Despite having just increased its dividend for the 53rd consecutive year, retail REIT Federal Realty Investment Trust (FRT) has been hit hard by the current pandemic. Conditions have started to improve (e.g. more tenants are re-opening and cash collections are increasing), but in order to succeed FRT will need to make smart capital allocation decisions and manage its liquidity carefully (its dividend payout ratio is near the high end of its historical range). This article reviews the health of the business, valuation, risks, dividend safety, and concludes with our opinion on whether FRT is worth considering if you are a long-term income-focused investor.
Overview:
Federal Realty Investment Trust is a shopping center-focused retail REIT that owns high-quality properties in eight of the largest metropolitan markets (Chicago, Boston, New York, Philadelphia, Washington DC, Miami, Los Angeles and Sillicon Valley). Its portfolio consists of 104 shopping centers spread across ~24 million sq. ft, of retail space and 2,800 residential units. FRT's portfolio includes grocery-anchored centers, super regional centers, power centers, and mixed-use urban centers. Its properties are present in best-in-class locations which are densely populated (162K average population) and affluent (median household income of ~$127k).
FRT’s tenant base is highly diversified (see figure below) with no single tenant accounting for more than 2.6% of its annual rent. In fact, the top 25 tenants only account for 28% of its total annual rent. As per Q220 update, 24% of its rent comes from essential services such as grocery, drug, banks. Another 21% comes from residential and office tenants which have largely remained relatively immune to the COVID-19 pandemic. The remaining 55% of its rent includes exposure to industries such as Restaurants (15% of the portfolio), Apparel (16%), health & beauty (5%), Fitness (4%), Experiential and Others (9%). These sectors have been impacted because of the shutdown but are slowly recovering.
Tenant Diversification (as a % of Annual Rent), source: Company Presentation
As state economies are reopening, the percentage of tenants that are open in its portfolio has accelerated to 92% as of July 31 (versus just 47% as of May 1). As a result, cash collection has shown strong momentum tracking those re-openings. Cash collection for the second quarter finished at 68% and has accelerated to 76% for July 2020.
(source: Company Presentation)
FRT boasts of a strong development pipeline with all projects in first ring suburbs of major metropolitan markets with significant demand drivers. The attractive location of these properties reduces the risk of leasing. In fact, commercial space in these development projects is already 66% leased. The company noted that its properties remain in demand despite the crisis. During Q2, it signed nearly 100,000 square feet of new and renewed office deals, in addition to the 277,000 feet of retail deals. And regarding the retail space, it was leased for 11% more rent than the previous tenant.
53 Consecutive Years of Dividend Increase
FRT is one of thirty publicly traded company which is considered a “dividend aristocrat” and has the longest record of consecutive annual dividend increases in the REIT sector. It has delivered 53 consecutive years of increased dividends, with the most recent increase coming in Q220. It increased its quarterly dividend by ~1% to $1.06 during Q2. At the current annualized dividend per share of $4.24, FRT delivers a dividend yield of 5.3% which is fairly attractive. The payout ratio was ~92% for the first half of 2020, which is on the higher end but is likely to further improve going ahead as growth resumes. FRT noted in its Q2 earnings call that it remains confident in its ability to support a dividend of $4.24 based on its FFO expectations going forward.
(source: Company Presentation)
Additionally, FRT has ample liquidity and a strong balance sheet to fund any short-term dividend shortfall. For example, the company’s credit metrics remain strong with net debt to EBITDA ratio of 6.5x and fixed charge coverage at 3.6x. As of Q220, the company has almost $2 billion in liquidity with $980 million of available cash and an undrawn $1 billion credit facility. Further, the debt maturity schedule is in excellent shape as the weighted average maturity is 9 years, with limited near-term maturities (just $340 million through year end 2021). FRT is one of only six “A rated REITs” which provides it with continued access to the unsecured bond market at attractive interest rates. This leads to lower cost of capital and an improved ability to raise capital. Importantly, easy access to capital supports FRT’s ability to sustain and grow its dividend.
Management has no near-term liquidity concerns and expects ~$1.3 billion in cash and unused credit line by February 2021, noting the following during its most recent Q2 earnings call:
“On February 1, 2021, even when and assuming that the declaration and payment of our next two full quarterly dividends, which could be declared in August and November and paid in October and January. Even assuming the continued and unabated construction at the partially completed projects at Santana West, Assembly Row, Pike & Rose and CocoWalk, even assuming the collection of rents only marginally better than the 76% plus that we collect in the last month of July and assuming no asset sales or equity issuance during that period. With all of those assumptions, we still wind up with $1.3 billion worth of cash on February 1, 2021.”
This gives us comfort and confidence in FRT’s ability to sustain and grow its dividend in the future.
Proven Track Record During Downturns
FRT has a long history of managing through (and outperforming) during difficult times with smart risk-adjusted capital allocation decisions throughout investment cycles. And perhaps worth mentioning, the company has delivered a total annual return of 10.3% since 2003, higher than other shopping center REITs (~4.7%) and the S&P 500 (~9.7%). History and track record arguably matters significantly at a time like this, and at the very least it gives us more confidence that FRT can successfully manage through the current challenging environment.
(source: Company Presentation)
Valuation:
On a Price to Funds from Operations (“FFO”) basis, FRT is trading at ~14.9x its TTM FFO. And as can be seen in the table below, FRT has the lowest dividend yield among peers. These metrics suggests the market perceives FRT as significantly less risky—a quality that may appeal to many income-focused risk-averse investors. FRT’s price to FFO multiple is a touch on the higher side versus peers, and reflection of its higher quality. Specifically, we see it as a validation of FRT’s unique strategy which has resulted in outperformance against peers since 2003, and it’s record of 53 consecutive years of dividend increases (which is unparalleled in the REIT sector).
(source: Blue Harbinger Research, Yahoo Finance, Company data)
Risks:
Tenant bankruptcy: FRT is exposed to the risk of tenants not being able to meet their rental obligations. While FRT is well diversified with no significant tenant concentration, it seems unlikely to threaten its dividend safety. However, should one or more of these tenants face financial trouble it could lead to future cash flow interruption.
Interest rate risk: In the US, the Federal Reserve has cut interest rates to essentially zero, and even though we expect rates to remain relatively tame, dramatically rising rates could create challenges. For one, REITs are often seen as an alternative to bonds, and higher interest rates could mean decreased demand for REITs, thereby causing a decline in the share price. Also, higher interest rates could put significant downward pressure on earnings as interest costs rise.
Lower consumer spending: With projections from respected institutions such as the IMF pointing to a global recession, we think consumer spending and confidence will be hit and in general will be negative for retail-focused REITs. However, here again we point out that the resilient nature of FRT’s business should help it weather any downturn. Although, the company is much better placed than peers, a global recession could cause further negative impacts on earnings.
Conclusion:
In our view, FRT is in much better shape than its retail REIT peers, especially considering its strong liquidity, strong balance sheet and history of smart capital allocation decisions. To some extent, these qualities are reflected in the share price already, considering price-to-FFO is comparatively higher and the dividend yield is lower. However, in our view, FRT is a much safer bet than its peer group, and it has potential for healthy share price gains in the years ahead (and that is in addition to ongoing dividend increases). If you are a long-term income-focused investor, we believe shares of FRT are worth considering for a spot in your prudently diversified portfolio.