Strip malls are a cornerstone of the American economy, generally featuring a grocery store. That's exactly what real estate investment trust (REIT) Kimco (KIM -0.93%) specializes in owning. And when tenant Albertsons (ACI -0.83%) ran into trouble some years ago, the REIT stepped in to help, eventually ending up with an ownership stake. Albertsons is now public again, and this stake is a huge hidden plus for Kimco and its shareholders.
That's a lot of money!
At the end of the third quarter, Kimco estimated that its stake in Albertsons was worth roughly $1.2 billion. That's a nice chunk of change thanks to a big rally since the grocer's mid-2020 initial public offering (IPO). In truth, the IPO was something of a dud, as the company was hoping to price the stock between $18 and $20 per share but ended up pricing it at $16. Today, however, it is worth around $34 per share, up a hefty 115% or so in around 17 months.
Clearly, Kimco has benefited greatly from that price advance, given that its cost basis is in the $100 million range. But the real benefit isn't in the asset itself -- it is in what Kimco can do with the cash that would be generated by selling its stake in Albertsons. While the prospects of suddenly having $1.2 billion in cash sounds great, it isn't actually a possibility. There's a lock-up period that won't end until later in 2022 and, well, there are some other complications given that Kimco is a REIT.
As a REIT, Kimco is limited in how much income it can generate from non-real estate activities. Management estimates that if it wanted to maximize the cash it could pull from the investment, it could sell between $350 million and $400 million per year. Some simple math here leads to between three and four years of cash, depending on how quickly the company sells. It hasn't, however, said it would do that much selling or try to reduce its stake that quickly. So Albertsons could be a gift that keeps on giving for many years to come.
The options are open
What's really important to recognize is that, as a REIT, Kimco has to pass most of its cash on to investors as dividends. That leaves precious little money for other purposes, like investing in redevelopment projects and acquiring new assets. So REITs usually end up tapping the bond and equity markets for growth capital. That's not an inherently bad thing, but Kimco now has another lever for funding its growth -- one that doesn't add debt to its balance sheet or risk diluting current shareholders.
And spacing out the cash is no hardship, given that spending $1.2 billion wouldn't be an easy task. Leaving it sitting on the balance sheet, given the low interest rates today, would be problematic, too.
In fact, if you look at the company's history, the cash that's locked in Albertsons' stock could last a very long time. Between 2015 and 2021, the company redeveloped over 100 properties at a total cost of around $1 billion. The company estimates that its return on investment was around 8.3% across all of these projects.
Acquisitions, which are unpredictable, could be funded with the sale of Albertsons stock, as well, which could increase the burn rate, if you will. But after a big recent deal, another blockbuster acquisition is probably off the table for now. So bolt-on purchases, which would be easier to fund with small sales of Albertsons' stock, could be the norm.
The thing is, it would be highly unlikely that Kimco would use only the sale of Albertsons stock to fund either of these efforts. It would probably be a mixture of debt, stock sales, and cash that was put to work to maximize the company's returns. The Albertsons stake simply makes the math easier for Kimco on the cash side of things.
Perhaps equally important, it gives the REIT another avenue for raising cash should interest rates rise (making debt more expensive) or issuing stock become difficult for some reason (such as a downturn in the REIT market). In other words, Kimco has optionality.
What comes next?
As it is, Kimco isn't telegraphing any imminent sales efforts when it comes to Albertsons. It is just explaining what it could do, if it wanted. So, for now, the grocery store stake is a backstop. However, it is one that investors should keep in the back of their minds, because it is a valuable source of growth capital that Kimco can use to expand its business over time. How that will happen isn't clear right now, but at some point it will happen, and it should be a big win for investors when it does.