Seritage: Berkshire doesn’t cut their hair here (NYSE: SRG)
Serage growth properties (NYSE: SRG) is a stock we’ve been tracking for a long, long time. It’s fair to say that we never overcame the issues with the company to come to a bullish verdict. In fact, every call has been bearish or neutral.
We won’t apologize for that, as the company failed to deliver on several different levels. What we want to examine, however, is the current risk-reward after the last minor crisis and see if we can finally take the plunge.
Income properties Dream Is Dead
SRG transforming itself into a premier class A mall owner was the idea that was floated when it was listed. We never bought into that for two reasons. The first being that we have seen its properties as B to B+ at best. This was actually stated by one of Sears Holdings (OTCPK:SHLDQ) and SRG’s biggest bulls, Bruce Borowitz.
The second being that the final value, even at the best of times, wasn’t worth it. This took into account that we could buy Class A shopping center operators like Simon Property Group (SPG) at exceptionally low funds-in-operation (FFO) multiples. So if we applied an 8X-10X FFO multiple to SRG’s best case, we saw that the stock wouldn’t even justify the $40 it was trading at, at the highs. This dream was abandoned, with the company now moving away from the REIT structure and focusing on selling assets.
All About Accelerated Asset Sales
The 10-Q made a nice mention on the “going concern” analysis. The clock is now on.
In addition to the above-mentioned $85.0 million of assets under contract, the Company currently markets or is in the process of marketing assets with an estimated fair value of $636.3 million, which , if sold, would allow the Company to meet the $640 principal repayment of the term loan facility required to extend the facility. Although these assets are held for sale and the Company believes that they will be closed prior to maturity, there can be no assurance that these assets will be under contract within the one-year period during which the outstanding balance of the term loan must be taken into account in the Company’s going concern analysis.
Over the past few years, we have seen SRG successfully sell over $1.5 billion worth of properties by disposing of approximately 120 properties. There are 161 properties left.
In general, SRG sold off its lower quality properties while developing its best projects first. Given the real estate cost inflation we have seen over the past 5 years and the capital expenditures being poured into these projects (well over $1 billion), it would be very difficult to say that those remaining 161 properties are not worth much above the $1.5 billion mark. . Another way to look at this is to take the GAAP values on the balance sheet and go from there. The historical cost likely underestimates the potential significantly, and SRG has generally seen significant sales gains over these values. But even using those numbers, including the $400 million in construction underway, we get a decent buffer over their $1.4 billion term loan from Berkshire Hathaway (BRK.A) (BRK.B ).
Why we are always cautious
SSR stocks are deep in junk bond territory. The bulls may disagree, but when your total NOI can’t cover half of your interest charges, you’d probably be lucky to get a CCC from the rating agencies. The market is also now incredibly hostile. NGL Energy Partners LP (NGL) is in a favorable sector and has an EBITDA interest coverage of nearly 2.0X. Its 15-month bonds are still yielding almost 14%. We believe SRG can pull off this asset sale and reward risk has finally shifted into the favorable category. We therefore believe that a price target of $10 with a slightly bullish view is achievable. But don’t equate this with a “hand on fist” or a lay up.
Where there are better deals
Seritage Growth Properties 7% CUM PFD SR A (NYSE:SRG.PA) is the best choice here. With a 62% rise, the preferred stock exceeds our SRG price target by 44%. It also defeats him with much less risk. There are also a few unlikely, but possible, scenarios where SRG actually suffers a loss, while the preferred stock is actually redeemed at par. SRG.PA is currently yielding 11.33%, so it offers a big bonus for next year beyond the expected returns of 62%. Of course, investors should always consider that the dividend could be stopped. The company is no longer a REIT and these preferred shares were an outlet to pay out any taxable gains as dividends. Still, a cut is unlikely as it would cause panic among the shareholder base. The shares also only cost the company $4.9 million a year, so a cut is unlikely to really help whatever is currently plaguing them. These dividends are also cumulative, so a reduction is not helpful if the plan is to start returning capital to common shareholders down the line. Here is the secondary spectacle of the case against SRG brought by SHLDQ. We see this as a possible risk, but primarily for common stocks, as any settlement should be modest and will not derail the face value of the preferred stock.
The other choice would be a call-spread. Buying the January 2023 $7 calls and selling the $11 calls for a net premium of $1 would be our way forward.
This creates a breakeven point of $8.00 and a maximum upside return of 300% in the event the trade is announced above $11.00. We don’t think the maximum value is higher than $15 at best, so this setup looks like a good choice over going long in the stock. In this case, the best return would be 115% in the trip from $6.94 to $15.00. But the risks are much higher.
SRG now has compelling long games. Although we view common stocks as neutral, we are willing to buy preferred stocks and would not hesitate to venture into options games to take advantage of the upside. We could even have opted for an outright purchase of common shares if we thought the macroeconomic climate was more favorable. But at this time, we still think the risks for SPX 3,200 are high and centered, and we approach all long-side ideas defensively.
Please note that this is not financial advice. It may seem, seem, but surprisingly, it is not. Investors are required to do their own due diligence and consult a professional who knows their objectives and constraints.