Walter Bibikow
Over the past couple of years, the Macerich Company (NYSE:MAC) has experienced significant upside and downside volatility, which has been associated with notable share issuances to fund the cash flow gaps and subsequent recovery followed by yet another disappointment in terms of additional equity dilution.
In Q1, 2024 we saw a similar pattern, where the new Management announced an aggressive plan to bring down the leverage by divesting non-core assets, directing surplus liquidity toward debt reduction, and, importantly, tapping the secondary equity market in order to accelerate this process.
Given that MAC indeed has a very strong asset portfolio consisting of trophy-like malls, there is definitely a considerable value potential embedded in MAC. Back when the previous earnings report was released, I issued an article on the Company, arguing that under more balanced leverage levels, MAC could be a truly great pick for income investors. Yet, my recommendation was to pause a bit and let the new Management deliver the first results on the capital structure targets (including issuing those additional shares to access the necessary funding) that would minimize the uncertainty a bit.
Since the issuance of my previous article on MAC, the stock has performed well and is more or less in line with the overall REIT market. However, given the level of risk that MAC carries as well as the fact that on a TTM basis, MAC trails the index by ~19%, one would expect much higher reward from a long position in this REIT.
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With this being said, let’s now take a look at the recently published Q2 2024 earnings results and see how the Management is progressing with the ambitious targets to get the Company back on track.
Thesis
As one could have expected, the Q2 performance did not result in growing FFO generation due to the various transactions associated with portfolio clean-up and debt reduction. In fact, the inherent cash flow unpredictability that comes with such notable moves led the management to suspend the FFO guidance earlier this year.
The FFO per share came in at $0.39 per share, which is $0.01 per share below the Q2 2023 result. The primary reason for this drop is the combination of flat sales and increasing interest expense component, which also includes the accruals for potential tenant bankruptcies.
One of the key metrics driving the FFO performance – occupancy level – decreased by 10 basis points to 93.3% (relative to the previous quarter). Compared to the same period last year, the occupancy level is up by 70 basis points, which should theoretically also contribute to the higher FFO per share figure.
However, the seven tenant bankruptcies did indeed impose a headwind on MAC’s FFO generation. The largest tenant bankruptcy was Express, which has 26 separate locations taking 206,000 square feet in MAC’s portfolio. Of these 26 locations, 10 are set to be closed, which would bring down the overall portfolio occupancy by 40 basis points (we should see a full impact on this in a Q3 report).
An additional aspect that adds pressure on MAC’s occupancy (and thus FFO generation) is the 2024 lease expirations, which usually result in some further location vacancies. However, as of Q2 2024, MAC had already committed 76% of the expiring square footage and signed a letter of intent with tenants representing another 18% of the expiring space. This is a very solid statistic, where even the Management has communicated that it expects the 2024 renewal retention rate to be very healthy (i.e., in the low 90% range). In other words, the reliance on new tenant attraction is set to be quite low this year, benefiting MAC not only from the occupancy perspective but also through the inherently lower CapEx spend that usually comes with complete store refurbishment (or adjustments) for the new tenant needs.
Now, if we further dissect the Q2 data points, we will see that the Management has indeed been very active in delivering on the balance sheet targets. For instance, during Q2 MAC sold an Outparcel deal for $7.1 million, and fully divested its 50% JV interest in Biltmore Fashion Park, which will allow to access $110 million fresh liquidity. On the loan giveback end, MAC stepped away from Country Club Plaza property and, as of Q2, were still in the discussions with lenders about potentially defaulting Santa Monica Place. Here, the combination of these proceeds from asset sales and loan givebacks will enable MAC to reduce its outstanding debt by circa $564 million.
In my opinion, this could be deemed as very solid progress, sending the right message for investors that the process of achieving the target capital structure will be relatively quick and productive. In fact, the Management now expects to decrease the outstanding debt by $1 billion to $1.4 billion by the end of 2024. If MAC succeeds and retires $1 billion of debt during this year, half of the pre-communicated debt reduction objective will be already met.
We have to also factor in that the portfolio simplification process is not only about divesting non-core assets but also about enhancing the existing core assets as well as increasing the JV interests in those properties, which are essential for MAC’s strategy. For instance, during Q2, MAC acquired the remaining 40% minority interest from its partner in Arrowhead and South Plains by paying roughly $37 million.
In order to execute the program effectively at relatively low, it is critical to have access to optimal financings. Here, Scott Kingsmore’s commentary in the recent earnings call sends clearly a positive signal on this front:
The financing market for Class A retail real estate remains wide open and is very, very strong. Year-to-date in 2024, we have closed five transactions totaling nearly $700 million or $539 million at our share. This follows a very robust 2023, during which our financing activity totaled $2.6 billion or $1.8 billion at our share.
With all of this being said, we have to admit that the current leverage (including the target level for the end of 2024) is still relatively high. During the H1 2024 period, after conducting several notable asset sales and retaining part of undistributed FFO generation, MAC has brought down the leverage from 8.76x to 8.48x. The expectation is to reduce it further to the low 8x range by the end of 2024.
The Bottom Line
In a nutshell, the Q2 2024 earnings report brought several positive messages, especially, on the balance sheet optimization front. Even the underlying portfolio performance was, in my opinion, solid given that the FFO per share declined only by $0.01 against the backdrop of multiple headwinds (e.g., tenant bankruptcies, incremental bad debt accruals).
However, the current leverage profile still remains too high for me to enter, especially considering the uncertainty around further bankruptcies and, importantly, MAC’s track record of failing to optimize the balance sheet properly. In my humble opinion, it is worth waiting for a couple of quarters to see how the progress is continuing and entering the Company at a more balanced financial risk.
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