SRG - Seritage Growth Properties

[SlowAppreciation]

You can also do a straight up DCF analysis on http://www.gurufocus.com/fair_value_dcf.php

 

Just make sure to adjust the starting earnings/share for the 31.6m (56.5% of the total reported figures in the supplement). Also I'm not sure if one should use FFO or NOI as the starting figure.

 

My assumptions where a requirement of 2x the rate of return on the anticipated 30 year bond. Currently it's 2.2% and I assumed it will be 4.5-5% and that you demand 9-10% as the cap rate.

 

Another assumption you'll have to make is what you see as the ultimate base rent per square foot and the time to achieve that. It's a decent clip...So far, they are 'mining' in place Sears base rents to non-Sears at a run-rate of about 10.6% per year.

 

While the large amount of square footage does suggest quite a bit of un-mined potential, just like in a gold mine, you have proved reserves and probable+inferred reserves. I would say that a % of the total square footage is probable+inferred. If you use the Pareto principle, there will always be 20% of anything that you might want to cut out as being largely unproductive. Not sure if their square footage includes parking space and auto centers and those might be considered last or much later in the development process. First they are going after the gold nuggets just lying around on the ground :)

 

(Btw, using those assumptions above gets you at or above current market price. But I see it much simpler. If redevelopment return is 12% and DCF shows a number even 1 cent higher than today's price with a cap rate of 9-10%, then you are going to get your 10-12% return.

 

The 4  variables you might want to answer are,

-will base rents be higher in 10 years by a factor of at least 2.

-will a recession increase your return greater than 12% by waiting for said recession and consequent drop in price.

-will the long bond experience a freak inflation accident and go above 5% in the next decade.

-will SRG require more dilutive capital/debt due to a recession or over budget costs.)

 

Thanks, this helps to clarify my thinking a bit more.

 

Just make sure to adjust the starting earnings/share for the 31.6m (56.5% of the total reported figures in the supplement). Also I'm not sure if one should use FFO or NOI as the starting figure.

 

What's the 31.6m figure? Do you mean the starting #s were only for a half year so adjust those for a full year? Or are you referring to one time acq/startup costs?

 

And are you using the fully diluted share #count (I think it was 53.3m?)

[scorpioncapital]

31.6mm shares outstanding of SRG stock. 55.8 million total including OP units.

I just find it easier to compare to market cap of SRG as that's publicly traded.

 

 

[SlowAppreciation]

Gotcha. I noticed the VIC write up includes OP units.

 

I'm not too familiar with REIT structures, so is it common to exclude these?

[scorpioncapital]

I think how you parcel it out doesn't make a big difference.

 

E.g. Let's say SRG has $130m in FCF today and in 5 years will have $300m of FCF. That's on 55.7m shares. So on SRG as a stock it'd be 56.7% of 300m = $170m. SRG market cap today is 1.4 billion.

 

My rule of thumb is internal reinvestment rate is the attractor that pulls up or down all starting yields. Was it Munger who said eventually all your investments converge to internal rate of return on investment given enough time? However, this is probably no argument against LBOs which start at a high initial yield and even if it drops over time, whether you converge from the top or the bottom, I rather converge from above to below than below to above. However, if the attractor was a very high number with debt included, you're converging from below in 90% of the cases except some freak world accident...the real problem is very few investments provide certainty of return on investment project. Most companies don't even break it down, making what investors call investments, speculations most of the time. Not even management knows what they are getting. With SRG, I sort of see what Buffett might be seeing, a capped return of 12-13% (maybe a speculative upside on top of that if inflation picks up) and a measured, achievable reinvestment path to get there by retooling and making pretty old commercial retail buildings.

If you want 15% instead of 12% with high probability, I'd wait until the stock was $40 or lower. But if it you are happy with 12% and a potential kicker then no time like the present.

 

 

 

 

 

 

[SlowAppreciation]

So is it fair to say that NAV is essentially an adjusted BV and NOI is adjusted net income? In other words, NAV is the implied value of the real estate you'd expect a buyer (e.g. Private Equity, Brookfield Asset Manager, etc.) to pay based for the properties given a certain cap rate?

 

And the alternative—whether NOI or AFFO—is more or less a traditional DCF valuation but excluding certain charges like depreciation and interest?

 

[scorpioncapital]

Also if you will value SRG on cash-flows, I'm thinking their character should change due to the difference between maintenance capex vs growth capex. Growth capex should be higher in the next few years capped only by available cash and rate of redevelopment, but maintenance capex should dominate thereafter so I would bake in a higher FFO to NOI fraction in the end years.

 

 

[SlowAppreciation]

Also if you will value SRG on cash-flows, I'm thinking their character should change due to the difference between maintenance capex vs growth capex. Growth capex should be higher in the next few years capped only by available cash and rate of redevelopment, but maintenance capex should dominate thereafter so I would bake in a higher FFO to NOI fraction in the end years.

 

Makes sense. What do you estimate for growth capex, maintenance capex, and annual depreciation charges?

[scorpioncapital]

I haven't dived in to all the details but I took the (potentially too conservative) approach of assuming average rent per sq = 2x current rent and that if the stated return of 12% is accurate and terminal cash flow is 320m (Sears in place rent: 80% of 150m * 2 - 150m) and today total rent is 200m, then 120m of incremental fcf cash flows @ 12% = 1 billion growth capex.

 

I'm not sure how to measure maintenance capex. Funny, in the supplement on pg. 9 maintenance capital expenditures has a '-' in both 3 & 6 month periods of 2016. For July to Dec 2015 it's 21m. My suspicion is that if you could separate it out in a few years it won't be large enough to affect the valuation too much but that may not be true.

 

[SlowAppreciation]

I haven't dived in to all the details but I took the (potentially too conservative) approach of assuming average rent per sq = 2x current rent and that if the stated return of 12% is accurate and terminal cash flow is 320m (Sears in place rent: 80% of 150m * 2 - 150m) and today total rent is 200m, then 120m of incremental fcf cash flows @ 12% = 1 billion growth capex.

 

I'm not sure how to measure maintenance capex. Funny, in the supplement on pg. 9 maintenance capital expenditures has a '-' in both 3 & 6 month periods of 2016. For July to Dec 2015 it's 21m. My suspicion is that if you could separate it out in a few years it won't be large enough to affect the valuation too much but that may not be true.

 

I've spent more time on Seritage this weekend, and so far I really like what I see. I've tried "killing" it a number of ways, and even with very conservative estimates, 12%-13% per/yr return seems very attainable.

 

One thing I'm looking for more clarification on: I read that management estimates $100/sqft for recapturing/capex costs. The model I built has them recapturing ~2m sqft/yr for the next 10 years, but that would require ~$200m/yr in capex costs. AFFO would then be negative for the first ~5 years. Are my cost estimates too high?

[scorpioncapital]

Maybe someone can chime in on the last question, but pg 14 of the sup (dec 2015) shows the current projects at 1 million square feet at $160m or so cost. (June shows 350k sq ft, ~50m, ~10m revenue). Even higher redevelopment cost at 160/sq ft. However, they seem to project cash flow of $33 sq ft. ($20 sq ft June 2016)

On the face of it, it appears they are going for their highest value developments first and then will move down to lower cost ones.

But I see no requirement to complete this in 1 year. They seem to have 70m fcf so this could take 2-3 years for 1 m square feet. On the other hand, they do have some cash on hand of $250m to dip into. I hope they can self-sustain but I can see the counter-argument that to speed this process up they might need more cash. It's like your own business. If you don't have enough cash you can wait until your bank account builds up or you can go and get a loan if you are in a hurry to do something.

 

However I'm totally stumped why they pay a $1 dividend at all which doesn't make any sense to me other than a vague thought that they want to pay shareholders for "waiting around". This doesn't strike me as entirely rational. I'm not too clear on REIT laws though and whether they must pay out based on NOI or based on free cash flow after all capex. They could easily engineer to have zero or close to zero fcf if that allowed them to avoid paying a dividend and develop faster. On the other hand, Seritage appears to be a low cost supplier pushing large new supply into the retail real estate market. Perhaps there is also an argument to be made that too fast development would depress prices and the goal is a measured, steady supply coming online in conjunction with economic recovery.

 

 

 

 

[Guest notorious546]

RBC Initiation report attached. might be of interest.

2016-09-06_RBC_Seritage_Initiating_Coverage_Report.pdf

[scorpioncapital]

"To that end, Seritage has the opportunity to

re-imagine that space with an eye toward adding other elements that may be

missing including entertainment, residential units, office space or even a hotel. "

 

This is interesting, I've seen a number of these mall/hotel/office hybrids popping up with great success in my suburb. Likewise, atop rail/metro lines. If this goes through, the upside above and beyond just stores redesign could be understated.

 

[glorysk87]

One comment on the RBC piece - they barely touched on the potential for a Sears bankruptcy...

[merkhet]

If Sears goes bankrupt, then the maximum amount of time that they can extend the time to decide on assuming or rejecting the lease is 210 days. (Starts at 120 days with the option to petition the court for an extra 90 days, but that's it.)

 

Alternatively, in theory, if Sears vacates those stores, then isn't that better for Seritage as they now can reclaim significantly more square footage (and release at a higher rent) than originally thought under the current agreement?

 

What's the main worry if Sears goes bankrupt? It's not like they can force Seritage to re-lease the properties to them for $1 per square foot from $4 per square foot.

 

Are the main considerations here (A) absorption of the additional square footage and (B) possible loss of rent during that period and/or low recovery prospects for 210 days of rent as an unsecured claimant?

[Mephistopheles]

 

Alternatively, in theory, if Sears vacates those stores, then isn't that better for Seritage as they now can reclaim significantly more square footage (and release at a higher rent) than originally thought under the current agreement?

 

What's the main worry if Sears goes bankrupt? It's not like they can force Seritage to re-lease the properties to them for $1 per square foot from $4 per square foot.

 

Are the main considerations here (A) absorption of the additional square footage and (B) possible loss of rent during that period and/or low recovery prospects for 210 days of rent as an unsecured claimant?

 

My understanding is that since SHLD accounts for 79% of SRG's rental income, and since it's a triple net lease, a bankruptcy would leave SRG not only with a huge lost income stream, but all the maintenance and tax expenses that go with the properties. Sure they can reclaim 100% of the property but before they re-lease it they would need to re-purpose which would require a massive amounts of cash that they don't have yet, while paying all the expenses/loss of income.

[glorysk87]

If Sears goes bankrupt, then the maximum amount of time that they can extend the time to decide on assuming or rejecting the lease is 210 days. (Starts at 120 days with the option to petition the court for an extra 90 days, but that's it.)

 

Alternatively, in theory, if Sears vacates those stores, then isn't that better for Seritage as they now can reclaim significantly more square footage (and release at a higher rent) than originally thought under the current agreement?

 

What's the main worry if Sears goes bankrupt? It's not like they can force Seritage to re-lease the properties to them for $1 per square foot from $4 per square foot.

 

Are the main considerations here (A) absorption of the additional square footage and (B) possible loss of rent during that period and/or low recovery prospects for 210 days of rent as an unsecured claimant?

 

Someone has to pay the property level expenses if Sears goes bankrupt. Property taxes, utilities, etc...

 

SRG doesn't have much cash to pay those properties for too long...

[Mephistopheles]

Now, they aren't that leveraged so they can set up a larger line of credit and more borrowings and perhaps JV more of their stores as a precaution against a SHLD bankruptcy so I don't see it as a huge risk.

 

I also don't see SHLD going bankrupt anytime soon as they still have the inventory, KCD and the rest of the real estate that they can monetize.

[FCharlie]

People have been claiming Sears and Kmart would be bankrupt for over a decade.

 

Also, even if they filed bankruptcy, unless it was a liquidation, wouldn't Sears have to continue to honor the leases at least in the beginning?

 

Finally, I know everyone thinks Eddie Lampert is an idiot and is going to ride his SHLD stock to zero, but let's refresh our memory about how aggressively Eddie dumped his Orchard Supply shares when it because obvious they were going bankrupt.....  All we have ever seen from Eddie regarding SHLD is accumulation of stock, repurchase of stock, paying himself in stock, loaning money to SHLD personally and/or through his hedge fund etc...    In other words... I think bankruptcy fears are WAY overblown.

 

 

 

https://www.sec.gov/Archives/edgar/data/860585/000118143113031604/xslF345X03/rrd381721.xml

 

https://www.sec.gov/Archives/edgar/data/860585/000118143113029487/xslF345X03/rrd380748.xml

 

https://www.sec.gov/Archives/edgar/data/860585/000118143113027478/xslF345X03/rrd379615.xml

 

https://www.sec.gov/Archives/edgar/data/860585/000118143113026292/xslF345X03/rrd379043.xml

 

https://www.sec.gov/Archives/edgar/data/860585/000118143113025302/xslF345X03/rrd378531.xml

 

https://www.sec.gov/Archives/edgar/data/860585/000118143113023855/xslF345X03/rrd377827.xml

 

https://www.sec.gov/Archives/edgar/data/860585/000118143113023324/xslF345X03/rrd377473.xml

 

https://www.sec.gov/Archives/edgar/data/860585/000118143113022019/xslF345X03/rrd376720.xml

 

https://www.sec.gov/Archives/edgar/data/860585/000118143113020660/xslF345X03/rrd376025.xml

 

https://www.sec.gov/Archives/edgar/data/860585/000118143113019420/xslF345X03/rrd375413.xml

 

https://www.sec.gov/Archives/edgar/data/860585/000118143113018648/xslF345X03/rrd375066.xml

 

 

 

 

[eclecticvalue]

Let's not fool ourselves the share performance hasn't been great for SHLD in the past 10 years. And how long it will be until Eddie and company create value?

[FCharlie]

Creating value and share performance are one thing.... But the worries among some of the posters here that SHLD will go bankrupt and dump all their leases on Seritage makes no sense to me. Even if eventually SHLD is bankrupt, it won't be soon. They have been figuring out a way to get by for half a decade. Net inventory, asset sales, loans from Eddie & Bruce... people under appreciate those things....

 

My SHLD bonds are at 88 cents on the dollar right now. Look at Chesapeake Energy, a lot of their debt was at 15 cents on the dollar and they are still around. People over simplify things and forget that corporations are capable of doing many things to stay afloat.

 

 

[glorysk87]

Anyone interested in this should look at the CMBS sponsored by Seritage in conjunction with the spinoff last year, originated by JPM.  The annex file for the CMBS issue contains property level financial data for almost all the properties that Seritage owns, including rent coverage (EBITDAR/Rent) on a store-level.  The data is obviously a year old at this point but I still think it paints a really interesting picture.  The large majority of the properties they own have significant rent coverage, indicating that even in a bankruptcy situation the chances of Sears rejecting their lease is relatively low (keep in mind they can't pick and choose which stores to reject leases for considering they signed one master lease with SRG, so it's all or nothing).  Chances are even in a worst case scenario Sears would look to restructure their lease rather than simply dump the properties, since most of them are cash flow positive even after rent payment. Anyone interested it's CUSIP 46645CAA5.

[Mjs3382]

Anyone interested in this should look at the CMBS sponsored by Seritage in conjunction with the spinoff last year, originated by JPM.  The annex file for the CMBS issue contains property level financial data for almost all the properties that Seritage owns, including rent coverage (EBITDAR/Rent) on a store-level.  The data is obviously a year old at this point but I still think it paints a really interesting picture.  The large majority of the properties they own have significant rent coverage, indicating that even in a bankruptcy situation the chances of Sears rejecting their lease is relatively low (keep in mind they can't pick and choose which stores to reject leases for considering they signed one master lease with SRG, so it's all or nothing).  Chances are even in a worst case scenario Sears would look to restructure their lease rather than simply dump the properties, since most of them are cash flow positive even after rent payment. Anyone interested it's CUSIP 46645CAA5.

 

Could you post a link? Having trouble finding the document. Thanks.

[literally_it]

Here's the CMBS Annex file. Not sure how to get these aside from a Bloomberg terminal.

SRG_CMBS_Annex.xlsx

[SlowAppreciation]

Here's the CMBS Annex file. Not sure how to get these aside from a Bloomberg terminal.

 

Thanks for sharing, this is really good info.

[SlowAppreciation]

http://seekingalpha.com/article/4009166-seritage-expensive-reit-failing-tenants