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This research report was jointly produced by High Dividend Opportunities research team and Seeking Alpha author Julian Lin.
CBL & Associates Properties (CBL) is the most experienced operator of B mall properties. As their common share price continues to struggle, they have also seen their preferred stock drop considerably. Preferred dividends must be paid before those of the common, making their distributions inherently safer. In spite of tremendous cash flow coverage, their preferred shares nonetheless trade at a very opportunistic 10.4% yield. Shares have 25% upside, including dividends. The following are the two Preferred Shares of CBL:
- CBL & Associates Properties, 7.375% Series D Cumulative Redeemable Preferred (CBL-D) – Last price $17.80 (Annual Dividend $1.84375, Yield 10.36%).
- CBL & Associates Properties, 6.625% Series E Cumulative Redeemable Preferred (CBL-E) – Last Price $16.60 (Annual Dividend $1.65625, Yield 9.98%)
Note that your investment broker may list the preferred stock as CBL-PD and CBL-PE instead of CBL-D and CBL-E. Some other brokers such as IB list them as (CBL PRD) and (CBL PRE).
Business Overview: A Story Of Stability And Transformation
This is a portfolio which has undergone an impressive transformation. After the 2008 recession, management has reduced debt to EBITDA from 8.5 times to 6.7 times. Since 2013, CBL has disposed of 20 underperforming properties, increasing their net operating income (‘NOI’) exposure to Tier 1 & Tier 2 malls from 78% to 86%. This has also led to increases of tenant sales per square foot:
In spite of the headlines that malls are dying, CBL has maintained very stable mall occupancy rates, indicating the strong demand for leasing space in B malls:
This shows that strong management matters in this tough retail environment. It is not enough to have the best properties – only the strong operators will survive. This is a management team that endured the 2008 recession and adapted by cleaning up the balance sheet.
With their common stock trading at around $4.40 per share, this is a multiple of 2.5 times 2018 funds from operations (‘FFO’) and an 18% dividend yield, which is dirt cheap. With such a low valuation, future rent concessions appear to have been more or less priced in. We are reiterating our strong buy rating for the CBL common shares. This article, however, focuses on the preferred stock issues, which are also attractive, recently yielding 10.4%. These preferred shares have fallen considerably after trading near par for quite some time:
Preferred stock, in comparison to their common counterparts, is usually less volatile due to their more secured dividend payouts. This is a unique opportunity to take advantage of unexpected volatility.
Free Cash Flow Coverage
Using the midpoint of 2018 guidance, CBL will have approximately $350 million in funds from operations and $167 million in common dividends. CBL has guided for $75-125 million of annual redevelopment spending along with $90 million of annual capital expenditures and $50 million of annual debt principal repayment. As we can see, the majority of redevelopment spending is likely to be internally funded.
Using FFO, the $44.9 million in total preferred dividends are handily covered at 7.8 times. After recurring capital expenditures (including amortization), the preferred dividends are covered 4.68 times. This is also known as “free cash flow” coverage.
And finally, even after accounting for redevelopment expense, they are still covered at ~2 times. We can see the cash flow coverage laid out below:
(Chart by Author)
Anyway you put it, the preferred stock dividends are very well covered and appear to be very safe.
The main threat would be violation of any of their debt covenants, but even here CBL is still very strong:
Impact of Moody’s and S&P Downgrade
In February 2018, Moody’s downgraded CBL’s unsecured credit rating to Ba1, down from Baa3. This comes after S&P had downgraded the corporate credit rating (note the distinction) to BB+ from BBB-. They did maintain their BBB- unsecured credit rating. As stated in their 2017 10-K, CBL has elected to use their unsecured credit rating to determine the interest rates on three unsecured credit facilities and two unsecured term loans. As of December 31, 2017, the “three unsecured credit facilities bear interest at LIBOR plus 120 basis points and our unsecured term loans bear interest at LIBOR plus 135 and 150 basis points, respectively.” If they were to receive a downgrade from Standard and Poor’s (S&P) on their unsecured credit rating, then the unsecured credit facilities “would bear interest at LIBOR plus 155 basis points and the interest rate on our two unsecured term loans would bear interest at LIBOR plus 175 basis points and 200 basis points, respectively.”
The approximate impact to interest expense related to these unsecured credit facilities and unsecured term loans is shown below. Again, S&P has not yet downgraded the unsecured credit rating, thus, this is only a projected impact (in 000’s, only showing credit-rating sensitive loans):
(Chart by Author, data from 2017 10-K)
As we can see, the net near-term impact to interest expense would be just over $4 million, which is not very significant considering the approximately $350 million in funds from operations. Further, we anticipate that CBL will be able to regain their investment grade rating from Moody’s as their redevelopments begin to bear fruit.
Which Preferred Issue Is Better?
CBL has two preferred issues, as seen below:
(Chart by Author)
Both issues are cumulative, meaning any unpaid preferred dividends would accumulate until they are paid in full in the future. Both issues also are currently callable. Preferred shares have a natural cap on the upside around call value (or par value) of $25/share. For example, in general, investors do not like to buy preferred stocks at above par their value of $25/share plus accrued interest. A trade-off is that the preferred D shares have significantly greater liquidity, with 1.815 million shares outstanding versus 0.69 million outstanding E shares. Both issues are strong buys at the current prices.
Comparison With Peers
Mall REIT peers Washington Prime Group (WPG) and Pennsylvania Real Estate Investment Trust (PEI) both also have preferred stock, but these are yielding around 8.5%, considerably lower than what is seen at CBL. We believe that this discount is undeserved as in comparison with these two peers, CBL will be able to fund the majority of their redevelopment expense with cash flow alone. The tremendous cash flow coverage of the CBL preferred shares also makes them comparably less risky than those from these two peers.
Our short-term price target is $20.50 per CBL-D share or $18.40 per CBL-E share for a 9% yield. Including dividends, this would be a 25% total return in a period of 12 months. We believe that both issues have more upside potential if held for longer than 1 year.
The biggest risk to the preferred issues is if CBL suffers a liquidity crisis and would need to dilute preferred shareholders in order to redeem debt maturities. This, however, does not seem likely due to the currently low leverage of their balance sheet. These also have a significant cash flow cushion and the common dividend must be cut first before any suspension to the preferred dividend. This does look to be a distorted risk to the reward proposition.
CBL is investing heavily into redeveloping their mall properties. The market is not giving them any credit for their ability to internally fund these value-enhancing capital expenditures, and this pessimism has reached their preferred stock. The CBL preferred stocks are not only safe but too cheap to pass up at 10.4% yields. These have the greatest cash flow coverage compared to peers and are unlikely to remain this cheap for long.
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Note: All images/tables above were extracted from the Company’s website unless otherwise stated.
Disclosure: I am/we are long CBL, WPG.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.