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Near-Term Outlook Appears Gloomy for Retail REIT Stocks

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The Zacks REIT and Equity Trust - Retail industry represents a group of REITs that are engaged in owning, developing, managing and renting space in a variety of retail real estates. These retail real estate assets include regional malls, outlet centers, grocery-anchored shopping centers, as well as power centers, which include big-box retailers. In addition, net lease REITs have ownership of freestanding properties, wherein both rent and majority of operating expenses for the properties are borne by tenants.

Some of the prominent players in this industry are Simon Property Group (SPG - Free Report) , Regency Centers Corporation (REG - Free Report) , Federal Realty Investment Trust (FRT - Free Report) and Kimco Realty Corporation (KIM - Free Report) .

Let’s take a look at the industry’s three major themes:

Store Closures and Retailers’ Bankruptcies Continue to Thwart Demand: The retail real estate market has been adversely impacted in recent years, as e-commerce is gaining market share from the traditional brick-and-mortar stores, in turn, compelling retailers to reconsider their physical footprint and focus more on investing in online platforms. Mall traffic continues to suffer and retailers that are not being able to cope with competition are filing bankruptcies. This has raised concerns over the fate of cash flows of physical stores and landlords as the trend is considerably curtailing demand for retail real estate space and any recovery is unlikely in the near term. These will also continue to lead to tenants demanding substantial lease concessions.

Structural Changes, Omni-Channel Strategy to Continue: Nevertheless, retail REITs will continue with the transformation measures of their traditional retail hubs into entertainment destinations and lifestyle resorts, in a bid to counter the above-discussed challenges and lure customers. Retail REITs are likely to focus on expansion of dining options, opening movie theaters, as well as offer recreational facilities and fitness centers. Moreover, despite choosing online retailing options, consumers still prefer exploring the option of visiting physical stores as well, indicating that omni-channel will keep being the focal point for retailers, while physical stores will remain an integral and effective sales channel. Therefore, retail real estate landlords are embracing digitally-native brands and offering incentives, helping open, operate and scale stores as a complement to e-commerce. Apart from these, focus on mixed-use development is anticipated to continue, which has gained immense popularity, of late, although with huge outlay for redevelopments, growth in profit margins of retail REITs in the near term might be affected. Also, retail landlords are coming to the rescue of struggling retailers and buying them out of bankruptcy.

U.S. Economy and Consumer Spending: However, strength of the economy, together with the job-market environment, plays a key role in shaping up the retail REIT industry’s performance, as these determine consumers’ spending capacity for buying retail goods and services. There are, undoubtedly, lingering issues for the economy, and retail-store closures and bankruptcies are still grabbing headlines. Retail spending, however, is likely to remain healthy with a solid job market and high consumer confidence stimulating consumer spending. This is anticipated to send across positive ripple effects across the industry and help the retail real estate sector grow at a steady pace.

Zacks Industry Rank Indicates Bleak Prospects

The Zacks REIT and Equity Trust - Retail industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #222, which places it at the bottom 13% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of the negative funds from operations (FFO) per share outlook for the constituent companies in aggregate. Looking at the aggregate FFO per share estimate revisions, it appears that analysts are losing confidence in this group’s growth potential. Over the past year, the industry’s FFO per share estimate for 2020 and 2021 moved down 4.2% and 0.30%, respectively.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Lags on Stock Market Performance

The REIT and Equity Trust - Retail Industry has underperformed the broader Zacks Finance sector, as well as the S&P 500 composite in a year’s time.

The industry has edged down 0.1% during this period compared with the S&P 500’s rally of 11%. During the same time frame, the broader Finance sector has inched up 1.5%.

One Year Price Performance

 


Industry’s Current Valuation

On the basis of forward 12-month price-to-FFO (funds from operations) ratio, which is a commonly used multiple for valuing Retail REITs, we see that the industry is currently trading at 14.72X compared with the S&P 500’s forward 12-month price-to-earnings (P/E) of 17.81X. However, the industry is trading above the Finance sector’s forward 12-month P/E of 13.96X. This is shown in the chart below.

Forward 12 Month Price-to-FFO (P/FFO) Ratio

 

Over the last five years, the industry has traded as high as 19.44X, as low as 12.57X, with a median of 15.04X.

Bottom Line

In a nutshell, with a healthy job market and a resilient domestic economy, consumer confidence continues to grow and paints a favorable picture for consumer spending for the near term and supports the retail REIT industry, in turn.  Nonetheless, concerns regarding cash flows of mall landlords amid declining mall traffic, store closures and retailers’ bankruptcy filing, will likely prevail. Of course, though retail REITs’ efforts to boost productivity of retail assets by grabbing attention from new and productive tenants, and disposing the non-productive ones are commendable, huge outlays will keep eroding any near-term gain.

Currently, there are no stocks with a Zacks Rank # 1 (Strong Buy) or 2 (Buy). Nevertheless, as REITs strive to bring their mojo back, we handpick three stocks from the industry with a Zacks Rank of 3 (Hold) to watch for.

  You can see the complete list of today’s Zacks #1 Rank stocks here.

Realty Income Corporation (O - Free Report) : The REIT is engaged in acquisition and management of freestanding commercial properties that generate rental revenues under long-term net lease agreements. It derives more than 90% of its annualized retail rental revenues from tenants belonging to service, non-discretionary and low-price retail businesses. Such businesses are less susceptible to economic recessions, as well as competition from Internet retailing. Along with its well-known commercial tenants, investors might love the fact that the firm pays a monthly dividend. This REIT’s current-year FFO per share consensus estimate of $3.51 indicates a projected year-over-year increase of 5.7%. Revenues are expected to be up 12.5% year on year to $1.68 billion in 2020.

 

National Retail Properties, Inc. (NNN - Free Report) : This retail REIT is based in Orlando, FL, and invests in high-grade retail properties subject usually to long-term, net leases. The current-year FFO per share consensus estimate of $2.87 indicates an estimated increase of 4% year over year. Revenues are expected to grow 6.3% year on year to $711.6 million in the ongoing year.


STORE Capital Corporation (STOR - Free Report) : This net-lease REIT based in Scottsdale, AZ, is engaged in the acquisition, investment and management of Single Tenant Operational Real Estate (STORE properties). The company’s 2020 consensus estimate for FFO per share of $2.02, suggests an uptick of 1.5% year on year, while the revenue estimate of $707.3 million indicates 13.1% growth during the same time period.  


Note: Funds from operations (FFO) is a widely used metric to gauge the performance of REITs rather than net income as it indicates cash flow from their operations. FFO is obtained after adding depreciation and amortization to earnings and subtracting the gains on sales.

5 Stocks Set to Double

Each was hand-picked by a Zacks expert as the #1 favorite stock to gain +100% or more in 2020. Each comes from a different sector and has unique qualities and catalysts that could fuel exceptional growth.

Most of the stocks in this report are flying under Wall Street radar, which provides a great opportunity to get in on the ground floor.

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