Urban Edge Offers Strong Value

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REITs of just about all types have struggled in the current climate. Property values have declined in some cases, many tenants are struggling to pay rent, and the outlook isn’t all that great. However, in a lot of cases, the market has overreacted, in my view, and that has created some opportunities with cheap stocks.

One such example is Urban Edge Properties (UE), an urban market-focused REIT that owns 78 properties totaling ~15 million square feet. Urban Edge has seen its share price nearly cut in half from pre-crisis highs, and despite the suspended dividend and deteriorated earnings outlook for this year, I think it offers investors value and the potential for a strong yield on today’s cost.

Supply-limited markets create opportunity

Urban Edge is much like any other real property REIT in that it acquires, redevelops, and leases what it owns. However, Urban Edge has taken the approach of owning real estate in supply-constrained markets. Mostly, this means the suburban area in and around the New York City metropolitan area.

Source: Investor presentation

The trust buys properties in areas that are very densely populated and have limited retail real estate supply. It also seeks to have high foot traffic tenants as anchors to help drive traffic to other tenants, typically through a grocery store, home improvement store, or something similar.

Source: Investor presentation

Urban Edge has properties all over the US, but it is overwhelmingly concentrated in the northeast US. Indeed, the Washington, DC to Boston corridor, which roughly approximates part of interstate 95, contains ~90% of the trust’s total net operating income, or NOI.

This is far from an accident, however, as populations are extremely concentrated in this corridor, which creates high demand for real estate. And with these markets being supply-constrained, conditions are perfect for Urban Edge’s strategy.

Source: Investor presentation

Interestingly, Urban Edge is not only concentrated in the northeast US, but it is further concentrated in the NYC MSA. Indeed, 46 of its properties, and a staggering 80% of its total portfolio value are in this area. Urban Edge seeks highly populated, supply-constrained markets, and no market in the US fits that definition better than NYC.

I generally would want more diversification than this geographically simply because external factors – such as the massive COVID-19 outbreak NYC experienced earlier this year – can cause deterioration locally. Urban Edge is extremely susceptible to this type of thing, and it isn’t hypothetical; it actually happened earlier this year, and the trust is suffering for it now. This is perhaps the largest risk in owning Urban Edge today.

Apart from a lack of geographical diversification, Urban Edge has done a nice job building its portfolio with a mix of essential and discretionary tenants.

Source: Investor presentation

The trust’s largest exposures are to grocery stores, home improvement stores, apparel retailers, and general retailers. This mix of essential and non-essential is ideal for normal times because it means the trust is exposed to many different types of businesses that may have upswings and downswings at different times during the economic cycle.

Of course, many of these discretionary tenants would have struggled immensely during the early part of this year due to shutdowns, and many are still working through those issues. Outside of COVID-19 conditions, however, I like Urban Edge’s mix of tenants.

Speaking of COVID-19, Urban Edge reckons it has a smaller exposure to tenants exposed to the virus compared to its peers.

Source: Investor presentation

Urban Edge says it is less than 30% exposed to COVID-19 at-risk tenants, with those being mostly restaurants and smaller retailers. I don’t want to paint the picture that Urban Edge is escaping COVID-19 unscathed, because that is a long way from the truth. However, its largest tenants should be okay and able to pay rent, even if it is deferred, so I still think the trust is in better shape than the stock is pricing in.

To be fair, rent collection has been pretty poor in the past three months.

Source: Investor presentation

Total rent collection was 67% in April, 65% in May, and 65% for June. Those aren’t good numbers and are certainly unsustainable for Urban Edge. Essential rent was much better at 94%, 91%, and 94%, respectively, for those months, but non-essential and restaurant rent collection was abysmal.

The bottom line here is that Urban Edge has to see better rent collection into the fall months or it may be in some measure of trouble from an earnings perspective.

On the plus side, even if things don’t pick up, Urban Edge has a very clean balance sheet with no debt maturities for the next 18 months or so.

Source: Investor presentation

The first debt maturity is just $87 million in 2022, followed by much higher amounts for 2023 and 2024. However, we should be back to some sort of normal well before that, so I think this is an advantage for Urban Edge. It already has relatively cheap debt on its balance sheet and isn’t in a position where it has to refinance under crisis conditions; it can simply ride out the storm and carry on as normal.

The valuation and potential yield on cost are attractive

We know that this year’s funds-from-operations, or FFO, are going to be weak. We’ve just seen how poor rent collection has been this year, and without a clear path forward, and huge exposure to NYC, Urban Edge is going to see lower earnings this year.

Source: Seeking Alpha

Currently, analysts have the trust earning 91 cents per share this year, followed by $1.00 in 2021. These are down from $1.16 in 2019, so the declines are meaningful to be sure. However, keep in mind the share price is about half of what it was to end the year last year, but FFO is nowhere near down by half, so I think shares offer relative value in that sense.

Source: Seeking Alpha

In addition, price-to-tangible book value, seen above, is showing a lot of value. This ratio has been well in excess of 5 in the past few years, but is just 1.45 today. That’s an extreme undervaluation in my view, even taking into account the risks I presented above. This trust is not perfect, or close to it for that matter, but 1.45X tangible book value is about one-quarter of prior valuation highs, and right at half of what it was pre-crisis.

Now, what is likely causing this undervaluation of assets is the lack of a dividend.

Source: Seeking Alpha

We can see that Urban Edge had previously paid a quarterly dividend of 22 cents per share, but that stopped after the March payment this year. There is no time frame for resumption of the dividend, but I think it will start back up sooner than later.

The prior payout was 88 cents per share annually, but we know that FFO estimates for this year are in excess of that amount at 91 cents, and for next year, it is $1.00. Both of those totals could easily afford the prior dividend, and especially if something lower than the prior total is paid at the restart of the dividend.

The point is that while Urban Edge probably did the right thing in terms of suspending the payout, I think it can restart basically whenever it wants. I have seen no indication of when that may be, but the lower valuation due to a lack of a dividend is creating an opportunity.

Apart from very cheap valuation metrics discussed above, the yield on cost today if/when the trust pays $0.88 per share annually again is 8%. That’s a huge dividend yield for a trust with very high-quality assets in perhaps the most desirable market in the US.

While Urban Edge has some issues to work through, it looks to me like the stock has been punished too harshly, and it is a buy as a result.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in UE over 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.

Source: Seeking Alpha

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