It's no secret that mall traffic has been falling quickly in recent years, with the worst malls seeing the biggest declines. Mall REIT CBL & Associates (OTC:CBL) has been hit hard by this trend, as most of its malls are below average in quality.
CBL just suffered another blow, as it agreed to pay $90 million to settle a class-action lawsuit. As a result, the REIT will suspend its dividend for at least two quarters.
Moreover, the settlement payout increases the risk that CBL will run into further financial difficulties in the next few years. This news caused CBL shares to plunge 20% as of noon EDT on Wednesday.
Income has been eroding quickly
CBL's adjusted funds from operations (FFO) -- a key earnings metric for REITs that is somewhat comparable to earnings per share for other companies -- hit a recent peak of $2.41 in 2016. It's been all downhill from there, as the retail apocalypse has decimated CBL's malls. Adjusted FFO plummeted to $2.08 in 2017 and $1.73 in 2018.
The bankruptcies of Bon-Ton Stores and Sears Holdings last year have only added to CBL's woes. Bon-Ton ended up liquidating entirely, while Sears has closed a huge number of stores. In addition to losing rent from these department stores, anchor-store closures often trigger "co-tenancy clauses" that reduce smaller tenants' rents until the relevant anchor box is filled again.
As a result, the company's initial 2019 guidance called for another sharp drop in adjusted FFO, to a range of $1.41 to $1.46. Additionally, CBL may have to ramp up capital expenditures (capex) in the coming years to redevelop empty Sears and Bon-Ton buildings in order to avoid even faster FFO declines.
Due to this growing cash crunch, CBL reduced its quarterly dividend from $0.265 to $0.20 in late 2017. A year later, it announced an even more dramatic cut, slashing its quarterly payout to just $0.075. Yet the REIT's cash flow problems continue.
Another setback for CBL
Three years ago, CBL and various affiliates were sued by a tenant who claimed the REIT had overcharged it -- and other tenants -- for electricity. (It's common for commercial real estate owners to pass property operating expenses like utility costs through to tenants.) The plaintiff eventually succeeded in turning the lawsuit into a class-action proceeding.
In recent months, CBL suffered a series of legal setbacks, and a trial was scheduled to begin in early April. It decided to settle instead, agreeing to provide $60 million of compensation to current and former tenants. Current tenants will receive rent credits over the next five years, while former tenants will have their claims settled in cash. CBL also agreed to pay $28 million in plaintiff's legal fees, along with administration costs of up to $150,000.
This may seem like a small sum of money compared to CBL's 2018 operating cash flow of $375 million. However, CBL said last month that its cash flow and asset sale proceeds would be just enough to cover its capex, dividend, and required debt payments in 2019.
As a result, the settlement requires CBL to suspend its dividend for at least two quarters, starting with the third quarter of this year. That will preserve about $26 million of cash. CBL would be permitted to resume its dividend thereafter -- but it's not clear what it will be able to afford.
This is one sick business
CBL's temporary dividend suspension will cover only part of the 2019 cash cost of the recently announced settlement. The REIT will probably have to turn to its new credit facility to fund the difference. Meanwhile, because a substantial chunk of the compensation is being paid out as rent credits over the next five years, the settlement will continue to weigh on CBL's cash flow for quite a while.
Shareholders have to hope that CBL's redevelopment activity brings in enough new tenants to offset the rent concessions it has made to keep existing tenants in place. That said, CBL is still early in the redevelopment process. In the short term, redevelopment will be a major expense, and most of the benefits won't be felt for at least two years.
An even bigger issue is that after a decade-long expansion, there are growing signs that the U.S. economy could fall into recession within the next couple of years. Given that CBL has reported anemic growth in sales per square foot at its malls in recent years, a recession would likely lead to sharp declines in traffic and sales, causing even more tenants to flee.
Thus, a $90 million settlement payout is the last thing CBL needs right now. The REIT was already skating on thin ice in terms of balancing required dividend payments with debt service and desperately needed capex investments. Its turnaround prospects are even dimmer today.