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Portfolio > Portfolio Construction

REITs: Building Attractive Growth

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Michael R. Widner
Stifel Nicolaus
[email protected]

We see a lot to like here, and while we say that about several of the agency REITs, Capstead Mortgage (CMO) has moved a bit higher on our near-term favorites list. While some investors may be put off by the slightly sub-10% yield, we expect the dividend has bottomed, we see potential for dividend recovery in 2Q’13 and beyond, and we like the price at an 8% discount to book. 

The biggest uncertainty in our outlook is that we find it difficult to predict the prepayment behavior of highly seasoned current reset adjustable-rate mortgages (ARMs), which is a focus in CMO’s portfolio. But that’s an uncertainty we’re increasingly comfortable with, as we also value the protection they provide (relative to fixed-rate [mortgages] or longer-duration ARMs) in the event of a material steepening or surprise rising of the yield curve.

Our current expectation is for [prepay] speeds to peak in January based on the October peak in refinancing applications. We’re not expecting a big drop in speeds in Q1 based on refi applications remaining elevated and mortgage rates remaining near trough levels. But so far, the curve steepening, applications slowing, and mortgage rates ticking a bit higher are at least steps in the right direction.

We maintain our Buy rating on the shares with a $14.50 target price based on 1.07 times estimated current book value of $13.50.

Capstead has been grinding along with a short-duration approach, which we see as about the best protection an agency REIT can have against interest rate uncertainty. 

Nathan Isbee
Stifel Nicolaus
[email protected]

SuperValu, one of the largest grocery store operators in the U.S. with 2,400 stores, announced the sale of five grocery brands encompassing 877 stores for $3.3 billion, $100 million cash and $3.2 billion of debt to a Cerberus-led investor consortium that includes Kimco Realty (KIM). The consortium will also conduct a tender offer for up to 30% of SuperValu’s common stock. KIM will own an approximate 15% interest in the investor group.

The consortium is acquiring five of the strongest SuperValu’s brands in more dense, infill markets, with stronger demographics; Albertsons ([in] Nevada, Northwest U.S., and Southern Calif.), Acme (Del., Md., N.J., and Pa.), Jewel-Osco (Chicago), Shaw’s and Star Market (Boston and New England).

KIM is joining the same group of investors, who in 2006 purchased 661 “non-core/underperforming” Albertsons stores in the SuperValu led acquisition of Albertsons. The group sold stores, closed underperforming stores, and improved operations at remaining stores. KIM has received $245 million in distributions from its original $51 million investment representing pre-tax income of $180 million. 

KIM has a long successful history of investing in troubled retailers, including Montgomery Ward, Venture, Ames, Service Merchandise, Albertsons and Hechinger to unlock the value of the real estate controlled by these retailers and generate a profitable return for shareholders.

Albertson’s LLC, a majority-owned Cerberus company run by Robert Miller, will operate the newly acquired grocery locations. Albertson’s LLC currently operates 190 Albertsons stores and two Super Savers in eight states.

The new management team will first look to improve the performance of the stores, which have been undermanaged and undercapitalized for many years. While the traditional grocer model is facing strong competition on many fronts, there is likely a lot of low-hanging fruit which management will look to harvest.

James Milam
Sandler O’Neill Partners
[email protected]

LTC Properties Inc.’s (LTC) surprise announcement of a nearly $100 million investment in an assisted-living and memory-care portfolio should be immediately accretive and continues to orient the company toward private pay communities. 

LTC announced several acquisitions, most of which are expected to close before year end. (We note the potential change of tax law in 2013 as a possible motivation for the seller, who we believe had agreed to sell this portfolio to Care Investment Trust, CVTR, in a transaction that failed to close earlier this fall). 

The company will acquire three assisted-living facilities with 202 units and three memory-care facilities with 136 units from Juniper Communities for $94 million ($278,000/unit). The properties are located in Colorado (two), New Jersey (three) and Pennsylvania (one) and will be leased to Juniper for 15 years (with two five-year renewal options) at a 7.0% initial cash yield (8.1% GAAP) with 1.5% increases in each of the first two years and 2.25% thereafter. $82 million is expected to close by year-end, with the remainder closing in 2013 after receiving approval for a $6.8 million HUD loan assumption (3.75% interest rate maturing in 2051). 

LTC will also provide a $5.1 million two-year bridge loan on a fourth [assisted-living facility] at a 7.0% initial yield. The company also announced a construction loan to fund the development of a $10.6 million 106-unit ($100,000 loan to cost/unit) skilled-nursing replacement facility in Wisconsin that will be leased to Fundamental, for which LTC will have a purchase option one year after the certificate of occupancy is received, with the property to be added to an existing master lease with Fundamental at the escalated loan rate (9.0% initially with annual steps of 25 basis points).

We are not changing our 2012 estimate, but we are increasing our 2013 estimate of normalized funds from operations (FFO) by $0.04 to $2.44. Our 2012 normalized adjusted FFO estimate is unchanged, but we are increasing our 2013 estimate by $0.03 to $2.37, respectively. Our revised estimates assume the new investments are funded initially with the line of credit, but that LTC issues $75 million of unsecured debt in 1Q13 to refinance this balance. 

We forecast the company’s net debt plus preferreds to adjusted EBITDA to rise to 3.7 times from 3.0 times at 3Q12 following the completion of these transactions, still a very reasonable level in our view.

Our price target of $36 represents 15.2 times our 2013 estimate of adjusted FFO and a pro forma 2013 dividend yield of 5.3%. LTC is improving the private pay percentage of its portfolio through investing in assisted-living and memory-care facilities, while continuing to improve the quality and age of its skilled-nursing portfolio through acquiring newer facilities and building replacement properties. 

In addition, the renovation and expansion projects within its portfolio should contribute to accelerating earnings growth in the second half of ‘13 and beyond. The company remains committed to a strong balance sheet and pays a well-covered dividend that we expect to continue growing. Though the issue with the company’s largest tenant, Assisted Living Concepts (ALC), carries some headline risk, we believe LTC will be able to successfully manage this exposure to a satisfactory outcome. With the stock trading at 14.2 times our 2013 estimates of adjusted FFO versus 16.4 times for the other health-care REITs we cover, we are maintaining our buy rating.

R.J. Milligan
Raymond James & Associates

We reiterate our Outperform rating on shares of National Retail Properties (NNN). We believe National Retail’s stable portfolio and well-covered dividend (5.0% yield) provide investors with a very attractive risk/reward opportunity. In addition, we believe we could see further upward estimate revisions as the company continues to acquire, thereby taking advantage of the large spread between cap rates and interest rates. 

National Retail Properties reported 3Q12 FFO per share of $0.52, which included $9.6 million ($0.09 per share) of one-time items. Excluding these items, recurring 3Q12 FFO per share of $0.43 was a penny shy of our estimate and consensus of $0.44. Investment portfolio occupancy was 97.9% at the end of the quarter, down 30 basis points sequentially but up 70 basis points from the year-ago quarter. 

The company acquired 30 properties for $139.6 million during the quarter at an average 8.65% cap rate. Despite an extremely competitive market for net-lease assets, investments yields have continued to surpass our expectations due to management’s ability to source off-market transactions through existing relationships. 

[Through late 2012], National Retail has acquired 124 properties for $452.6 million (at an average 8.5% yield), with management now expecting acquisitions totaling $500 million for the full year (up from prior guidance of $300 million to $350 million). For 2013, management is anticipating acquisitions totaling $200 million, with the timing tilted toward the second half of the year. We believe (and management indicated as much on the call) that investment activity in the coming year could exceed that goal, which could result in upward revisions to earnings estimates. 

Management increased its 2012 FFO per share guidance from $1.67-$1.72 to $1.71-$1.73. Management also issued 2013 FFO per share guidance of $1.77-$1.81 (below consensus, however only assumes $200 million in acquisitions). We are revising our 2012 and 2013 FFO per share estimates to $1.72 and $1.81 from $1.73 and $1.80, respectively. We are also introducing a 2014 FFO per share estimate of $1.89. Our model assumes acquisitions of $250 million and dispositions of $50 million in 2013.

Valuation: We believe that the market should view National Retail Properties’ cash flows as positioned between equities and fixed income given the long-term structure of the tenant leases, and therefore we think the dividend discount model is the most appropriate methodology for valuing the stock. 

NNN is trading at a 7% premium to our dividend discount model value of $29.59, which assumes an 8.5% cost of capital and a 3.0% dividend growth rate. However, in this low-yield environment, we view the stock’s 5.0% yield as very attractive (compared to 10-year Treasuries yielding 1.7%). Our new price target of $33 (from $31) is based on the stock trading at about 18.2 times our 2013 FFO per share estimate, in line with the current 2012 FFO multiple. [The company’s] leverage is holding about flat at 8 times, which we expect to remain the same going forward.

Maintain Buy.


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