Earlier this week, Washington Prime (NYSE:WPG) shareholders awoke to an unusual sight: a huge increase in the struggling mall REIT's share price. It wasn't because of any good news, though. The company simply completed a 1-for-9 reverse stock split designed to get the trading price back above $1 to comply with New York Stock Exchange rules.

Washington Prime stock didn't waste any time resuming its downward march. The reverse split went into effect at the beginning of trading on Tuesday, and by the end of the day the stock had plummeted 13%. The REIT's extensive holdings of mediocre malls could mean more pain ahead.

WPG Chart

Washington Prime stock performance data by YCharts.

A business under pressure

Washington Prime was struggling before the COVID-19 pandemic. However, its business has taken a dramatic turn for the worse this year. Comparable net operating income (NOI) plunged 44.6% in the second quarter and 32.6% in the third quarter. Including the REIT's tier two malls, which it somewhat arbitrarily excludes from its main reporting metrics, NOI fell approximately 36% last quarter.

Obviously, the pandemic is driving the bulk of these NOI declines. But NOI was already falling at a high-single-digit rate in 2019. Furthermore, some of this year's NOI erosion will likely prove permanent. Many retailers and restaurants have gone out of business or closed stores in 2020. If too many stores at a particular mall close their doors, the mall could fall into a downward spiral, as shoppers have less and less reason to visit. Many retail analysts expect at least a quarter of U.S. malls to close permanently within five years.

Highlighting the problem, Washington Prime reported a leased occupancy rate of just 87.5% at its tier one malls as of Sept. 30. Two years earlier, that figure stood at 93.6%. Of course, 87.5% is just an average; some properties are doing better, but some are doing worse. Those that are underperforming could be approaching the point of no return.

An empty shopping mall corridor

Image source: Getty Images.

A whole lot of debt

Washington Prime's debt has been rising gradually in recent years, as dividends and capital expenditures have exceeded cash from operations. As of Sept. 30, the REIT carried $3.84 billion of debt, including its share of joint venture debt.

Meanwhile, adjusted EBITDA has been plummeting, dropping from $528 million in 2018 to $464 million in 2019 and falling even faster in 2020. That's making it increasingly difficult for Washington Prime to support its debt load. Even if EBITDA rebounded to $400 million in a couple of years, that wouldn't necessarily make Washington Prime's portfolio worth more than the company's debt. Washington Prime also has about $200 million of outstanding preferred stock, and it needs to pay dividends on those shares before it can even consider paying dividends on its common stock.

There's no easy way for Washington Prime to get out from under its crushing debt load. The REIT has identified 30 former department store spaces in need of redevelopment. Management expects to spend about $250 million over the next three or four years to complete those projects, most of which are still in the early stages. That capital spending will use up any cash Washington Prime manages to raise from asset sales.

Stay away

Thus far, Washington Prime has managed to avoid bankruptcy, unlike some of its mall REIT peers. The company has benefited from getting about 40% of its NOI from open-air centers as of earlier this year. (Open-air centers have held up better than traditional enclosed malls during the retail apocalypse.) Washington Prime has also negotiated relief from loan covenants through the third quarter of 2021 in exchange for providing collateral to secure some previously unsecured debt.

However, if Washington Prime can't get its finances in order by next fall, lenders may be unwilling to continue waiving debt covenants. Furthermore, the REIT has over $1.3 billion of unsecured debt coming due in an 11-day span between Dec. 30, 2022 and Jan. 10, 2023. That's barely more than two years from now. Considering Washington Prime's awful CC credit rating and the sky-high yield on its publicly traded unsecured debt, it's doubtful that the company could roll over maturing debt.

In short, there are plenty of potential paths to disaster for Washington Prime shareholders -- and not many plausible routes to good outcomes. Investors should steer clear: No matter what your risk tolerance is, there are far better places to put your money.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.