VNO - Vornado Realty: I Backed Up The Truck Ahead Of Earnings

2024-01-20 21:05:36 ET

Summary

• Vornado Realty's preferred shares are trading at a near 40% discount to their liquidation value.
• I've been buying the Series N, which currently offers an 8.56% yield on cost.
• VNO currently spends $15.5 million per quarter on quarterly payments to its preferred shareholders. These payments were 7.74x covered by FFO generated during its last reported quarter.

Vornado Realty ( VNO ) Series N Preferreds ( VNO.PR.N ) is now one of the largest hybrid fixed income securities I have in my income portfolio after a late 2023 buying spree that doubled my position. This article intends to expand the rationale behind this action, building on the bullish thesis put forward for the preferreds when I last covered the ticker. Critically, VNO's balance sheet is extremely liquid with cash and equivalents of $1 billion and restricted cash of $262 million set against well-laddered debt maturities.

The last two years for the Manhattan retail and office REIT have been turbulent, the preferreds have lost 42% of their value, and the commons are down 32% over the same time frame with the loss of its investment grade status all contributing to the dire backdrop. VNO saw its credit rating downgraded a notch by Fitch to " BB+ " from "BBB-" with the rating agency citing elevated leverage and weakening fundamentals of the Manhattan office market as a result of the work-from-home trend.

VNO most recently declared its delayed cash dividend of $0.30 per share in December, a 20% reduction from the first quarter of 2023 as the REIT suspended distributions in the second and third quarters. VNO intends to pay a single dividend in 2024 during the fourth quarter, a move that should save roughly $173 million in cash for paying down debt. This estimate assumes $0.90 per share in skipped distributions for three quarters through to the fourth quarter with VNO's weighted average shares outstanding at 192,921,000 at the end of its last reported fiscal 2023 third quarter. The REIT is set to report fourth-quarter earnings on 12 February after market close.

Balance Sheet Depth And Manhattan CRE Fundamentals

Firstly, the choice to go with Series N was based on its competitive yield on cost versus the other four preferreds and a steep near-40% discount to its $25 per share liquidation value despite VNO's balance sheet depth. VNO currently spends $15.5 million per quarter on quarterly payments to its universe of preferreds, 7.74x covered by an FFO of $120 million realized during its third quarter.

Bears would of course flag high leverage, debt maturities, and lease expirations as core headwinds for FFO. VNO's total debt stood at $8.3 billion at the end of its third quarter with a debt-to-equity ratio of 1.43x. Whilst leverage dipped from a record high earlier in 2023, it's important to note that equity is highly influenced by office properties whose market value might be less than their book value. VNO owns 555 California Street in San Francisco, a market that saw its office vacancy rate reach a record high of 35.9% during the fourth quarter, up 200 basis points sequentially.

However, as of the time of its credit downgrade, the REIT had three mortgages worth a total of $291 million coming due through the end of 2024. This was set against an aggregate liquidity of $3.2 billion if $1.9 billion of undrawn capacity under VNO's credit revolver is included. Critically, whilst VNO continues to build out its active development pipeline including a joint venture with Hudson Pacific Properties ( HPP ) and Blackstone ( BX ) to develop Manhattan's first purpose-built studio campus at Pier 94, it has completed most of its capital development spend on its current projects. VNO's $750 million PENN 2 redevelopment is complete with the REIT recently naming Cushman & Wakefield as the exclusive leasing agent for the 1.8 million square-foot PENN DISTRICT office tower.

Trophy and Class A office properties are capturing an outsized share of Manhattan office market demand. These represented 72.6% of leasing activity in the first half of 2023 with a continued 'flight to quality' set to underpin demand for PENN 2. VNO's high-quality Manhattan properties let on long-term leases to tenants with strong credit quality sets the backdrop of a recovery of the preferreds once the Fed starts to cut back interest rates.

The CME FedWatch tool is showing expectations of rates being cut by at least 150 basis points by the end of 2024. This would be an outcome that would see the preferreds trade up close to $20 per share on the positive duration effect. Further, whilst VNO's New York office occupancy at 91.6% at the end of its third quarter dipped by 30 basis points sequentially, occupancy remains high with VNO upbeat on leasing velocity improving. There were 17 leases completed for an aggregate 236,000 square feet at average starting rents of over $93 per square foot during the third quarter. This reflects the quality and depth of VNO's portfolio.

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