The ABCs Of ROIC
Brat Thomas wrote this article and it has previously appeared on Seeking Alpha.
- Some retail REIT investors have opted to run for the hills, in attempt to avoid the continued volatility in the sector.
- I find the correction a bit overdone, and perhaps an opportune time to plant new seeds.
- I consider the quality rating an essential part of the underlying research and I am maintaining a BUY on shares at this time.
Last week I wrote an article titled Waiting For The Shoe To Drop and the purpose for the article was to set the stage for the ongoing to debate related to bricks versus clicks.
I was pleased to see a number of comments (over 170) related to the selloff in the retail REIT sector, and it seemed that there was an equal number of bulls and bears. I don’t think anyone is arguing that Sears (NASDAQ:SHLD) will survive, the large majority believe that it (bankruptcy) will be sooner than later. Here’s how I summed it up,
There is clearly a secular shift when it comes to technology and Amazon has truly disrupted the land of brick and mortar. At some point (Q1-18?), Amazon will be declared a winner (over Sears), but that does not mean that all retailers will go away. In fact, I would argue that most retailers have adapted to the changes and are successfully thriving in both retail, outlet, and online channels.
Some retail REIT investors have opted to run for the hills, in attempt to avoid the continued volatility in the sector. While I don’t disagree that there could be more pain ahead, I find the correction a bit overdone, and perhaps an opportune time to plant new seeds.
As Benjamin Graham wrote in The Intelligent Investor, the value investor’s purpose is to capitalize upon “a favorable difference between price on the one hand and indicated or appraised value on the other.”
After surveying the list of vetted retail REITs and considering which of the companies are worthy of ownership, I find Retail Opportunity Investment Corp. (ROIC) one of the best REITs to own, and that is why I decided to focus one this particular REIT today. If I had to own just one shopping center REIT, it would be ROIC.
In 2008 ROIC raised equity through a special purpose acquisition company (or SPAC), in essence, a blind pool with $400MM of cash at the trough of the real estate market.
Accordingly, CEO, Stuart Tanz, took advantage of the situation to start buying properties in familiar West Coast markets where Pan Pacific (the company Tanz previously ran) had deep experience (and strong relationships).
So when the last recession officially ended, ROIC was ready to list shares on Nasdaq (in November 2009) and begin to take advantage of the disruption in the retail market.
To make it clear, my first encounter with ROIC was not a blind date. The company's core management team consists of its current President and CEO Stuart Tanz and several other leading shopping center veterans.
Tanz is no stranger to the shopping center business as he was the former CEO of Pan Pacific RetailProperties Inc. where, during his nine-year tenure, he grew the company's market cap from $447 million to around $4 billion.
Through a series of consolidative acquisitions, PNP purchased around $2 billion of retail assets (over 18 million square feet), and later PNP was sold to Kimco (NYSE:KIM) for around $4.1 billion (in 2006).
Another notable shopping center veteran, Richard Schoebel (currently COO at ROIC), was also directly involved in the success of PNP where he directed leasing and property management for around 38 shopping centers (and over 5 million square feet). With a long career in creating value, Tanz and his team have integrated a proven development and redevelopment platform with a proven track record for repositioning assets and identifying inefficiencies in the retail sector.
As evidenced by the early enthusiasm with ROIC's IPO, Tanz's track record (at PNP) was fundamental to the success of the investment model. During the period of PNP's public ownership, the company provided a 529% total return, compared with 355% for shopping center REITs, and 67% for the S&P 500 over the same period.
So clearly, Tanz brings a veteran bench over to ROIC and included is a formidable culture for profitability and success.
Keep in mind that because there is a greater amount of discretionary equity required to buy (and refinance) commercial real estate, ROIC entered the public markets at a perfect time by capitalizing on market place inefficiencies (distressed with developers over their skills due to higher LTV ratios). Here's a snapshot of ROIC's performance since its IPO.
As you may recall, I have been covering ROIC for quite some time, my initial research report was on July 2011 and I have written at least a dozen follow-up articles since then (all BUY recommendations).
I also want to point out that I became a shareholder in ROIC in October 9, 2013, and since that time, shares have increased by 74.4%, over double that of the Vanguard REIT ETF (NYSEARCA:VNQ), that has grown shares by 28.9%.
ROIC is the best-performing Shopping Center REIT YTD, as evidenced below:
“A” Stands for “Attractive Real Estate”
To begin with, let's take a look at one key differentiator for ROIC, as you can see below, all of the shopping centers are located in desirable West Coast metropolitan markets.
Within these markets (Seattle, Portland, San Francisco, Sacramento, Los Angeles, Orange County, and San Diego) ROIC owns shopping centers that are well located in the heart of mature, affluent communities.
Keep in mind that because ROIC commenced as a new equity REIT (in 2009), it has no legacy assets and the company originally targeted 11 of the top 15 U.S. retail markets - all enjoying strong, densely populated trade areas with lower unemployment.
Also, these top tier markets enjoy above average household income levels and disposable income to support the retail investment model. In addition, ROIC was targeting markets deemed historically difficult for new development, as zoning tends to be more restrictive.
As ROIC began to build the portfolio (in 2009 and 2010), it acquired performing and non-performing loans at discounts to the long-term intrinsic values. However, over the last several years, the company has shifted its focus on stabilized, high-quality, well-located, grocery-anchored shopping centers, where the company can build value through increasing occupancy and rents as leases roll over. Here's a snapshot of ROIC's acquisition volume since 2010:
With over $2.8 billion in Total Assets ($3.8 billion total cap) and over 1,500 tenants, ROIC has been able to diversify its business model. As you can see below, ROIC has a diversified revenue stream with many recession resistant tenants listed in the Top 10 list (i.e. Albertsons (NYSE:ABS), Kroger (NYSE:KR), Savemart, CVS (NYSE:CVS), and Rite Aid (NYSE:RAD)).
ROIC’s top 10 tenants only account for 20% of Total Annualized Base Rent and the largest tenant (Albertson’s / Safeway) only accounts for 6% of ABR (the second largest tenant (Kroger) only accounts for 2.8% of ABR. All other top tenants account for less than 2% of ABR individually.
7 of 10 top tenants are daily-necessity retailers (supermarkets & pharmacies) and 80% of ABR is derived from 1,272 tenants (each accounting for less than 1/2 of a percent individually).
By owning a high percentage of grocery-anchored centers, ROIC has been able to recapture leases and replace those with stronger retail with higher rents. As the new tenants take occupancy and start paying rent, ROIC expects to see a positive impact to same-center cash numbers.
ROIC maintains strong portfolio at over 97% (ending Q1-17 specifically at 97.2%).
Breaking that down between anchor and non-anchor space, ROIC had one anchor space available in the portfolio (prior to Q1). During the first quarter, the company signed a new tenant for that space achieving a 129% increase in base rent.
Without one remaining anchor space now spoken for, at March 31st, ROIC’s anchor space was 100% leased and the shop space, at quarter end, stood at 94% lease.
“B” Stands for “Balance Sheet”
At the end of Q1-17 ROIC had a total market cap of approximately $3.8 billion with approximately $1.3 billion of debt outstanding, equating to a debt of total market cap ratio of 33%.
And for the first quarter, the company's interest coverage was a strong 4x as ROIC primarily utilizes unsecured debt to maintain liquidity and flexibility - 94% of total debt is unsecured (only 6% secured). With respect to the $1.3 billion of debt, the vast majority of that is unsecured.
ROIC has $1.5 billion acquisition facility capacity and the company maintains a well-laddered maturity schedule (only 42% matures in next six years).
So now you can see that one of the secrets to ROIC's success has been its balanced approach to funding growth. By maintaining a conservative and flexible investment grade balance sheet (33% debt, 4x interest coverage, and well-laddered maturities) this pure-play REIT has all of the ingredients for success.
Note: ROIC was awarded investment grade ratings from Moody’s and S&P.
“C” Stands for “Consistent”
By combining its West Coast expertise with its fortress balance sheet, ROIC has been able to produce highly consistent profits. As you can see below, ROIC has grown assets by an average of 35% per year since 2010.
But it's clear that this REIT is not "empire building," instead its mission is to grow returns for investors. As you can see below, ROIC has a tactical investment strategy in which it seeks out high-quality shopping centers that generate above-average growth in its core markets. Take a look at ROIC’s shareholder appreciaition history:
Remember, as I explained above, ROIC's management team has a long track record in the shopping center business so it has the ability to source off-market deals. By acquiring off-market centers, ROIC generates above average returns (~50 bps above market) and also many of ROIC's deals are acquired using OP units (a cheap form of currency). As ROIC’s CEO, Stuart Tanz, explains on the latest earnings call,
Many of these acquisitions are shopping centers that have been privately owned, closely held by families for years, some of which have never traded before, in other words, next to impossible for the market to get their hands on.
We're sourcing these unique acquisition opportunities through our network of relationships with private owners. Some being relationships from whom we have previously acquired shopping centers, some being relationships that we are diligently working on in pursuing for a number of years are now coming to provision and some being situations where the owners have sort us out given our market presence, reputation and ability to underwrite and close quickly…
several of the private owners were keenly interested in taking ROIC common equity in lieu of cash…
ROIC also grew same center NOI for its 21st consecutive quarter, sector-leading in terms of consistency and size:
The sum of ROIC's success can be "summed up" in regards to the reliable and predictable earnings (or FFO) growth. For the first quarter of 2017, FFO totaled $34.3 million as compared to FFO of $29.9 million for the first quarter of 2016. On a per share basis, FFO increased to $0.28 per diluted share for the first quarter of 2017.
ROIC is on track with its previously stated guidance of achieving FFO between a $1.10 and $1.14 per diluted share for the full year 2017. Here’s a snapshot of ROIC’s FFO/share growth (forecast) compared with the peers:
As you can see, ROIC is forecasted to maintain consistent FFO/share growth of 6% (through 2019) and the stable west coast assets provide the REIT with the most reliable and predictable growth. It’s the sum of the ABC’s that has led this REIT to sector-beating ROIC.
Quality Wins the Race
I can’t say this enough, “quality wins the race”, and I believe that ROIC represents one of the safest REIT investments today. Yes, the company os exposed to retail risk, but the properties are extremely insulated due to the strong barrier to entry attributes (referenced above). Let’s compare ROIC;s dividend yield to the peer group:
Yes, 3.7% is not like Washington Prime’s (NYSE:WPG) 12.3%, but there is a difference between “investing” in ROIC and “gambling” with WPG. It will take more than a few dividend checks to dig out of WPG’s hole (see my value trap article HERE on WPG).
Now let’s compare ROIC’s P/FFO multiple:
Again, there is no “blue light special” with ROIC, but we aren’t shopping at K-Mart. We are talking about a high-quality shopping center REIT that has all of the ingredients to generate stable earnings and dividends.
Note: I have STRONG BUYs on KIM and Brixmor (NYSE:BRX), based on valuation; however, I consider ROIC to be the best overall shopping center REIT in terms of the underlying fundamentals and quality of management.
As you can see, ROIC has a very stable history and the dividend is well covered (with a payout ratio of 65%). While the shares are soundly valued, I consider the quality rating an essential part of the underlying research and I am maintaining a BUY on shares at this time.
If you are seeking a retail REIT that offers one of the most defensive profiles (in the shopping center sector) along with a trusted management team, this REIT could be a good fit. Next week I plan to visit Seattle and I plan to visit a number of properties there owned by ROIC. I will provide you with a “mystery shopper” article highlighting the properties that I visit.
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Disclosure: I am on the Advisory Board of NY Residential REIT, and I am also a shareholder and publisher on the Maven.
Sources: FAST Graphs and ROIC Investor Presentation.
REITs mentioned: (WHLR), (WSR),(UBA), (FRT), (KIM), (RPAI), (REG), (WRI), (RPT), (DDR), (WPG), (BRX), (UE), (AKR), and (KRG).
Author Note: Brad Thomas is a Wall Street writer, and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors, if they are overlooked.
Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking. If you have not followed him, please take five seconds and click his name above (top of the page).
Disclosure: I am/we are long APTS, ARI, BRX, BXMT, CCI, CCP, CHCT, CLDT, CONE, CORR, CUBE, DLR, DOC, EXR, FPI, GMRE, GPT, HASI, HTA, IRM, JCAP, KIM, LADR, LTC, LXP, NXRT, O, OHI, PEB, PEI, PK, QTS, ROIC, SKT, SNR, SPG, STAG, STOR, STWD, TCO, VER, VTR, WP.
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.