Renowned investor Mohnish Pabrai (Trades, Portfolio) revealed earlier this week he trimmed his stake in Seritage Growth Properties (SRG, Financial) by 26.98%.
The stock traded for an average price of $15.28 during the fourth quarter of 2021. GuruFocus data shows Pabrai established the position in the second quarter of 2020, when it traded for an average price of $10.04 per share.
According to GuruFocus, fellow investor Edward Lampert (Trades, Portfolio), the chairman of the board at Seritage, has completely sold out his hedge fund's (RBS Partners L.P.) position as well.
However, Lampert continues to hold a personal investment of over 4 million shares (or 9.34%) in the real estate investment trust.
Seritage Growth Properties was spun off of Sears Holdings Corp. (SHLDQ) six years ago (June 2015) as a rights offering to the struggling retailer's shareholders. Sears Holdings then declared bankruptcy in October 2018 . The value of the REIT derives from the redevelopment potential of the former Sears and K-Mart properties spread across the U.S. Both retailers were paying very low rent (around $5 per square foot per year) and the investment rationale for Seritage was that the best properties could be redeveloped and released at much higher rates while the less desirable properties could be sold off to fund redevelopment.
The company is engaged in the ownership, development, redevelopment, management and leasing of diversified retail and mixed-use properties. As of Sept. 30, its portfolio consisted of interests in 170 properties comprised of approximately 10.0 million square feet of gross leasable area or build-to-suit leased area, approximately 4.0 million of which is held by unconsolidated entities, approximately 600 acres held for or under development and approximately 10 million square feet (or approximately 850 acres) to be disposed of.
Seritage’s primary objective is to create value for its shareholders through the re-leasing and redevelopment of the majority of its wholly-owned and joint venture properties. It seeks to do so through the following methods:
- Converting single-tenant buildings (currently or formerly occupied by Sears or Kmart prior to redevelopment) into multi-tenant properties at higher rent.
- Develop its urban land holdings through mixed-use (retail, residential, office etc.) densification.
- Leverage existing and future joint venture relationships with leading real estate and financial partners.
The following is a snapshot of the REIT's current balance sheet.
Source: Simplywall.st
Seritage recently refinanced the term loan with interest of 7% with Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) and extended the loan by two years ,with the new maturity date of July 31, 2025 provided that the term loan facility’s principal has been reduced to $800 million by then. Seritage also made a prepayment of $160 million towards the loan.
According to the GF Value Line, Seritage is modestly undervalued. Notice, however, that the line is steeply declining. This is because the REIT is selling off existing properties in its portfolio to fund its development efforts. Also, even for the properties it intends to develop, as leases are terminated the properties go into development, there are no rents coming in until development is complete and the property leased. This is creating gaps in operating cash flow.
Cash flow is now negative as the company is in full-blown redevelopment mode.
Property rental income, which is the company’s primary source of operating cash flow, did not fully fund obligations incurred during the nine months ended Sept. 30, 2021 and the company recorded net operating cash outflows of $85.6 million. Additionally, Seritage generated investing cash inflows of $95.8 million during the nine-month period, which were driven by asset sales and partially offset by development expenditures.
Conclusion
While it is good news that Seritage has extended the loan from Berkshire for another two years, it is an expensive loan and the company remains at risk that Berkshire could foreclose on the properties if it is unable to refinance in 2025. This could wipe out the equity holders. This could also happen if the economy tips into a recession or if development and leasing activity does not pan out as expected.
As a result, Seritage may be forced to sell off key development projects with its partners at firesale prices. The company is going through a critical time in its development. The next couple of years could make or break this REIT. It remains a high-risk venture that is burning cash with about 20% of the shares sold short. This scrip is suitable for investors with considerable tolerance for risk. However, I feel Seritage is undervalued for the following reason: the price per unit was bouncing around ~$40 before covid, but now its in the low teens. Nothing much has changed and prices of other related REITs have more or less recovered to their pre-covid levels (see chart below). The price thus is illogical and should be much higher.
The above chart compares SRG with ROOF (IQ U.S. Real Estate Small Cap ETF)
