Where it all comes together!
London office forecasts are upgraded as flex space EBITDAs recover, subletting is low, we expect space freed up by working from home will be absorbed by lower desk densities, and the supply pipeline is increasingly constricted. We expect a 'reverse square root' recovery followed by bumpy corrugations (Exhibit 1). We upgrade BLND to Buy (Hold) and downgrade SGRO to Hold (Buy).
Summary
Lodging REITs Lose Momentum, Remain Attractive In Our View. After falling sharply at the end of 1Q, Lodging REITs rallied in 2Q through early June (rising +49.8% through June 8), before losing momentum near the end of the quarter (ending the quarter +5.5% for 2Q). We believe the group retreated as investors became overly optimistic surrounding the outlook for lodging, which stretched valuations across the sector. That being said, we believe the group has once again become oversold, and while we continue to expect there to be near-term noise, we believe Lodging REITs offer compelling value to shareholders with a long-term view. 2Q numbers will largely be ignored, with investors instead likely to be focused on commentary surrounding operating trends, cash burn, the transactions' environment, business mix and balance sheet management. Our top pick in the group remains DiamondRock Hospitality (DRH, $5.13, Buy).
Key Points
Industry Numbers Begin to Move Higher, But Could Stall Late Summer. Industry numbers likely saw a bottom in April, with Smith Travel reporting a RevPAR decline of 79.9%, compared to June RevPAR of down 60.6%. Although numbers have trended in a more positive direction, it is important to note that a number of lodging REITs are more concentrated in the luxury and upper-upscale segments, which continue to be more severely impacted. To this point, the luxury segment reported June RevPAR down 80.8% and the upper-upscale segment down 80.6%. While we continue to expect April to represent the trough for industry, numbers could regress post-summer, as portfolios begin to lose leisure demand, which has been a large driver of hotel demand this summer. Additionally, concerns surrounding a second wave of state shutdowns (Florida, Texas, California) could stall some of the progress that the industry has experienced. We believe it is important to note that STR has started to exclude closed hotels from their data, which in our view, is making the recovery read-through more difficult to gauge. Nonetheless, we continue to view the sector as offering attractive long-term risk/reward, as the group offers compelling value at currently depressed levels.
Who We Like In The Current Environment: DRH. Going into earnings season we favor DRH. While we expect RevPAR for DRH to outperform in 2Q due to the company's higher resorts exposure, we believe 2Q numbers are of little importance to investors. That being said, we continue to favor the company due to its strong liquidity position ($360 million of liquidity as of the end of 2Q), no near-term debt maturities, and its more attractive business mix for the current environment (less group exposure, higher leisure component). Additionally, over the long-term, we believe the company completing and reopening its property in St. Thomas should be an additional EBITDA tailwind over the medium to long-term.
2Q20/FY20 Numbers Are Largely Irrelevant, Focus On 2021/2022. Similar to 1Q, we strongly believe that 2Q numbers (EBITDA and FFO) as well as FY20 will be largely considered irrelevant by investors. There is more of a focus on determining a realistic portfolio run-rate for names in the group. To this point, we believe determining a realistic 2021/2022 run-rate, and the timing of when we could potentially begin to see operations start to stabilize, are much more important in considering the space. Additionally, we believe cash burn, and its implications for leverage, should be an additional focus of investors.
Management Commentary/Overall Macro Environment To Drive Near-Term Performance. With near-term numbers being mostly irrelevant, we believe investors will instead be focused on management commentary, surrounding cash burn, liquidity, permanent and temporary cost cuts, and potential acquisitions will be a focus of investors. Additionally, the heavily cyclical reliant sector will be impacted by both positive and negative macro news, which will be a key driver for the group.
Pricing as of the close, July 22, 2020.
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Simon Yarmak, CFA | (443) 224-1345 | yarmaks@stifel.com Moshe Levin, CFA | (443) 224-1264 | levinm@stifel.com Connor Shockley | (443) 224-1357 | shockleyc@stifel.com Stifel Equity Trading Desk | (800) 424-8870
FULL REPORT
Regency Centers to Acquire Equity One – Making the Case Bigger Is Better
Regency Centers (REG, $69.86, Hold) and Equity One (EQY, $27.87, Hold) have agreed to merge in a $15.6 billion transaction. The transaction combines the portfolios of two of the highest quality shopping centers REITs, in our view. The transaction is 100% stock in which each EQY shareholder will receive 0.45 of REG shares, implying a price of $31.44, a 13% premium to yesterday’s closing price. REG is acquiring a high quality/infill portfolio with above-average NOI growth and redevelopment opportunities. REG is paying full price for the EQY portfolio and it could take an extended period of time for REG to realize the associated synergies given the inherent challenges integrating the large national portfolio, in our view.
REG and EQY have agreed to merge in a $15.6 billion transaction. Both REITs own portfolios of high quality shopping centers and the transaction increases REG’s presence in some of its core markets, including San Francisco, Los Angeles, San Diego, Southeast Florida, Washington D.C., and metro New York. REG will acquire EQY for $31.44 per share based on fixed exchange ratio of 0.45 – an implied 4.7% cap rate and a slight premium to our $30 Hold-rated target price.
The transaction creates a high quality shopping center portfolio with 429 properties totaling 57 million sf. REG is planning to dispose of some centers following the completion of the merger. REG has actively recycled capital throughout its history, selling lower quality or slowing growing centers and recycling the proceeds into higher quality acquisitions and/or its development/redevelopment pipeline.
REG is estimating $27 million of annualized cost savings from the transaction by 2018. The savings will mostly come from the elimination of duplicative corporate and property-level operating costs. However, it could take time for REG to fully realize the operational efficiencies created by combining the two portfolios given the significant time and effort it can take to fully merge two portfolios.
EQY’s portfolio of high quality shopping centers as well as its substantial redevelopment pipeline in dense infill markets provides REG with a number of compelling value-creation opportunities. EQY planned to spend $1 billion on development/redevelopment opportunities through 2025 with much of the planned spend targeted at 12 of its larger, market dominant centers in dense infill markets. EQY’s largest in-process redevelopment is the redevelopment and expansion of Serramonte Center in Daly City, CA with an estimated cost of $109.1 million. The combined entity will have over $450 million of development and redevelopment projects in-process.
While some of the projects in EQY’s redevelopment pipeline have the potential for mixed-use components, REG is focused on the retail-only portion of these opportunities. REG will bring in partners for any mixed-use densification opportunities. Construction-in-process as a percentage of enterprise value of the combined entity is only 3%.
The transaction is expected to close in 1Q17 or early 2Q17. REG expects the transaction to be accretive to core FFO due to the cost savings, NOI growth benefits in addition to GAAP accounting adjustments. We await additional exposure on the acquisition benefits.
Both REG and EQY have strong balance sheets, in our view. EQY’s net-debt-to-EBITDA was 5.2x and REG’s was 4.4x on a trailing 12-month basis. Both REITs have been paying off mortgage debt as it matured and have taken advantage of the low interest rate environment to issue debt at lower rates and redeem debt at higher interest rates. REG estimates the combined entity will have a net-debt-to-EBTIDA ratio of 4.8x and a 4.1x fixed charge coverage ratio. REG will have to term out roughly $540 million of EQY’s bank debt and is assuming $700 million of new unsecured debt with three, four, and ten year terms, likely raising interest costs for REG.
Legacy REG shareholders will own 62% of the combined entity while EQY shareholders will own 38%. Gazit-Globe, EQY’s largest shareholder at 34%, will own ~13% of the combined entity. REG’s Board of Directors will increase to 12 members from nine and include Chaim Katzman, EQY’s Chairman and Gazit-Globe’s CEO, who will join REG’s investment committee. The two additional board members will come from EQY’s Board of Directors.
The all-stock transaction allows EQY shareholders to share in the upside of the value-creation opportunities within the combined portfolio. However, the sale price is a 6% discount to the 52-week high EQY shares traded at on August 1st, but we don’t expect a topping bid. Gazit-Globe has pledged to vote for the transaction and likely pushed for the merger, in our view. The combined entity has more liquidity than EQY and gives Gazit-Globe the ability to effectively reduce its ownership stake. Gazit-Globe will be subject to standstill provisions, but more information regarding Gazit-Globe’s ownership stake and provisions will be in the proxy.
Additional transaction details, such as the breakup fee, should be disclosed in the proxy that is expected to be filed in mid-December. REG plans to release initial 2017 guidance in January and will likely provide an update on the transaction and expected timing on cost synergies at that time.
EQY – Target Price Methodology and Risks:
Our $30 target price is based on a 7% premium to our $28 NAV at a 5.25% cap rate. Risks to our target price include a broad-based economic downturn or recession, interest rate movements, and general market risk, including weakening of commercial real estate fundamentals. Company-specific risks include weakening of commercial real estate fundamentals and balance sheet risk.
Our sole Buy-rated shopping REIT is being taken out
Rating: Buy
Market Cap (M): $3,985; Price: $27.87 as of 11/14/2016
Price Target: $35.00
Sector: Retail REITs
This evening REG announced the acquisition/merger of EQY, under which EQY will merge into REG, creating an ~$16bn total enterprise value company. The merger will be an all-stock deal, in which each EQY stock will be converted into 0.45 of REG stock. Offer price for EQY stock implies $31.44/sh (implied cap rate of 5.24%), representing 12.8% premium over today’s closing price of $27.87/sh.
Net-net: At first blush, we think REG’s offer for EQY shareholders appears to be close to fair value (but not at a premium to our NAV), given that the offer price of $31.44/sh is in-line with our EQY estimated NAV of $31.46/sh using 5.24% applied cap (note that consensus NAV is $29.91/sh). Our NAV estimate implicitly includes net discounted value stemming from value creation from development projects (Potrero Center, Westwood Complex, Piemont Crossing, Serramonte, Medford Shaw’s Supermarket, etc.) and potential upside from small shop occupancy.
As a reminder, we have had a favorable view on EQY (our previous note) and EQY remains our only BUY-rated shopping center REIT. Our NAV estimate of $31.46/sh is higher than consensus of $29.91, reflecting our granular assessment of EQY’s high quality portfolio, upside from development projects, below market leases, and significant upside potential from small shop occupancy. We will further analyze the transaction in the upcoming days, while we maintain our Buy rating.
The Transaction: The 100% stock-for-stock transaction involves 0.45 REG shares issued for each EQY share. The new combined company will consist of ~62% of REG shareholders and ~38% EQY shareholders, of which ~13% is Gazit-Globe Ltd. The merger is expected to close in early 2017. We still need to update our models and run the numbers, but management projects $27m of annual G&A synergies, realizable by 2018. The transaction is expected to be FFO accretive, exclusive of GAAP mark-to-market accounting. Management’s underlying underwriting assumptions also include assets sales (unknown amount); excluding these dispositions, FFO could potentially be more accretive.
Pro Forma Portfolio: The pro forma portfolio will consists of 429 properties totaling 57msqf with an ABR/sf of $19.94. The top 5 markets will be Southern California (14% of total ABR), Northern California (13%), Southeast Florida (12%), New York Metro (9%), and DC Metro (7%). Based on a 3-mile radius, the portfolio boasts excellent demographics including median population of 145,000 with a median household income level of $85,000.
REITS
Robert Stevenson,
Gladstone Land Corporation (LAND) - BUY
3Q16 LAND Earnings REITView: In-Line 3Q16
Flash Takeaways:
LAND reported 3Q16 FFOPS of $0.13 ($0.15 CORE). We were at $0.12 as was Consensus. Beyond earnings, the incremental information was that LAND’s NAV (as calculated by management) remained at $13.68 at 9/30/16 (+29% versus the close) compared to $13.68 at 6/30/16, $13.87 at 3/31/16, and $14.20 at 12/31/15, and the acquisition of 9 farms for $40.4M in 3Q16.
Analysts Notes:
Renews 1 lease in 3Q16. In 3Q16, LAND renewed its final 2016 lease expiration with the existing tenant in Salinas, CA, resulting in a 9.0% net increase in annualized income.
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$40.4M of investments in 3Q16. During 3Q16, LAND closed on the acquisitions of 9 new farms, totaling 10,344 acres, for $40.4M. LAND acquired these farms at an initial overall capitalization rate of 4.8%, which is expected to increase due to certain lease provisions. These acquisitions were partially financed through the issuance of 469,427 OP units at a weighted average price of $11.31, amounting to roughly $5.3M.
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$6.5M of investments closed thus far in 4Q16. So far in 4Q16, LAND has acquired a 197 acre almond orchard in CA for $6.5M at a 5.0% initial cap rate, but is expected to yield between 7.0% and 10.0% when accounting for the revenue-sharing portion of the lease.
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Issued $28.8M of preferred and upsized credit facility to $200M. In 3Q16, LAND issued $28.8M of 6.375% term preferred stock and raised $4.1M in long-term borrowings at an average rate of 3.1%. Subsequent to 3Q16, LAND amended its credit facility, which increased the facility size from $125M to $200M, fixed the interest rate on ~$86M of borrowings for 10 years at 3.16% ($163K savings per year), and also obtained $25.5M in new 10 year date at 3.16%.
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FULL REPORT
Highlights from Host Hotels & Resorts Investor Day
Priced intraday 11-14-2016.
In November 2016, net rents (includes changes in street rates and promotions) decreased by -3.7% YoY, weaker than last month’s -0.3% YoY result. This month, Street rates decreased -2.9% YoY and promotions usage increased +0.8% YoY. Overall, we believe the storyline of a noticeable deceleration in pricing power remains vastly unchanged. Weakness continues to be driven by key markets such as New York, Denver, Houston, D.C. and Chicago, which is in-line with 3Q16 results. As a reminder, we are not as much concerned with the magnitude of deceleration; rather we look more at our data directionally.
Overall, we continue to be cautious on the sector as a whole after continued weakness in third-quarter results. For the second quarter in a row, PSA explicitly mentioned the increasing use of promotional discounts to new tenants in their 10Q. Congruent with PSA’s language, we noticed a 1.6% increase in promotional usage this month in our survey. Today and tomorrow at NAREIT, we will look for more clarity into the particular types of promotion usage as well as how their peers plan to compete for the remainder of the year and into 2017.
Fujita Kanko announced Q1-Q3 (Jan-Sep) results on 7 November. While the company posted operating losses of ¥0.1bn, the result marks a y-y improvement of ¥0.9bn and is generally on pace with 16/12 guidance. We make no changes to our forecasts. However, we lower our fair-value market cap from ¥106.8bn (equates to target price of about ¥880) to ¥92.3bn (¥770). We still calculate it based on the sum of our end-17/12 shareholder equity forecast, unrealized gains on Hotel Chinzanso Tokyo and Taiko-en, and the value of the WHG business (Washington Hotels/Gracery Hotels). However, upside for average daily room rate (ADR) seems limited as hotel occupancy rates have topped out. We therefore lower the earnings multiple we use to value the WHG business to 14x, from 20x. The average P/E of the TSE First Section is 14-15x. Our fair-value market cap calculation breaks down as ¥28.3bn from our shareholders' equity forecast, ¥38.5bn from unrealized gains, and ¥25.5bn (¥1.82bn x 14) for the value of WHG business.
The company put up solid 3Q results, once again beating its own guidance and raising for the year. However, the bigger news of the quarter was the closed and pending acquisitions volume and the fact that management has begun the process of internalizing the management team.
Leaving overall 17/3 OP forecast unchanged, but revise down for Japan and up for overseas
We have fine-tuned our forecasts following the 17/3 H1 results briefing (see our 1 November Global Research report Japan construction sector: Sanwa Holdings’ results briefing ). We retain our Neutral rating, but amid lackluster business conditions in Japan earnings are stronger than at rivals, underpinned by the company’s adept cost control abilities and efforts to diversify both in Japan and overseas. We revise down our outlook for Japanese operations, having lowered our product volume forecasts for the industry for 17/3 and beyond. We revise up our forecasts for overseas operations to reflect steady progress in H1, despite assuming a stronger yen, and leave our overall 17/3 operating profit forecast unchanged. Our 17/3 EPS forecast is also unchanged, but a rise in the average P/E for the benchmark Russell/Nomura Large Cap (manufacturing) index lifts our target price to ¥1,140.