Taubman Centers’ Payday Has Come
In the Fall of 2019, as high-end mall owner Taubman Centers (TCO) slid downward over poor quarterly results and the Forever 21 bankruptcy, I remained bullish on the stock. I wrote two articles here on Seeking Alpha, one in September and the other in November, arguing that the company was strongly undervalued.
Taubman’s mall assets are unparalleled in quality. As of Q3, 2019, its portfolio’s tenant sales per square foot stood at $868, up 12%. Sales per square foot had risen for 13 consecutive quarters at that point, and in Q4, 2019, that streak was extended to 14 straight quarters with a 2.7% rise in sales PSF. In Q4, funds from operations per share slightly beat expectations (up 5.8% YoY), and revenue (up 5.5% YoY) beat by $3.5 million. Average rent per square foot also increased 0.8%, while net operating income (excluding lease cancellations) jumped 4.6% and same-center occupancy remained roughly flat.
Fundamentally, I believed that the market would recognize the quality of Taubman’s assets eventually. It appeared, for a time, that I was wrong. It appeared that Taubman’s stock price was sliding toward oblivion and that the market would continue to totally discount its quality. But, thankfully, what the market didn’t or couldn’t recognize, mall landlord peer Simon Property Group (SPG) could and did.
That came in the form of a merger announcement, in which Simon plans to purchase 100% of Taubman’s common shares for $52.50 in cash, a ~50% premium to the stock price at the previous closing. (It was also a 47.1% premium to my own average cost basis of $35.68.) The implied cap rate of Taubman’s assets is 6.2%, higher than the mid 4s cap rate at which partial interests in Taubman’s new Asian malls were recently sold. However, given the “retail apocalypse” headwinds riddling the United States – headwinds that are much milder, to say the least, in Eastern Asia – a 6.2% cap rate strikes me as roughly fair value.
In any case, it is clear that Simon recognized Taubman Centers as the diamond in the rough that it is.
But that leaves Taubman shareholders like me with a decision to make about what to do with their shares at this point. Those that bought recently are sitting on a nice gain. Anyone who bought from 2012 to 2018, on the other hand, is staring at a permanent loss of capital.
Whatever the case may be for Taubman shareholders, we must decide what to do with our shares at some point in the first half of this year. To do nothing would result in at least one more dividend payment (and likely a pro-rated dividend at closing) along with $52.50 in cash per share when the transaction is complete. That doesn’t sound like too bad of an option, but I have a different idea.
My Plan To Reinvest Taubman Proceeds
The current Taubman share price of $53.15-$53.20 prices in one or two more dividend payments in addition to that $52.50 per share in cash at closing.
Meanwhile, Simon Property Group’s shares are down about 23% over the past twelve months, and the stock price of fellow high-end retail landlord Federal Realty Investment Trust (FRT) is down over 9%.
In my judgement, these two companies together provide exposure to very similar real estate elements as Taubman. It’s easy to see how owning Simon provides overlap with Taubman. After all, it is about to be the owner of Taubman’s entire mall portfolio! What’s more, Simon owns a very large portfolio of its own regional malls and outlet centers (233 properties fully or partially owned). That portfolio is high quality in its own right, but not as high quality as Taubman’s, which will raise Simon’s tenant sales ($693 in the TTM) and rent per square foot ($54.59) averages. It will also raise Simon’s percentage of assets in top 50 US markets.
The Galleria Houston – Owned By Simon
And, of course, it should be noted that the addition of Taubman’s malls will lower Simon’s exposure to Sears and J.C. Penney (JCP), which means fewer forced redevelopments of massive department store spaces as a percentage of the total portfolio.
After the merger is complete, Simon’s net debt load will rise above 6x EBITDA, but management expects to maintain Simon’s A-credit rating. More importantly, the newly combined mall giant will have plenty of free cash flow with which to deleverage. Taubman’s high quality assets combined with Simon’s superb balance sheet strength should result in a stellar collaboration.
Thus, I view it as a good idea to sell Taubman shares and buy Simon while the latter’s shares are a bargain. Consider, for instance, that while Taubman yields 5.08%, Simon yields 5.84%. It seems like a logical way to use a portion of my Taubman proceeds to keep the same high-end mall exposure.
With the other portion of my Taubman proceeds, I plan to keep with the theme of high end retail/mixed-use real estate and top-tier balance sheet by buying Federal Realty Trust.
Source: Federal Realty Trust Website
Like Simon, Federal Realty boasts an A-credit rating, giving the company access to ultra-low-cost debt, which it uses judiciously (net debt at 5.3x EBITDA). Fixed charge (including preferred dividends) coverage came in at 4.16x for FY 2019. The landlord is also a Dividend King, with the longest dividend growth streak of any REIT at 52 years. And with a 68.1% payout ratio based on 2019’s FY FFO of $6.17, or 64.7% based on the midpoint of 2020 guidance, the dividend is very comfortable and capable of continued growth.
Unlike Simon, however, Federal Realty’s properties are all open-air centers: Class A shopping centers and mixed-use town centers.
Most of Federal’s properties (85%) are located in the top 20 US metropolitan markets such as Los Angeles, New York City, San Francisco, Chicago, Baltimore, Miami, Boston, and so on. These are markets where the barriers to entry are very high, creating a natural competitive advantage (or “moat”) for the owner of these trophy properties.
As evidence of the desirability of Federal’s spaces, the landlord has enjoyed double-digit leasing spreads in recent years, along with a 10% average rent growth on comparable leases. Although, in Q4, rent rollover on comparable spaces “only” grew 7% on a cash basis. The company enjoyed strong rent growth even through the recession years of 2008, 2009, and 2010. And with apartments and office space making up about 20% of annual base rent, revenues are more diversified by industry than for either Taubman or Simon.
Federal’s shares dropped 3.1% on Tuesday after Monday’s earnings report disappointed investors. As I review the results, however, I find them pretty decent, which makes the lower-priced shares a bargain right now, in my opinion.
First off, Q4 FFO per share of $1.58 barely missed the expectation for $1.60, though it was only a slight rise from last year’s $1.57. Comparable property NOI was up 2.4% YoY (2.9% for the full year), and revenue was up 1.6% (beating estimates). The midpoint of guidance for 2020, at $6.49, is lower than the analyst consensus of $6.55, but only slightly. And this will likely prove a temporary dip as Federal redevelops former Kmart space, the leases of which were bought out by the landlord in 2019. Occupancy also remains strong at 94.2%.
Using the proceeds from the sale of Taubman shares to buy Federal Realty makes like a logical way to keep my exposure to high-end retail real estate while adding some diversification with the apartments and office spaces from the mixed-use centers. And like the products of Federal’s largest tenant by revenue, T.J. Maxx (TJX), shares are a great bargain.
Both Simon and Federal are trading near their lowest price-to-sales ratios since coming out of the Great Recession:
Likewise, looking at price to cash flow from operations, we find both trading at low to fair valuations:
Since Taubman shareholders will need to figure out what to do with the cash proceeds of their shares eventually, whether now or later this year, it makes sense to me to recycle them into REITs that offer similar exposure to high-end, urban, premium retail and mixed-use properties.
That way, in my portfolio at least, the legacy of Taubman Centers will live on.
*** Let me know what you think of this idea in the comments! Is there a more logical way to recycle Taubman Centers’ shares while keeping the exposure to similar real estate?
Disclosure: I am/we are long TCO, SPG, 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.