Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders ‘Loading Up’ – Macerich Company (NYSE:MAC)

Co-produced with Beyond Saving and PendragonY

We are providing an update on Macerich Company (MAC), a mall REIT that we hold in our Core Portfolio. Included in this report is an update on Forever 21’s impact on MAC. We continue to be very bullish on MAC.

Our goal is to find opportunities in the market where we can achieve a high current yield while managing the level of risk we take. Many investors see a high-yield and automatically assume an investment is high-risk. That frequently is not the case.

Today we look at a REIT in the troubled mall REIT sector. Malls are going through a fundamental change as struggling retailers have gone through bankruptcy and liquidated. This has created a glut of space that has to be filled with new tenants – a process that is neither immediate nor free.

The REIT we are looking at today has seen their dividend yield increase due to dividend raises, combined with a dramatic decrease in their share price. Despite a falling share price, their fundamentals are among the strongest in the sector. Rent has increased every year for over 10 years, tenant sales are at all-time highs and their occupancy rate is over 94%.

The “bad” news – to the extent that it’s bad (or news) that Sears (OTCPK:SHLDQ) and other failing retailers are closing – is already known and has already been reflected in results. Fundamentals have been improving despite these well-known headwinds. Yet Mr. Market has punished this company anyway for little reason other than the fact that it is a mall REIT.

To us, that spells an opportunity to obtain a 10%+yield from a company that has historically traded at 3%-4% yields, even though the company itself is of higher quality and lower risk than it was seven years ago.

Macerich Company (MAC) is a high-quality mall REIT with a 10%+ yield. This is despite MAC cultivating one of the highest-quality portfolios in the industry. MAC is getting very little credit in the market, despite being proactive. Their FFO/share is down, but that is primarily due to an aggressive disposition program.

Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders 'Loading Up' - Macerich Company (NYSE:MAC)Source: Macerich Presentation

In 2012, MAC decided they needed to “trim the fat” from their portfolio. They started selling their lower-quality, lower-growth properties, cashing out for $1.8 billion before the “retail apocalypse” started. In late 2015 and early 2016, shareholders were directly rewarded with two $2 special dividends.

MAC demonstrated not only a sound long-term vision but also a willingness to reward shareholders.

High-Quality Portfolio

Today, MAC has a smaller, leaner and much higher-quality portfolio.

Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders 'Loading Up' - Macerich Company (NYSE:MAC)Source: Macerich Presentation

Sales per square foot have increased at 6.9% CAGR over the past 10 years, with only a small stutter in 2015 to 2016. This means that tenants at MAC malls are doing better and experiencing growing revenue.

While many malls have struggled with flat or even declining sales, tenants at MAC locations are seeing more revenue. When it comes to deciding which locations to close, are national tenants going to close locations with growing revenues over locations with flat or declining revenues? Of course not.

MAC’s space remains in high demand as illustrated by their growing average base rent, which has grown every single year for 10 years and the rate of growth has accelerated in 2019.

Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders 'Loading Up' - Macerich Company (NYSE:MAC)Source: Macerich Presentation

This has also translated into their same-store NOI, which over the past five years has exceeded all other premium peers. MAC already has an impressive Top 10 lineup.

Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders 'Loading Up' - Macerich Company (NYSE:MAC)Source: Macerich Supplement

These are trophy malls in ultra-premium locations that cannot be easily duplicated. These are high-demand locations for tenants and attract high-dollar customers.

Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders 'Loading Up' - Macerich Company (NYSE:MAC)Source: Macerich Supplement

Even towards the bottom end of MAC’s portfolio, we see strong metrics. Of the 45 malls in MAC’s portfolio, 40 of them have sales over $335/square foot.

Forever 21

One recent development that has sent MAC’s share price back down is Forever 21 filing bankruptcy. Forever 21 is one of MAC’s top 10 tenants, and they have exposure to 30 stores, 8 of which are anchors. The bankruptcy of Forever 21 did not come as a surprise, it has been widely anticipated for quite some time. As expected, Forever 21 filed for Chapter 11 bankruptcy, that means that the company is going to restructure their debt and will not completely liquidate.

Despite the hysteria in the news, the sky is not falling. Forever 21 may close 178, or approximately 1/3rd of their US stores. It is typical for retailers in bankruptcy to use the opportunity to terminate their leases in locations where their sales have been struggling. Bankruptcy provides the retailer the option to walk away from a lease, having failed to obtain concessions from landlords, they can use the threat of walking away as a last-ditch effort to get a landlord to agree to rent reductions.

Forever 21 has released the list of 178 locations they are considering closing. 16 of the locations are at MAC properties, and 7 of these are anchors. We know they have been in contact with MAC as in the Aug. 1 earnings call CEO Tom O’Hearn said,

Yes, we’ve had multiple discussions with Forever 21 and their advisors. And at this point, we don’t believe that any concessions that we are going to be making will be material. And we’ve got 30 stores for them that’s possible if a few might close.

But it won’t be significant to our overall rent and our guidance for 2019. Those discussions are underway. It’s a little early to conclude anything yet, but based on what we’ve heard from them we don’t think it’s going to be material.

The stores’ placement on the list does not necessarily mean they will close. Once in bankruptcy, Forever 21’s creditors will have a say and the leases will be paid in full up until the point that they are formally rejected. Alternatively, in the locations where Forever 21 has an anchor, they might look to lease a smaller space. To be on the cautious side, we should assume that the 16 stores included will close.

As discussed above, MAC has the cream of the cream malls. With their high-quality properties, MAC will have no issues finding good replacements. We consider it a good thing that MAC is sticking to their guns and refusing to offer additional concessions. Their property is valuable and they know they need to get an appropriately high rent for it.

Development

Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders 'Loading Up' - Macerich Company (NYSE:MAC)Source: CBS

MAC recently had their grand opening of Fashion District of Philadelphia, a 50/50 joint venture with Pennsylvania Real Estate Investment Trust (PEI), where we like the 9%+ yielding preferred shares. By all reports, the grand opening was packed and the opening generated a lot of media buzz. The Fashion District is expected to produce sales in excess of $700/sf, and will produce $14 million to $16 million in NOI for MAC.

As a testament to how high in quality MAC’s properties are, $700/sf will put Fashion District near the top of PEI’s malls in spot number 2. For MAC, it will be middle of the pack at spot number 21.

Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders 'Loading Up' - Macerich Company (NYSE:MAC)Source: Macerich Presentation

Like all mall REITs, MAC not only has their new developments like Fashion District or One Westside (building new office space that will be leased to Alphabet (GOOGL) (NASDAQ:GOOG)); they also have redevelopment opportunities due to the Sears bankruptcy.

Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders 'Loading Up' - Macerich Company (NYSE:MAC)Source: Macerich Presentation

MAC is handling these properties through a combination of retail redevelopment and mixed-use densification. They have several projects that will be completed between 2020 and 2022, providing steady growth in cash-flow compared to Q2 of 2019.

As we have discussed in several articles on the 25%-yielding Washington Prime Group (WPG), redevelopment takes time, but the result is inevitably a much more profitable property without Sears than the property was with Sears.

Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders 'Loading Up' - Macerich Company (NYSE:MAC)

New Tenants

The overarching bear storyline is that brick-and-mortar retail is failing and that the internet is going to take over all of retail. There is absolutely no denying that the internet has had a huge impact on our lives and on how we shop. Yet internet companies are among the fastest-growing tenants for bricks and mortar landlords.

MAC is leasing 548,000 square feet to GOOGL, one of the kings of the digital era. They are not alone in seeking mall space.

Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders 'Loading Up' - Macerich Company (NYSE:MAC)Source: Macerich Presentation

Digital retailers are realizing that there is a benefit to being able to integrate with bricks and mortar. Consumers want both the convenience of online shopping and the ability to see, touch, feel and ask a real human being questions about the product. The future of retail is not digital versus brick & mortar – the winners will be the companies that most effectively tie together the two experiences.

MAC has been at the forefront of introducing new tenants to physical mall space.

Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders 'Loading Up' - Macerich Company (NYSE:MAC)Source: Macerich Presentation

At the end of the day, mall landlords are not tied to any particular use of space. A mall is simply a large centralized location where consumers can go to serve several needs/desires. The mall landlord does not really care whether the trendy thing is clothes, food, experiences or technology. All that matters to the landlord is that space is rented. Many of MAC’s malls were around long before most of these companies were in business, and they will be around long after most of them have gone out of business.

Finances

Redevelopment is not free, so it is important that a REIT is able to access enough cash to fund their redevelopment needs. For MAC, this is not a problem at all.

Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders 'Loading Up' - Macerich Company (NYSE:MAC)Source: Macerich Presentation

By the end of 2019, MAC will have received $604 million through property level mortgages. Additionally, they had $690 million in capacity on their revolving line of credit. They expect to end the year with just under $1 billion in liquidity. More than enough to fund all of their cash needs.

Additionally, management has openly discussed on their past two earnings calls that they intend to sell some properties into a joint venture. In Q2, CEO Tom O’Hern said (emphasis added),

Well, ideally, these are multiple negotiations on multiple properties and given that this would probably generate a significant amount of capital gain, ideally we’d like to close a part of these transactions in late 2019 and the balance carrying over to the beginning of 2020.

Management has previously stated that they would only enter into new JVs if the result were neutral or an improvement to FFO/share. That means that they believe they can get a high enough price that the lost FFO is offset by debt reduction and/or share buybacks.

It is also noteworthy that while some have raised the issue of a risk to the dividend, MAC is intentionally seeking to spread their JV agreements across tax years to avoid having to pay a special dividend. We believe there is no material risk to their dividend.

Catalysts

Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders 'Loading Up' - Macerich Company (NYSE:MAC)Source: Macerich Presentation

Current consensus NAV is $58/share. That means that at the current share price, MAC is trading at a 45%+ discount to NAV. Furthermore, there are a few potential near-term catalysts that suggest this discount will not last long.

First, as discussed above, MAC is likely to enter into at least one JV by the end of the year. Based on management commentary, we expect that these transactions will occur at cap rates that are much lower than the market expects. There has not been a lot of private market transactions of trophy-class properties, so these transactions will provide a much-needed data point for the market to assess the value of MAC’s remaining properties.

There is little doubt these transactions will reveal that the current share price is too low. We believe there is a strong possibility they will reveal that consensus NAV estimates are entirely too low.

Second, malls in general are going to start demonstrating recovery from the Sears bankruptcy. Q3 and Q4 of 2019 will include numerous store openings, as well as provide the first same-store comps comparing against periods in which Sears filed bankruptcy. Improving same-store comps across the industry will have a positive impact on MAC.

We saw a boost in mall REITs across the board in early September, and we believe this is the first crack to appear in what has been unrelenting bearish pressure. As malls demonstrate growing cash flows, we expect that true price recovery will begin.

Finally, MAC was clearly impacted by 2019 guidance for declining FFO. We fully expect that when MAC releases their 2020 guidance, it will be for a healthy increase to FFO. They will experience rising NOI from Fashion District and other redevelopments expected to open in 2020, as well as benefits from back-filling space from tenants that filed bankruptcy in 2019.

Insiders are ‘Loading Up’

Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders 'Loading Up' - Macerich Company (NYSE:MAC)Source: OpenInsider

We are also pleased that insiders have been putting their money where their mouth is. There was a significant uptick in insider buying in Q2 and Q3, with insiders acquiring over 130,000 shares, investing more than $4 million of their own money into MAC.

Insiders are well aligned with shareholders and they recognize the great discount for what it is. The fact that insiders are loading up makes this story even more compelling!

Conclusion

Malls have been an unpopular sector in 2019 as the “retail apocalypse” story line was fueled by several large mall tenants filing bankruptcy. The reality is that companies like Sears, or Payless Shoesource have been struggling for years. They were poorly run companies that failed to keep up with evolving consumer preferences. Malls are better off without them.

There is some pain through the transition due to the reality that reconfiguring physical space for a new tenant takes time and funds. This is especially true with the large anchor spaces that are being redeveloped to uses that are completely different, like the mixed-use developments.

Despite these headwinds, MAC has managed to have consistently improving fundamentals. Tenant sales are higher than they have ever been, the average rent is higher than it has ever been, and occupancy has remained stable, fluctuating in a range of 93% to 96% since 2012.

MAC sold off most of their lower-quality properties before malls went out of style, and now it has a well-curated portfolio of premium properties. Despite having high-quality properties, consistent same-store NOI growth and plenty of liquidity, MAC’s share price has suffered along with those of most mall REITs.

The market has become utterly irrational regarding anything mall-related. By focusing on the fundamentals, we can recognize MAC for the gem that it is. When gems are selling at a 45%+ discount, buy them!

We expect the next dividend announcement to be the last week of October and ex-div will be Nov. 8. This is historically the quarter they announce changes to the dividend. While we are not counting on a dividend increase, it is possible that there is a small $0.005 to $0.01 increase to the quarterly dividend.

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Macerich: 10%-Yield Gem Is On Sale For A Limited Time; Insiders 'Loading Up' - Macerich Company (NYSE:MAC)

Disclosure: I am/we are long MAC. 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.