Macerich: Now a Dividend Growth Stock (NYSE: MAC)

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Three years ago, macerich (New York stock market :Mac) offered shareholders a double-digit dividend yield as the mall owner’s share price fell on investor concerns about the impact of changing shopping habits on its business. However, the REIT was plagued by speculation that its dividend was unsustainable.

Sure enough, Macerich had to drastically cut his dividend when the COVID-19 pandemic hit. Over the past two years or so, Macerich’s quarterly payment came in at $0.15 per share, down 80% from its pre-pandemic quarterly dividend of $0.75 per share.

Fortunately, tenant sales exceeded pre-pandemic levels in 2022. Strong sales trends have led to a resurgence in demand for space in Macerich malls. As a result, Macerich announced its first dividend increase since 2018 in late October. The company has set its dividend at $0.17 per share for Q4: +13.3% compared to its previous level. And despite the headwind of soaring interest rates, Macerich has the opportunity to continue to increase its dividend in the years to come.

From falling dividends to growing dividends

As Macerich stock plunged from over $60 at the start of 2018 to under $30 at the end of 2019, the REIT’s dividend yield jumped from around 4.5% to over 11%. When the stock price fell, the company repeatedly faced questions from analysts on the dividend reduction.

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Data by Y-Charts

However, management consistently dismissed these questions, noting that the FFOs were sufficient to cover the dividend. They also said that while the company’s required distributions under REIT rules averaged about $2/share, Macerich was marketing several joint venture assets and interests for sale, which could result in significant capital gains. These transactions would have reduced Macerich’s leverage while bringing its required distributions closer to $3/share.

While these points have some merit, Macerich never completed the asset sales he envisioned in 2019. Meanwhile, paying around $3/share in dividends per year (over $450 million) meant that the company was not retaining enough cash to cover its CapEx, which averaged more than $400 million per year from 2017 to 2019. This caused Macerich’s debt (including its share in joint ventures) to grow ) from $7.53 billion at the start of 2017 to $8.07 billion at the end of 2019.

Combined with a decline in adjusted EBITDA during this period, Macerich’s growing leverage drove its debt ratio to an unacceptable level. This made him particularly vulnerable when the pandemic hit. Macerich had to cut its dividend to $0.50/share in the second quarter of 2020, of which only 20% was paid in cash. A quarter later, it cut the dividend to $0.15/share (all paid in cash).

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Data by Y-Charts

Additionally, Macerich was forced to issue more than 60 million shares through a dilutive market offering in 2021 to refinance its credit line and strengthen its balance sheet. As a result, its diluted number of shares has ballooned by almost 50% since 2019, permanently reducing its potential dividend per share.

That said, Macerich’s steep dividend cuts during the pandemic have left it with a very conservative payout ratio. Even after last week’s dividend increase, Macerich will pay just over $150 million in dividends per year, up from over $450 million in 2019. While EBITDA is lower than it was in 2019 due to various asset sales and the lingering impact of the pandemic, Macerich now has room for gradually increase its dividend while maintaining enough capital to cover CapEx and modestly reduce its debt.

Company fundamentals look good

On Thursday, Macerich reported strong results for the third quarter of 2022. While adjusted FFO per share missed analyst consensus by $0.01 and the company cut the midpoint of its full-year FFO guidance, Macerich raised its full-year NOI (net operating income) growth guidance for the same treasury center to a range of 7 % to 7.5%. A quarter earlier, he expected growth of 5.5% to 6.75% on this basis. At the start of the year, Macerich predicted growth of just 4% to 5.5% in cash NOI at the same center.

Importantly, mall occupancy rates in Macerich are returning to pre-pandemic levels. The company ended the third quarter with an occupancy rate of 92.1%: up 30 basis points sequentially and 180 basis points year-over-year. Just six quarters ago, the occupancy rate hit a low of 88.5%.

With less vacancy at its malls (especially its more successful properties), Macerich’s pricing power is starting to improve. Rental spreads reached 6.6% for the past 12 months, with new small store leases having an average base rent of $61.40 per square foot, compared to $57.60 for expiring leases.

A chart showing Macerich's base rent for expired and new leases.

Source: Macerich Q3 2022 Supplementary, p. 21.

However, this figure actually underestimates the improvement in leasing spreads. For the 12 months ending June 30, 2022, new small store leases had an average base rent of $57.58 per square foot: a gap of just 0.6%. Clearly, Macerich got extremely high prices on the new leases he signed in the third quarter to drive such a big improvement in the 12-month numbers in a single quarter. Rental volumes too remain near multi-year highs.

Rising interest rates are a real problem

While Macerich’s underlying business is improving rapidly, the company faces a major external headwind: soaring interest rates. In 2022, the Federal Reserve raised interest rates at a rate not seen in decades to combat high inflation. Worse still, recession fears and uncertainty about how high Fed interest rates will be have prompted lenders to demand higher spreads over Treasuries to refinance or extend loans.

Macerich ended the third quarter with $6 billion in fixed-rate debt, compared to just $771 million in floating-rate debt. Still, rising short-term rates could potentially represent a $20 million year-over-year headwind for interest charges on Macerich’s existing floating-rate debt in 2023.

Additionally, Macerich has several major deadlines in the coming months. That includes a $312 million loan (apart) on Washington Square Mall that matures later this month. Currently, the loan has a fixed rate of 3.65%, but Macerich is negotiating an extension at a floating rate of SOFR+4.0%. This will likely put the effective rate north of 8% by the end of the year, resulting in a headwind of around $15 million in 2023 for this property alone. (The loan will have an interest rate cap in place, but Macerich did not disclose the level of the cap.)

Several other fixed-rate mortgages with a combined balance of more than $500 million are expected to mature between early February and early April 2023. Although Macerich may negotiate more favorable spreads over SOFR, extending or refinancing of these loans will likely increase annualized interest expense by $15 million in Q2 2023.

In short, interest expense could jump by about $50 million next year. So while Macerich is poised for another year of solid NOI growth in 2023 due to its large portfolio of new signed leases, adjusted FFO per share will likely decline from the 2022 figure (currently guided between 1 $.93 and $1.99).

Fortunately, the pace of Macerich fixed-rate debt maturities slows after next April. So even if interest rates remain high by recent standards, the year-on-year headwind of rising interest costs will subside beyond 2023. Indeed, somewhat more than half of Macerich’s debt is in fixed-rate mortgages that are locked in until at least 2026. .

Period

Fixed rate maturities

Nov. 2022-April 2023

$840 million

May 2023-Dec. 2023

$242 million

2024

$758 million

2025

$720 million

2026

$988 million

After

$2.4 billion

Table by author. The data source: Macerich Q3 2022 Supplement.

Macerich remains deeply undervalued

Over the past five weeks, Macerich stock has rebounded more than 50%, from less than $8 at the end of September to a Friday closing price of $12.11. Even after this rapid recovery, Macerich shares are down 44% from a year ago and are trading at a favorable price of just 6 times the company’s forecast FFO for 2022. And following the recent increase in the dividend, the Macerich share yields a good 5.6%.

Assuming NOI growth only offsets half of Macerich’s projected $50 million increase in interest expense next year, FFO should still comfortably exceed $1.80. So, even on a forward-looking basis, Macerich’s shares trade at less than 7x FFO, and its dividend payout ratio would be less than 40%.

Interest rates will likely start to moderate within the next year or two, dampening the headwind on interest charges. Meanwhile, Macerich should be able to continue to increase the NOI at a healthy pace beyond 2023 as occupancy returns to historic highs, rents continue to rise and the company completes several high potential refits and anchor replacements.

This paves the way for a return to FFO growth, most likely in 2024. This will allow Macerich to gradually increase its dividend in the coming years.

In the long run, high inflation coupled with higher interest rates should actually benefit Macerich. Real estate generally retains its real value during periods of inflation. In practice, inflation is one of the contributing factors to higher sales per square foot in Macerich malls, which will support higher rents (and therefore higher real estate values) in the future.

Given Macerich’s excellent real estate quality, improved balance sheet, and strong REIT NOI momentum, I believe Macerich’s stock should trade at least 10x FFO (i.e. i.e. over $18), despite the rising rate environment. With interest rates moderating and FFO returning to growth, the company’s valuation should improve further. This gives Macerich stock excellent potential for capital appreciation in addition to its attractive yield.

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