KLPEF - KlePierre: Prime Shopping Mall Operator Positioned To Deliver

2023-11-13 10:30:52 ET

Summary

• KlePierre is a large European shopping mall REIT with over 70 premier shopping malls, maintaining strong occupancy of 95.8%.
• European shopping malls are more than just shopping destinations, offering experiences such as dining, entertainment, and services, making them resilient to e-commerce.
• KlePierre's tenant mix includes grocery stores, providing higher footfall and stable rent collections, contributing to its resilience and potential for growth.

Investment Thesis

KlePierre ( KLPEF ) is a large European shopping mall REIT. In fact, it is the second largest mall owner in Europe with over 70 premier shopping malls. Retailer volumes have largely recovered from the pandemic and as a result the REIT has been able to record strong leasing over the first nine months of 2023 and maintain strong occupancy of 95.8%. Management has recently issued increased guidance which calls for 7% YoY growth in net current cash flow. It seems likely that they will deliver this growth. Consequently, the 7.7% dividend yield is likely to remain very well covered and provide solid income while investors wait for 20%+ upside from a reversal to NAV.

Overview

KlePierre's malls are located primarily in France (41%), Italy (21%), Spain (13%), Scandinavia (13%) and the Netherlands (7%).

The company is unique in their focus on high quality A-class malls, positioned in some of the best locations of dense, affluent and growing cities. The company doesn't own strip malls nor outlets in neighborhoods, but true trophy assets in some of the most desirable locations in Europe.

This makes the company quite comparable to Simon Property Group ( SPG ) which also happens to be a 22% shareholder of KlePierre. There are, however, several key differences that should make KlePierre more resilient to current trends that retail is facing (especially e-commerce) and frankly make KlePierre my favorite between the two.

Key differences between EU and U.S. mall culture

These differences mainly stem from a different mall culture in Europe vs the US.

In particular:

1. European shopping malls are about much more than just shopping, they have become a destination where people meet and enjoy themselves. Shopping remains part of the experience, but it's also about eating out, watching movies, going to a sauna, getting your hair done or simply dressing-up and having a coffee with friends. This experiential factor, which accounts for almost a quarter of all floor space, is what makes KlePierre's malls significantly more resilient to e-commerce and also an economic downturn with weaker consumer spending. It's also why there is a big focus on architecture and interesting eye-catching layouts.

2. Apart from experiences, the tenant mix of KlePierre's malls is also heavily concentrated towards grocery stores (27% of all floor space). This is another key difference, as European malls tend to have grocery store anchor tenants, which is in direct contrast to the US where most malls are anchored by large department stores. Grocery stores bring a number of benefits, including (1) much higher overall footfall and (2) safer (more stable) rent collections, especially in a high inflation environment as grocery stores are able to pass inflation onto the final consumer very easily (unlike department stores). The latter may prove especially important in light of the ever-increasing proportion of fashion sales moving online and a potentially weaker consumer spending if the Fed succeeds in forcing a recession.

3. Since European malls act as a destination rather than convenience, they tend to be large and well located. This means that there are only a couple of premier malls in each city and they often occupy the best locations, which creates very high barriers to entry. This is why total mall density in European markets where KlePierre operates is 5-6x lower than in the US. This makes for much better supply and demand dynamics and consequently much lower pressure on occupancy and rents.

It's no secret that retailers were hit hard by Covid, but thankfully that seems to be a thing of the past now. In 2022 retail sales finally surpassed 2019 pre-Covid levels and during the first three quarters of 2023 they continued to grow, adding another 7%.

In KlePierre's markets this growth was mostly fueled by 14% increases in the Netherlands and Germany, while sales in France (their biggest market) grew by only 5% YoY. In terms of segments, fashion sales which account for the largest portion (32%) of reported sales grew by 5% YoY, while Food & Beverage saw the fastest growth of 14% YoY.

With increasing sales, retailers are happy to re-new their leases at higher rates. Last year the company signed 1,360 leases with an average rent increase of 4.1% above average indexation of 3.7% (7.8% total rent increase). During the first 9 months of this year a further 1197 leases were signed at an average reversion rate (i.e. rent increase) of 4.1% over indexation of roughly 5% (9.1% total rent increase). This has brought occupancy up 110 bps YoY to 95.8%.

Financials

Last year, the company increased their net revenue income by 18% YoY to EUR1.04 Billion, as the company was finally able to hike rents with Covid-related incentives finally out of the way. Net current cashflow, which is similar to FFO and a good measure to assess the dividend coverage, came in at EUR 2.62 per share, which was significantly above the midpoint of guidance (13% over initial guidance and 7% over revised July guidance).

To be fair, these results included some nonrecurring one-offs. In particular a EUR89 Million reversal of provisions as the company was able to collect much more than expected on owed rent from 2020 and 2021 and EUR25 Million of net rental income produced by assets that were sold during the year. Excluding these one-offs, the adjusted net current cash flow totaled EUR 2.24 per share, up 7% YoY.

Following strong performance last year, the REIT has increased its dividend by 3% YoY to EUR 1.75 per share. At today's stock price of EUR 22.60 per share, the dividend translates into a yield of 7.7%, and is quite well covered by net current cash flow of EUR 2.62 (or adjusted EUR 2.24).

Strong growth in net rental revenue continued also during the first nine months of this year as it increased by 8.6% YoY. For the rest of the year, management has issued upbeat guidance which calls for net current cash flow of at least EUR 2.40 per share. This is up from guidance of EUR 2.35 issued last quarter and represent annual increase of 7.1% YoY. That's quite optimistic relative to what peers are expecting, but given recent double digit rent spreads on leases and excellent financial management (discussed later), I see it as achievable.

Klepierre has been able to reduce their debt very significantly over the past two years and key debt metrics reflect this as they are now on par with pre-Covid values. Their BBB+ rated balance sheet now has a net debt/EBITDA of 7.8x (as of Q3 2023) with an LTV on reported book value of under 38%.

The REIT also has manageable debt maturities over the next few years and currently enjoys an extremely low cost of debt of 1.3%, with 100% rate hedging this year and 90% hedging next year.

Of course, if rates remain high for a longer period and as debt maturities come due, their cost of debt will increase gradually. This year for example, assuming that the EUR 726 Million of debt gets refinanced at a 4% higher rate, the interest expense would increase by EUR 30 Million. But to offset that, all the REIT needs to do is raise rents on their EUR 1 Billion in net rental income by about 3%. That's below guidance and much below what they have been able to achieve lately, which leads me to believe that even a higher for longer scenario is not particularly painful for Klepierre, especially if interest rates remain high due to high inflation, which is very easy to pass onto tenants.

And let's not forget that of top of already high liquidity of EUR 2.6 Billion the company also retains almost EUR150 Million in cash each year and can dispose of some of its assets if it needs to lower its debt further. All of this puts KlePierre in a pretty good position financially.

Valuation

KlePierre keeps their properties on the books at EUR 31 per share which would imply that the stock is trading at a nearly 30% discount to NAV. The values reported are based on a portfolio-wide average cap rate of 5.6% and a 10-year net rental income CAGR of 2.9%.

The cap rates used to value the portfolio have been coming up slowly, most recently by 20 bps from Q3 2022 (the portfolio is revalued annually so it'll be interesting to see the updated assumptions when 2023 values come out).

In March 2023, Savills reported an average prime shopping center cap rate of 5.7% which is in line with the assumptions used above. They also stated that for prime assets in good locations they only expect additional 0-10 bps increase over the course of this year. I always take their research with a grain of salt, because they are being paid by the likes of KlePierre, which inevitably gives them a bias. But the thing is that recent disposals have more or less confirmed these valuations. In 2022, KlePierre disposed of EUR 602 Million worth of assets at prices just 2.4% below book value.

As we already saw, the stock is now trading at 10x net current income (think FFO) and way below book value. In fact, with NOI of roughly EUR 950 Million, the market is valuing the properties at an implied cap rate of 6.8%. While I do expect the portfolio NAV to come down a little more, perhaps to the EUR 28-30 range, at a price of EUR 22.60 per share, the stock trades at least 20% below fair NAV. That's a significant margin of safety and good potential upside in addition to an already pretty high 7.7% dividend yield.

Risks

The bullish thesis faces two distinct risks. Firstly, high interest rates put pressure on KlePierre's net interest expense and cash flows. If rates stay higher for longer than the market is currently expecting, this will likely result in further downside over the short-term. My medium to long-term view however remains that interest rates will drop. Secondly, most of KlePierre's tenants are consumer discretionary companies. Consequently a recession which would reduce consumer spending would could have a substantial negative effect on tenant's earnings which would likely impact KlePierre as the landlord as well and the REIT may seem rent coverage shrink and may have a hard time re-leasing space as leases expire.

Conclusion

In summary, the industry seems to have largely recovered from the pandemic with retailer sales surpassing pre-Covid levels in 2023. As a results and thanks to strong leasing, KlePierre has increased its occupancy to 95.8% and is seeing almost double-digit rent spreads on newly signed leases (in addition to high portfolio-wide indexation). Disciplined financial management over the past two years has brought debt down to pre-pandemic levels and with reasonable maturities over the next few years and significant hedging, the upward pressure of cost of debt can be easily offset by higher raising rents. In the meantime, the stock trades at a 20% discount to fair NAV, leaving sufficient upside on top of a sizeable dividend. Valuations are not as depressed as during the pandemic and most of the upside has already been realized on the recovery. Still KlePierre can represent a good (more resilient) alternative to the likes of SPG and can add solid dividend income to any portfolio.

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