Forever 21 recently filed for Chapter 11 bankruptcy. It's yet another fashion retailer that has hit the skids because it couldn't keep up with the changes in customer buying habits taking shape today. The company announced plans to close stores and refocus its efforts around its best locations. That means that the growth of online shopping is once again buffeting the mall real estate investment trusts (REITs) in which stores like Forever 21 are located.
This time, however, the potential impact highlights some important differences between mall owners like Simon Property Group (SPG 0.96%), Taubman (TCO), and Macerich (MAC 2.87%).
Not as bad as you may think
The first thing most investors will likely think about when noting the Forever 21 bankruptcy is the so-called "retail apocalypse." That's an overhyped phrase used to highlight the increasing importance of online shopping. Truth be told, the bankruptcy is partly a sign of this issue. However, a big portion of Forever 21's problem is that it expanded at the wrong time. It also started to increase the size of its individual stores, which made it that much harder to afford its rent. So the damage was at least partly self-inflicted.
Image source: Getty Images.
That said, despite this bankruptcy and the many others before it, the truth is that higher-quality malls are not dying. For example, Simon's occupancy was still a solid 94.4% in the second quarter. Taubman and Macerich were at 92.2% and 94.1% occupancy, respectively. This trio owns three of the best-positioned mall portfolios in the sector. Essentially, retailers still need to have physical locations and good malls are still a great place to put a store. In fact, many retailers that started online have begun to move into brick-and-mortar locations, most notably Amazon.com, but also smaller names like Warby Parker.
The retail industry is a transition period. That doesn't mean the transition will be easy, but suggesting that it will lead to the death of malls is going too far. Malls in bad locations that are old and in disrepair will get hit hard, but that's likely going to make the better malls even more desirable once the retail world works through the transition. But still, all mall REITs are not created equal, and working through the "retail apocalypse" will take time.
Looking a bit deeper
Mall REITs with a lot of second-tier assets, such as CBL, are in a bad situation and there's not a whole lot to be done about it. However, there are still nuances to the better-positioned mall REITs that need to be examined. For example, owning good malls helps but there are diversification issues that need to be considered as well. Of the roughly 200 retail assets Simon owns, around half are enclosed malls, with the rest a mix of outlet centers and other retail assets. Taubman and Macerich only own focused portfolios of enclosed malls, with around 25 and 45 locations, respectively.
Having a larger and more diversified portfolio gives Simon a more robust income stream, even though all three types work with the same general tenant pool. Putting some numbers on that, Forever 21 is Simon's seventh-largest tenant, but it is the second-largest tenant at Macerich, and it's the single largest tenant in Taubman's portfolio. That means Forever 21 store closures could be far more painful at Macerich and Taubman than they would be at Simon.
Another issue that differentiates Simon from these two peers is their dividend payout ratios. Simon's payout ratio is about 70% using its second-quarter guidance for 2019 full-year funds from operations (FFO). Taubman's isn't too far off of that, at roughly 75%. But Macerich's payout ratio is notably higher at about 85%. That leaves far less room for Macerich to muddle through this difficult period with its dividend unaffected.
SPG Times Interest Earned (TTM) data by YCharts.
But the payout ratio isn't the only thing that differentiates Simon. It also has a stronger balance sheet, with a debt-to-equity ratio of 0.5. Shareholder equity comes in at 4.3 times its interest expenses. Macerich's debt-to-equity ratio is 1.0 and it only covers its interest expenses by 1.7 times. Taubman brings up the rear here, with a debt-to-equity ratio of nearly 1.7 and interest coverage of just 1.3 times. When things get tough, as they are today, Simon is in a better financial position to handle the blow. Even a small hit to Taubman or Macerich could mean that their heavier use of leverage leads to a dividend cut. It's one of the reasons why the two sport dividend yields of 7.4% and 10.8%, respectively, compared to Simon's 5.6% yield. Investors see the higher risks and are pricing Simon at an easily justified premium.
Tread carefully
Although malls are highly unlikely to go away, that doesn't mean that dividend investors can ignore the impact of the retail apocalypse. Better-positioned malls, like the ones that Simon, Taubman, and Macerich own, are likely to survive. However, there are other issues to examine when considering an investment here. And when you look at factors such as diversification, payout ratios, and balance sheet strength, Simon stands out from Taubman and Macerich. The heavy exposure Taubman and Macerich have to Forever 21 shows why these differences are so important to consider as the mall sector continues to deal with the changing shape of the retail landscape.
