Seritage Growth Properties — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing was signed March 1, 2019. Quarterly figures below are unaudited; annual results largely predate Sears Holdings’ bankruptcy and do not reflect the subsequent Holdco lease transition.
Business context
Seritage is a retail real estate REIT focused on acquiring, leasing, redeveloping and densifying properties. At year-end, its portfolio comprised 206 wholly owned properties and interests in 26 joint venture properties, totaling approximately 36.3 million square feet of GLA. Its strategy is to replace Sears-occupied space with diversified tenants, generally at higher rents, and pursue retail and mixed-use redevelopment.
Key financial metrics
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Total revenue | $214.8 million | $241.0 million |
| Net loss | $114.9 million | $120.8 million |
| Net loss attributable to common shareholders | $78.4 million | $74.0 million |
| Basic and diluted loss per share | $2.20 | $2.19 |
| Total NOI (non-GAAP) | $143.1 million | $174.8 million |
| FFO (non-GAAP) | $24.1 million | $91.7 million |
| Company FFO (non-GAAP) | $15.7 million | $81.8 million |
| Cash from operating activities | $54.9 million | $59.6 million |
FY 2018 rental income was $156.1 million, down from $178.5 million. Sears-related rental income was $86.2 million, or 61.9% of rental income, versus $112.9 million and 73.2% in 2017. Tenant reimbursements were $57.5 million, compared with $62.5 million. The property operating expense recovery rate fell to 80.8% from 95.7% as vacancies increased and Seritage incurred costs at vacated properties.
FY 2018 interest expense was $90.0 million, up from $70.1 million. Depreciation and amortization was $226.7 million, down from $262.2 million, but included accelerated amortization related to recaptures, lease terminations and Sears’ bankruptcy. Real estate sale gains were $96.2 million. The filing does not provide a clearly stated operating margin; NOI and FFO are non-GAAP measures, not substitutes for GAAP earnings or cash flow.
For Q4 2018, revenue was $55.1 million, total expenses were $120.8 million, net loss was $85.7 million and loss per share was $1.57. Q4 2017 revenue was $53.7 million, net loss was $70.4 million and loss per share was $1.27.
At December 31, 2018, cash and cash equivalents were $532.9 million, total assets $2.88 billion, total liabilities $1.73 billion and total equity $1.15 billion. Debt was $1.6 billion, all under a fixed-rate term loan; cash flow from operations was insufficient to cover the year’s $313.6 million of real estate development spending. No restricted cash remained at year-end.
Material changes versus prior period
- Revenue declined 10.9% year over year; Total NOI fell 18.1%, FFO 73.7% and Company FFO 80.7%.
- Occupancy based on signed leases, including leases not yet open, declined to 67.0% from 80.0%. Annual rent was $210.8 million versus $214.7 million; reported rent per square foot increased to $9.36 from $7.20.
- Diversified non-Sears rental income increased to $53.2 million from $41.4 million. On an annualized signed-lease basis, diversified tenants represented 70.9% of base rent at year-end, but this includes leases not yet producing rent.
- In July 2018, Seritage refinanced its prior mortgage and unsecured loans with a $2.0 billion secured term facility, initially drawing $1.6 billion. It repaid the prior mortgage debt and $145 million unsecured loan. The new facility bears 7.0% interest and matures July 31, 2023.
- Seritage sold 21 properties for $114.3 million gross proceeds and contributed three redevelopment properties to new joint ventures. These transactions generated $231.3 million of gross proceeds in total; cash-flow statements report $210.1 million of net proceeds from property sales.
- The common dividend remained $1.00 per share for 2018. The Board declared a $0.25-per-share dividend for Q1 2019 but said it did not expect further common dividends for the rest of 2019.
Outlook, risks and unusual items
- Sears bankruptcy and replacement lease: Sears filed for Chapter 11 on October 15, 2018. Holdco acquired certain Sears assets in February 2019; Seritage and Holdco affiliates then signed a master lease for 51 wholly owned properties. Its commencement is conditional on rejection of the Sears master lease, and timing and performance are not assured. The new lease provides approximately $32.5 million in initial annual base rent, subject to potential rent concessions of up to about $12 million in each of its first two years, plus estimated annual reimbursements of about $11.5 million.
- Lease flexibility and concentration: The Holdco lease allows Seritage recapture rights, but also gives Holdco termination rights, including specified numbers of properties that may be terminated without a fee in future lease years. Holdco remains a material tenant until the portfolio is further diversified. The existing JV master leases had not been assumed or rejected as of the filing date.
- Debt covenants and liquidity: Management reported $532.9 million of unrestricted cash and a $400 million incremental facility, but access to the latter depends on specified non-Sears rental-income tests. Seritage expects to breach one or more term-loan financial metrics following rejection of the Sears lease and effectiveness of the Holdco lease. This could restrict asset sales and joint ventures and allow the lender to request mortgage collateral; the filing says this is not, by itself, an event of default.
- Redevelopment execution: The company reported 82 redevelopment projects with estimated total investment of approximately $1.45 billion ($1.37 billion at its share), of which about $907 million ($849 million at share) remained to be spent. Returns depend on completion, leasing, occupancy, costs and financing; delays, vacancies or cost overruns could reduce returns.
- Legal contingency: Sears’ creditors and others alleged the 2015 Sears-Seritage transaction was a fraudulent conveyance and indicated intent to litigate. Claims were preserved in the bankruptcy court’s approval of the Holdco acquisition. The filing does not provide a clear estimate of potential exposure.
- Other unusual items and risks: The year included accelerated lease-intangible amortization, $96.2 million of real estate sale gains, and a $4.4 million reduction to the West Hartford JV gain after certain development costs were deemed non-reimbursable. Environmental reserve was $9.5 million; management said it was not aware of environmental issues expected to materially affect operations. The filing also identifies retail-market, tenant credit, environmental, REIT qualification and related-party risks.
Management stated that it believed liquidity was sufficient for operating needs and redevelopment, subject to available cash, operations, the conditional incremental facility and financing alternatives. No quantified earnings or cash-flow guidance was provided. The 2018 hurricane season, primarily Hurricane Michael, had no material reported impact.
Most important facts for investors to verify
- Whether and when the Sears master lease rejection became effective, and whether the Holdco master lease commenced and rent and reimbursements were paid as contracted.
- Current Sears/Holdco exposure, including the status of JV master leases, store closures, lease termination rights and recapture activity.
- Actual covenant compliance after the lease transition, lender collateral demands and restrictions on asset sales, joint ventures or distributions.
- Cash available after redevelopment commitments, project costs to complete, leasing progress and whether signed-but-not-open leases convert to paying occupancy.
- Status and potential financial impact of the fraudulent-conveyance claims, including any developments not quantified in this filing.
- Dividend policy: distinguish the declared Q1 2019 common dividend from the Board’s stated expectation of no further common dividends in 2019; separately assess the 7.00% preferred shares and their senior claims.