Not Every Mall Is Dying. Two Value Funds Are Betting on It.

Does large-mall real estate investment trust Macerich have a future, and is it cheap? Two value funds think so.

Does large-mall real estate investment trust Macerich have a future, and is it cheap? Two value funds think so.

Followers of real estate stocks know about a website called Dead Malls, dedicated to chronicling abandoned U.S. malls, most but not all of them in the Midwest. And everyone knows that Amazon is taking a toll on large parts of bricks-and-mortar retailing.

With all that, does large-mall real estate investment trust Macerich (ticker: MAC) have a future, and is it cheap? Two value funds think so.

Macerich is the owner of 47 malls, which it calls “trophy properties.” That may be an exaggeration, but not one that kills a bullish thesis for Macerich’s stock. Santa Monica Place, steps from the Pacific Ocean, and Tysons Corner Center outside of Washington, D.C., probably count as a trophy properties. Kings Plaza in Brooklyn and the Mall of Victor Valley in Victorville, Calif., maybe not.

Nevertheless, Macerich generated $3.89 a share in funds from operations, or FFO, over the past four quarters. And at a share price of around $27.50, it is trading at roughly 7 times that figure. That is awfully cheap for a REIT. High-end apartments, by contrast, are trading at more than 20 times FFO. Moreover, $3.89 a share is slightly more than the $3.81 the firm generated in 2015. Macerich may not be growing much on an FFO basis, but it seems to be holding steady.

The cash it generates to pay its dividend might be considered tight. It is paying 75 cents a quarter and averages around 95 cents a share each quarter in FFO. At its current price, the stock is yielding 10.9% and the market seems to be anticipating a dividend cut. Funds from operations is a measure that adjusts net income for depreciation and property sales, but it doesn’t add anything back for long-term expenditures required to maintain or transform properties. For this reason, Macerich’s coverage might be tighter than it looks.

Ryan Dobratz, manager of the Third Avenue Real Estate Value fund (TAREX), thinks coverage is tight, but only because the firm has an opportunity to transform some of its upscale malls. Dobratz thinks restaurants, fitness centers, movie theaters and other facilities can replace some of the department-store space at some of Macerich’s properties. Accomplishing the transformation likely means diverting some of the cash flow that is financing the dividend into capital improvements. Macerich is the 10th-largest holding in the Third Avenue fund, and constitutes nearly 4% of its assets.

Tony Scherrer at Smead Capital Management, a value-oriented investor, agrees that the prospects for Macerich are bright, and that the stock is too cheap. Macerich has increased its net operating income by more than 4% annualized over the past four years, compared with 1.5% for its competitors, according to Scherrer, who noted that the fund started buying shares a few months ago after noticing insider buying. Macerich is the 19th-largest holding and a nearly 3% position of the Smead Value Fund (SMVLX), which is one of a handful of funds in Morningstar’s large-value category to beat the S&P 500 over the past decade.

Insider ownership is one of the hallmarks of the fund’s approach, and recent insider buying, along with Macerich’s healthy cash flow, clinched it for Scherrer and Smead. Dobratz concurred that insider purchases have given him confidence recently.

Finally, Macerich is financially healthy, having restructured its debt. Scherrer and Dobratz differ slightly on the interest payments, but both put them at around 4%. Scherrer noted that, at that rate, the banks aren’t lending money to Macerich as if it is distressed. Dobratz said earnings before interest, taxes, depreciation and amortization are a comfortable 3 times higher than interest payments.

Cheap securities are hard to find, and they always have some problems. But Macerich’s cheap valuation and stable financial condition should pique the interest of value investors.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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