Like many mall owners, Pennsylvania Real Estate Investment Trust (PEI) has suffered severe earnings pressure in recent years, due to the effects of the so-called retail apocalypse. A rising tide of department store closures and bankruptcy filings for major in-line tenants has forced PREIT and its peers to scramble to backfill space and to invest heavily to improve their properties.
Not surprisingly, investors have responded by dumping PREIT stock. Shares of the embattled retail REIT have lost a third of their value over the past year and about two-thirds of their value over the past three years. This has caused its dividend yield to balloon to around 13%.
PREIT's third-quarter earnings report, released on Tuesday afternoon, won't help matters. The REIT posted a big decrease in funds from operations (FFO) for Q3 and cut its 2019 guidance for the second time this year.
A weak quarter, as expected
In the third quarter, PREIT's same-store net operating income (NOI) fell 5.8% year over year, excluding lease termination revenue. Tenant bankruptcies were the biggest driver of this decline. Numerous major mall-focused retailers have filed for bankruptcy this year, including Payless ShoeSource, Gymboree, Charlotte Russe, Things Remembered, Charming Charlie, Destination Maternity, and Forever 21. Many of these companies ended up closing most or all of their stores.
Total NOI fell 9.1% last quarter, with the additional decrease driven by falling occupancy at noncore malls. (Near the end of the quarter, PREIT handed over the keys to one of those properties -- Wyoming Valley Mall -- to its mortgage lender.)
This sharp decline in NOI caused adjusted FFO to plunge 34% to $0.23 per share. That was actually an improvement from the second quarter, when adjusted FFO per share plummeted 44% to $0.22 from $0.39 a year earlier.
Full-year guidance falls again
While PREIT's weak FFO last quarter was hardly a bullish sign, management had signaled in July that FFO would be similar in Q3 to what it was in Q2. By contrast, CFO Robert McCadden projected at the time that FFO could rebound to around $0.55 per share in the fourth quarter, up from $0.52 in Q4 2018.
That projection went out the window this week. PREIT cut its full-year guidance for adjusted FFO per share to a range of $1.08 to $1.14, compared to $1.20 to $1.30 at the end of Q2 and $1.20 to $1.34 at the beginning of the year. The new guidance range implies that adjusted FFO per share will wind up between $0.37 and $0.43 this quarter -- way below the roughly $0.55 that management had previously expected.
This guidance cut is sure to disappoint shareholders. PREIT has completed three major redevelopment projects since mid-September, and that was supposed to be the catalyst for a return to growth. But the good news is that most of this guidance reduction is due to temporary factors that don't reflect on PREIT's long-term potential.
Most notably, PREIT no longer expects to complete any major land sales this quarter. It also reduced its forecast for lease termination revenue significantly. Those two factors drove about 70% of the reduction to PREIT's full-year guidance. Recent bankruptcies (and the resulting vacancies and rent reductions) along with a handful of delayed store openings account for most of the rest.
The outlook for 2020 and beyond is still promising
PREIT's management hasn't shown itself to be very adept at forecasting in recent years. Thus, investors should take its 2020 projections -- which imply a rebound in adjusted FFO to around $1.40 per share -- with a grain of salt.
That said, the REIT does seem poised for a return to strong growth next year. For one thing, it will face much easier year-over-year comparisons. Additionally, occupancy at Fashion District Philadelphia -- its premier redevelopment project -- will continue to rise over the next 12 months. PREIT also has major new tenants slated to open at five properties in the first half of 2020 as part of anchor replacement projects.
PREIT also expects to reach sale agreements for at least some of the available land parcels at its malls in the Philadelphia and Washington, D.C. areas by the end of 2019. (It already has offers from 12 bidders.) That will set the table for it to start completing deals in early 2020. Management believes it could raise $150 million to $300 million from this initiative, allowing it to make a sizable dent in its roughly $2 billion debt load.
With occupancy at its redevelopments slated to spool up over the course of 2020, PREIT has a good chance to post even better results in 2021, when it will get the full benefit of its recent investments. PREIT's third-quarter earnings report represents a setback, but it shouldn't take long for the REIT to bounce back.