SRG - Seritage Growth Properties

[Mephistopheles]

So just did some quick back of the envelope calculations, adjusted for proportion of JV and for operating partnership units:

 

SQFT: 39.67 million

Cash: $161.14 million

Debt: $1,145.10 million

Shares: 55.6 million

Stock price: $50

EV: $3,762.31

 

EV/SQFT is roughly $95. If they spend $100/SQFT on renovations, that's about $200/SQFT implied valuation. Latest signed but not open leases are $23/SQFT for next quarter.

 

If you assume $23 average rent for the entire 39.67 million SQFT, including all the Class A Sears and POS Kmarts, it's a 10% implied cap rate. So 3 questions:

 

1) Is $23 a fair assumption for average rent across their portfolio?

2) Is $100 across the board capex reasonable?

3) Is 10% a fair cap rate for the Kmarts but cheap for Sears?

 

[glorysk87]

So just did some quick back of the envelope calculations, adjusted for proportion of JV and for operating partnership units:

 

SQFT: 39.67 million

Cash: $161.14 million

Debt: $1,145.10 million

Shares: 55.6 million

Stock price: $50

EV: $3,762.31

 

EV/SQFT is roughly $95. If they spend $100/SQFT on renovations, that's about $200/SQFT implied valuation. Latest signed but not open leases are $23/SQFT for next quarter.

 

If you assume $23 average rent for the entire 39.67 million SQFT, including all the Class A Sears and POS Kmarts, it's a 10% implied cap rate. So 3 questions:

 

1) Is $23 a fair assumption for average rent across their portfolio?

2) Is $100 across the board capex reasonable?

3) Is 10% a fair cap rate for the Kmarts but cheap for Sears?

 

 

1) I'm using a more conservative view, and assuming that going forward all new tenants will be signed at around $14 psf. I think $23 may be a little high, as SRG is likely picking off the high-quality long hanging fruit first. But I could be wrong. I'd rather be conservative with it though.

 

2) Management has indicated that $100 psf for redevelopment is a good number to use going forward

 

3) I don't think 10% is fair for any of the properties. It's much higher than anything comparable you'll find. Espescially after redevelopment and re-tenanting.

[scorpioncapital]

A rule of thumb I like to think about with RE is:

 

Low inflation - development is cheaper. Building while debt costs and rates are low are like storing food in the summer for the winter.

 

Moderate-high inflation - you reap the rewards of your previous development because what you build in the past is now going to be much more expensive to redevelop, in fact, that is a competitive advantage you have by using up all - or even more of your free cash flow while rates were low. Actually this applies to all companies, those that are investing today when nobody is investing to sustain or improve their earning power in a future environment will reap benefits while others may go bankrupt or struggle immensely.

 

So essentially it's a balancing act. The more they can get done in this environment the better. In fact, an ideal scenario would be very low rates for maybe 5 more years. I think they'll have achieved a big chunk of their mission by then.

 

 

[SlowAppreciation]

New short thesis on VIC: https://www.valueinvestorsclub.com/idea/SERITAGE_GROWTH_PROPERTIES_9583B/138911

[scorpioncapital]

An even more negative short thesis I suppose -

http://seekingalpha.com/instablog/22912651-daniel-jennings/4923635-seritage-growth-properties-worst-reit-america

 

Although I would debate some of the points made such as 'No cash from operations according to ycharts.'

Clearly they have cash from operations, virtually all companies do!

 

 

 

[SlowAppreciation]

An even more negative short thesis I suppose -

http://seekingalpha.com/instablog/22912651-daniel-jennings/4923635-seritage-growth-properties-worst-reit-america

 

Although I would debate some of the points made such as 'No cash from operations according to ycharts.'

Clearly they have cash from operations, virtually all companies do!

 

I'm all for hearing alternate arguments, but this is probably the weakest short thesis on SRG I've come across. Doesn't seem like this guy has done his homework, and his argument of "more dividends = better" doesn't give me much confidence in his ability to analyze a business.

[Guest wellmont]

No cash from operations according to ycharts is all I need to know about that pitch.

[mcliu]

What about a Sears bankruptcy? Isn't that a huge risk here?

[Foreign Tuffett]

What about a Sears bankruptcy? Isn't that a huge risk here?

 

You might want to read back through the thread. I believe this prospect has been extensively discussed.

[FCharlie]

People have been saying Sears is going bankrupt since Sears (Kmart) came out of bankruptcy thirteen years ago.

 

This has me fascinated as SHLD seems to pollute practically everything it touches.

 

Since it keeps coming up, I wonder what everyone's opinion is on either of the following scenarios.

 

1) What would be the value of SRG if SHLD were not losing money and had stable sales?

 

2) Ignoring time being a factor, what would be the value of SRG after they upfit all of their existing real estate, with a variety of tenants, none of which being SHLD?

 

I suppose enterprise value is the most appropriate measure.

 

 

 

 

[Foreign Tuffett]

Does anyone have the recent Boenning & Scattergood report on Seritage?

[scorpioncapital]

Have you seen this one from April?

http://www.boenningib.com/pdfs/Research_Disclosures/SRG.pdf

 

[aceskc]

The capital raise concerns and equity dilution baked into their model seem considerably overblown...Berkowitz/Buffett/Lampert all have sizable stakes in SRG and wont allow it...besides SRG's growing NOI/FFO  seems adequate to fund recap expenditures all of which have been sized in their Q3 Earnings release

[Foreign Tuffett]

The capital raise concerns and equity dilution baked into their model seem considerably overblown...Berkowitz/Buffett/Lampert all have sizable stakes in SRG and wont allow it...besides SRG's growing NOI/FFO  seems adequate to fund recap expenditures all of which have been sized in their Q3 Earnings release

 

I'm inclined to agree with you. They are making substantial progress transforming the portfolio and should be able to raise more cash on decent terms given their existing pipeline (see attached - Q4 2015 to Q3 2016) of signed leases.

 

[SlowAppreciation]

Seems like Seritage adds back D&A, G&A, and acquisition-related expenses to operating income to get to NOI. But this seems like a legitimate operating expense to me?

[BG2008]

Seems like Seritage adds back D&A, G&A, and acquisition-related expenses to operating income to get to NOI. But this seems like a legitimate operating expense to me?

 

I've found that this is the norm in the real estate space.  Almost all RE assets trade on this NOI figure with D&A, SG&A, and acquisition related expense.  The truth is that that's how private buyers will price each individual asset in arms length transaction.  Depending on the asset type, some D&A will be true expenses while others won't. 

[SlowAppreciation]

Seems like Seritage adds back D&A, G&A, and acquisition-related expenses to operating income to get to NOI. But this seems like a legitimate operating expense to me?

 

I've found that this is the norm in the real estate space.  Almost all RE assets trade on this NOI figure with D&A, SG&A, and acquisition related expense.  The truth is that that's how private buyers will price each individual asset in arms length transaction.  Depending on the asset type, some D&A will be true expenses while others won't.

 

Should have clarified that I meant the G&A was an operating expense (I understand the reasoning for adding back D&A and Acq-relate charges). I just don't see how G&A isn't an operating expense...

 

"Our primary cash expenses consist of our property operating expenses, general and administrative expenses, interest expense and construction and development related costs. Property operating expenses include: real estate taxes, repairs and maintenance, management expenses, insurance, ground lease costs and utilities; general and administrative expenses include payroll, office expenses, professional fees, and other administrative expenses; and interest expense is primarily on our mortgage loan payable."

[KJP]

Seems like Seritage adds back D&A, G&A, and acquisition-related expenses to operating income to get to NOI. But this seems like a legitimate operating expense to me?

 

I've found that this is the norm in the real estate space.  Almost all RE assets trade on this NOI figure with D&A, SG&A, and acquisition related expense.  The truth is that that's how private buyers will price each individual asset in arms length transaction.  Depending on the asset type, some D&A will be true expenses while others won't.

 

Should have clarified that I meant the G&A was an operating expense (I understand the reasoning for adding back D&A and Acq-relate charges). I just don't see how G&A isn't an operating expense...

 

"Our primary cash expenses consist of our property operating expenses, general and administrative expenses, interest expense and construction and development related costs. Property operating expenses include: real estate taxes, repairs and maintenance, management expenses, insurance, ground lease costs and utilities; general and administrative expenses include payroll, office expenses, professional fees, and other administrative expenses; and interest expense is primarily on our mortgage loan payable."

 

I assume you mean they are adding back the "general and administrative expenses" referred to in your quote, but not the "property operating expenses."  As BG mentioned, you see this alot with RE companies.  They ask investors to focus on NOI (which only includes property-level expenses, not corporate) because assets are bought and sold based on NOI, and ignore the significant corporate expenses that skim off the top and ultimately create a significant drag on investor returns if the underlying RE assets aren't sold in a relatively short period of time. 

 

The companies are not alone in this.  Many investment pitches for RE companies do the same thing -- they purport to value the company's assets, but ignore significant corporate overhead.  That's understandable if the thesis is the company is going to be sold (and thus G&A eliminated by the buyer), but it doesn't make sense to me if there's no reasonable expectation of a sale.  The lengthy recent writeups of FRP Holdings are an example of this. 

[glorysk87]

Should have clarified that I meant the G&A was an operating expense (I understand the reasoning for adding back D&A and Acq-relate charges). I just don't see how G&A isn't an operating expense...

 

"Our primary cash expenses consist of our property operating expenses, general and administrative expenses, interest expense and construction and development related costs. Property operating expenses include: real estate taxes, repairs and maintenance, management expenses, insurance, ground lease costs and utilities; general and administrative expenses include payroll, office expenses, professional fees, and other administrative expenses; and interest expense is primarily on our mortgage loan payable."

 

G&A is an operating expense of course, but NOI is a measure of property level income. It allows for investors to get an idea of the performance of the portfolio at the property level, insulating the performance of the actual real estate from the impacts of corporate expenses. It's not intended to be used to value the company as a whole. Make sense?

[BTShine]

In the case of SRG, they have significantly increased their employee count to help in the leasing and redevelopment of properties, which is appropriate to remove in their calculation of stable NOI. 

 

In a company where all properties are stable they would require less manpower, thereby having a lower S,G&A.

[SlowAppreciation]

Should have clarified that I meant the G&A was an operating expense (I understand the reasoning for adding back D&A and Acq-relate charges). I just don't see how G&A isn't an operating expense...

 

"Our primary cash expenses consist of our property operating expenses, general and administrative expenses, interest expense and construction and development related costs. Property operating expenses include: real estate taxes, repairs and maintenance, management expenses, insurance, ground lease costs and utilities; general and administrative expenses include payroll, office expenses, professional fees, and other administrative expenses; and interest expense is primarily on our mortgage loan payable."

 

G&A is an operating expense of course, but NOI is a measure of property level income. It allows for investors to get an idea of the performance of the portfolio at the property level, insulating the performance of the actual real estate from the impacts of corporate expenses. It's not intended to be used to value the company as a whole. Make sense?

 

Thanks for clarifying. Yeah, I think this makes sense if someone were to acquire the company but I still feel more comfortable valuing it as if I were buying an operating business. SGA costs are costs that have to be paid, and the buildings aren't going to rent themselves out.

 

I'm long SRG and keep trying to "kill" it, and this generally means using very conservative assumptions. I do have a few more questions on SRG (and REITs in general):

 

• What are you guys estimating for maintenance Capex for AFFO? $20m?
  
• If we assume SRG reclaims 2m sqft/yr and it costs $100/sqft to do so, FCF doesn't support current valuations. Is FCF flawed with REITs?
  
• I've seen a lot of various ways to get to a NAV (balance sheet-based vs inferring it from a given cap rate). Any preference here?
  

 

 

[glorysk87]

Thanks for clarifying. Yeah, I think this makes sense if someone were to acquire the company but I still feel more comfortable valuing it as if I were buying an operating business. SGA costs are costs that have to be paid, and the buildings aren't going to rent themselves out.

 

I'm long SRG and keep trying to "kill" it, and this generally means using very conservative assumptions. I do have a few more questions on SRG (and REITs in general):

 

• What are you guys estimating for maintenance Capex for AFFO? $20m?
  
• If we assume SRG reclaims 2m sqft/yr and it costs $100/sqft to do so, FCF doesn't support current valuations. Is FCF flawed with REITs?
  
• I've seen a lot of various ways to get to a NAV (balance sheet-based vs inferring it from a given cap rate). Any preference here?
  

 

You're free to value the company as you see fit. I just wanted to clarify the definition of NOI.

[SlowAppreciation]

Thanks for clarifying. Yeah, I think this makes sense if someone were to acquire the company but I still feel more comfortable valuing it as if I were buying an operating business. SGA costs are costs that have to be paid, and the buildings aren't going to rent themselves out.

 

I'm long SRG and keep trying to "kill" it, and this generally means using very conservative assumptions. I do have a few more questions on SRG (and REITs in general):

 

• What are you guys estimating for maintenance Capex for AFFO? $20m?
  
• If we assume SRG reclaims 2m sqft/yr and it costs $100/sqft to do so, FCF doesn't support current valuations. Is FCF flawed with REITs?
  
• I've seen a lot of various ways to get to a NAV (balance sheet-based vs inferring it from a given cap rate). Any preference here?
  

 

You're free to value the company as you see fit. I just wanted to clarify the definition of NOI.

 

Sorry, wasn't saying you're wrong or anything, and I do sincerely appreciate the definition.

[scorpioncapital]

A company developing property probably shouldn't have any free cash flow. I don't think the idea of free cash flow supporting development cost is necessarily the metric to consider. Look at a cable company. In fact, a case can be made that no cash flow is just fine during this phase of the process. But when the building is complete and the rents are coming in, you are in the harvesting phase and then FCF is most certainly warranted. What is important, of course, is to match development cost with resources on hand, or raising capital, or developing slowly enough to support the venture. I also don't think the dividend is warranted but it suggests they are not developing at top speed yet. I wouldn't be upset or surprised if the dividend was cut to zero during this process.

[BTShine]

They likely would be able to access mortgage financing for much of their existing property.  They're not very leveraged.