SRG - Seritage Growth Properties

[SlowAppreciation]

As I said, I'm pretty sure he's calculating NAV.  He doesn't write out the actual calculation there, but he's using some assumptions to get from rent psf to NAV. The actual calculation is relatively simple.  Rent psf > rental revenue - operating expenses = NOI / Cap Rate = Real estate value.  Then he subtracts the liabilities to get NAV.

I could be wrong, but I'm pretty sure that's what he's doing.

Sorry, I should have been more clear. I meant what are you doing for your valuation? I've seen DCFs, NAV, FFO, and AFFO for SRG and since I don't have a ton of experience analyzing REITs, just wanted to be sure I was looking at it the right way.

[glorysk87]

Ohh.

I have two valuations, one based on NAV and one based on FFO.  For both I have a "downside" scenario, which calculates the valuation if Sears were to go bankrupt and immediately vacate all the properties (ie. pay no rent past the day of declaring bankruptcy).

[SlowAppreciation]

Ohh.

I have two valuations, one based on NAV and one based on FFO.  For both I have a "downside" scenario, which calculates the valuation if Sears were to go bankrupt and immediately vacate all the properties (ie. pay no rent past the day of declaring bankruptcy).

Gotcha. So you're just looking at multiples/comps or are you making estimates each year on recapture rates/annual rent per sq ft and then discounting?

[scorpioncapital]

You can also do a straight up DCF analysis on http://www.gurufocus.com/fair_value_dcf.php

Just make sure to adjust the starting earnings/share for the 31.6m (56.5% of the total reported figures in the supplement). Also I'm not sure if one should use FFO or NOI as the starting figure.

My assumptions where a requirement of 2x the rate of return on the anticipated 30 year bond. Currently it's 2.2% and I assumed it will be 4.5-5% and that you demand 9-10% as the cap rate.

Another assumption you'll have to make is what you see as the ultimate base rent per square foot and the time to achieve that. It's a decent clip...So far, they are 'mining' in place Sears base rents to non-Sears at a run-rate of about 10.6% per year.

While the large amount of square footage does suggest quite a bit of un-mined potential, just like in a gold mine, you have proved reserves and probable+inferred reserves. I would say that a % of the total square footage is probable+inferred. If you use the Pareto principle, there will always be 20% of anything that you might want to cut out as being largely unproductive. Not sure if their square footage includes parking space and auto centers and those might be considered last or much later in the development process. First they are going after the gold nuggets just lying around on the ground

(Btw, using those assumptions above gets you at or above current market price. But I see it much simpler. If redevelopment return is 12% and DCF shows a number even 1 cent higher than today's price with a cap rate of 9-10%, then you are going to get your 10-12% return.

The 4  variables you might want to answer are,
-will base rents be higher in 10 years by a factor of at least 2.
-will a recession increase your return greater than 12% by waiting for said recession and consequent drop in price.
-will the long bond experience a freak inflation accident and go above 5% in the next decade.
-will SRG require more dilutive capital/debt due to a recession or over budget costs.)

[glorysk87]

Ohh.

I have two valuations, one based on NAV and one based on FFO.  For both I have a "downside" scenario, which calculates the valuation if Sears were to go bankrupt and immediately vacate all the properties (ie. pay no rent past the day of declaring bankruptcy).

Gotcha. So you're just looking at multiples/comps or are you making estimates each year on recapture rates/annual rent per sq ft and then discounting?

The model I put together uses the following inputs:

- Sq Ft redeveloped per quarter
- SNO Rent PSF for recaptured space
- Redevelopment cost per sq ft
- Usable life of the asset (for amortization of redevelopment costs)

I also have a full financial model and the inputs above generally influence both the rental revenue and the expenses.

From there I have a cap rate sensitivity table for my NAV outputs and I have a comp multiple table for my FFO output.

[SlowAppreciation]

You can also do a straight up DCF analysis on http://www.gurufocus.com/fair_value_dcf.php

Just make sure to adjust the starting earnings/share for the 31.6m (56.5% of the total reported figures in the supplement). Also I'm not sure if one should use FFO or NOI as the starting figure.

My assumptions where a requirement of 2x the rate of return on the anticipated 30 year bond. Currently it's 2.2% and I assumed it will be 4.5-5% and that you demand 9-10% as the cap rate.

Another assumption you'll have to make is what you see as the ultimate base rent per square foot and the time to achieve that. It's a decent clip...So far, they are 'mining' in place Sears base rents to non-Sears at a run-rate of about 10.6% per year.

While the large amount of square footage does suggest quite a bit of un-mined potential, just like in a gold mine, you have proved reserves and probable+inferred reserves. I would say that a % of the total square footage is probable+inferred. If you use the Pareto principle, there will always be 20% of anything that you might want to cut out as being largely unproductive. Not sure if their square footage includes parking space and auto centers and those might be considered last or much later in the development process. First they are going after the gold nuggets just lying around on the ground

(Btw, using those assumptions above gets you at or above current market price. But I see it much simpler. If redevelopment return is 12% and DCF shows a number even 1 cent higher than today's price with a cap rate of 9-10%, then you are going to get your 10-12% return.

The 4  variables you might want to answer are,
-will base rents be higher in 10 years by a factor of at least 2.
-will a recession increase your return greater than 12% by waiting for said recession and consequent drop in price.
-will the long bond experience a freak inflation accident and go above 5% in the next decade.
-will SRG require more dilutive capital/debt due to a recession or over budget costs.)

Thanks, this helps to clarify my thinking a bit more.

Just make sure to adjust the starting earnings/share for the 31.6m (56.5% of the total reported figures in the supplement). Also I'm not sure if one should use FFO or NOI as the starting figure.

What's the 31.6m figure? Do you mean the starting #s were only for a half year so adjust those for a full year? Or are you referring to one time acq/startup costs?

And are you using the fully diluted share #count (I think it was 53.3m?)

[scorpioncapital]

31.6mm shares outstanding of SRG stock. 55.8 million total including OP units.
I just find it easier to compare to market cap of SRG as that's publicly traded.

[SlowAppreciation]

Gotcha. I noticed the VIC write up includes OP units.

I'm not too familiar with REIT structures, so is it common to exclude these?

[scorpioncapital]

I think how you parcel it out doesn't make a big difference.

E.g. Let's say SRG has $130m in FCF today and in 5 years will have $300m of FCF. That's on 55.7m shares. So on SRG as a stock it'd be 56.7% of 300m = $170m. SRG market cap today is 1.4 billion.

My rule of thumb is internal reinvestment rate is the attractor that pulls up or down all starting yields. Was it Munger who said eventually all your investments converge to internal rate of return on investment given enough time? However, this is probably no argument against LBOs which start at a high initial yield and even if it drops over time, whether you converge from the top or the bottom, I rather converge from above to below than below to above. However, if the attractor was a very high number with debt included, you're converging from below in 90% of the cases except some freak world accident...the real problem is very few investments provide certainty of return on investment project. Most companies don't even break it down, making what investors call investments, speculations most of the time. Not even management knows what they are getting. With SRG, I sort of see what Buffett might be seeing, a capped return of 12-13% (maybe a speculative upside on top of that if inflation picks up) and a measured, achievable reinvestment path to get there by retooling and making pretty old commercial retail buildings.
If you want 15% instead of 12% with high probability, I'd wait until the stock was $40 or lower. But if it you are happy with 12% and a potential kicker then no time like the present.

[SlowAppreciation]

So is it fair to say that NAV is essentially an adjusted BV and NOI is adjusted net income? In other words, NAV is the implied value of the real estate you'd expect a buyer (e.g. Private Equity, Brookfield Asset Manager, etc.) to pay based for the properties given a certain cap rate?

And the alternative—whether NOI or AFFO—is more or less a traditional DCF valuation but excluding certain charges like depreciation and interest?