Buy This 16.2% Yielding REIT Now, Bargain Price, The CEO Is Buying

This research report was jointly produced with High Dividend Opportunities co-author Philip Mause.

The markets continue to act in an irrational manner when it comes to property REITs. The news on the bankruptcy of Toys "R" Us this week has sent the share price of mall REITs, including CBL & Associates (CBL) and Washington Prime Group (WPG) even lower this week, despite the fact that this bankruptcy was expected, and exposure of both companies to Toys "R" Us is either very limited or non-existent. Readers should note that CBL and WPG have a highly diversified property portfolio and are very unlikely to be much affected by the bankruptcy of a single tenant.

• CBL posted a list of its 25 largest tenants as of the end of 2016. Toys "R" Us was not on the list. The smallest tenant on the list accounted for 0.75% of revenue - thus, Toys "R" Us percentage of CBL portfolio must be below that number.


• WPG posted in its June 2017 supplement document listing its 20 largest tenants. Toys "R" Us was not on the list. The smallest tenant on the list accounted for 0.1% of annual base rent so that Toys "R" Us must be below that number. In addition, WPG has no single tenant with more than 3% of total rent.


• Many Toys "R" Us stores were stand-alone and not in malls.


• It seems as if the financial impact on WPG and CBL will be minimal, although the bankruptcy will affect sentiment and underlines the problems for traditional retailers.

Despite the fact that we are seeing evidence that mall REIT rents and occupancies are stabilizing, the shares prices are still trading at multi-year low valuations - their lowest since the 2008 Financial Crisis.

Buy This 16.2% Yielding REIT Now, Bargain Price, The CEO Is Buying

Washington Prime Group traded recently at $6.19 and pays a dividend of $1.00 per share per year for a yield of 16.2%. The $1.00/year dividend was amply covered by its AFFO of $1.63 per share, the bull case is fairly simple. WPG trades at roughly 4 times funds from operations (AFFO). In the REIT sector, FFO multiples are critical because they disclose cash flow; REITs selling for less than 10 times FFO are generally considered bargains and many REITs trade for more than 15 times FFO.

The Business - WPG resulted from a spin-off of less desirable assets by the Simon Property Group (NYSE:SPG) and a subsequent merger with another mall REIT. WPG"s properties tend to be located away from the more competitive and dynamic "Standard Metropolitan Statistical Areas" (or geographical regions with a relatively high population ). This factor is a double-edged sword. On the negative side, WPG"s properties will not attract the matrons of Beverly Hills or Silicon Valley. On the other hand, WPG"s properties are generally located far from competition and tend to have the "only game in town" advantage. A recent investor presentation highlights this advantage and should be consulted by investors to get the flavor of the new CEO"s dynamic approach. WPG"s locational advantage is significant. The average drive time to the nearest competitor of a WPG property is 38 minutes; the average drive time to the nearest Class A mall is 70 minutes. WPG tends to serve the part of the country which is actually underserved by shopping malls.

WPG"s strategy has been to aggressively re-purpose its properties. With an innovative and energetic CEO - Lou Conforti - WPG is converting properties into dominant town centers. WPG is attracting entertainment and dining tenants; in 2017, 47% of the new leasing volume was in the "lifestyle" category (food, beverage, and entertainment). WPG has actually opened its own candy stores in several properties and these are doing very well. WPG is also emphasizing the important role of the general managers of these properties. The town centers are actually growing revenue at a pretty good clip - 2017 was up 4.5% year over year. They are becoming the place to go in regions that are underserved with retail and entertainment venues.

WPG has been spinning off its Tier-2 properties and using the funds to pay down debt (debt declined by $400 million in 2017). It has positioned itself to continue investing in its Tier-1 and Open Air properties. WPG has reduced exposure to traditional department stores (including Sears (NASDAQ:SHLD), J. C. Penney (NYSE:JCP), Macy"s (NYSE:M), Dillard"s (NYSE:DDS), and others) to only 3.6% of its annual base rent.

Source: WPG Website

WPG"s portfolio is now highly diversified with no single tenant with more than 3% of total rent.

WPG"s management is definitely on the right track, and we would argue this management is one of the best in the mall REIT space.

CEO is buying - The CEO Mr. Conforti has recently put his money where his mouth is and purchased US$183,000 worth of WPG stock on the open market (in February 2018), which shows that he has some degree of confidence that the company is on the right path.

Source

Following the purchase, Mr. Conforti owns now about 121 thousand shares valued at $750 thousand at the current price.

Economic Performance - WPG achieved AFFO (used rather than FFO because certain one-time items artificially inflated FFO) of $1.63 a share in 2017. It is projected FFO of between $1.48 and $1.56 for 2018. Using the mid-point of $1.52, WPG now trades at a price/forward FFO ratio of 4.1 and would have dividend coverage of 152%. Put another way, after paying its dividend, WPG has more than $100 million of cash flow to spend on debt reduction and investment in its properties. WPG has been reducing its debt, and its debt/EBITDA ratio has declined from 7.9 in 2015 to a current level of 6.5.

Same center performance for Tier-1 and Open Air properties has been solid but Tier-2 properties have been posting negative results. As Tier-2 accounts for only 10% of net operating income and this percentage is likely to decline due to divestiture of underperforming assets, WPG should trend in the direction of stable or growing overall performance over time.

In fact, based on the latest earnings report, WPG"s "net operating income" went down by just 1%, the average sales per square foot remain at close to all-time-highs, while the leasing performance suggests strong demand for space by retailers. This suggests to us that WPG is not only trading at a dirt-cheap valuation but that too much bad news is priced into the stock.

Bottom Line - The mall sector is in the doghouse and WPG (as well as CBL Properties) is probably not even being allowed into the nicer parts of the doghouse by the other occupants. The market is clearly pricing in dramatic declines in FFO and large dividend cuts. The key issue is whether WPG can stabilize its FFO and other financial results so that the market will price in steady FFO or slightly increasing FFO rather than pricing in an expectation of continued declines. If stability is achieved, WPG should be able to trade at a level of at least 8 times FFO.

At the current price, WPG is a bargain and a classic case in which income investor gets paid handsomely (a 16.2% yield) to wait. Investors have also the opportunity to add shares at a time the CEO is buying. We are watching announcements and earnings reports as there may be a sign that the downward trajectory is turning around soon, and that could lead to a substantial increase in the price/FFO multiple. Using a very conservative assumption that they can stabilize FFO at a level of even $1.25 a share (or at 18% lower from the 2018 projected FFO level), a multiple of 8 would yield a price of $10.00 a share - more than 50% up from the current price. WPG could be the big winner in your high-yield portfolio given a period of 12 to 24 months.

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Disclosure: I am/we are long CBL, WPG.

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.