Seritage Growth Properties — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; unaudited. Seritage is a retail-property REIT pursuing retenanting and redevelopment of former Sears space. At quarter-end its portfolio comprised 237 properties, about 37.5 million square feet, including 211 wholly owned properties and interests in 26 joint-venture properties.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $56.6m | $64.0m | $159.6m | $187.3m |
| Operating loss | $(20.2)m | $(18.0)m | $(52.4)m | $(49.4)m |
| Net income (loss) | $(34.7)m | $17.3m | $(29.1)m | $(50.4)m |
| Net income (loss) attributable to common shareholders | $(23.4)m | $10.5m | $(22.3)m | $(30.5)m |
| FFO attributable to common shareholders and unitholders (non-GAAP) | $(0.4)m | $25.8m | $17.1m | $80.6m |
| Company FFO attributable to common shareholders and unitholders (non-GAAP) | $(0.8)m | $17.6m | $20.2m | $70.3m |
- Revenue and tenant mix: Q3 rental income was $41.2m, down from $48.2m; nine-month rental income was $114.1m, down from $139.5m. Management attributed the decline principally to lower Sears rent and termination fees, partly offset by higher non-Sears rent. Non-Sears tenants provided 39.7% of Q3 rental income and 36.8% for the nine-month period, on the filing’s stated basis. Including signed leases not yet paying rent, management estimated non-Sears tenants would represent about 60.1% of annualized base rent at September 30.
- Property economics: Q3 NOI was $30.9m versus $37.7m; Total NOI, including the company’s share of unconsolidated properties, was $35.7m versus $43.6m. Nine-month NOI was $98.3m versus $120.2m; Total NOI was $109.1m versus $135.2m. Tenant reimbursements covered 82.6% of property operating and real-estate-tax expenses in Q3, compared with 101.5% a year earlier.
- Cash flow: Nine-month operating cash flow was $14.3m, down from $46.2m. Investing cash flow was a $47.3m use, including $210.3m of real-estate development, partly offset by $170.7m of sale proceeds. Financing cash flow was $197.4m provided, principally reflecting new borrowing and repayment of prior facilities.
- Liquidity and debt: At September 30, cash and cash equivalents were $581.6m, with no restricted cash. The company reported $1.598bn of term-loan debt, net of financing costs; principal outstanding was $1.6bn. Its July 2018 refinancing replaced the mortgage and unsecured facilities with a $1.6bn funded senior secured term loan at a fixed 7.0%, maturing July 31, 2023, plus a $400m incremental facility. The incremental facility is conditional, including on non-Sears annualized rental income of at least $200m and a forward projection meeting that threshold. Management said it believed liquidity was sufficient, citing cash, the incremental facility and expected operating cash flow.
- Equity and distributions: Total equity was $1.251bn at September 30, compared with $1.321bn at December 31, 2017. The company declared quarterly common dividends of $0.25 per share and Series A preferred dividends of $0.4375 per share during 2018.
Material changes and unusual items
- Q3 shifted from reported net income to a net loss. Nine-month net loss narrowed year over year, but results included $93.4m of real-estate sale gains in 2018, versus $13.0m in 2017; the prior-year period also included a $43.7m gain on sale of joint-venture interests. These gains materially affect comparisons with ongoing operations.
- Interest expense rose to $30.7m in Q3 from $18.0m and to $65.0m for nine months from $53.1m. The company cited higher debt balances and rates, and accelerated amortization of financing costs when old debt was repaid.
- General and administrative expense increased to $8.3m in Q3 from $5.3m and to $24.8m for nine months from $16.6m, including higher performance-based stock compensation and personnel costs.
- During the first nine months, Seritage contributed Santa Monica, San Diego and West Hartford properties to joint ventures, retaining interests and recognizing gains. Certain transaction values and gains remain subject to future revaluation and cash settlement.
- The redevelopment pipeline included 79 projects with estimated total investment above $1.4bn ($1.3bn at Seritage’s share); approximately $940m ($880m at share) remained to be spent.
Outlook, risks and contingencies
- Sears bankruptcy: Sears Holdings filed for Chapter 11 on October 15, 2018, after quarter-end. At September 30, Sears was still a tenant at 129 wholly owned and 22 JV properties; after recapture, termination and transaction activity, the filing says it remained a tenant at 82 wholly owned and 19 JV properties. Sears’ bankruptcy, rent-payment capacity and the treatment of the unitary Master Lease are uncertain and could materially reduce rental income, operating cash flow, redevelopment funding capacity and distributions.
- As of September 30, Sears had terminated the Master Lease at 65 stores and given notice to terminate at 22 more, representing about $11.3m of annual base rent. The company disclosed estimated termination fees of approximately $20.7m for those 22 stores. Reletting vacated space may require time and additional capital, and comparable rent is not assured.
- The term-loan agreement has financial metrics and restrictions affecting asset sales, joint ventures, additional debt and distributions. Failure to meet specified metrics can restrict asset dispositions and trigger additional collateral requirements; the filing states this would not, by itself, constitute an event of default. The company reported it was in compliance with material loan terms.
- No formal earnings or operating guidance is provided. Management expects remaining loan proceeds and potential incremental borrowings to support redevelopment and operating expenses, subject to facility terms.
- Hurricane Michael damaged a wholly owned property in Panama City, Florida after quarter-end. The company could not reliably estimate damage, but did not expect interruption of rent or material repair costs. It also reported ordinary-course legal matters and environmental exposures; management did not expect them to have a material effect based on information available.
Key facts investors should verify
- Developments in Sears’ Chapter 11 case, including rent payments, lease assumption or rejection, and any effect on the Master Lease and JV leases.
- Actual non-Sears rent commencement, occupancy, and leasing economics compared with signed-but-not-open leases and the $200m threshold for incremental borrowing.
- Available liquidity after redevelopment spending, debt service and distributions, and the company’s compliance with term-loan covenants and collateral triggers.
- Project costs, completion timing and lease-up for the $1.4bn redevelopment pipeline, together with final valuation and settlement outcomes for the three JV contributions.
- Underlying recurring performance apart from property-sale gains, termination fees and other adjustments; non-GAAP NOI and FFO measures are not substitutes for GAAP results or cash available for distributions.