Shopping Center REITs have been a focus for me lately. The higher-risk portions of my active-investing portfolio are discussed in The RPD 2020 Active-Investing Retirement Portfolio.
Now it is time to build out the portfolio with investments from other economic sectors, some of which should be in defensive and blue-chip names. This past week’s market plunge makes it even a better time to look toward finding bargains on blue-chip stocks.
For broad stock exposure, some of my funds are in the Dividend Aristocrats, via the ETF (NOBL). Amongst REITs, the grocery-anchored shopping center REITs are widely considered to be a defensive sector, since people still need groceries during recessions.
Since 2010 Regency has sold nearly $100 million of properties and acquired more than $200 million. By selling off "non-strategic" assets, Regency reinvests capital back into centers that meet high-quality standards.
Yet when comparing the investor presentation by REG to the slide deck for the renowned, blue-chip, shopping-center REIT Federal Realty Trust (FRT), some things bothered me. Here I will take you through my observations and thoughts. In the end, my conclusion is that REG is likely to do well as a total return vehicle, subject to market fluctuations as always. But I would not choose REG for dividend growth investing ("DGI").
A Trip Through Happy Face Slides
The information and material in this section is drawn from the Q4 2019 Investor Presentation. We soon learn that REG was founded in 1963, has 419 properties, and that over 80% of them are grocery anchored (Figure 1).
They are located along the coasts, in Texas, and in a few other cities. They get >25% of their Net Operating Income ("NOI") from California, and >10% from each of Florida, New York, New Jersey, Connecticut, and Massachusetts.
Figure 1. Among other high-end grocers, Wegmans is a major tenant of REG.
REG maintains 22 local offices to get “boots on the ground”. They do self-funded growth and recycle their portfolio to improve its performance.
They boast of their 4% CAGR dividend growth rate since 2014. They show that they have payed out 70% to 75% of AFFO as dividends since 2016.
As Figure 2 shows, their balance sheet numbers look quite good, and support their solid investment-grade credit rating. Leverage on equity is low, and the fixed coverage ratio, at 4.3x, is excellent. Though not in the slide deck, their Debt to Assets, at 26%, is also excellent.
Figure 2. Aspects of credit and balance sheet.
REG claims to be variously high-quality, astute, sector-leading, best in class, and to have a strong brand and culture. These are nice claims, made on a very pretty slide. Most of their management team has been with REG for more than 20 years.
A key slide (Figure 3, page 19 of the presentation) shows the investor how REG intends to deliver superior returns.
We find evidence that they have achieved these goals in the five years from 2014 through 2019. It is worth showing, in Figure 4, the dividend track record that they provide.
We also see ample evidence of their work to increase both Net Asset Value (“NAV”) and NOI by active redevelopment spending averaging about $250M per year. Note again that this is internally funded.
REG has a wide range of excellent tenants. The public tenants having the largest share of Average Base Rent (“ABR”) all have investment-grade credit ratings.
Well, aren’t you ready to run out and buy this stock? Everything sounds so great, doesn’t it? The perfect DGI stock, it seems. But stay tuned ….
What is Missing or Of Concern
As is typical, the slide deck provides lots of self-praise for undocumented sorts of excellence. This is persuasion 101. One uses positive terms to bring the listener emotionally on board, thereby screwing up their ability to think. I find this particular presentation worse than some but far from the worst I have seen.
The major thing that bothered me about the slide deck is this: Except for the founding date (1963) and the long tenure of several executives, from this presentation the company could be only SIX years old.
I have been publicly critical before of financial firms who pretend that nothing existed before 2009, and so always show results that look great. REG shows nothing at all about any year before 2014. This is, at best, somewhat sleazy. Let’s look further.
A next clue is to consider this. REG has a market cap of $9.6B on Feb 28, 2020. Their total asset value is $15.7B. Their Debt to Assets is low. These numbers are in the range of the A- rated REITs. Yet their credit rating is only BBB+. This strikes me as strange. It should seemingly be higher.
Then, if one looks closely at page 26 of the investor presentation, one sees the material shown in Figure 5. The grocery sales were flat from 2015 to 2017 and are only up about 10% total from 2013 to 2018. This seems like not so much growth.
Figure 5. Total grocery sales by REG tenants.
All this leads to wanting to look further. And it leads especially to wanting to look back more than six years.
A Longer Look Back
As I looked further at the historical data on REG, I suspected I might find something pretty ugly. To the contrary, I found that they have done pretty well in many respects.
REG turns out to have done well at price appreciation. They have done much better in fact than their current “strategic objective” of 4% growth.
Figure 6. Long term returns from REG. Source: author calculations.
Figure 6 shows returns over two intervals. On a long-term basis, REG has generated a stock-price return near 6%. Total return has exceeded 10% over 25 years and approached 8% since 2010.
One can also look at growth in NOI, which is of course more fundamental than stock price. Approximating NOI before 2011 as Revenues less Operating Expenses plus Depreciation & Amortization, one finds the following. The CAGR of NOI from 1995 through 2018 is an excellent 16%. During the difficult decade from 2008 through 2018 it is 10%.
These NOI numbers are quite solid, and suggest that the price return should be somewhat larger than it has been. It is helpful to look at the long-term price chart. Figure 7 compares the long-term price of REG with that of FRT.
Figure 7. Ycharts plot of REG and FRT stock prices from 1995 to the present.
This is really interesting, isn't it? Overall, both follow the same trends as the market has become more or less enamored of shopping centers.
In detail, REG tracked FRT very closely until the Great Recession. But they fell further at that time. Since then, REG share prices have only doubled while those of FRT have tripled. Much of the difference lies during the years from 2010 through 2015, left out of their presentation.
We can get more clues by looking at dividends. Figure 8 shows the full history of dividend payments by REG as a REIT. Remarkably, the dividend has never moved far from $2 per share, even as the stock price has more than tripled. In detail, the dividend yield ran well above 5% in the roaring 90s and has been closer to 3% during the past few years.
Figure 8. History of REG dividend payouts. Source.
One also sees that REG has cut the dividend in each of the past two recessions. They cut it in 2001 and again in mid-2009.
After the Great Recession, REG struggled to get back to dividend growth. BlueCut Capital provided a negative take on them in this article from early 2010:
The development pipeline now represents 18% of gross real estate assets, nearly 3 times that of its peers. With bad debt reserves from tenants continuing to grow, Regency will face cash flow problems that only a strong rebound in the retail sector will solve. Unfortunately, that is not going to happen.
The article was in many ways too negative, stuck in recency bias about grocery-anchored retail. Sound familiar today?
Even so, generating enough growth to support increased dividends took quite a while. Brad Thomas was early in expecting growth to resume. In his 2013 article he remarked
I would expect to see an increase from Regency as the company has demonstrated that it has the capacity (payout ratio is 72%) to start growing its dividend. In addition, several of Regency's peers have been increasing its dividend.
To their credit, though, REG did not cut the dividend by a lot, sustained it after that, and eventually did return to increasing it.
Perspectives on REG as a Company and an Investment
REG portrays themselves in their slide deck like a classic dividend growth stock. This is supported by their "strategic objectives" and by selective presentation of only the past five years.
My conclusion from their long-term story is that their corporate DNA is not that of a dividend growth stock. From the start, they paid too high a dividend to be able to sustain it even through the comparatively mild recession of 2000.
After that, REG again grew their dividend too fast, and also managed their balance sheet in a way that led to another cut during the Great Recession. On the one hand, they did not cut the dividend very much compared to many of their peers. On the other hand, they did not cut the dividend far enough to be able to grow it steadily after that.
I want to emphasize that I in no way object to these choices. REITs are good vehicles for firms that pay out substantial dividends, grow less than they might otherwise, and perhaps make modest dividend reductions in recessions.
However, I personally would not tend to describe REG as a SWAN stock. One does not have to give up much yield to go into FRT, which clearly is.
A holder of REG seems likely to get steady dividends, perhaps growing. That holder also seems likely to reap long-term price returns, though as with any stock this may require waiting out market cycles and tantrums.
At the moment, some extra appreciation in the stock price seems likely over the intermediate term. This will have to wait while the market gets over the flu and, more importantly, realizes that the so-called “retail apocalypse” is not going to threaten the viability of this type of retail.
Not being centrally focused on DGI and not being a SWAN-only investor, I did put a little bit of REG into my portfolio last week. But I bought twice as much FRT.
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