Description

We are long shares of DDR, a retail REIT focused on power centers (typically 300-500k sq ft) which are often anchored by a mass merchant (Wal-Mart, Target, Costco- in many cases DDR is not the owner of the WMT/TGT/COST but is simply co-located) and/or home improvement retailer (HD/Lowe’s) and include a leading discount apparel concept (TJX/Ross) and may or may not include a grocery/Bed Bath & Beyond/Ulta.  After declining 50% year to date (and down ~60% from post GFC high of $20), shares trade at attractive multiples (6.8x normalized FFO, ~9% cap rate, and 86% of stated book/53% of adj book) and we see 50+% upside.  Shares have been beaten up as investors are concerned about:

1. Puerto Rican exposure - PR represents ~13% of NOI (pro-forma for YTD divestitures).  
2. US retail REITs are out of favor - death of bricks and mortar retail, uptick in vacancy/slight decline in US NOI.  The bankruptcies of Sports Authority/HH Gregg have added to vacancies this year (though the company has since received LOIs to let this space).
3. Historical declines in NOI/FFO due to divestitures - DDR is at the tail end of a multi-year asset divestiture program designed to de-leverage and reduce exposure to non-core/weaker assets.  De-leveraging and paying down debt at 4-5% while selling assets at 7-8% cap rate is dilutive to FFO.  
4. Bed Bath & Beyond exposure - similar to Brixmor (very good writeup here on VIC , BBBY represents ~3.8% of rents.  There is also exposure to such investor favorites as OfficeMax/Staples (1.2% and 0.7%, respectively), Ascena (1.3%) and Toy’s R’US (1.2%).  The top 50 exposures can be found on page 13 of the most recent supplement. 
5. Writedown of exposure to preferred stock in a JV with Blackstone.  

Well WeighingMachine, why do you own this?

1. We think there is inherent strength in the company’s significant exposure to A) strong retailers, i.e. WMT/COST/TGT/HD/LOW/TJX/ULTA/FIVE and (b) these retailers not only drive traffic but drive a high frequency of visits (necessities/TJ MaXX never the same place twice, etc).  We believe that the benefits of being exposed to strong retailers will drive frequent traffic and allow management to re-let space at positive spreads as vacancies emerge and increase letting of vacant small spaces which have significantly higher ABRs.  
2. Nearing end of major asset sale/divestiture phase.  At 3Q, the company noted that it is looking to divest another $900 mn or so of assets 
3. Management - DDR has been a revolving door with multiple management teams over the past few years.  The current mgmt team (CEO/COO/CFO) come from Equity One which was sold to Regency Centers (REG) late last year.  Management is executing on divestitures/de-leveraging and will soon shift its focus to re-development/operations (boosting smaller shop occupancy which it sees as a $40 mn NOI opportunity).
4. Improved balance sheet - the asset sale program has allowed DDR to bring its leverage ratio from to the current level of 6.3x (incl share of JV debt/income but excluding preferred) and will take the ratio below 6x.  
5. We think the strong will get stronger as 1) customers gravitate toward locations offering a wide range of value priced products (2) financially strong players with access to the capital markets are able to continue to invest and renovate (3) strong leasing team focused on bringing in tenants which are NOI accretive and drive additional traffic to the location.  
6. While the asset divestiture program has been dilutive to FFO, according to the most recent management presentation, divestitures have been done at lower cap rates than DDR trades - for wholly owned properties, divestitures have been done at 7.2% whereas we have the DDR enterprise trading at an 8.6% cap rate.  
7. While the equity has declined 50% and trades at a 10% dividend yield, DDR has funded itself at attractive rates thus far in 2017 - most recently it sold 7 year senior unsecured at 4%. The company has extended its 
8. Valuation - DDR trades at an 9+% cap rate, roughly 7x normalized FFO and sports a 10.2% dividend yield.  We see a disconnect in how retailers (we are shorting a basket here) are valued vs. the valuation of DDR.  While DDR optically looks considerably more levered than a typical retailer, the gap is narrowed when considering off balance sheet operating leases.

Here is my take on valuation:

Risks

1) Bricks and mortar is dead and I’m an idiot for buying this. 

Catalyst

1. Retail relief rally spreads to shopping center REITs
2. Though I don’t see a deal getting done in the very near future, if the market doesn’t begin to see value here within the next 18 months, I would not be surprised to see the company sold.  I think my base case would be a reasonable take-out price which would leave plenty of meat on the bones for a strategic acquirer.