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Nicola Guida
Nicola Guida
Articles (12)  | Author's Website |

Seritage Is Closer to Breakeven

The REIT is in the middle of a challenging property redevelopment process

March 13, 2019 | About:

Overview

Seritage Growth Properties (NYSE:SRG) is a real estate investment trust that was created in July 2015, when Sears Holdings (SHLDQ) spun off some of its properties.

The new company raised about $1.6 billion in an initial rights offering to acquire the real estate.

I first became interested in Seritage in November 2015, when Warren Buffett (Trades, Portfolio) acquired 2 million shares for around $36 per share, giving him an 8% stake in the company.

The company's goal is quite straightforward: unlock the value of the real estate by renting the space previously occupied by Sears at higher rates to third-party tenants.

In order to maximize the space available to rent to multiple parties, Seritage needed to redevelop the properties. This is quite a capital-intensive activity, so liquidity levels (and its sources) were the real challenge, especially since the company already had debt on the balance sheet.

Risks

Every REIT has risk, but for Seritage, it basically boiled down to Sears going bankrupt.

In fact, Seritage's revenue largely depended on Sears at its inception (more than 70%).
However, Sears has continued to decline and store closures have been accelerating since the REIT was created.

As a result of the company's 4 times conversion rate, Sears' store closures should be quite welcome to Seritage. While this is true, the REIT still needs Sears-related income to execute its plan. So in order to have a smooth transition to a diversified base of third-party tenants, the closure rate should not be too high.

In 2015, the two companies agreed to limit the number of locations that can be shuttered per year. With around $1 billion in debt and a declining revenue stream, Seritage's chances of feeding its pipeline of redevelopment projects was in jeopardy.

Berkshire's loan and Sears' bankruptcy

The real turning point for Seritage came last July, when the company announced it "entered into a $2.0 billion term loan facility with Berkshire Hathaway Life Insurance Company of Nebraska."

The loan matures on July 31, 2023.

This big injection of liquidity clearly reduced the risk of running out of money (at least in the short term), while allocating the resources needed to execute its redevelopment plans. The REIT also used it to repay previous debts (simplifying its structure).

Three months later, on Oct. 15, Sears declared bankruptcy.

Sears CEO Eddie Lampert saved the struggling retailer (and around 45,000 jobs) by offering $5.2 billion for its 425 stores through his investiment vehicle, ESL Investments. On Feb. 7, a federal bankruptcy court approved the sale of Sears Holdings to ESL.

This was a relief to Seritage, as it gives the company more time to put online its signed not operating revenues before Sears sales are reduced to zero.

These two events heavily shifted the odds in favor of Seritage, which has a much greater chance to successfully execute its redevelopment plan.

The last two quarters

Let's briefly compare the last two quarters in terms of tenant distribution.

Seritage Q3 Tenant Overview

On Sept. 30, the company derived 39.9% of its rent from Sears. Of the remaining 60.1%, 33% was related to SNO leases and 27.1% consisted of In-place, non-Sears leases.

Seritage Q4 Tenant Overview

On Dec. 31, Sears' share of revenue was down to 29.1%, while the remaining 70.9% consisted of 39.5% in SNO leases and 31.4% in non-Sears in-place leases.

In absolute terms, the rent Sears is paying to Seritage was down from $91 million to $61 million, so around one-third evaporated in only three months!

The in-place, non-Sears rents increased from $61 million to $66 million, so the share of total rent which goes "online" is slower than the ones Sears is putting offline.

The SNO leases annual rent grew from $75 million to $83 million, a more than 10% increase as a result of new leases signed during the fourth quarter (878,000 square feet).

My expectation is that, even if Sears continues to close stores, because it desperately needs to cut costs at an accelerated pace, Seritage will be able to reach the breakeven point in one or two quarters.

Another important aspect is Sears currently accounts for 29.1% of total annual rent, but for 56% of total leased gross leasable area. This is due to fact the Sears PSF Annual Rent is only $4.86, while the (combined) non-Sears PSF Annual Rent is $15.11. This means Seritage only needs to rent one-fourth of the current Sears-related GLA to generate the same amount of rent.

Conclusion

Seritage has the right amount of liquidity to fund the redevelopment pipeline, has significantly reduced the amount of money it derives from Sears leases and is close to breakeven.

Moreover, the company will pay only the first quarter dividend for this year, which will give it even more flexibility on capital allocation.

Finally, I consider Seritage to be fairly valued currently considering the remaining risk. For those willing to be patient and wait for the redevolpment plans to be executed (most of the projects will be finalized in the next 24 months), the final prize could be quite rewarding.

Disclosure: The author owns shares of Seritage Growth Properties (NYSE:SRG).

About the author:

Nicola Guida
I'm a Software Engineer with a big passion for Value Investing. I love looking for undervalued companies both to feed my investment pipeline and to write articles in order to share my investment thoughts.

Visit Nicola Guida's Website


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