Contrarian Value Ideas

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>>> Beware the Big Price Tag for a Mall REIT With Roots in Sears


Barron's

By Bill Alpert

March 6, 2020


https://www.barrons.com/articles/beware-the-big-price-tag-for-a-mall-reit-with-roots-in-sears-51583548833?siteid=yhoof2&yptr=yahoo


Real estate was the ace in the hole in Eddie Lampert’s investment strategy for Sears Holdings. So in 2015—a decade after the hedge fund manager’s ESL Investments took over the struggling retail chain— Sears spun off its interests in some 260 shopping mall properties into a real estate investment trust called Seritage Growth Properties.

Before that year was out, Berkshire Hathaway CEO Warren Buffett used his own money to buy a 7% stake in Seritage (SRG) for about $35 a share. The stock hit $57 the next year amid enthusiasm that Seritage would replace the bargain rents paid by Sears with market-rate tenants. The real estate play looked like a winner to Barron’s in early 2017.

But Sears was still Seritage’s main tenant. When Sears Holdings (SHLDQ) filed for bankruptcy protection in 2018, the retailer still filled 70% of Seritage’s space.

Seritage stock now goes for about $31 a share. That prices the enterprise at $3 billion and, by most measures, values Seritage on a par with the better mall REITs. Looking closely at Seritage’s recent results, it is hard to understand why its stock deserves that generosity. Seritage and Lampert declined our requests for comment, while Buffett didn’t respond to our query.

After Sears’ bankruptcy, the chain vacated over 200 Seritage properties. Its contribution to the REIT’s rental income has dropped to 5% of the total. Revenue at Seritage in 2019 was $169 million, down sharply from the 2016 level of $250 million. Its net loss in 2019 was $64 million, or 1.77 cents a share. REITs use an operating cash-flow measure called funds from operations, or FFO, and that number sank at Seritage from a positive $16 million in 2018 to a negative $34 million in 2019, or minus 61 cents a share. It pays no dividends on its common stock.

The red ink will be about as deep this year, Wall Street says. One has to look to 2021 to find a positive forecast for Seritage funds from operations. The sole analyst polled by FactSet projects about $20 million in FFO for next year, or 38 cents a share, on revenue of $260 million. That means today’s stock price for Seritage is 80 times next year’s forecast for FFO.

By way of comparison, the classiest of the class-A mall operators, Simon Property Group (SPG)—at its current stock price of $119—trades for just nine times the consensus forecast for 2021 funds from operations. Macerich (MAC) trades for six times. A well-regarded shopping center REIT, such as Regency Centers (REG), trades for 15 times next year’s FFO.

Malls are a forlorn sector these days, but even in its unhappy class, Seritage stands out for how many of its properties stand vacant. The company’s annual report makes painful reading, with a six-page list of wholly owned properties studded with empty malls in towns like Burnsville, Minn., and Lebanon, Pa. In all, only 43% of Seritage’s 29 million square feet of space was leased at the end of December. At Simon Property, 95% of retail space was occupied.

A main theme in the Seritage strategy has been the re-leasing of Sears locations to new tenants, at rents several-fold higher. But many retail tenants are struggling, these days. In addition to the 6% of its rent roll still paid by Sears and Kmart at year end, Seritage’s top tenants included the arcade chain Dave & Buster’s Entertainment (PLAY), the At Home Group (HOME) furnishings chain, and the clothing discounter Burlington Stores (BURL)—totaling 18% of the REIT’s annual rent and all causing angst in their own investors lately, amid faltering revenue.

Seritage’s other strategy is to redevelop its retail space and parking lots as fitness centers, restaurants, medical offices, or multifamily dwellings. In recent visits with investors, Seritage executives called attention to mixed-use projects near Seattle, Dallas, and Chicago that will together cost over $325 million in just the initial phase.

The REIT has good reason for staying in touch with institutional investors. Seritage has some remaining credit facilities, but without operating cash flow, it will have to fund its billions of dollars worth of redevelopment ambitions by selling off property and by selling stock. So shareholders should brace for dilution.

Meanwhile, if you’ve got a clever use for an empty Sears store, give Seritage a call.

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