Brixmor Property Group: Weighing The Impact Of Non-Essential Retail And Tenant Quality

seekingalpha11-04

Brixmor Property Group has delivered over 37% total returns since November 2023, with a current forward yield of 4.16% and a low P/FFO multiple of 12.92x.Looking at BRX stock, I can see a compelling ...

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Maxxa_Satori  It was a great time to buy Brixmor Property Group (NYSE:BRX) back in November 2023, when the current yield stood above 5% and the growth outlook seemed robust enough to deliver strong total return performance. Since then, BRX has registered more than 37% in total returns, from which roughly 32% has come in the form of pure price appreciation. However, you should notice that over this time period, management has grown the underlying FFO generation, which automatically decreases the potential negative effects on the thesis that could come from higher multiple. In fact, currently, BRX produces a FWD yield of 4.16% and trades at a P/FFO multiple of 12.92. Peers who enjoy higher multiples are the following: Regency Centers (REG), Kimco Realty (KIM), and Federal Realty (FRT). Nevertheless, my investment thesis is neutral on BRX, based on exposure to low tenant quality, non-essential retail and below average household income. A dividend discount model is presented at the end of the article and strengthens my neutral rating. In the chart below, you can see that from the P/CFO perspective, BRX trades well below the average level of REG, KIM and FRT.   YCharts On the first appearance, this situation seems to create an opportunity for investors, especially considering the inherent similarities among all of these four equity REITs:  Investment grade balance sheets with well-laddered debt maturities. REIT focused on shopping centers. Strong occupancy ratios.  With this in mind, let's try to review the underlying financial dynamics of KRG to determine whether it is still worth buying the stock and whether besides the valuation aspect, it embodies some meaningful advantage over its peers. Thesis review Before I dissect the details of BRX, I just want to underscore that while I will be identifying some selected advantages and disadvantages compared to its peers, in my opinion, BRX is fundamentally a solid REIT, which should be included in your dividend portfolio unless investors are already heavily invested in, say, KIM or FRT, where making additional investments in BRX would just make the risk exposure excessive to the shopping center sector. Now, if we look at the most recent quarterly results, we will see that BRX has managed to register an FFO per share growth of 4% relative to the same period last year (Q3, 2023). In the context of historically high interest rates, the FFO growth is indeed acceptable, not far from what REG, KIM and FRT have recorded in their recent earnings reports: 4.9%, 7.5% and 3.6% respectively. BRX has even a more attractive FFO payout ratio of 51.81%, compared to REG at 63.76%, KIM at 59.85% and FRT at 64.37%. This gives BRX ample of liquidity to directly fund new acquisitions or blend it together with debt at favorable conditions, since its balance sheet has strengthened recently. PECO presentation As the bar chart above shows, BRX's Net Debt/EBITDA ratio is very close to that of KIM and FRT. So why does BRX have a lower valuation multiple? To try to answer this question, I will check the following three aspects: tenant quality, essential retail exposure and exposure to median household income. Tenant Quality The first aspect that is worth factoring in is BRX's tenant quality, which, in my view, partly explains why the REIT trades below its comparable peers in terms of the valuation multiples. Tenants with lower-than-average credit ratings are more likely to default on their lease payments, leading to potential revenue losses for BRX. Lower credit tenants may struggle to meet their lease obligations, resulting in higher vacancy rates and reduced occupancy levels. Moreover, a portfolio with lower credit tenants can negatively impact the perceived value of BRX's properties, making it harder to attract new tenants or secure favorable financing.   BRX presentation As you can see above, among BRX's top 10 tenants, four retailers have a subpar credit rating. I'm talking about Burlington, Publix, LA FITNESS and Albertsons. In its latest earnings call transcript, BRX's Chief Operating Officer mentioned Trader Joe's backfilling a former Bed Bath box in suburban Denver. It's notable that Trader Joe's does not have an investment grade credit rating. I would like to see BRX's management clearly address the issue of tenant quality in their next investor presentation. Essential Retail Exposure Another aspect that could explain the valuation gap is BRX's low exposure to essential retail. These necessity-based tenants tend to perform better during economic downturns, as people continue to purchase necessities. A low exposure to these tenants can make BRX more vulnerable to economic recessions. Non-essential retail tenants may be more susceptible to closures during challenging economic times, leading to higher vacancy rates.   BRX presentation While the ability of each retail category to resist during a recession is debatable, my article included the following widely accepted categories to the \"essential retail\" classification: Grocery, Medical, Pet stores, Hardware/Auto, Banks and Pharmacy. As the picture above shows, essential retail constitutes only 27% of ABR (including \"Other Retail\" which is 4%). I would like to see BRX increase that percentage to 34% and thus gain more investor confidence: this figure would be double the share of restaurants, with the latter considered the riskiest type of tenant during a recession. Moreover, the share of non-essential retail excluding restaurants would be reduced to below 50% of ABR. Median Household Income The final aspect that affects the valuation gap is the median household income where BRX's properties are located. A low median household income is associated with a below-average propensity to spend among consumers. This ultimately reduces the ability of tenants to increase their profit. Thus, properties in lower-income areas may have limited potential for rent increases and value appreciation, impacting the REIT's overall growth. FRT presentation As you can see above, BRX is at the bottom of the sector in the 3-mile average household income criteria. While some would argue that those are 2023 numbers and that the company made an improvement since then, actually all the figures grew in the past five years due to inflation. Anyway, the main point is that BRX is still lagging behind compared to KIM, REG and FRT.   FRT presentation As you can see, FRT has the lowest exposure to median household income that is lower than $75,000. This category of household is the most affected by inflation. On the other hand, BRX has the highest exposure to this income segment. I would like to see more improvement from BRX on that front before assigning a higher valuation multiple to the stock. Potential Impact on Revenue Based on the three aspects mentioned above, I would like to project the potential impact of tenant defaults or lease renegotiations on BRX's revenue during an average recession.   Category Essential Retail Restaurants Other Retail   Assumed % loss of rental income 5% 30% 15%   Click to enlarge Using these projections, we can calculate the overall impact on rental income. Total projected rental income loss:  Essential Tenants: 27%×5%=1.35% Restaurants: 17%×30%=5.1% Other Retail: 56%×15%=8.4%  Total loss = 1.35%+5.1%+8.4%=14.85% Investors should consider these projections and the underlying risks when evaluating BRX's overall financial stability and future performance. Latest Q3 earnings BRX's recent results were solid, reflecting the attractive market condition for retail properties. The company executed 1.1 million square feet of new and renewal leases at a blended cash spread of 22%, including record new small shop base rent of $31 per square foot. This led to another quarter of record overall occupancy at 95.6%, with anchor occupancy of 97.7%, and small shop occupancy at 91.1%. Moreover, same-property NOI increased by 4.1% and FFO per share of $0.52 came in line with expectations. Given that BRX's signed but not commenced rent totaled a decent $59 million, which includes $52 million of net new rent, I expect the strong performance of 2024 to continue at least till the first quarter of next year. Valuation Model BRX's P/FFO of 12.84x implies an average upside of 25% compared to REG (16.88x), KIM (14.71x) and FRT (16.53x). However, I don't expect BRX to fill the valuation gap due to the three aspects discussed above. To have a deeper insight regarding BRX's valuation, I have run a dividend discount model. I assumed the expected dividend for next year to be $1.2075 which is a 5% growth compared to 2024. I assumed the long-term annual growth rate of dividend to be 3% which is optimistic, given that BRX lacks a long track record of maintaining the dividend. I set the discount rate at 7.5% to reflect the risks of the shopping center sector. For those who are unfamiliar with the model, the long-term dividend growth rate should be subtracted from the discount rate. Then you divide the 2025 dividend by the result to get the fair value of the stock. What I reached is a fair value of $26.83 which implies a slight overvaluation of 2%.   2025 dividend $1.2075   Long-term growth rate of dividend 3%   Discount rate 7.5%   Fair value of BRX $26.83   Click to enlarge Conclusion All in all, BRX is indeed a decent REIT, where the 4.16% dividend is underpinned by a solid balance sheet, robust cash generation profile and conservative FFO payout ratio that should help fuel further growth opportunities. In addition, the fact that BRX trades at the lowest multiple among competitors REG, KIM and FRT enhances the overall investment case as well. Yet, BRX's exposure to low tenant quality, non-essential retail and below average household income, is a clear disadvantage. In my opinion, these three aspects combined justify the valuation gap with the three peers mentioned above. My dividend discount model adds to the conviction that BRX does not deserve any additional upside, with the current stock slightly overvalued. Thus, a \"sector perform\" rating is appropriate for the stock.  Putting all of these pieces together, I would recommend adding BRX only for diversification purposes when such blue-chip stocks like FRT are already at the core of a stable income-driven portfolio. And given that the sector has already witnessed a decent rally since April, I have a Hold rating on BRX.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2480376196"}