Description

2020.09.26 Writeup of RPT D Preferred Long ($38.58)

I like RPT Series D Preferred Equity (ticker: RPT D) as a long.  RPT is a retail REIT comprised of entirely open-air centers.  2/3 of base rent comes from centers with a grocery component. 

The pitch is relatively simple, but the issuance is too small (only $71.3mm at market value) for large funds to get involved here.  This is a cumulative preferred paying a 7.25% annualized coupon that last traded at $38.58 per share on its $50 liquidation preference / face value, or ~77% of face.  This translates to a 9.4% current yield. 

More importantly, there is significant capital appreciation potential as it trades back up towards par.  For instance, a return to par in 12 months would translate to a 39% total return.  A return to par in 24 months would translate to a 48% total return.  While it isn’t hard to find truly distressed paper trading at wider yields today, I believe that RPT D is significantly mispriced. 

While RPT D is a preferred equity and not debt, it has several strong protections.  First, to keep its REIT status, RPT must continue paying dividends to the extent of its taxable income.  Second, it is a cumulative preferred.  Third, it has continued to pay its preferred dividends in cash despite omitting the dividends on its common stock for Q2 and Q3 so far.  Fourth, RPT D is the company’s only preferred stock, and a relatively thin sliver at that.

RPT D also has optionality beyond par.  Unlike many listed preferreds, this one is convertible into RPT’s common stock at a strike price of $13.17 / common share.  As such, RPT D had traded above par almost continuously for more than 7 years pre-Covid.  In fact, it traded above $70 a few times and finished 2019 at $59.86, or nearly 120% of par.  Admittedly, RPT common today at $5.38 is a long way from the strike price, but RPT common did end 2019 at $15.04. 

Perhaps more importantly, RPT D is NOT callable.  This is important in enabling RPT D to trade meaningfully back above par in the future, either based on its conversion feature and RPT common recovering, OR in the event that long rates stay at record lows or move lower still.  Relatedly, this also should give RPT a strong incentive to try to repurchase or tender for RPT D after the environment has stabilized.

Considering where RPT D is trading, the company’s liquidity position and balance sheet may positively surprise you.  RPT ended Q2 with $250mm of cash on the balance sheet and only $175mm drawn on its $350mm unsecured revolver.  46 of its 49 properties and 91% of NOI are unencumbered.  Only 8% of total debt matures prior to 2023 (nothing in H2 of 2020; $37mm in 2021; and $50mm in 2022). 

2/3 of the rent roll comes from centers with a grocer component and 87% of the tenant base is national/regional tenants.  Collections overall have trended positively.  As of 7/31/20, 65% of Q2 base rent and recoverable expense reimbursements had been collected in cash and 75% of July had been collected.  Including deferral agreements at that time, 77% of Q2 had been addressed and 84% of July.  As of 9/8/20, Q2 collections had increased to 70%, July had increased to 79%, and August collections were up to 86%.  Including deferral agreements at that time, 93% of August billed rent and recovery income had been addressed.  And 96% of tenants had reopened.

Interestingly, it is the local small shops (<5,000 SF) that have disproportionately higher than company average cash collections of billed rent across all time periods.  It is the national and larger tenants that make up the bulk of the deferral agreements and non-payments.  Specifically, on the Q2 call, RPT said that 93% of deferred amounts are for national or regional tenants.  For now, I see this attribute in a positive light.  It would appear that many of the most stressed tenants with less access to capital have been the ones most likely to pay their rent.  And many of the tenants who have negotiated deferral agreements are the ones with the best access to capital and a greater ability to pay.  It would seem these tenants have tried to use Covid to exert leverage over their landlords on an opportunistic basis rather than out of necessity.  That suggests a high likelihood of deferred rents getting collected. 

RPT also noted that the average deferral was for 2-3 months of rent.  ~40% of deferred rents are scheduled to be paid back during the remainder of 2020, with the balance to be repaid in 2021.  Cash collections should continue to increase as deferrals roll off ad as previously deferred rents begin getting paid.

In the meantime, at current collection levels RPT is generating FCF.  That is especially the case with the common dividend currently suspended and saving ~$18mm of cash per quarter.  RPT also noted that it can skip the Q4 common dividend without any risk of a shortfall on dividend payments to keep REIT status.  (The Q4’19 common dividend also counts toward meeting the required payout of 2020 taxable income and not 2019 taxable income).  RPT has made it clear that when it does reinstate the common dividend, it will do so at a lower rate than in the past and from a lower level upon which it will grow it.  This is obviously credit positive and thus should benefit the preferreds.

RPT has plenty of liquidity and minimal short term debt maturities, but leverage is elevated.  When the world ultimately normalizes, RPT could conceivably monetize several properties and rapidly delever the balance sheet to a more comfortable level at that time.

RPT also benefits from the JV formed in December with GIC to purchase new assets.  RPT received $118mm in proceeds upon contributing 5 assets into the JV shortly before Covid.  More importantly, $200mm of GIC capital has not yet been tapped, representing a much more capital efficient way to acquire assets.  Selling some wholly owned properties to third parties and buying new properties via the GIC JV is a plausible scenario in the coming couple years to the extent that the market for transactions thaws.  Contributing additional wholly owned assets to the GIC JV seems unlikely, but could be another option for deleveraging in the future if the credit markets were to worsen materially.

RPT was also performing well prior to Covid, with YoY SSNOI growth varying between +3.9% and +4.7% in the 4 quarters of 2019.   Total occupancy increased 260 bps yoy in fy19, significantly outpacing all peers.  And future development, redevelopment, and capex obligations are minimal.

In short, I think RPT D Preferreds are a good long on an outright basis.  But they seem even more mispriced relative to the comps.  For instance, SITC and BFS each have 2 series of preferreds trading around par and 6.1 - 6.3% current yields.  KIM has 2 series of preferreds trading ~106% of face value and with current yields of only 4.8 -5.0%.  The comps have essentially all rebounded to near par already despite generally being inferior securities on a fundamental basis.  In contrast, even after the significant RPT D share price increase in recent months, there is still 30% upside to par and ~9.4% current yield. 

Yet the lower dollar price and richer yield of the RPT D preferreds dramatically understates their relative attractiveness versus the comps.  Each of these peer preferreds is callable at par in the next several years, dramatically limiting their duration-based upside relative to the non-callable RPT preferreds.  And unlike the convertible RPT Ds that had previously traded more than 40% above of par due to that conversion feature, none of these peer preferreds are convertible. 

I suppose the peer preferreds could be used as hedges, but I’m comfortable owning RPT D Preferreds outright. 

Catalysts

Yield compresses as time passes

Cash collections continue to improve

Balance sheet leverage declines

RPT buys the RPT Ds in the open market or via tender offers

Risks

Recession decimates shopping center tenants and asset values

Share price can dislocate wildly from fundamentals given the lack of trading liquidity and small issue size

Another round of widespread lockdowns if Covid turns out to be much worse than expected this winter

Catalyst

Yield compresses as time passes

Cash collections continue to improve

Balance sheet leverage declines

RPT buys the RPT Ds in the open market or via tender offers