Last week, Pennsylvania Real Estate Investment Trust (PEI) reported adjusted funds from operations (FFO) of $0.26 per share for the first quarter, down from $0.29 a year earlier but a penny ahead of the analyst consensus. Yet this modest earnings beat powered a 16% jump in PREIT stock on the day after the earnings release.
There are three factors that may explain investors' newfound enthusiasm for PREIT stock. First, management reassured investors that the ongoing wave of retail bankruptcies won't hurt results too much. Second, PREIT is making progress on shoring up its balance sheet. Third, the REIT's strategy of redeveloping its properties -- particularly the replacement of struggling department stores with stronger tenants -- is starting to pay off.
Retail bankruptcies are not hurting that much
Retailers have already announced more than 6,000 store closures in the U.S. this year. This has included the outright liquidation of several major chains such as Payless ShoeSource, Charlotte Russe, and Gymboree.
Not surprisingly, PREIT is dealing with its share of store closures from the disappearance of these mall standbys. (Indeed, Charlotte Russe was one of its top 20 tenants as of the end of 2018, accounting for 1.3% of its annual rent.) However, PREIT has moved quickly to backfill the space rented to retailers that are going out of business in 2019.
In fact, during PREIT's earnings call on Friday, management noted that it has signed leases for 87% of the space impacted by retailer bankruptcies this year. Some storefronts will be vacant for a quarter or two before being filled by new tenants prior to the holiday season. In other cases, PREIT has offered short-term rent concessions to struggling tenants to keep space occupied while it works to line up new tenants that will pay market-rate rents.
The bottom line is that the REIT was able to maintain its full-year guidance for 2019 despite the retail industry's turmoil.
The balance sheet is starting to improve
Another piece of good news from the quarterly report was that PREIT has made substantial progress toward fixing its weak balance sheet.
In March, it sold part of a land parcel it owns in Gainesville, Florida, for $5 million. In April, the REIT sold a stand-alone Whole Foods store at one of its malls for $22.1 million. It also sold a land parcel in New Garden Township, Pennsylvania, during April for a total consideration of $11 million, including $8.25 million in cash.
In total, these and other moves executed since the beginning of 2019 have raised more than $40 million of cash and provided more than $70 million of incremental liquidity. PREIT also has the rest of its land in Gainesville under contract to be sold for about $10 million. That deal is expected to close in the third quarter.
PREIT still plans to spend upwards of $100 million over the next year to complete most of its ongoing redevelopment projects. However, it expects to more than cover that spending by selling excess land at its malls to multifamily residential developers. Management estimates that there is room to add a total of 5,000 to 7,000 multifamily units at its malls in the Philadelphia and Washington, D.C., metro areas. That could make the underlying land worth between $150 million and $300 million -- enough to fund the rest of PREIT's redevelopment spending while also paying down debt.
PREIT's redevelopment strategy is working
Lastly, the Q1 earnings report provided yet more evidence that PREIT's redevelopment strategy is boosting traffic and sales per square foot at its malls. In the long run, this should help it maintain high occupancy levels while increasing rents.
Over the past 12 months, sales per square foot reached $517 at PREIT's core malls, up from $503 a year earlier. The trends are even better for malls where redevelopment work has recently concluded or is winding down. For example, over the past 12 months, comparable-store sales rose 8.8% at the Mall at Prince Georges (in the Washington, D.C., area) and rose 6.6% at the Capital City Mall (in the Harrisburg, Pennsylvania, area). Both malls also achieved strong increases in occupancy to more than 98%.
This bodes well for the future, given that PREIT has major redevelopment projects underway at another five of its 18 core malls -- all of which should wrap up by mid-2020. With lots of new high-traffic tenants set to open over the next 15 months, PREIT is primed for strong growth in traffic and sales per square foot in the next few years.
Even after a big rally on Friday, PREIT shares trade for less than six times the company's projected 2019 FFO. That leaves tons of upside for investors if this REIT can continue to execute its transformation plan successfully.