Since being spun off from Sears Holdings a few years ago, Seritage Growth Properties (NYSE:SRG) has consistently paid a $0.25 quarterly dividend. Yet the REIT's profitability (as measured by funds from operations, or FFO) has been trending steadily lower since 2016.
In the fourth quarter of 2015 (Seritage's first full quarter as an independent company), adjusted FFO came in at $0.59 per share. That declined to $0.54 per share in the final quarter of 2016 and $0.21 per share in Q4 2017. By the third quarter of 2018, adjusted FFO had fallen to just below breakeven.
With FFO likely to stay in negative territory for a few quarters, Seritage Growth Properties plans to suspend its dividend following its upcoming $0.25 per share payment for the first quarter. However, that's not necessarily a bad thing for shareholders.
Seritage has a lot of work ahead of it
Seritage's business plan has always called for spending a substantial sum of money to redevelop Sears and Kmart stores for new tenants that can pay higher rents. However, Sears Holdings' gradual slide into bankruptcy over the past few years has caused it to close a huge number of stores throughout Seritage's portfolio. Sears Holdings currently occupies fewer than 100 Seritage properties, down from more than 250 three years ago.
This has contributed to the rapid erosion of Seritage's FFO since 2016. It has also increased the REIT's need for capital in the short-to-medium term.
As of Sept. 30, 2018, Seritage estimated that it would have to spend another $880 million to complete its ongoing redevelopment projects. Virtually all of that money will be spent by the end of 2020. Furthermore, it has a lot of vacant properties for which it has not yet begun any redevelopment activity. These will require incremental capital.
Seritage Growth Properties ended 2018 with $937 million of liquidity, plus 13 assets under contract to be sold for a combined $59.8 million. Thus, it has enough capital to meet its near-term needs, but there isn't much cushion to absorb operating losses or fund future needs.
The dividend is going away -- for now
In other words, to the extent that Seritage can reduce the amount of cash going out the door, it should do so. The current dividend uses $14 million per quarter, not a negligible sum. While REITs are required to pay out at least 90% of their taxable income as dividends, Seritage's plunging profitability has significantly reduced its payout requirement for 2019.
As a result, while Seritage will pay a $0.25-per-share dividend on April 11 to shareholders of record as of March 29, it announced earlier this week, "The Company's Board of Trustees does not currently expect to declare additional dividends on the Company's Class A and Class C common shares for the remainder of 2019, based on its assessment of the Company's investment opportunities and its expectations of taxable income for the year."
Cutting the dividend temporarily will free up some extra cash that Seritage can direct toward its planned 2019 and 2020 redevelopment activity. As long as those projects deliver high returns, this move looks like a positive for long-term shareholders.
The dividend will be back before long
While Seritage currently has negative FFO, that will only be true for a few quarters. As of the end of 2018, it had 167 "signed-not-opened" leases for the properties in its redevelopment pipeline. As those tenants open their doors over the next two years, they will contribute $81.3 million of rent annually. That will more than offset the $46 million of annualized rent from Sears Holdings that Seritage lost over the course of 2018.
Furthermore, Seritage hasn't fully leased the projects it is currently redeveloping. Management estimates that when they are fully leased up -- which should happen within the next two years or so -- Seritage will be generating $225 million in annual rental income from third-party tenants.
As a result, Seritage could potentially be producing record FFO by 2021, even if Sears and Kmart go out of business between now and then. That would enable the REIT to restore its quarterly dividend to at least $0.25 per share, with ample room for growth in the following years.