In late 2016, activist investor Jonathan Litt of Land and Buildings Investment Management took Taubman Centers (NYSE:TCO) to task. He argued that the owner of high-end malls was dramatically underperforming compared to its potential due to bloated costs, poor capital allocation, and incompetent management -- enabled by a passive board of directors. At the time, Litt argued that cost cuts, better governance, and a sharper focus on the REIT's best properties could allow Taubman Centers shares to double from $71 to around $144 within a year.
Three years later, Taubman Centers shares are changing hands for roughly $42, mainly due to continued governance issues, fears about the future of retail, and Taubman's high debt load.
That said, Taubman Centers still has the most productive U.S. mall portfolio of any REIT -- easily surpassing No. 2 Macerich (NYSE:MAC) -- and it has finally moved to monetize some of its Asian properties. This makes the stock an intriguing speculative buy at its current marked-down price. Nevertheless, many of the same risks continue to haunt Taubman Centers, making Macerich stock more attractive.
Taubman does own great malls
Today, Taubman Centers owns all or a portion of roughly two dozen malls. Most of its properties are in the U.S. and Puerto Rico, but it also owns stakes in three malls in Asia, plus another one under development. Nearly all of the properties are of excellent quality.
In fact, sales per square foot for Taubman Centers' domestic properties reached $940 for the 12-month period ending in June, posting a stellar 12.2% comp sales increase. That was more than 20% ahead of Macerich, which came in a distant No. 2 with sales per square foot of $776. While there are a few weaker properties in Taubman's portfolio, most of its U.S. malls are in the top 10% in the country in terms of sales productivity.
Excellent demographic fundamentals underpin this stellar sales productivity. On average, nearly 1.9 million people live within 15 miles of Taubman's domestic malls, significantly more than any other mall REIT other than Macerich, which is known for a focus on urban properties. Meanwhile, the average household income in that 15-mile ring was $104,567 for Taubman Centers last year -- 10% ahead of Simon Property Group, which was No. 2 on that metric.
But underperformance continues
Unfortunately for investors, Taubman Centers has done a poor job of converting its strong and rising sales per square foot into rent increases. While domestic sales per square foot have surged from $792 in 2016 to $940 today, average rents have increased less than 1% annually. Moreover, Taubman generates barely more rent per square foot than Macerich, despite its superior sales productivity.
Additionally, after reporting modest growth in funds from operations (FFO) in recent years, Taubman Centers is expecting a setback in 2019. FFO per share fell 5% to $1.71 and adjusted FFO per share fell 1.6% to $1.88 in the first half of the year, despite a $7.5 million gain from insurance proceeds related to the impact of Hurricane Maria on Mall of San Juan in 2017. For the full year, management expects FFO per share between $3.47 and $3.57 and adjusted FFO per share between $3.64 and $3.74. That would be down from $3.71 and $3.83, respectively, in 2018.
Investors can't be too confident in a quick rebound in FFO trends. Taubman reported releasing spreads (the percentage change between the rent for expiring leases and the new rent) of just 3.3% for the 12-month period ending in June, compared to 9.4% for Macerich.
Still a mixed bag for investors
Taubman Centers is a frustrating case for investors. The REIT clearly has a ton of potential, due to the high quality of its properties -- it's just not living up to that potential. That's probably why Litt (the activist investor) continues to own the stock and hound the board and management to make changes.
There have been some positive signs of change. Earlier this year, Taubman agreed to sell half of its stakes in three Asian malls to Blackstone at a valuation of $480 million. The first sale closed last week. These deals will reduce Taubman's debt load by hundreds of millions of dollars, and the related interest cost savings should more than offset the lost income from selling these stakes.
This is a step in the right direction. But, unfortunately, rather than following Litt's advice and exiting Asia entirely -- which would allow Taubman Centers to reduce its overhead substantially -- the REIT is talking about "recycling" the capital into new development projects. Considering its mixed track record in terms of getting reasonable returns on new developments, this seems like unwise empire-building behavior.
Taubman Centers stock is deeply undervalued compared to the value of its assets. The stock also has a healthy 6.5% dividend yield. However, lots of mall REITs have high yields and trade well below net asset value. Investors looking to bet on the long-term staying power of high-end malls would probably be better off putting their money on Macerich. Its near-term growth catalysts, stronger long-term track record for capital allocation and operating performance, and sky-high 9.4% dividend yield make it a better buy than Taubman Centers.