Great Value in Retail REITs
Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Kimco Realty (NYSE: KIM) and Macerich (NYSE: MAC) are retail real estate investment trusts (REITs) specializing in shopping centers. REITs buy, sell, lease, and manage buildings for profit. Companies functioning as REITs must distribute 90% of their taxable income to shareholders in the form of dividends.
Due to the fact that they give out so much money as dividends (thereby hampering their growth, as that money could otherwise be used to invest further in the company), I usually treat REITs as income investments. Kimco and Macerich, however, have some great growth opportunities over the next few years.
A quick note on methodology
In this article, I avoid comparisons with Simon Property Group and General Growth Properties, which primarily or exclusively own and operate mall properties. In my opinion, malls and shopping centers are different retail property types (for example, shopping centers often have grocery stores as anchors, while malls rarely do), so I worked to avoid lumping them together.
Kimco is making good portfolio re-positioning decisions right now. It recently acquired a partner’s stake in 70 high-performing shopping centers (with 96% occupancy), while management also divested from several properties in Mexico. Kimco’s Mexican portfolio under-performed in terms of both income and occupancy compared to the American and Canadian portfolios, so I view this divestiture as a good move.
Management’s new investment strategy is to purchase and consolidate ownership in large, stable shopping centers in areas with high median incomes while selling older, under-performing properties in secondary and tertiary markets. This will position Kimco well for future profits.
Macerich has focused on redeveloping properties in densely-populated markets to assure that its properties capture a large market share. Management anticipates annual returns of 8%-10% for these redevelopments. About 63% of Macerich leases have increases chained to the consumer price index (CPI), which will limit the damage inflation does to net operating income by stepping-up the leases with the inflation rate.
Macerich also has big plans to construct a 22-story Class A office tower, new luxury apartments, and a large Hyatt hotel adjacent to Tyson’s Corner in Northern Virginia. Given its proximity to the shopping center and a new metro stop under construction, the apartments will rent at a premium.
Macerich has also pre-leased 60% of the office building to Intelsat and Deloitte, thereby guaranteeing a strong cash flow. I like Macerich’s overall strategy of focusing on the top end of the market. I believe both companies will profit from their investment decisions over the next several years.
Financial platform and growth
Kimco reported earnings per share (EPS) of $0.42 in 2012. The REIT reported funds from operations (FFO) of $1.26 in 2012. This is a popular supplementary metric used by REITs; FFO functions like EPS but excludes depreciation and one-time profits and losses from property sales (the idea being that buildings held for investment purposes don’t depreciate as quickly as the IRS thinks – and in many cases, will even appreciate in value).
Q1 of 2013 saw meaningful increases for Kimco, with FFO clocking in at $0.33 compared to $0.31 for the same quarter last year; same-property net operating income (NOI) increased 4% compared to Q1 of 2012. EPS for Q1 of 2013 grew significantly from prior years ($0.13, as compared to $0.09 and $0.03 for Q1 of 2012 and 2011, respectively).
Kimco’s price/earnings (P/E) ratio for the trailing twelve months is roughly 47, assuming a share price of $21.70. The stock seems a little expensive, but when you factor in an almost 4% dividend yield (which is sustainable given Kimco’s FFO) and Kimco’s excellent growth prospects, I think it’s still a good deal.
Macerich reported EPS of $2.51 and FFO of $3.18 for 2012. The bottom line turned from a loss of $0.11 per share for Q1 2012 to a gain of $0.13 per share in Q1 of 2013. Macerich’s P/E ratio for the trailing twelve months is roughly 23, assuming a share price of $63. With a dividend yield similar to Kimco’s (and similarly sustainable), Macerich is an even better deal given how much cheaper the stock is.
One note of caution about Macerich – it is more leveraged than Kimco (Macerich’s debt/equity ratio is about 1.8, compared to Kimco’s, which is 0.7 according to Morningstar). While neither is carrying a debt load that is concerning for a REIT, Kimco may have an easier path for expansion via debt than Macerich.
A more speculative play
Retail Opportunity Investments (NASDAQ: ROIC) is another shopping center REIT with great growth potential. It had a Q1 2013 FFO of $0.19 (a nice increase from $0.17 per share in Q1 of 2012) and has a strong balance sheet, with a debt/equity ratio of 0.5 according to Morningstar.
Revenue growth has been fantastic, with $16 million in revenue for 2010 growing to $75 million in revenue for 2012. The company is expanding rapidly, with four recent shopping center acquisitions. Its business model is built around grocery store-anchored neighborhood shopping centers, which is smart since fewer people are eating in restaurants right now.
The company is a little pricey for my taste with a P/E ratio of approximately 86, according to Morningstar. Also, it is West Coast-based; I tend to prefer companies with more geographic diversification (which I view as a good hedge for risk). Depending on your investment style, Retail Opportunity may be right for you, but personally, I tend to favor more established companies like Kimco and Macerich.
The bottom line
Kimco and Macerich are great, long-term investments. Let the 4% annual dividend yields pay you to hold these companies while they retool their portfolios for greater profitability. As the American economy recovers, consumers will increase their spending, making these higher-class shopping centers more attractive (and therefore more profitable for their owners).
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Michael Douglass has no position in any stocks mentioned. The Motley Fool recommends Retail Opportunity Investments. The Motley Fool owns shares of Retail Opportunity Investments. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!