Seeking Alpha

The Macerich Company: Mall REIT Purgatory

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About: The Macerich Company (MAC), Includes: BPR, BPRAP, BPY, BPYPP, CBL, CBL.PD, CBL.PE, PEI, PEI.PB, PEI.PC, PEI.PD, SKT, SPG, SPG.PJ, TCO, TCO.PJ, TCO.PK, WPG, WPG.PH, WPG.PI
by: Williams Equity Research
Williams Equity Research
Long/short equity, special situations, dividend investing, oil & gas
Summary

I don't envy the situation Macerich management and investors find themselves in. It's been a tough couple of years as the stock has declined from over $80 to below $25.

The key question is which "group" Macerich's asset and balance sheet quality is more like: Simon Property Group or Washington Prime Group.

Forever 21, Macy's, and other retailers face serious issues. Macerich has exposure and its FFO has been declining year after year.

Let's thoroughly evaluate Macerich and determine what level of dividend and leverage is sustainable. We'll use Simon Property Group as a ballast to gauge Macerich's performance.

Macerich Stock

The Macerich Company (MAC) is one we've been monitoring for years but never owned. We've always found better relative value in peers like Simon Property Group (SPG). Several subscribers owned MAC prior to joining our service and asked if we'd author research on it.

To make a long story short, Macerich is increasingly desperate to be included alongside Taubman (TCO) and Simon in the "highest quality" mall owner and operator group.

Quick Update: Prior to submitting this article to Seeking Alpha editors for review, Simon purchased Taubman. This reinforces our overarching thesis of Macerich's strong and logical desire to be in the "high quality mall REIT club" rather than among those that are considered weaker. It also indirectly supports the idea that Macerich is less attractive than Taubman. In our experience, it is almost a forgone conclusion that Simon evaluated a purchase of Macerich as well as it has done in the past. While the bulk of the article is unchanged by the announcement, we'll add in our thoughts when appropriate.

Let's explore why Macerich wants to differentiate itself from the less solidified mall owners.

Source: Yahoo! Finance

In the past two years, Simon is down only ~10% (remarkably) so investors have an approximately flat total return. With its $2.1 billion market capitalization, much smaller Taubman has held up better than most in this segment but is down about 35% including dividends over the same period. Update: due to the proposed Simon deal, Taubman erased all capital losses due to the "Retail Apocalypse" of the last two years and generated a single-digit annual return for investors thanks to its dividend. This compares to Macerich's 60% decline meaning investors have about half the money they started with including dividends. Macerich's stock has not responded to the Simon/Taubman deal; this reinforces our thesis that while Macerich has several very high quality assets on its balance sheet, the attractiveness of the overall firm is significantly lower than Taubman. We are aware there are similarities on certain operating metrics which we'll cover at length.

Let's look at Macerich through a different lens.

Source: Yahoo! Finance

Compared to CBL & Associates (CBL) and Pennsylvania REIT (PEI), Macerich doesn't look so bad. Washington Prime Group (WPG) did better at -52.50% in the last couple of years but its long-term chart is not pretty with most equity value evaporated.

Source

The $1,000,000 question is if Macerich resides near the top of the bottom or the bottom of the top. Why? The market believes only the top quality mall/retail oriented REITs will still be around in 10 to 20 years. Given the stock market is forward looking, the losers will not survive for close to that long.

At the same time, investors know that mall/retail REIT valuations are too low (e.g. Tanger (SKT) and Simon Property Group) but are wary of picking a company that might not see the other side of this storm. The strategy of the last couple years, and with growing intensity, is to avoid what are perceived to be the weaker firms at all cost.

Macerich Portfolio

Source: Macerich Q1-Q3 Report

That reality is precisely why Macerich has a column in their Q4 report comparing Macerich to SPG and TCO and not CBL, PEI, and WPG. While there is cherry picking occurring on behalf of management, many aspects of MAC's portfolio and operational performance are closer to that of its highest quality peers. Macerich has taken many actions in recent years to reinforce the idea it belongs to the "A Team." For a little history lesson, Simon tried to buy Mace Siegel and Richard Cohen's company back in 2015 for $16.8 billion. Today's market capitalization is approximately $3.6 billion for context.

Macerich raised $1.8 billion over the past six years through its capital recycling program. The strategy disposed of lower quality properties in less favorable secondary and tertiary markets.

Source: Macerich Q1-Q3 Report

Many of these properties, including 16 Sears stores, resembled those of Washington Prime Group or CBL rather than Simon. Macerich was likely wise to cull exposure to dying department store giants. It has more work to do but the stock's losses would be magnified even further if it had held on to all those assets.

Source: Macerich Q1-Q3 Report

Notice Macerich's trends in sales per square foot and average base rents. Outside of 2016, these metrics have generally moved in the right direction. These results come with asterisks that we'll touch on later.

Source: Macerich Q1-Q3 Report

Occupancy has stayed relatively consistent since 2014 though Q4 suffered a drop back toward recession levels of ~92%. Simon's also dropped a couple hundred basis points to ~95% so it was expected given the environment.

Source: Macerich Q1-Q3 Report

Macerich touts similar same-store net operating income trends as Simon and actually bests Taubman by 700 basis points in the above diagram. We've seen this chart several times in other SA authors' work on Macerich. But do not forget our premise: Macerich is determined to be compared to the best of breed REITs. The dates chosen in this September 30, 2019 investor presentation are not by chance.

Here is the actual data from the last two years.

Source: Macerich Q4 8-K

Do you see material growth in Same Center performance? We do not. Assuming the 3.9% Same Center growth figure provided by Macerich is accurate, it is heavily weighted to 2013 through 2017. I don't know about you, but we are much more interested in what happened in the last two years than what happened between 2013 and 2017 when the "Retail Apocalypse" was barely on the radar. Simon is projecting 2.0% Same Center NOI growth for 2020 while Macerich is guiding approximately flat to up 100 basis points. We expect it'll come in around +50 basis points if the economy continues to hold up well. Average rents have done better and rose 3.3% from December 31, 2018 through the end of 2019.

Macerich's operating and portfolio metrics are not as solid as management's presentations and commentary suggest, but the data reviewed thus far is closer to "high quality" peers like Taubman and Simon than the likes of CBL and Washington Prime Group.

Source: Macerich Q1-Q3 Report

While Macerich has made progress, it still maintains significant exposure to Macy's (NYSE:M) and J.C. Penney (NYSE:JCP), both of which continue to close stores and experience solvency risk long term. Here are useful specifics from the recently released Q4 10-Q (emphasis mine):

Sears

On October 15, 2018, Sears filed for bankruptcy and announced additional store closings. At the time of the bankruptcy filing, the Company had twenty-one Sears stores in its portfolio totaling approximately 3.1 million square feet and accounting for less than 1% of the Company's total leasing revenue. The twenty-one stores included seven owned by the Company, nine owned by the Company's joint venture with Seritage Growth Properties ("Seritage"), one store that was owned by Sears and four stores that were owned by Seritage. Although, in the short-term, the bankruptcy of an Anchor such as Sears may lead to lost base rent and the triggering of co-tenancy clauses, there is also the potential to create additional future value through the recapturing of space and releasing that space to new tenants at higher rent per square foot, which the Company has demonstrated through its joint venture with Seritage and the completed redevelopment of a former Sears store at Kings Plaza Shopping Center in July 2018.

As of September 30, 2019, the Company recaptured ten Sears locations, including seven through its joint venture with Seritage, through formal lease rejections and lease terminations. The Company currently anticipates aggregate redevelopment investments at these locations of $130.0 million to $160.0 million (at the Company's pro rata share) over the next several years. New tenants are expected to open at several projects in late 2020.

Forever 21

On September 29, 2019, Forever 21, Inc. filed for Chapter 11 bankruptcy. At the time of the bankruptcy filing, the Company had 29 Forever 21 stores in its portfolio totaling approximately 1.2 million square feet. As of December 31, 2018, Forever 21 stores represented 2.5% of total minimum and percentage rental revenues of the Company. The Company is in ongoing discussion with Forever 21 regarding the status of those stores. Based on a court filing dated October 28, 2019, the Company expects that four of the Forever 21 stores will close, three of which are owned by the Company (Danbury Fair Mall, Arrowhead Towne Center and Pacific View), and one of which is not owned by the Company (Vintage Faire Mall). The Company anticipates that it may provide certain rent concessions in connection with a number of the remaining stores.

These issues make turning the corner in 2020 or even 2021 difficult. While the Simon deal to keep Forever 21 afloat is good news for all mall operators, the fine print in the filings confirms that significant rent reduction and or store closures are expected. Macerich is vulnerable and losing 2.5% to its occupancy to Forever 21 will be painful from a cash flow perspective. Macy's reports on February 25th with JCP two days later. We have valuable insight from Macy's investor day that just occurred on February 10th.

Store Closures and Staffing

The company completed a rigorous evaluation of Macy's store portfolio. This included a store-level assessment of each store's overall value to the fleet, including predicted profitability based on consumer trends and demographics. As a result, Macy's plans to close approximately 125 of its least productive stores over the next three years, including approximately 30 stores that are in the process of closure now. These approximately 125 stores currently account for approximately $1.4 billion in annual sales.

This new information does not bode well for Macerich and others with significant exposure to large department stores. We don't know precisely how many of Macerich's 38 Macy's stores will be negatively impacted, but based on Macy's own guidance, it's safe to say there is a significant risk that a double digit number could translate into further losses in FFO. As far as we can tell, Macerich does not break down tenant concentrations as we looked through 8-Ks, 10-Qs, 10-Ks, investor presentations, or any supplements filed since the start of 2018 and were unable to locate them.

Macy's does provide significant detail and 110,000 square foot per store is a good estimate. J.C. Penney's average store size is very similar resulting in approximately 3 million square feet in exposure for Macerich. It could be as much as 30% larger given the type of stores in the portfolio which are primarily in malls. That results in roughly 6% of Macerich's 51 million square feet portfolio allocated to J.C. Penney and Macy's, approximately 1% exposure to Sears, and the aforementioned 2.5% to Forever 21. At minimum, 9.5% of Macerich's portfolio by square feet consists of extremely weak retailers that are publicly shuttering stores and or going through a restructuring process.

That excludes organic store closures and other struggling retailers.

With that, let's move on to the financials.

Macerich Financial Position

Source: Macerich Q1-Q3 Report

Macerich produced a useful report dated September 30, 2019. Not once was actual or percentage changes in FFO/AFFO/MFFO or one of those figures on a per share mentioned. It's not coincidence what is included and excluded from investor presentations. For that, investors need to look at supplemental filings which is where we extracted most of the information used in this article.

Macerich notes that the "Consensus NAV per Share" is $52; Friday's close represents 44% of this value. The average loan duration of 5.0 years is on the short side but is not alarming. The interest coverage ratio of 3.1x, however, is problematic. Its higher quality peers are in the ballpark of 5.0x and includes Simon.

Source: REIT.com & S&P Global

This is a helpful visual representation of our concerns. There are very few (<15%) publicly traded REITs with worse coverage ratios than Macerich. Prior to the Great Recession, shown in light blue bars, were common. You can take a wild guess how that turned out. We can't realistically expect it to be any different the next time the economy experiences a substantial slowdown. Better structured REITs, such as Simon, Realty Income (O), W.P. Carey (WPC), and most other favorites of Seeking Alpha's REIT community, have categorically transitioned toward much improved coverage ratios as shown above.

The 12.9% of the capital stack that was floating rate debt in mid-2019 declined to 8.5% by year end. This remains higher than its top quality peers, which are at or close to 0%, but is not at precarious levels. The 50% loan-to-value ("LTV") is middle of the road. That figure is probably one of the least understood by investors and most misleading regarding Macerich's financial situation. Property level loan-to-values is only one of several ways REITs' financial risk must be analyzed.

Source: Macerich Q1-Q3 Report

Macerich's leverage is way too high. At nearly 9x, this is nearly double its highest quality peers. Simon is consistently in the 5.0-5.5x range for context. Management is clearly cognizant of this and is projecting leverage falling to 7.8x by the end of 2022. This chart made me laugh; notice the scale on the left starts at 7.5x and ends at 8.7x. With a typical linear scale, the decline in leverage over the next few years would barely be noticeable. It's unwise to put too much faith into management's projections given the difficult situation Macerich finds itself.

Source: Q4 2019 8-K

Note the highlighted figures above; debt as a percentage of Macerich's total market capitalization has increased just over 50% since 2017 to 66.4% as of the end of 2019.

Source: Macerich Q1-Q3 Report

Macerich's 3.93% weighted average interest rate is compelling on its own and especially so given the REIT's overall financial situation. It's also a problem; 2021 and 2022 represent large chunks of the maturity schedule and we have serious concerns regarding Macerich's ability to refinance at similar rates. The REIT does not have firm level covenants since it applies leverage at the asset level, but we have clues from a 2016 filing on the line of credit. If the sentiment in retail real estate continues to sour and or a light recession occurs, it's not going to be easy to refinance the debt and loan facilities. Even with rates retreating, it's going to be nearly impossible for Macerich to avoid increased borrowing costs given its deteriorating risk profile. The catch is going to be if it is 25 or 125 basis points higher.

Source: Macerich Q1-Q3 Report

Macerich states:

We expect to have ample liquidity over the next few years from a combination of AFFO/cash flow generation, net proceeds from debt financing, revolver capacity and cash on hand.

Macerich is transparent about the fact it will have to tap its revolver and the credit markets to fund its dividend and development plans. That dividend, by the way, is underwritten by Macerich's own management to remain the same through the end of 2022 in the above illustration. We give them credit for not assuming growth as that's responsible.

Q4 Highlights & FFO Estimates

The latest supplemental to the SEC filing provides valuable data on Q4.

• Mall tenant annual sales per square foot for the portfolio increased by 10.3% to $801 for the twelve months ended December 31, 2019, compared to $726 for the twelve months ended December 31, 2018.

• Mall portfolio occupancy was 94.0% at December 31, 2019, compared to 93.8% at September 31, 2019 and 95.4% at December 31, 2018.

• Leasing volumes remain strong, with 2019 volume up nearly 20% over 2018 volume.

• Average rent per square foot increased 3.3% to $61.06 at December 31, 2019, compared to $59.09 at December 31, 2018.

• During 2019, the Company completed over $2 billion of financings at an average interest rate of 4.0% and an average maturity of 9.3 years, yielding $560 million of excess loan proceeds and liquidity at the Company's share.

You have to dig a little deeper than normal to find useful FFO figures from Macerich's filings and reports.

Source: Macerich Q4 2019 Earnings Supplement

Here we find FFO per share of approximately $3.45 expected for 2020. Let's take a step back to guidance for 2019.

Source: Macerich Q4 2018 Earnings Supplement

The midpoint of 2019's guidance was 7.0% higher than 2020's.

Source: Macerich Q4 2017 Earnings Supplement

The midpoint of 2018's guidance was 7.6% higher than 2019's. 2019 generated fully diluted per share FFO of $3.58 which was a 5.4% decline from 2018.

Macerich is in decline. Not only is its cash flow per share decreasing year after year, but spending on redevelopments has increased due to issues with tenants like Sears. This results in an increasingly stressed financial condition and heavier reliance on dispositions.

Calculating Margin For Error

Starting with interest expense, Q4 2019's came in at $48.0 million.

Source: Q4 2019 8-K

Total revenues last quarter were $241.8 million. Subtracting all cash costs except interest and taxes (~EBIT) leaves the firm with $143.6 million to work with. Now we see where the claimed 3.1x fixed charge coverage ratio (143.6/48.0=3.0x for Q4) comes from.

Macerich is one unexpectedly bad year from a lowly 2.0x fixed charge coverage ratio.

The 2016 8-K is the only document on SEC.gov outlining covenants on the line of credit. Remember that Macerich uses asset level financing so there are no covenants on bonds unlike most of its peers. This almost certainly contributed to Macerich taking on far too much leverage. (2) and (4) cited above could be problematic in the next 12-24 months if MAC's financial condition worsens but none are a very near-term concern. The other items do not currently generate concern.

After covering interest expense, remaining quarterly cash flow based off Q4's numbers is $95.6 million. The $0.75 quarterly distribution paid on approximately 152 million shares equates to a payment of $114 million. We include expenses associated with the Chandler Freehold arrangement; Macerich decided to exclude these expenses starting in Q1 2018 which pushes FFO per share higher by approximately 3.0%.

The picture is not rosy and we haven't discussed redevelopment costs which are estimated as another $650 million in the medium-term and $300 million+ in the next two years. Like dividends, these must eventually be paid for with cash flow (interest and principal). We use that specific terminology because Macerich plans on using debt financing to fund a portion of the costs.

Valuation & Conclusion

Macerich has many portfolio quality and operational characteristics in line with its higher quality peer group including Simon and Taubman. The market is discounting its Class A properties versus the competition no matter how you aggregate the data. Simultaneously, it has the leverage profile and distribution coverage issues of its weaker brethren.

After accounting for continually decreased FFO projections, a worrisomely low fixed charge coverage ratio (3.1x), and elevated leverage ratios (>8.4x net debt to EBITDA), it's no surprise Macerich's stock price is suffering. Depending on how economic future borrowings and asset dispositions are, it is theoretically possible for Macerich to walk a very thin line and maintain the current dividend. That's investing on hope and hope is not a strategy.

If the firm maintains its distribution, it will not enable the firm to de-risk its over-levered balance sheet quickly enough. It also risks Macerich finding itself in the unenviable situation where covenants on the credit facility are violated. In recent quarters, 50-65% of the dividend has been necessary due to the 90% taxable income rules applicable to REITs. In other words, the most management can responsibly cut the dividend is the remaining 35% to 50% assuming past data is appropriate going forward.

In a non-existent perfect world, Macerich's board of directors should immediately reduce the distribution by the maximum amount permitted under REIT rules. The $300 million spending plan over the next couple years could then be funded primarily by cash flow and it is feasible for the firm to avoid tripping the covenants on their line of credit. A likely contributor to Macerich's irresponsibly high leverage is their use of asset-level rather than company level debt. A few firms, such as Brookfield Property REIT (BPR) (BPY), utilize this strategy successfully but most stick to the tried-and-true unencumbered asset base financing model. After the dividend cut, MAC could pay as high as $0.4875 annually though as low as $0.375 is on the table. In reality, that should not be investors' primary concern as MAC is already down over 70% in recent years and this is now a value play, not income. The real risk is if they continue on this path to the point the firm is forced to sell some of its excellent assets to Simon, Brookfield, or Blackstone (BX) at distressed prices and leaving investors with a shell of a REIT.

Given our expectation of a looming dividend cut and near certainty that the stock will sell off, we urge caution concerning Macerich. The firm trades at a similar forward FFO multiple as Tanger Factory Outlet but is materially higher risk in almost every single category (leverage, distribution payout ratio, fixed charge coverage ratio, maturity schedule, et cetera).

Source

For those looking to obtain MAC at the optimum price, history and experience suggest to wait until the dividend cut is announced. We'll be investing in firms like Simon instead but acknowledge that MAC is growing more appealing from a risk-adjusted perspective and are optimistic management will eventually right the ship.

As a final note/update regarding the Taubman deal, we think this is net bullish for Macerich but not to the extent that it changes our core thesis. The major benefit is it demonstrated the health of the capital markets in this sector; Macerich's reasonable 50% asset-level leverage means it has the potential to sell off tranches of trophy assets to the likes of Simon. That'll undoubtedly help in the short term, but in the long term it simply transforms Macerich into Washington Prime Group or CBL.

Disclosure: I am/we are long SPG, BPR, 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.