Description

Long shares of Brixmor (BRX).  Brixmor owns 445 shopping centers which average 172k sq feet, 70% of which are grocery anchored.  There is an excellent write-up from Mostly Ugly here on VIC ~13 months ago which gives a great overview of the REIT, its history, management as well as a framework for thinking about the company’s capital allocation.  I’d also recommend the company’s investor day material as well as the most recent quarterly presentation & supplement as background.  

While BRX has made what I would consider to be better than expected progress on its plans over the past year, like many second tier shopping center REITs, shares have produced a negative total return over that time period.  Besides rising interest rates and the retail apocalypse narrative, I suspect the reason for the poor share price performance is that the company has been a net seller of properties over the past twelve months which has been dilutive to FFO/share as the cap rate on the properties is higher than the interest rate on debt (a large portion of the proceeds from such sales have been used to reduce debt).  However, while these sales have been dilutive to FFO, they have been accretive to per share NAV.  

I think we are near an inflection point as 1) asset sales moderate going forward (2) the gap between leases signed and commenced (this differential is at an all-time high for BRX) narrows (3) Brixmor continues to deliver redevelopment projects in 2019 & 2020.  

I believe the future is likely to be brighter than the past for BRX shareholders and have been steadily accumulating BRX shares.  Progress made by Brixmor over the past year:

• Divested ~$1 billion worth of shopping centers (9-10% of total assets).  These transactions have occurred one by one, rather than in a large portfolio transaction.  Overall, the cap rate for divested centers has been sub 8% despite these centers ranking of in the bottom quartile of the shopping centers owned by Brixmor in terms of population density and household income.  
• Brixmor has delivered 3 completed redevelopment projects over the past year.  The company continues to build & progress through its pipeline - it has a dozen in process projects and a pipeline of 30 more.  Managment expects to do $150-200 million of development projects per year at an anticpated NOI yield of 9-11%.  
• The company has executed ~3 million sq ft of leases per quarter over the past year at acceptable spreads.  While billed occupancy stood at just 89.4% at 9/30/18, the leased rate stood at 92.5%.  There tends to be a 12-15 month lag between the signing of a lease and the tenant being up, running and paying rent.  3.1% is the largest gap seen at BRX between leased and occupied for BRX  and bodes well for future NOI growth as these figures converge.  
• ND/ EBITDA has declined from 6.8 to 6.5x.  
• The company has repurchased ~5 million shares.  

The way I look at this, these accomplishments significantly de-risk BRX as an investment.  Coming into 2018 with interest rates set to increase and retail armageddon headlines blaring, my biggest concern for BRX and the public shopping centers was that they would be unable to divest their weaker properties which could put them in a precarious position should the economy turn as these centers would be the toughest to lease.  Similarly, these divestitures have allowed additional de-leveraging.  Further, the company (and sector as a whole) has shown strong leasing momentum throughout 2018 - with 8 years being the typical lease duration. This year’s strong leasing momentum will provide benefits to Brixmor for years to come - not only in terms of the rents received from the leases signed (most of which don’t commence until 2019/2020) but by bringing in an attractive stable of tenants, this improves the overall quality of the centers and will make future vacancy easier to deal with (spaces near successful tenants with lots of traffic are easier to lease).

Going forward, Brixmor will continue to pare its portfolio - the company still has ~35 single market assets which it will look to divest but the pace of sales will be much more gradual.  Proceeds from asset sales will be recycled into redevelopment projects, likely $150-200 million per year.  Mostly Ugly’s writeup did a great job of describing the return profile of these projects and the adjustments which need to be made to get to a cleaner return number.  While the economic yield on these projects may be lower than the cap rate received on divestitures, I believe that this swap is value enhancing as the appropriate cap rate for the properties in which Brixmor is investing is lower than that of which they divest.  When done correctly, the investment put into a shopping center should lower the cap rate used to value the center - when engaging in redevelopment projects BRX pre-leases the space to tenants management believes are not only creditworthy but enhance the overall profile of a center by driving traffic.  By adding relevant tenants who drive traffic,  Brixmor adds value to the other tenants present.  In addition, bringing in new relevant concepts gives Brixmor more leverage in leasing up vacancy within a center at better terms and rents.  Brixmor estimates that it sees a 600-800 bp increase in small shop occupany (sub 10k sq foot spaces - ABRs here tend to be more than 2x that of 10k+ spaces) after redevelopment.  This benefit is not included in the 9-11% NOI yield estimate.  These projects also reduce the risk profile of a center - as tenants churn, Brixmor is better positioned to deal with future vacancy by having a well-invested center with a strong tenant base driving traffic to the center.  

At its Investor Day in December 2017, BRX announced that it targeted NOI growth of 3-4% o/w 2.5% will come from contractual rent growth (escalators) and mark-to-market realization with the reaminder coming from redevelopment.

Valuation - 

I am incapable of formatting anything in VIC so I'm putting the BRX cap rate calc & REIT shopping center comps in the messages section 

At $15.33, BRX shares trade at a 9% cap rate (using 2019 estimated NOI).  The simple reason this is too cheap is because the company sold $1 billion in much lower quality assets at a sub-8% cap rate over the past year.  Again, this was not to a single misguided buyer but took place via dozens of transactions.  Similarly, other shopping center REITs like Kimco have also aggressively disposed of over $600 million worth of lower quality shopping centers at 7.5-8% cap rates over the past year.  We’ve seen similar transactions by a number of other publicly traded REITs.

I value the company at $23/share which is a 7.25% cap rate using the 2019 NOI estimate above (this 2019 # is my best guess at stripping out the NOI of divested centers and then growing same center NOI at 2.5%).  My rationale for 7.25% is simply that the company sold a large quantity of assets which were of considerably lower quality for a sub 8% cap rate.  While this may look aggressive based on the table below, I'd note that the companies below have sold properties in the 7.5-8% range (and again these are properties that they believed to be of inferior quality).  Relativley few shopping centers are contained in the public sphere and the private market has demonstrated a willingness to pay prices in excess of those we've seen in 

Risks

Retail apocalypse

Continued upward movement in interest rates

Catalyst

I have no idea.  Maybe a public to private transaction takes place? 

Maybe FFO stabilization (now that we are at the end of the large divestiture program)? 

NOI growth - BRX confirmed that it targets 3-4% NOI growth in 2019 (guided toward the bottom of the range to account for Mattress Firm/Sears bankrupcies).  Achievement of this makes the stock more difficult to ignore in my view.