Federal Realty Is Facing The Pain, But Offers Attractive Value

Summary

• Federal Realty collected ~53% of total April 2020 billed recurring rents, driven by low collections from retail tenants.
• The company has the ability to make it without resorting to a dividend cut, defending its track record of 52 consecutive years of increased dividends.
• This is in part due to its very strong balance sheet ($995M of cash), with Debt to Total Market Cap ~25% and Net Debt to EBITDA ~5.5x.
• Federal Realty's properties are best-in-class, becoming more and more mixed-use neighborhoods.
• Federal Realty is a blue-chip company on sale.

Federal Realty (NYSE:FRT) is a high-quality, blue-chip, retail-oriented REIT, with properties ranging from grocery-anchored shopping centers to large-scale mixed-use neighborhoods. In addition, 20% of ABR (annualized base rent) comes from office and residential (over 2,700 residential units). The breakdown is as follows:

Source: COVID-19 Business Update - May 6, 2020, slide 2

Unfortunately, the company is feeling the financial pain caused by the coronavirus, with shares down ~40% YTD:

Data by YCharts

As of May 1, the company collected ~53% of total April 2020 billed recurring rents, driven by low collections from retail tenants. Specifically, the company collected only 45% collections from retail tenants versus 87% from office tenants and 95% from residential tenants. The worst-performing segments in terms of rent collections are as follows:

• Fitness (4% of ABR, 5% collections)
• Experiential Tenants (2% of ABR, 13% collections)
• Houseware & Furnishings (5% of ABR, 14% collections)
• Full Price Apparel (8% of ABR, 16% collections)
• Restaurants (15% of ABR, 27% collections)

This is no surprise due to nationwide lockdown measures. It is also no surprise that Grocery & Drug was the best performing category (9% of ABR, 100% collections). Other top performing categories include Banks/Financial Services (4% of ABR, 99% collections) and Communications & Home Office (4% of ABR, 90% collections).

It all boils down to sector-specific exposure within retail. Not all retail real estate is the same. There is a big difference between different categories, ranging from grocery-anchored centers to malls to experiential properties. In this respect, some companies are more lucky than others. For example:

• Realty Income (O), which focuses on defensive sectors, collected 82.9% of contractual rent due for April
• EPR Properties (EPR), an owner of experiential real estate (theaters, ski resorts, museums, marinas, etc.) collected only ~15% of April contractual base rent and mortgage payments
• The Forbes Company, a private owner of luxury malls, collected just 19% of rents in April, and expects that number to drop further in May.

It is fair to say that REITs with high exposure to retail, especially restaurants, apparel, fitness, and experiential, are amongst the worst-hit.

The good news is that FRT declared its $1.05/share quarterly dividend, in line with previous. So far, my take is that the company will make it without a dividend cut, defending its track record of 52 consecutive years of increased dividends (the longest record in the REIT Industry!).

Source: Investor Presentation

The company also benefits from a strong and flexible balance sheet with $1.4Bn of liquidity in cash ($995M) and undrawn availability under its revolving credit facility. Debt to Total Market Cap is just ~25% and Net Debt to EBITDA low at ~5.5x. In fact, FRT is one of only six “A” rated REITs (Moody's: A3 Stable, S&P: A- Stable, Fitch: A- Stable).

As the CEO mentioned during the Q1 2020 earnings release:

Our company went into this pandemic in a very strong position both from an operating and balance sheet perspective and fully expect to emerge retaining our market leadership position given our superior real estate and financial liquidity and flexibility.

Like other companies, due to uncertainty regarding the COVID-19 pandemic, FRT withdrew 2020 guidance. Again, my take is that the company will make it without a dividend cut, supported by its strong balance sheet, best-in-class properties and expectation that more rents will be collected going forward. Following the Q1 2020 results, the market is responding positively:

Source: Seeking Alpha

That said, one must be mindful of the complex and rapidly evolving situation around the COVID-19 pandemic. As of May 1, 2020, even though all 104 FRT properties are open and operating (good news), not all commercial tenants are open and operating (bad news). In fact, only ~47% of FRT's commercial tenants are open and operating (based on annualized base rent). Therefore, all eyes are on the remaining commercial tenants that are not open and operating. Today, after many weeks of nationwide lockdowns, there are some encouraging signs as states start to reopen. The success and pace will depend on recommendations and mandates of local/state governments and health authorities. I have no doubt that FRT will do whatever it takes to support its remaining retail tenants in reopening, but there might be a second wave of coronavirus (potentially more) and we might experience setbacks in lockdown lifting measures. It's a complex process and it takes time. As such, one must be cautious and disciplined, as it will be a rough and volatile ride, and the situation is far from "business as usual." Ultimately, a medical problem requires a medical solution. Being mindful of the risks, I believe that today's dividend yield of ~5.5% offers attractive value (supported by a low dividend payout ratio - as % of FFO - of 65%), with strong capital gains potential. I will refrain from adding more, for now, except if we experience large selloffs.

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