard to Tanger Outlets (SKT) and Simon Properties (SPG), while I have become much less enthusiastic with Macerich (MAC), Taubman Centers (TCO), and PREIT (PEI).
We once had buy recommendations on all of these REITs, but we have become increasingly skeptical of fundamentals as a result of the continual decline in department store earnings. As Lauren Thomas, retail reporter with CNBC explains:
“It was expected that America’s department store chains suffered through another disappointing holiday season. The category of retailers that includes J.C. Penney (NYSE:JCP), Nordstrom (NYSE:JWN), and Macy’s (NYSE:M) saw overall sales decline 1.8% from Nov. 1 through Dec. 24, according to a study by Mastercard Spending Pulse that tracked retail spending trends across all payment types, including cash and check.”
She went on to explains that “More shoppers are anticipated to have turned to retailers like Target (NYSE:TGT) and Walmart (NYSE:WMT) — which aren’t at traditional malls — for apparel, electronics, and other gifts. Many likely rung up purchases on Amazon as well. The e-commerce giant has already claimed 2019 was a record holiday.”
To be clear, it’s not just the department stores that concerns me, we have maintained underweight positioning with mall REITs and shopping center REITs (we’re now neutral weight on shopping centers), recognizing that there are still many retailers rightsizing their portfolios.
As an example, Pier One recently said “it intends to close up to 450 locations, or almost half its fleet of 942 stores, as it unexpectedly reported quarterly earnings amid bankruptcy rumors.”
Yet, the biggest difference between shopping centers and malls is that department stores (that anchor malls) are much larger, typically around 150,000 square feet (2-floors) that require substantially more cash to redevelop when a tenant vacates.
One of my attractions to outlets is that their capex requirements are much, much less when a tenant vacates. The spaces are smaller (2,000 to 10,000 sf) and provide a more generic white box solution. Similar to shopping centers, outlets provide a valuable low-cost setting for retailers that includes not only the base rent cost, but lower taxes, insurance, and maintenance.
Last year we published a research report in which we highlighted the continued rationalization of malls in the U.S. According to our research, of the 1,400 or so traditional malls in the U.S., we believe that around 700 to 800 of them could shutter. As we explained,
“This implies that 20%-30% of malls in the U.S. will close within the next decade. REIT ownership is skewed toward the upper-tier of the spectrum. And we see the three low-productivity mall REITs continuing to teeter on the edge of relevancy.
A sizable chunk of their malls is a recession away from extinction, highlighting the need for investors to be highly selective in their real estate allocation decisions.”
Now to be clear, I’m not suggesting that our downgrade of Washington Prime, Macerich, PREIT, Taubman Centers, and even Brookfield Property indicate that all of their malls are bad. In fact, that’s far from the truth.
I have visited many of the malls owned by Macerich, PREIT, Taubman, and Brookfield, and I found many of their properties attractive and highly productive. So let me provide you with my reasoning.
Seritage Growth Properties (NYSE:SRG) was created via a large-scale sale-leaseback with Sears (OTCPK:SHLDQ). One Dec. 10, 2015, Warren Buffett disclosed an 8.02% stake in the Seritage (in a Schedule 13G filing), representing 2.0 million shares valued at $70.6 million. Then in July 2018 Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) agreed to lend $2 billion to Seritage in the form of a term loan facility.
Seritage decided to stop paying a dividend last year and currently cannot cover interest on its debt. The company is essentially controlled by debt holders, as Trapping Value explains “deterioration has been so bad that in the last reported quarter, NOI covers just 66% of interest expenses.”
As we reflect on Seritage’s life thus far - as a REIT- it has been disappointing, to say the least. Shares have returned 4.0% (1% annually) since listing and that includes the $1.00 per share dividend that was generated in 2017-2019. The stock is obviously not trading on fundamentals, and I'm certain most retail investors have run for the hills.
Source: Yahoo Finance
As you may recall, CBL & Associates recently suspended all dividend payments in 2020 for the REIT’s common and preferred shares – the 7.375% Series D Cumulative Redeemable and 6.625% Series E Cumulative Redeemable shares.
We thankfully dodged that bullet, recognizing that CBL was cash strapped to pay dividends while also funding operations. “CBL was running at a 120% adjusted FFO (AFFO) common distribution payout ratio prior to the elimination of the dividend in March 2019.”
Source: Yahoo Finance
According to CNBC, “Macy's is starting off 2020 with store closures. The department store chain is shuttering 28 of its locations and a Bloomingdale's in Miami. Macy's same-store sales at the stores it owns and licenses fell 0.6% during November and December, the company reported.”
Source: Yahoo Finance
Reading the Tea Leaves…
Now, if this isn’t enough, remember that Forever 21 recently filed bankruptcy and said it plans to close nearly 200 stores (the company has 815 stores globally).
And just a reminder that Bon Ton is no longer (had around 200 stores) and J.C. Penney is estimated to report earnings on Feb. 27(just after Valentines Day on the 14th) and I can assure you that the struggling department store chain won’t be delivering candy.
Thus, after carefully analyzing all of the above referenced REITs in our coverage universe, we are making a few downgrades. But first let me provide you with a snapshot of the 2020 AFFO Payout Ratio (consensus estimates) for each REIT:
Keep in mind, the most relevant earnings metric, when it comes to analyzing dividend safety, is to utilize AFFO, hat stands for Adjusted Funds from Operations. We provide a definition below:
As you can see, many of these mall REITs are in danger of cutting their dividend in 2020. Some of them, like Washington Prime, have been unable to cut the dividend due to their taxable earnings (taking gains from friendly foreclosures), but we consider Washington Prime a leading candidate for a haircut, and we believe the company should cut its distribution by at least 50% or higher (from $1.00 to $.50 per share).
By cutting the dividend, these REITs would be in much better position, as the cheapest form of capital is the company’s retained capital.
When it comes to cutting the dividend, we believe it’s like dominoes. When Washington Prime cuts the dividend, it could entice others to follow suit. While cutting a dividend is the worst thing a company can do, most dedicated investors recognize that it’s a necessary tool since the company can benefit from retaining more cash for growth.
That’s precisely what Seritage and CBL have done… and we believe that 2020 could be “the year” in which several of these mall REITs come to terms with the cold hard reality that malls are highly capital intensive and every penny is precious for value creation.
In summary, here are our updated recommendations for these mall REITs. We suggest that you consider the three harbingers that we have provided, and pay very close attention to the overall safety of the dividend.
Washington Prime: Super Strong Sell
Brookfield Property: Spec Buy
Macerich: Strong Sell
Tanger: Strong Buy
Simon: Strong Buy
Stay tuned for "My Top 10 REITs To Own Over The Next Decade" (see it first on iREIT on Alpha).
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.
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Disclosure: I am/we are long SPG, SKT, BPY. 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 referenced Lauren Thomas in the article and she is a direct relative.