Value Meets Growth at This REIT

After a tremendous run the past few years, REITs are generally treading water, and a few have even seen their share prices fall 15% to 20% from their highs. Among them is General Growth Properties (NYSE: GGP  ) , which has one of the best track records in the business.

The business
In 2004, General Growth acquired Rouse properties, which allowed it to diversify into master planned communities as well as some office, industrial, and mixed-use properties. However, General Growth still derives the bulk of its revenues from its regional mall properties.

Owning malls might not seem like a glamorous business, but in many parts of the country zoning rules and current levels of development don't leave much room for new facilities. This cap on supply helps keep demand for space in healthy shopping properties high as companies like Abercrombie & Fitch (NYSE: ANF  ) , J Crew Group (NYSE: JCG  ) , and others expand. An important aspect of General Growth's business is its focus on the health of its tenant base before increasing occupancy.

Like a few other REITs, including KimcoRealty (NYSE: KIM  ) and AMB Properties (NYSE: AMB  ) , General Growth Properties derives some of its revenues internationally, specifically from properties it owns in Brazil and Turkey. It also has a property under construction in Costa Rica, which will add to its international growth. Though these international properties are currently a small part of the business, it's one I think is important to follow.

The financials
Over the years General Growth has been an extremely strong performer financially. The table below provides a subset of data for the past few years and shows how General Growth has grown, particularly with the Rouse acquisition.

Metric

TTM*

2005

2004

2003

Revenues

3,147.1

3,073.4

1,799.9

1,262.8

Net Operating Income

1,909.5

1,812.8

1,137.4

817.8

Funds from Operations (FFO)

726.2

730.0

611.8

480.0

FFO/Share

3.02

3.06

2.77

2.31

FFO Payout Ratio

52.65%

48.69%

45.49%

44.16%

Investments in Real Estate

23,449.2

23,296.7

23,800.8

9,206.7

Total Debt

20,695.1

20,418.9

20,310.9

6,649.5

*Trailing 12 months.
Except FFO/Share, dollars are in millions. Data provided by GGP website and Capital IQ, a division of S&P.

The table captures some of the remarkable growth the company has experienced, but it also illustrates how that growth has slowed, and, in the case of FFO, reversed. You can also see the high level of debt that General Growth is carrying, much of which comes from the Rouse acquisition. Of General Growth's $20 billion in debt, a little less than $5 billion is variable rate. That's a bit high, and it has been drag on FFO growth as interest rates have continued to rise. However, the company has been moving more of its debt to fixed rates, and if the interest rates remain stable or fall, the company will benefit as it pays down its debt.

From a valuation perspective, there is a lot to like about the company based on adjusted funds from operations or a dividend discount model. I've taken a few different cuts at the company's valuation and, assuming mid-single digit rates of growth, I conservatively estimate the shares to be worth $52 to $55. And if the company makes some headway on its debt and interest expense, the stock could be worth $60 or more. Add in the current 3.7% dividend yield and the potential for 5% to 8% annual growth in the dividend over 10 or more years, and you have a fairly attractive long-term situation.

Risks, intangibles, and wrap-up
The primary risks for General Growth are continuing interest rate increases and a softening economy, which could affect occupancy and impair the company's ability to gradually raise rents. Both of these situations could prove my mid-single digit growth estimates to be overly optimistic. However, even with flat growth for a few years, General Growth is still reasonably valued.

General Growth has a strong business with good long-term prospects. Its management team has been in place for more than a decade and knows the business inside and out. The company also provides clear and detailed disclosure in its press releases and supplemental materials. Finally, I'm not the only investor who finds the shares attractive. In the past six months, CFO Bernard Freibaum has purchased more than $4.7 million in shares at prices between $42.75 and $47.50. Insider buying isn't necessarily an important signal, but when an insider repeatedly makes large purchases over a period of weeks or months, it is worth taking note.

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At the time of publication, Nathan Parmelee owned shares in Health Care REIT but had no financial interest in any of the other companies mentioned. The Fool has a disclosure policy.


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