SPG - Macerich: Resilient Leasing Trends In The Face Of A Slowing Economy

2023-05-11 12:04:11 ET

Summary

• Macerich shares have performed poorly thus far in 2023, down 13%.
• Leasing trends remain very strong. Leasing trends remain robust following record leasing in 2022.
• Debt remains elevated at nearly 9x EBITDA, though Macerich has made substantial progress on dealing with maturities.
• With an implied cap rate in the mid-8s and a P/FFO below 6x, Macerich shares are inexpensive.
• I see Macerich shares as an attractive opportunity for contrarian investors.

It has been a rough ride for Macerich ( MAC ) shareholders, with the stock down 13% year-to-date (and down 25% over the past year). Rising interest rates and a tightening lending market coupled with fears of a consumer spending slowdown have caused investors to flee.

Despite these negative factors, Macerich has made steady progress on dealing with debt maturities. Following elevated store closures from 2015-2019, retailer demand for top quality space has rebounded - 2022 was Macerich's strongest year of leasing since the Great Financial Crisis and leasing trends remain strong thus far in 2023.

Trading at a deeply discounted valuation, I see Macerich shares as an attractive opportunity for contrarian investors.

Leasing Trends Remain Strong

As shown above, Macerich saw total leasing (by square footage) decline from 2015 to 2018. At the time, 'Retail Apocalypse' headlines dominated the news flow as traditional mall tenants sought to right-size store fleets and adjust their cost base. This was driven both by weaknesses in the tenant's business as well as the larger macro trend favoring e-commerce growth at the expense of physical brick-and-mortar retail.

As shown below, occupancy declined from 96% in 2015 to 94% in 2019 before plummeting below 90% as the pandemic wrought havoc on the mall.

Looking back, the pandemic seems to have served as a wash-out for the weakest retailers - the closure of retailers with unsustainable business models/over-leveraged balance sheets was dramatically accelerated (as evidenced by the dramatic fall in occupancy). However, since 2020 we have witnessed a marked turn in the retail leasing environment as:

• Most retailers have now right-sized their store footprint, and the era of mass store closures is over. This has led to an increased tenant renewal rate, which supports occupancy and rents.
• Newer retailers, many of which are digitally native, have started opening stores. This recent podcast highlights the journey of one digitally native brand, which in a short period has grown to nearly 100 stores.
• This was aided by a favorable backdrop as consumer spending surged following the pandemic era stimulus (as well as the spending of pent-up savings).

In 2021, retailers opened more stores than they closed (for the first time in years) and this trend has continued through 2022 and into 2023. While the economic environment deteriorated throughout 2022, leasing activity surpassed 2015 levels. 2015 was a strong year for malls - shares of Macerich and Simon ( SPG ) traded at multiples of their current share price.

As the calendar has flipped into 2023 and economic headwinds dominate headlines, mall leasing trends remain very strong:

Similarly, peer Simon Property sees no slowdown in leasing despite a weakening economy:

There is a lag between lease signing and the receipt of rents (and commensurate increase in NOI). Current strength in leasing sets Macerich up for NOI growth (shown below) in 2024 and 2025 even if we see a further slowdown in the economy.

In summary, despite fears of an economic slowdown, the inflection in leasing trends sets Macerich up for growth in NOI in 2024 and 2025.

Balance Sheet

Perhaps the biggest concern for Macerich is the company's heavy debt load. As we sit today, debt comprises nearly 80% of its capital structure and net debt to EBITDA sits just under 9x. To be clear, debt levels are higher than I (or the market) would like to see.

It is worth noting that over the past six months, Macerich has made substantial progress in dealing with debt maturities (show above). While the company's interest burden has increased (and will likely continue to increase), the balance sheet is in better shape than it was a year ago. Given my expectation for continued NOI growth, debt metrics are likely to further improve.

Valuation & Conclusion

As we sit today, Macerich trades at an implied cap rate in the mid 8s, a P/FFO of 5.5x and a dividend yield of nearly 7%. These valuation metrics are consistent with that of a business in decline. However, as I've attempted to show above, I believe that Macerich/malls have turned a corner and that the business has returned to sustainable growth.

Were shares to trade at a 7% cap rate and a 11x FFO multiple (would still be at the low end of pre-pandemic trading range), Macerich shares could double.

Given positive leasing trends and the potential for a substantial increase in the share price, I've taken a small position in Macerich shares. My enthusiasm is tempered by elevated levels of financial leverage, though as I note above, I believe this is manageable as maturities have been extended and NOI is set to grow in coming years.

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