jebmo’s posthaven

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

CBL Associates Properties, Inc. (NYSE:CBL), is an oversold mall REIT which traded recently at $7.30. It pays a dividend of 26.5 cents per quarter or $1.06 per year for a yield of 14.5%. CBL had FFO in 2016 of $2.69 and projects FFO this year of between $2.18 and $2.24 (there were one time items inflating the 2016 number). CBL sold off this week due to a mildly disappointing first quarter, a small downward revision in FFO projections and a generally negative market atmosphere for REITs and especially mall REITs. While CBL, and mall REITs in general, face some challenges and risks, at this price CBL is a strong buy with the risks more than priced in.

The Business - CBL operates malls, community centers, some office buildings and manages 3rd party properties (properties owned by others). It leases space in the malls and centers to retailers, restaurants and other tenants and is paid fixed rent and, in some cases, a percentage of revenue. CBL is geographically diverse but has somewhat of a concentration in the outer South - Missouri, Kentucky, Tennessee, North Carolina and Texas. By revenue percentage, its largest local concentrations are -

1. St Louis (7.7%),
2. Chattanooga (4.3%)
3. Lexington, Kentucky (3.6%),
4. Madison, Wisconsin, (3.4%).

No single tenant accounts for more than 3.59% of annual revenue. While CBL has quite a few Sears, J.C. Penney and Macy's stores, only J.C. Penny makes the list of largest tenants producing 1.01% of total revenue. Sears - and to a lesser extent, the others - owns a sizeable percentage of its stores and, in many instances, is not a tenant.

CBL has followed a strategy of disposing of its lower tier (less profitable) malls and centers and using the funds to pay down debt and invest in its higher growth opportunities. A few years ago, CBL targeted 25 properties for disposal and - as of the end of 2016 - 18 of those properties had been disposed of or were in the process of being disposed of. CBL will likely dispose of the others in the near future. CBL is an active manager seeking to optimize revenue and - in some cases - proactively acquiring lower performing anchor locations and redeveloping them to produce more revenue. Its overall objective is lower leverage and to trim its holdings to the higher performing tier one and tier two malls. It is well on the way to achieving this objective.

While CBL does not have premier malls in top SMSA's, it has many malls with a wide moat. According to a recent presentation, 87% of mall net operating income was generated by dominant or "only game in town" malls 27 miles from the nearest competition. CBL is internally managed and its management has been very proactive. While CBL has been affected by closings of Sears and J.C. Penny stores, in the past 4 years it has redeveloped 10 out of the 13 locations affected by the closings. The redevelopments have often reflected a change in focus from large box retailers to clusters of restaurants or sporting venues. Redevelopments have averaged an 8.5% per year unleveraged return on invested capital.

Financial Performance - CBL has been on a reasonable growth trajectory. Comparing 2016 to 2013, sales per square foot are up to $376 from $356; average base rent is up at $32.96 from $30.35, and the percentage of malls that are tier one or tier two has risen from 78 to 90. Between 2015 and 2016 occupancy increased from 93.6% to 94.8%. CBL has 4 redevelopment projects under way that should kick in this year or next and provide a tailwind to revenue. In 2016, FFO was $2.69 per share and AFFO was $2.41 per share. 2017 FFO is projected to be between $2.18 and $2.24 with a midpoint at $2.21; this would produce an ultra-cheap price/FFO ratio of 3.3. At the current dividend level, the projected FFO of $2.21 per share would provide a 208% coverage for the $1.06 annual dividend for a yield of 14.5%.

Balance Sheet - CBL has $4.47 billion of net debt and a debt/EBITDA ratio of 6.5 which CBL is working down (debt was $4.71 billion in the prior year). CBL recently announced significant asset sales and has an objective to reduce its net debt/EBITDA ratio to 6.0. CBL has authorizations in place for share repurchases and ATM stock offerings but, in the last year, has not used these mechanisms. In a recent presentation, CBL noted that it has a gross asset value of $10 billion. Subtracting $4.47 billion in debt and $730 million in preferred stock, CBL's common equity should be worth $4.8 billion. With an effective share count of 199 million, CBL's net asset value per share should be a bit more than $24; Put differently CBL is trading for a price which is 70% below net asset value. If the stock would trade up to its NAV, it would appreciate from 68% discount to NAV to 100% of NAV or by 210%. CBL's significant discount to the estimated NAV of its properties which suggests enormous potential for appreciation through the sale of properties, a takeover by a larger entity, or a private equity buy out. It also illustrates that the earning power of the assets is large in relation to the current share price.

Dividends - CBL pays a quarterly dividend of 26.5 cents (annual dividend of $1.06) for a yield of 14.5%. CBL paid a dividend as high as 54.5 cents per quarter in late 2007 prior to the Crash and then cut the dividend all the way down to 5 cents in late 2009. CBL has increased the dividend up to the current level since then and has paid the same quarterly rate of 26.5 cents since the 4th quarter of 2014. CBL's corporate strategy has been to reduce debt and CBL is now paying out considerably less than 50% of FFO as dividends. Given the 208% coverage of its current dividend, investors should consider the dividend to be relatively secure.

Another consideration is that, in the short term at least, CBL has been generating taxable income from asset sales and may not be able to cut its dividend without adverse tax consequences. Thus, investors should be able to count on at least the current level of dividends unless there is a substantial decline in financial performance. Indeed, it is possible that, assuming things go well, CBL will increase its dividend to a higher percentage of FFO as its debt declines.

Risks - The long term risk here is that bricks and mortar retail goes into a steady and steep decline. In reducing its projections for this year, CBL noted concerns about retail bankruptcies. CBL has generally done well releasing locations vacated due to defaults and bankruptcies but, if there were to be too many of them, it could create problems. Similarly, CBL has many Sears, J.C. Penny and Macy's stores as anchors and the sudden closing of many of these stores might overwhelm CBL's ability to redevelop or otherwise redeploy assets. While CBL derives very little rent from these three, anchor store closings could damage other mall traffic. On the other hand, shoppers might not refrain from visiting a mall just because its Sears anchor closed and it is probably not plausible that they would drive 27 miles just to visit another Sears. If closings proceed at a reasonable pace, CBL should be able to handle the situation with redevelopment efforts.

Investors should put this risk in perspective. Simon Property Group (NYSE:SPG) - the premier mall REIT - has some 108 malls in the United States with 70 Sears stores, 78 J.C. Penny stores and 94 Macy's stores (it has only 35 Nordstrom stores and only 6 Saks Fifth Avenue stores). Despite its exposure to Sears, J.C. Penny, and Macy's, SPG trades at 15 times FFO - a ratio which would produce a price of $34 for CBL. Sears, J.C. Penny and Macy's are very large retailers and among the largest department stores by gross sales volume. Any mall REIT of significant size is going to inevitably have exposure to these three. While there is some justification for pricing mall REITs conservatively in comparison with other REITs, there is really no plausible reason for pricing CBL at such a low ratio to FFO in comparison to other stocks in the same group.

Bottom Line - CBL is a table pounding buy at this price. In the intermediate to long term, CBL is a solid investment. With a dividend coverage of 208%, CBL is set to generate over 29% cash returns for those who invest today. The company's numbers should improve over time as management uses the substantial cash flow not used to pay dividends to pay down debt, engage in redevelopment projects or expand and increase revenue.

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Note: All images/tables above were extracted from the Company's website, unless otherwise stated.

Disclosure: I am/we are long CBL.

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.