BFS - Saul Centers: A Grocery-Focused REIT With A D.C. Concentration

2023-04-12 02:56:37 ET

Summary

• Saul Centers owns and operates a small portfolio of properties consisting of shopping centers and mixed-use commercial properties, located principally in the D.C. operating region.
• The company's exposure to grocery-anchored tenants offsets the downside risks of their weaker mixed-use properties.
• For income investors, the stock offers a dividend payout that currently yields over 6%.
• While the industry outlook is positive, I view rising interest costs as a headwind for future performance. Therefore, I maintain a neutral position on the stock.

Saul Centers ( BFS ) is a real estate investment trust ("REIT") that owns and operates a portfolio of 57 properties, located primarily in the Washington, D.C./Baltimore, Maryland metropolitan area.

Their portfolio is comprised of 50 neighborhood and community shopping centers, two-thirds of which are anchored by a grocery store, and seven mixed-use properties.

Their mixed-use properties are comprised of offices, retail space, and apartments. Accounting for over 50% in gross leasable area ("GLA"), offices represent the primary asset class in their mixed-use portfolio.

Their largest shopping center anchor tenant and the only one to account for over 2.5% of their total revenues is Giant Food ("Giant"). At the end of December 31, 2022, the company accounted for 5.1% of their revenues.

YTD, shares are down just over 6.5%. This slightly outperforms another competitor within the space, Urstadt Biddle Properties ( UBA ), which is down 8.5% over the same period.

The stock, however, has lost nearly 30% over the past year. This is significantly worse than both their peer and the broader markets.

At current pricing, BFS trades at about 12.5x forwards funds from operations ("FFO"). And for income investors, shares provide a quarterly dividend payout that currently yields over 6%. While the current trading multiple and yield may invite consideration for new positioning, I view rising interest costs as a headwind for future earnings growth. And from a valuation and yield perspective, I believe better opportunities exist elsewhere.

Recent Results and Current Portfolio Metrics

At the end of 2022, total occupancy in the shopping center portfolio stood at 94.7%. While this is up 130 basis points ("bps") from 2021, it is down from the 95.5% and 96% levels achieved in 2019 and 2018, respectively.

At their Seven Corners property in Virginia, which is their single largest property and only one to account for over 5% of total GLA, occupancy held at a strong 98%.

At 93.2%, portfolio-wide occupancy at year end was held back by an 82.5% occupancy rate in their mixed-use portfolio, driven by notable YOY occupancy declines in two properties, the Clarendon Center and the Park Van Ness Retail Center.

In the same-property portfolio, operating income was up 2.1%, driven by a 5.7% increase in operating income in their mixed-use portfolio and, to a lesser extent, a 0.9% increase in their shopping center portfolio.

Driving the gains in both were higher base rents . BFS did, however, realize higher rents of +$2.2M in their mixed-use portfolio versus +$1.2M in their shopping centers. In addition, the company realized an additional boost in the final quarter of the year on lower credit losses on operating lease receivables and reserves.

On an overall basis, FFO increased 2.4% to +$103.2M in 2022 from the prior year. On a per share basis, however, results were flat from the prior year on a diluted basis. In addition, FFO/share declined in Q4 to $0.72/share from $0.75/share in the same period last year due to higher interest expenses.

Liquidity and Debt Profile

BFS consistently generates positive operating cash flows. In 2022, for example, they generated +$121M in operating cash flows. This was up from +$118.4M and +$78.4M in 2021 and 2020, respectively.

In addition to consistently generating positive cash flows, the company has access to a $525M credit facility, +$212M of which remained available at year end.

While their overall debt burden in relation to EBITDA is high, at about 7.5x on a net basis, the company doesn't have material maturities to address until 2025.

The company does, however, have a large development pipeline. And I do expect commitments for those projects to create a strain on liquidity. Within the next year, for example, the company will require about +$260M in total funds to address their interest and principal payments on their debt obligations, as well as their development and predevelopment obligations.

Given the requirements in relation to their existing liquidity, I view additional debt raises/equity issuances as likely to satisfy these obligations. And one or both together could pose a continued drag on future earnings growth.

Dividend Safety

BFS currently provides a quarterly dividend of $0.59/share. At current pricing, this represents an annualized yield of about 6.2%. The yield on UBA, in contrast, presently stands at about 5.75%.

In 2022, the payout was increased by 3.5% to its current level after having been increased by about 3.6% in the year prior. In 2020, the dividend was notably preserved at its going rate as opposed to being cut or suspended, as was the case with UBA, who slashed their dividend in 2020 due to the uncertainties at the time.

In 2022, the company generated $3.04/share in FFO. Therefore, at current payout levels, the dividend would represent a payout ratio of just under 78%. This is above sector averages , but not overly so.

It is worth noting, however, that the company has a large pipeline for development, which could constrain coverage if they begin to face earnings headwinds from rising interest costs.

Final Thoughts

BFS operates a stable portfolio with a diverse mix of properties. And their exposure to primarily grocery-anchored shopping centers located in middle- and upper-income areas is a counterweight to risks associated with their geographic concentration around the D.C./Baltimore operating region and their holdings of mixed-used properties, which are creating a drag on overall portfolio occupancy levels.

After having lost 30% over the past year, shares appear to have stabilized on a YTD basis. The current dividend also provides investors with a yield of 6.2%. This compares favorably to the 5.75% offered by UBA. Additionally, the payout has remained more ingrained in recent years, even through the full 2020-COVID fiscal year.

Coverage of the payout, however, is weaker than both UBA and the sector average. Additionally, their dividend track record pales in comparison to UBA, which has been a continuous payer since their founding in 1969. Saul's rising interest burden could also constrain coverage levels further in future periods.

At 12.5x forward FFO, shares appear attractive. But UBA appears more so at 10.9x. For investors seeking new or further positioning, I view UBA as better positioned to capture scarce investor capital due to their larger portfolio and operational focus on neighborhood and community shopping centers. While BFS could track higher, I don't view the upside as meaningful for outsized gains. As such, I am maintaining a "hold" view on BFS.

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