Rent Will Be Paid, And Site Centers Will Come Back

Summary

• SITC collected only 50% of April rent.
• Its balance sheet is much more resilient than first glance, especially when considering the GAAP rules surrounding the covenants.
• SITC is very cheap at 5 times 2019 FFO - Wall Street is not appreciating the strength of its balance sheet or the resilience of its portfolio.
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Site Centers (NYSE:SITC) was one of the first shopping center REITs to report earnings since COVID-19 hit and, like peers, at times had to respond to analyst questions regarding future outlook with “I don’t know.” SITC collected 50% of April rent, but noted that certain well-capitalized tenants are choosing not to pay rent. SITC has suspended its quarterly dividend, which at first glance may be a sign of distress, but the company maintains strong liquidity with minimal near-term debt maturities and plenty of breathing room in its covenants. While it may be a while before SITC is able to return to “business as usual,” I believe that its strong balance sheet and quality portfolio should enable it to emerge from this mess mostly intact and deserving of a dramatically higher share price. I reiterate my buy rating.

COVID-19: What’s Open And Who’s Paying Rent?

SITC executed on a strong first quarter with SS NOI growth at 3.7% excluding redevelopments. I don’t think anyone cares about pre-coronavirus numbers, so let’s get right to business.

SITC noted that 49% of tenants are open (based on ABR), with 56% of tenants deemed essential. SITC breaks out the sectors which are open below:

(2020 Q1 Presentation)

On the conference call, SITC stated that “generally the tenants that are open are paying rent. Tenants that are closed are not paying rents.”

SITC has received 50% of April rent. 12% of the unpaid rent was from local non-credit tenants. SITC has offered 98 deferred rent payment plans primarily to local shops, totaling 1.9% of second quarter rent, with the expectation to receive the rent after 3-6 months. Local shops make up 7% of total rent.

SITC did note that there are some tenants who clearly can pay rent, but aren’t. For example, on the conference call they mentioned “a grocery store that does over $100 million in gross sales ask for rent assistance and they've been open. They haven't closed a day.” In regards to these tenants, SITC was clear in their expectation that rent will be paid.

“Our standard lease language is clear on payment obligations and specifically state that rent must be paid even if a tenant is not able to remain open. After all we continue to pay our property taxes, pay for life safety and maintenance expenses and property insurance costs. We are working with select tenants to defer rent where there's an economic return to Site Centers but we expect to enforce our legal contracts with respect to the obligations of the remaining tenants.”

Analyzing The Covenants

SITC disclosed that it had $514 million of cash on its balance sheet as well as $325 million of further liquidity available under its lines of credit. SITC’s balance sheet was conservatively leveraged with debt to EBITDA standing at 5.3 times based on first quarter cash flows (6.2 times including preferred stock). SITC noted that their current cash burn is around $12 million based on 50% collected rent, and that “mid-60’s” would be their break-even point. This implies that barring an extended period of zero rents, SITC has enough cash on its balance sheet to fund any cash flow shortfalls.

With shares trading at low single-digit multiples of FFO, you’d think that SITC was at immediate risk of violating its covenants. That isn’t the case. SITC emphasized that cash flow covenants use GAAP, not cash revenue. This is critical because it means that deferred April rent still counts as April revenue. Furthermore, I should note that typically the most strict covenant, debt to assets, is not such an issue because in SITC’s case, asset value is defined using undepreciated assets, which does not decline if cash flows decline:

(2020 Q1 Presentation)

Instead of looking at collected rent, those worried about breaching the covenants should instead see if SITC increases its bad debt reserves moving forward, as that would imply that they aren’t able to collect deferred rent (thus impacting GAAP revenue). On the conference call, SITC indicated that this isn’t yet a predicted issue:

“We did have increase in bad debt versus our budget and took some reserves on some tenants that have receivables, excuse me, we were worried about. On a go-forward basis, I think you're going to see less variability in bad debt over the course of the year then you will just simply see tenants go on cash accounting or the cash basis of accounting.”

While their balance sheet implies disaster, close analysis of the covenants suggests otherwise. SITC can be very patient and perhaps even issue additional debt if opportunities for external acquisitions present themselves.

Minimal Lease Expirations

One issue which may differentiate SITC from peers is their minimal lease expirations in 2020. Because SITC already signed renewal leases for tenants with expiring leases, it now has less than 2% of rent expiring in 2020. Aside from outright bankruptcy, the only real risk to revenues would be needing to renew or replace tenants with new leases paying less rent. In SITC’s case, this won't be an issue.

Dividend Cut Is Good Long Term

SITC suspended the second quarter dividend. SITC noted that based on their 2020 first quarter dividend and 2019 4th quarter dividend should be enough to account for all required dividend payments for 2020, based on their projections for taxable income. While investors would appreciate being paid, from a financial perspective, a dividend cut is very prudent and can even create long-term shareholder value. If SITC is able to use retained cash flows to acquire distressed properties for pennies on the dollar, then that would create more value than dividends paid during these times of crisis.

Share Repurchases Not On The Table... Yet

Management was asked about their intentions for share repurchases on the conference call. SITC did repurchase $7.5 million of stock at an average price of $9.18, but that looks to be a one-time deal. Management noted that the fact that they have drawn from their line of credit should imply their defensive nature, and thus they are not considering share repurchases at this time. However, they did note that given their strong balance sheet position, they would potentially be in a position to acquire distressed assets in the event of extensive vacancies.

Valuation And Price Target

SITC earned $1.14 per share in FFO in 2019, and previously paid an $0.80 per share dividend. At recent prices, SITC trades at 5 times 2019 FFO and a 14% trailing yield (I reiterate that no dividend is currently being paid out). I see shopping centers with strong balance sheets as being able to stabilize their portfolios and return to 2019 levels of cash flow within 12-18 months. My fair value estimate for SITC is 10.5 times FFO, or $12 - that implies 110% upside.

Risks

• It is unclear how many tenants will go bankrupt. SITC management did not seem so worried about widespread bankruptcies on the call, though if the US is unable to deal with COVID-19 in an acceptable manner, then it is anyone’s guess how serious the financial impact will be. If there are more vacancies than anticipated, then that would obviously delay SITC’s timeline for stabilization and potentially increase the time horizon needed to achieve the projected returns.

• While SITC’s balance sheet currently does not appear distressed, widespread bankruptcies and an overall inability by its tenant to pay rent may cause SITC to need to raise cash through shareholder dilution in order to pay the bills and/or pay down debt. There is no indication of needing to worry about this just as of yet, but a slower than expected economic recovery can cause this poor result.

• My upside scenario implies that Wall Street revalues SITC at multiples comparable to those prior to COVID-19. It is possible that Wall Street never revalues shopping centers at a healthy multiple again. In such a scenario, shareholders will need to rely on a resumption of the dividend for shareholder returns.

Conclusion

While SITC has only collected 50% of April rent, an economic recovery may improve those numbers, and it is important to note that the covenants are based on GAAP rents, not cash rents. SITC has a conservatively-run balance sheet which has room for more leverage if needed. The dividend cut may seem sour in the near term but it should “pay dividends” in the long term. Shares appear too cheap at only 5 times 2019 FFO - I rate shares a buy.

(Tipranks: Buy SITC)

Analyst’s Disclosure: I am/we are long SITC. 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.

DISCLAIMER: Julian Lin is not a Registered Investment Advisor or Financial Planner. While the information in his articles and his comments on SeekingAlpha.com or elsewhere may seem like financial advice, it is not, and it is provided for information purposes only. Do your own research or seek the advice of a qualified professional. You are responsible for your own investment decisions.