Seritage Growth Properties (SRG 2.04%) shares have suffered mightily since the COVID-19 pandemic hit. The pandemic disrupted management's redevelopment plans, led to a slew of lease cancellations, and left the Sears real estate spinoff burning lots of cash without any clear path to breaking even.
Under new CEO Andrea Olshan, Seritage has begun to enact a strategy shift over the past year. The company's fourth-quarter earnings report showed that the real estate investment trust (REIT) is finally making progress toward reducing cash burn and capitalizing on the substantial opportunities embedded in its real estate.
Sequential improvement accelerates
In November, Seritage Growth Properties reported that its net operating income (NOI) increased modestly in the third quarter, compared to the second quarter. However, the sequential improvement of just $0.5 million didn't move the needle, considering that Seritage has been burning over $100 million a year (before redevelopment costs).
The company's recent fourth-quarter report held better news. Total NOI improved to $10.5 million, up from $8.1 million a quarter earlier. Meanwhile, Seritage closed a dozen asset sales for total proceeds of $191.6 million last quarter. That nearly matched the $201 million it raised from asset sales in the first three quarters of 2021 combined.
This big asset-sale windfall enabled Seritage to repay $160 million of debt at the end of the quarter, reducing its term-loan balance from $1.6 billion to $1.44 billion. That will reduce annual interest expense by roughly $11 million going forward. As of March 15, the REIT had additional assets under contract for expected sale proceeds of $146.3 million. Those deals and the $113.8 million of cash Seritage held as of Dec. 31, 2021 will fund ongoing cash burn and projected redevelopment spending this year.
Finally, some leasing progress
Over the past two years, slow leasing activity has been a big red flag for Seritage investors. Entering 2020, Seritage had signed leases for $192 million of annual rent, including tenants that hadn't opened yet. By the end of Q3 2021, that figure had plummeted 37% to just $120.6 million.
Seritage finally started to turn things around on the leasing front in Q4, signing new leases for nearly $4 million of annual rent. Equally importantly, the impact of asset sales and lease terminations on Seritage's tenant base moderated. As a result, the company ended 2021 with leases for $123.2 million of annual rent, up $2.6 million sequentially. Moreover, the in-place portion of signed leases increased to $96.9 million from $92.1 million a quarter earlier.
Image source: Seritage Growth Properties.
Leasing momentum accelerated in early 2022. Year to date, Seritage has signed leases for $5.5 million of annual base rent, with most of that consisting of an office lease at the company's premier property in San Diego. Seritage is actively negotiating leases for over 250,000 square feet of additional space. That could amount to perhaps $10 million in additional annual base rent.
Lots of upside relative to risk
After being skeptical of Seritage's prospects for much of 2020 and 2021, I decided to make an investment in the company last month, due to its shift in focus toward streamlining its portfolio and paying down debt. The Q4 earnings report adds to my confidence.
Most of the leases Seritage has signed for future openings should convert to rent-paying status within a year or so, driving significant NOI growth over this period. Meanwhile, the company's ongoing asset-sale campaign will help it pay down more debt, further reducing its interest expense. While Seritage remains far from breakeven, quarterly cash burn could decline by half or more by the end of 2022, compared to mid-2021.
As cash burn declines and Seritage reduces its debt, the risk of bankruptcy or other adverse outcomes that could hurt Seritage stock will decrease significantly. That alone should cause the stock to trade closer to its net asset value, which is likely at least double the recent share price of approximately $11.
Additionally, Seritage recently announced a "review of strategic alternatives" that could lead to the company selling itself in whole or in part. That could help shareholders capitalize on the REIT's underlying value even faster than would be possible under the status quo strategy. Either way, the upside for Seritage Growth Properties shares over the next few years seems to vastly outweigh the downside, making this a very intriguing stock for risk-tolerant investors.
