Monday, November 30

Avoid Both Common And Preferred Shares

It’s been a disastrous year for mall REITs, and that on top of a past five-year period that was already awful. Not surprisingly, contrarian investors keep trying to buy the lows in the mall space. At some point they’re going to bounce, right? And sure, the higher-quality mall REITs such as Simon Property Group (SPG) eventually will, though not necessarily anytime soon. That last earnings report from Simon was surprisingly bad.

But in any case, we’re not talking about a Simon or Taubman (TCO) today. Rather, Simon’s old spin-off Washington Prime (WPG) is our focus here. Washington Prime and its B-tier mall peers were once popular dividend investments. The dividends now gone, the appeal of shares has diminished. Still, some traders are hoping for a comeback in the regional mall space.

Even with the share price now at just 65 cents as of this writing, there is, in fact, still quite a bit of drama around Washington Prime’s stock. For one thing, short interest comes in at 37% of the float, which is high even by WPG stock’s historical average. It turns out that even deep into penny stock land, short sellers are still willing to hold their bets on Washington Prime going all the way to zero rather than covering at this level.

Second, the Pfizer (PFE) vaccine news set off quite a rally in the retail and REITs sectors. Healthier mall REITs such as Brookfield Property (BPY) and Simon surged Monday following the news. WPG stock jumped as well, but it only reclaimed losses from the previous Friday, when it had touched new all-time lows:

ChartData by YCharts

The reason that Washington Prime hasn’t enjoyed nearly as much of a comeback with the vaccine news should be clear: The company is on the brink of a potential bankruptcy filing over the next year or two. And the upcoming vaccine is unlikely to change anything soon enough to matter to common shareholders.

Washington Prime: Marginally Better Than CBL And Pennsylvania REIT

For the past few years, bears on the mall REITs, such as myself, have argued that ominous developments at CBL & Associates (OTCPK:CBLAQ) and Pennsylvania REIT (PEI) would also reflect poorly on Washington Prime. In fact, I urged selling WPG stock once again last December following CBL’s dividend suspension, as it showed just how quickly the whole B-tier mall space was eroding.

That said, we should give the Washington Prime CEO Louis Conforti a bit of credit. Washington Prime did manage to best its rivals in one small way – while PEI and CBL have already filed bankruptcy, Washington Prime has managed to avoid that fate for the time being. That’s a tangible victory for the Washington Prime team. Ultimately, however, the old adage about CEOs not being able to overcoming poor sector economics played out, all the low-quality mall REITs all crashed at roughly the same speed and magnitude over the past five years:

ChartData by YCharts

As you can see, CBL & Associates (now traded as CBLAQ) is already close to defunct. The common stock has been delisted and now trades for three cents. PEI stock is also beating Washington Prime in the race to the bottom. To that point, Pennsylvania REIT recently declared bankruptcy as well. Unlike CBL & Associates, Pennsylvania REIT still hopes to restructure in a way that could leave the common and preferred stocks intact. But with the share price now at 45 cents, you can get a sense of how well the market is taking to that plan.

Thus, Washington Prime is looking like the last survivor of the low-end mall REITs. Even so, it’s in a dire situation.

Earnings: From Bad To Worse

Last Friday, WPG stock tanked as much as 25% following a headache-inducing earnings report. The company’s net loss ballooned to $44 million for the quarter as compared to a $4 million loss for the same quarter of 2019. Funds from operations plunged 85% to just 7 cents per share. As if that weren’t enough, the company has a massive 1:9 reverse split on deck to get the stock far enough out of penny stock territory to keep its NYSE listing.

The company is in better shape than CBL and PEI in that it has avoided immediate creditor problems. Washington Prime managed to be in compliance with its debt covenants at the end of the quarter, and has $112 million of cash at the moment. That’s something.

However, on the company’s conference call, we see that the balance sheet is strained enough that the firm’s flexibility is limited:

We should note that the company did exceed the thresholds for several of the leverage bond covenants as at the end of the third quarter. However, since these are in current space, they’re only measured if the company actually incurs new incremental debt, which did not occur during the quarter, so they were not applicable. And finally, I should mention the company has no current plans to incur additional debt.

As long as Washington Prime doesn’t take on new debt, it can keep going as is for at least a little bit. Therein, however, lies the problem.

The bull thesis in recent years for Washington Prime – once it became clear that the existing assets were declining quickly even in a great economy – was that the company had a wealth of potential as a redevelopment play. Some bulls even suggested Washington Prime would be better off without its anchors, as it could slot in replacement tenants at higher rents per square foot.

Pandemic or no pandemic, I vigorously disagree with that view; the whole point of having an enclosed mall is to bring people there with high-profile draws and then have folks walk around the interior of the premises in between the anchors. Swapping out the Nordstrom (JWN) or Macy’s (M) for a fitness club or other such secondary use is generally going to detract from the overall value of the property. Many of these replacement tenants don’t even open to the interior of the mall, which absolutely crushes in-line store traffic.

And now, many of these redevelopments are not even going to happen. If you read investor presentations from the likes of CBL and WPG in recent years, they were often targeting just 8-10% ROIs on their redevelopment opportunities. The goal – contrary to much of the bullish rhetoric – was simply to keep properties stable and cash flowing. Now though, in a post-Covid world, projects that were only going to make a high-single-digit ROI anyways aren’t going to get financed.

Additionally, many of the planned anchor replacement tenants, such as gyms, Dave & Buster’s (PLAY)-style entertainment facilities, and so on are on life support of their own. The pandemic in particular poses many specific challenges for the class of tenants that were supposed to save malls.

Even if that weren’t a problem, say 100% of the population is magically vaccinated tomorrow, there’s still the matter that Washington Prime can’t take on more debt due to its financial situation. Read the above quote I pulled from the conference call.

And while Washington Prime is avoiding debt covenant problems for the time being, the situation is grim. Moody’s has assigned a mere C credit rating to Washington Prime and S&P is at a CCC- rating, these both imply a high possibility of bankruptcy over the next year or two.

Not surprisingly, Washington Prime’s 6.5% bonds are now trading at just 58 cents on the dollar, which amounts to a 24% yield-to-maturity. That’s right, WPG’s bonds are now showing the same sort of outlandish yield that its common stock used to give off several years ago. While the 24% yield bonds are far from totally secure, at least there are real assets underlying them.

Compared to the bonds, Washington Prime’s preferred shares make little sense. For whatever inexplicable reason, WPG’s preferreds have bounced sharply off the lows, even as the common continues to drop and the bonds remain deeply depressed. Here’s a chart of the WPG H-class preferred over the past year:

Source: Seeking Alpha

As you can see, even with disastrous earnings and the ordinary stock hitting new lows, the Washington Prime H-class preferred (WPG.PH) is trading at $11, way up from the 52-week low of $3.78. This means that the preferred stock is yielding only 17%, as opposed to the 24% yield-to-maturity on the bonds. Furthermore, you get minimal protection in bankruptcy with a preferred share, whereas the bonds have a stronger claim on the underlying malls and shopping centers.

So why own the preferreds? The only reason that makes sense is to collect the borrow fee. The H-class preferreds, at least on November 10 at Interactive Brokers (IBKR), had a borrow fee of 43%/year. This implies that a sophisticated institutional owner of these preferreds could conceivably lend out the H-shares and get back most of that 43% as yield. Perhaps that, plus the actual yield off the preferred stock for as long as Washington Prime can still pay, is worth the risk. I still wouldn’t be comfortable owning it, but I understand if I were getting paid that 43%.

However, I suspect many if not most holders of the preferred shares are not institutional investors that get most of that borrow income refunded to them. If you’re not getting paid a huge fee for lending out your shares, there’s little reason to hold the preferreds as opposed to swapping for bonds, or – better yet – getting out of Washington Prime as an investment altogether.

I can’t say it frequently enough, don’t be afraid to sell. Any capital you can recover is better than an investment going to absolute zero. And don’t think for a second that this isn’t a likely outcome here. Washington Prime’s long-time peer company CBL & Associates now trades at 3 cents per share. CBL’s class-D preferred stock (CBL.PD), which still traded for $11 a year ago, is now at 65 cents.

CBL’s preferred shares did not fare well as the company descended into bankruptcy; the preferred shares are down 95% over the past year. | Source: Seeking Alpha

The same could very well happen to Washington Prime’s securities in coming months – just look at the credit ratings on WPG’s debt instruments. It’s not a pretty picture.

When you own a holding that’s deeply underwater, it’s always worth asking if you’d buy that position today, given all you now know.

It doesn’t matter what you thought might happen with malls a year or two ago. Or what the dividend used to be. That stuff is ancient history. The fact is that Washington Prime’s two closest peers have already filed for bankruptcy, as have a large number of Washington Prime’s tenants. The company is bumping up against debt covenants and its financial resources are dwindling. Is this really where you’d put money to work today? And if not, is there any reason to keep holding onto shares that you may already own?

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Credit: SeekingAlpha

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