The retail sector is being hit by the so-called "retail apocalypse," as online sales gain ground and physical-store sales languish. Real estate investment trust (REIT) Washington Prime Group (WPG) owns enclosed malls, which are facing the biggest threat.
Given the stock's 30% dividend yield, however, aggressive investors with a value bent might be tempted to take a stake. Here's what you need to know before you do that.
1. The wrong assets
The retail apocalypse is having the biggest impact on enclosed malls, which are largely what Washington Prime Group owns. It directly controls around 91 properties, with partial interests bringing its total mall exposure up to 108 assets. One of the biggest issues the REIT faces, however, is the quality of the malls it operates. The average sales per square foot at its malls are around the $400 mark, while better-positioned competitors have average rents between $650 and $850 per square foot.
Based on that information, it shouldn't be surprising that Washington Prime's properties are located in less desirable areas. For example, the average population density around its properties is lower than for most of its competitors. The average income in neighborhoods where it has assets is also toward the low end. Basically, it owns malls in regions with relatively sparse populations that are less affluent. That's not a great combination, as the weak sales-per-square-foot metric highlights. The malls Washington Prime operates are the ones being hit hardest by online sales.
2. Working hard, but it's rough
To be fair, Washington Prime isn't exactly sitting around hoping for better days: Management is hard at work trying to fill vacancies and keep its malls attractive for tenants and consumers. For example, like its peers, it's trying to reposition anchor-tenant properties vacated by retailers like Bon-Ton and Sears, both of which have gone bankrupt. It's also holding events that it hopes will bring customers to its malls.
But with companies like Ascena Retail Group still struggling, there are still rough waters ahead for mall REITs. Washington Prime's occupancy of 92.5% is troubling -- it fell 1.2 percentage points year over year in the second quarter. The company's occupancy numbers, like other key metrics, are toward the low end of its peer group. And with the likelihood of further headwinds, occupancy is likely to continue to fall before it stabilizes. That's why Washington Prime's most recent quarterly presentation ended with the tagline "Grind It Out."
3. Aggressive actions?
While the company is working to reposition its assets, it's also making some interesting financing moves. For example, in the most recent quarter, management noted that it had sold 20 outparcel properties. These are usually land parcels close to existing assets that either are raw land, or have a building that isn't directly attached to the mall. Mall REITs often hold on to these properties so they can expand. Selling one or two outparcels wouldn't be a huge deal, but 20 suggests the company is scrambling for cash.
That's buttressed by the sale leaseback transactions the company has entered into at four of its properties. Essentially, it still operates each mall, but sold the underlying land to a third party to raise cash. This is an interesting way to raise money, but it's still a troubling move.
To be fair, Washington Prime is being creative and taking advantage of every opportunity it can. But these decisions are clearly not coming from a position of strength, and thus should worry investors.
4. Not covering it
That brings up the dividend. At 30%, the dividend yield is incredible -- but Wall Street is obviously expecting a dividend cut. All the information above fuels that concern, but there's another, more direct fear: Washington Prime paid out $0.25 per share in dividends in the most recent quarter, and had funds from operations (FFO), the REIT equivalent of earnings, of $0.27 per share. That doesn't leave much room for error:
But there's more to this story than these numbers tell.
During the second-quarter conference call, management noted that FFO was helped along by the outparcel sales. So, coverage may not be as strong as management wants investors to believe. When pressed by an analyst on the dividend, management noted that "We think we're pretty close to covering the dividend in 2019."
That statement is important, because FFO doesn't include expenses like maintenance capital spending and the costs to reposition vacant anchor tenants. The number that includes those costs is adjusted funds from operations, which can provide a better picture of a REIT's dividend-paying ability. "Close to covering" is a lot less reassuring than what the FFO number suggests, and the company isn't sharing its expectations for adjusted FFO. All in all, the 30% yield doesn't look very secure.
Pass it by
Income investors should probably avoid Washington Prime Group today. There may be huge turnaround potential if the company can "grind it out," but it is definitely not the type of stock you can own and safely collect the dividend. If something goes wrong -- and there's a lot of opportunity for negative outcomes at Washington Prime -- the REIT will have little choice but to cut the dividend. Today, that 30% yield looks more like a yield trap than a bargain.