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I met up with a friend and former co-worker last week for a drink, and after catching up on work and professional changes, I asked him if he was familiar with Silvergate Capital (SI), a bank that caters to the crypto industry. I knew he follows some individual stocks and has been into some preferred shares in the past, and since I had just dabbled with a small position in Silvergate's preferred shares (SI.PA), I thought he might be curious to know about the distressed situation there. Though he wasn't familiar with Silvergate, we did share a moment crying over our drinks a little on some preferred share investments that had not worked out for us - between us we have had some big misses, including Chesapeake Energy (CHK) and Frontier Communications (FYBR). I have had some good investing success as well in preferred issues, especially Triton International (TRTN), but belonging on my list of swings and misses in preferred shares is CBL & Associates Properties (NYSE:CBL).
I won't delve into a lengthy history, but just summarize briefly for the benefit of anyone that may not know. CBL is a REIT that owned shopping mall properties that were broadly considered middle and lower tier quality locations. By 2019, the company's common shares were distressed already, and I bought some high-yielding preferred shares that year, before the pandemic, thinking there was an acceptable risk / reward. Unfortunately, the pandemic pretty much drove the final nail, and CBL declared bankruptcy in November 2020. Although I received some dividend payments from the preferred shares I had, I expected to be totally wiped out otherwise, but in fact preferred shareholders came out of the bankruptcy a year later with pennies on the dollar in the new common equity. Since I have been holding these handful of leftover common shares for more than I year, I have not really done a dive into the investment thesis of the new shares, so I think it is time to take a look whether I think makes sense to keep them, add to my position, or sell them and move on.
Description and Fundamentals
In its current incarnation, CBL owns around 90 properties in its portfolio with at least one location in 22 different states, mostly retail centers but a handful of other property types. (ie hotels and office space). While the retail properties range all over from north to south and east to west, there is definitely a higher concentration in mid-Atlantic states, such as Tennessee and the Carolinas, and in the Southwest, especially with multiple Texas locations. The types of retail properties include traditional enclosed shopping malls, as well as open-air and outlet centers.
Before bankruptcy, CBL was already getting squeezed by lower occupancy rates as retailers like Sears went under, and then essentially needing to borrow the money to pay for redeveloping some of its properties for uses other than traditional retail (such as casinos), all while its other fundamentals were getting worse. Now that the former debt has been discharged, the balance sheet looks much cleaner.
Overall, CBL is a smaller operator than it was two year ago, going from having $6 billion in gross properties as of 9/30/2020 to just $1.8 billion as of 9/30/2022. Whether those properties previously held had market values approaching their book value I don't know - I have not explored that question - but what is evident is that CBL is a slimmer outfit today. On the other side of the balance sheet, the consolidated debt has come down over the same period, from $3.7 billion to $2.0 billion, erasing a nice $1.7 billion in obligations and bringing interest expense down from $61 million in Q3 2020 to $38 million in the same period of 2022. The remaining debt is split pretty evenly between fixed-rate and variable rate facilities, with a weighted average interest rate as of Q3 2022 of 5.40%. The debt liabilities coming due in 2023 are just over $200 million, but CBL gets a reprieve in 2024 at $98 million. The real test of the debt wall comes into play in 2025 to 2027, with $813 million, $332 million and $361 million respectively.
Of course it is all well and good to see the debt and interest expense come down, but only if the new organization can support the new terms on its smaller base of working assets. So far, the trends look more promising, as revenue is fairly stabilized though still challenged, but enough to leave sufficient cash to meet its necessary operating expenses, interest, capex investment.
Revenue did come down slightly over the first three quarters last year, from $140.1 million to $136.3 million, but operating income has risen quite dramatically, from just $4.7 million in Q1 of 2022 to $12.1 million for Q3.
The board did start returning cash to the shareholders once again at the rate of $0.25 per share per quarter, or $1.00 per year. The past year was even strong enough that an additional $2.20 special dividend was required for meeting its REIT status related to distributing 90% of its taxable REIT income. The base dividend of $1.00 per year works out to a yield of 3.8% at the current share price. As retail center REITS go, 3.8% yield is modest although not absolutely unique, and I believe is a responsible starting point for sustainability in relation to investor expectations.
Assessing the New CBL's Risks and Valuation
With so much of the old CBL's shadow no longer lingering in terms of its debt burden, the question turns to whether or there is opportunity here under the radar. Clearly, there are challenges related to running a REIT of mall-style properties, as there are ongoing risks with the financial fundamentals of some key brick and mortar retail tenants; for example CBL has at least some exposure to Bed Bath & Beyond (BBBY) as a tenant. The overall exposure to any one deeply distressed retail name may be limited, but the risk that more big retail names will be under pressure between now and 2025 when the larger tranches of debt start coming due is a major investor consideration.
As of its November 2022 investor presentation, CBL had committed $42.5 million to redevelopment projects underway or recently completed, as the properties naturally adapt to changing circumstances. Many of the redevelopments are $2.5 million or less and are changing the space from one kind of retail use to another, but two of the larger redevelopments that opened in 2021 are more unique and merit specific mention. The first is a joint venture to create hotel on a former Sears parking lot site in Chattanooga; CBL will have 50% stake, and while the cost to CBL is $12 million, it is mostly in the form of the land itself, and the cash outlay for CBL will be only $1.2 million. The second one of note is a $14 million development in Houston to build a training center for HCA Healthcare (HCA) on an otherwise vacant lot. CBL owns this venture completely. These are both far more ambitious than changing a Staples store into a Nordstrom's (JWN).
On the whole, I believe CBL is taking measured risks with its plans to diversify away from such a high dependence on retail fortunes, and the right mix of retail, hospitality and healthcare could be attractive. So is it priced into the company's valuation?
Though its shares are down 10% over the last year (not including dividends), it is currently trading around $26 per share, right in the mid-range of its 52-week highs and lows.
For valuing REITs, the adjusted funds from operations [AFFO] or similar metric is usually one of the key data points relative to price, but CBL on a trailing twelve month basis is operating on a negative AFFO due to the massive impact of a net loss of ($544.8) million in Q4 of 2021. So taking instead the YTD 2022 results available through three quarters, by my rough math CBL has generated $29.6 million in AFFO: starting with a net loss of ($96.4) million, adding back in depreciation and amortization of $194.5 million, and then adjusting for gains on asset sales and capex and maintenance costs. On a rudimentary look, that would work out to $39.5 million on an annualized basis, leaving a price to AFFO of 21.1x. Relative to the REIT sector peers, this is a high multiple, but I bear in mind that my figure is a very rough estimate, and may not make the exact same adjustments as the data sourced from Seeking Alpha makes; between those caveats, the numbers may not reflect the most ideal comparisons for valuation judgments, but at least serve as a starting point for me.
Retail Mall REIT Valuations (Author's estimates and Seeking Alpha)
Comparing the estimated annual AFFO for CBL of $39.5 million to its fixed dividend costs is quick way to see if the estimate of AFFO was reasonable, and for CBL its regular $1.00 annual dividend would run about $32.3 million, or around 80% of the AFFO. There could be some room to increase the distribution if this estimate is close, but I expect the regular dividend to stay put for now, and special dividends paid out as needed for the near term.
Conclusion
At this juncture in the development of a new CBL & Associates, I find that while the past risks were largely cleared out in bankruptcy, at a great cost to the earlier shareholders, it is not attractively valued for its risks, even with the specific risk of being over-leveraged being off the table for the moment. Although I anticipate the true yield to be higher with special dividends, however for my tastes that is too speculative of a rational to consider it for a buy. My plans for the time being are just to hold the few shares I managed to salvage and continue to watch how the new CBL does. I will be open to reconsider as more information becomes available, but I am content to stay on the sidelines for the time being.
