In a market starved for yield, CBL stands out as an abnormally high yield company. At a current price of $9.50, it has a dividend yield of 11.2% and an adjusted AFFO multiple of 4.1 on 2015’s $2.32 in AFFO. 2016 midpoint guidance is $2.35. Most investors despise Class B & C malls and expect them to go the way of the dinosaur. While they’re not growth assets, they have a place in the universe in smaller cities. Over the next few pages, I’m going to show that these malls are actually stable if not growing slightly. As long as the malls don’t fall off a cliff, I know that 4.1 times AFFO is wrong.
B & C Malls 101
Half a century ago, malls were all about the anchor store. They were the draw that brought people in to then spend money at tenants that were paying higher rents. Over time, this dynamic slowly changed and the tenants themselves became the draw, with the anchors slowly dying off. One by one, the old school anchors have withered and consolidated. Wall Street has oddly focused on the demise of certain anchors like SHLD and JCP, however, most anchors pay substantially below market rents and are not profit centers for the malls anyway. The real cash flow is the rest of the mall and the anchors were only the draw.
In the 1980’s, malls transitioned from the place where you shopped at SHLD and JCP, to the place where you hung out. Remember “Mall Rats”? That was the inflection of shopping to entertainment. The anchors weren’t where the fun was. The fun was the food court and all the quirky shops along the hallways. The draw was that you could walk around in 250,000-4,000,000 sq. feet of air conditioning eating dippin’ dots and seeing your fellow neighbors. It became a focus of the community.
Fast forward to today, the quirky shops are also slowly deteriorating due to the internet, but the future of the mall is still bright because these retail locations are converting again—to food and beverage (F&B) and smaller interactive retail locations. This turnover and conversion is adding some volatility to quarterly numbers, but it clearly is happening. The mall of the future will have much more F&B, they will be the draw, but you’ll also be able to handle your banking, cell phone accessory purchases and explore new fashions in the retail locations that remain. Finally, there will always be the ubiquitous cinema.
The anchor hasn’t been the draw in ages. When was the last time you went to the Sears at the mall and then stayed to shop? I don’t think I’ve been in a Sears in 20 years for that matter. The anchors are cheap real estate that will be re-used for large format F&B (Cheesecake/Dave & Buster’s/Zoes Kitchen/etc.) along with shopertainment stores (Dicks/H&M/Hobby Lobby/ULTA/TJ Max/etc.) often at much higher rents. These will then be the draw. Since 2010, CBL has converted 20 Sears to other formats—there are 52 more to go. They have plenty more anchor locations with other deteriorating retailers. Page 12 of the most recent CBL presentation has a list of these redevelopments from 2015 and 2016 where a total of 719,000/ft of space is to be converted at 9% cash on cash returns on invested capital. If anything, the anchor boxes will become the growth that offsets any deterioration at the rest of the mall.
Why will CBL malls stay relevant?
Every community needs a focal center. This used to be the downtown, but downtowns often have their flaws like older spaces that cannot be readily converted to modern uses, lack of parking, bad access, non-uniform ownership, etc. These issues have lead people to go to the mall because it is the downtown, has good parking, easy access, but climate controlled and without a host of other issues. The mall is where you go for your food and entertainment, mainly because all of your friends are likely to be there. As malls transition to having more F&B, it seems only natural that they become more of a draw. Get dinner at Cheesecake Factory, get drinks after at the brewery, then go to the movies. It’s all in one place. For most cities that CBL is in, they are the only option. Based on CBL’s mall locations, the average competing mall is 25 miles away and 91% of mall NOI comes from “only game in town” malls. Basically, will you go after work to Chili’s by the highway and then drive 20 minutes to where your other friends are? Or will you go to the mall and park there, because your friends are going to be at the brewery later? I know it is anecdotal, but having spent over a week in small cities of South Texas, I can say that the mall is the focal point of the cities and they’ve made a transition from retailing to F&B/entertainment over the past few years.
Here’s my overall thesis. B & C malls are stable viable assets. There is volatility caused by bankruptcies and store size shrinkage as companies transition to more of an internet presence, but companies will never abandon the retail floors pace. If national retailers downsize, local retailers will take up the slack. Offsetting this, B & C malls are moving into F&B and entertainment. Finally, the legacy anchors are being converted into boxes at high cash on cash returns. All of this is adding to some quarterly volatility, but overall, revenues are increasing—which is the opposite of the idea that B & C malls are dying.
Don’t believe me? Here’s CBL’s annual stabilized mall same small space gross rent (spaces less than 10,000 ft), sales per square foot and same store NOI. I’ll admit that there’s some discrepancies due to the purchase and sale of properties, but overall, I think this paints a picture of a business that is stable to growing slightly.
CBL is a bit leveraged, but I think it’s sustainable at 2.0X interest coverage (AFFO/Interest Expense). More importantly, interest expense is overstated as the company has a number of properties that they’re likely to put back to the bank that have interest expenses that roughly match or exceed property level NOI, leading to a lower overall interest coverage for the rest of the portfolio. Additionally, despite having a weighted average interest rate of 4.56%, there are many properties with interest expense over 6% that will be re-financed over time to lower rates over time. Finally, I believe that the company will de-lever through asset sales and annual growth. The AFFO payout ratio has been in the mid to high 40% range for the past 5 years, allowing the company to re-invest and pay down debt.
Asset Purchases and Sales
Over the past few years, the company has slowly migrated away from C malls and towards more B+ malls. Based on cap rates on exit vs. purchase, I suspect that they’re giving up a bit of AFFO in the hope that higher sales per foot number will give them a better market multiple and lower cost of funds. I don’t know if this is smart or not, but it does make quarterly and annual comparisons a bit difficult at times. However, the overall change from one year to the next is somewhat negligible and the core of their malls has stayed constant.
Recent Legal Issues
I don’t believe that recent news regarding Senator Corker is relevant to the company. Is it even illegal for senators to trade on inside information? On the subject of fudging some loan docs, they may have done this or may not have. The company denies it, but even if true, I think it’s a non-event. However, this gives investors the opportunity to buy shares at just over 4 times AFFO.
I don’t expect anything heroic out of CBL on the performance side. If B & C malls can stay stable, I don’t see why CBL can’t be a double from here (8x AFFO). If same store NOI continues to grow, this could be a triple (10x AFFO is still cheaper than most triple-net REITs that have no growth either). Besides, it pays you well (11%) to wait.
Think About It....
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.
B & C malls turn out to be stable.
Yield focused investors realize that this is one of the cheapest REITs out there.