Quality is in the eye of the beholder, and even if the market is content to chase high-priced names in tech, I would much rather own high-quality companies that have tangible assets that won’t be disrupted at any time. Soon.
This is, in my opinion, the case of the Regency Centers (NASDAQ:REG), which I covered here in September with a “Buy” rating, highlighting its strong portfolio statistics and high rental rates. The stock performed well as concerns about a higher, longer interest rate environment largely subsided, providing investors with a total return of 5.4% since my last article, almost matching the upside by 6.9% of the S&P 500 (TO SPY) over the same period.
In this article, I take stock and explain why REG should remain on income investors’ radar for profitable growth and income at the current valuation. To start!
Regency Centers is one of the largest shopping center REITs in the United States, especially after its acquisition of longtime Northeast-based REIT Urstadt Biddle Properties in August of this year. REG was founded in 1963, just one year after its counterpart Federal Realty Investment Trust (FRT) was founded and is a member of the S&P 500 index.
What sets REG apart from its better-known counterpart, FRT, is its focus on grocery-anchored properties, which make up 80% of its 480+ properties across the United States. This means that REG centers are more focused on necessity, service or convenience. making it less vulnerable to recessions and e-commerce.
REG maintains close relationships and manages these 480+ properties through more than 20 offices nationwide. As noted below, REG’s geographic exposure is primarily to either large metropolitan areas or growing secondary markets such as those in Nashville, Raleigh, Charlotte and Austin across the Sunbelt.
Its exposure to areas with a high population density and above-average household rent allows it to charge rents above those of the market, especially since the higher cost of development in these areas constitutes a natural barrier to entry for competitors. As shown below, REG ranks third in annual base rent per square foot compared to its peers, behind Acadia Realty Trust (AKR) and FRT.
REG’s attractive rents are supported by its high-quality tenant base, which includes renowned grocers like Publix, Kroger (KR), Whole Foods (AMZN) and Safeway (ACI). This is reflected in the fact that 77% of REG grocers hold a No. 1 or No. 2 market share in their markets.
Meanwhile, REG continues to perform respectably, with same property NOI growth of 3% year-on-year during the third quarter, while same property rental rate also increased by 70 points base year-on-year to reach 95.4%. REG has room for further improvement, as the rental rate remains lower than it was before the pandemic, although it has increased noticeably over the past two years, as shown below.
Additionally, tenant demand remains strong, as REG recorded blended rent spreads (on new leases and renewals) of 9.3% on a cash basis and 17% on a straight-line GAAP basis. These good results notably enabled REG to raise its FFO/share forecasts for the whole year to $4.14 halfway, from $4.10 earlier his year.
Looking ahead, REG’s investment thesis is supported by favorable structural factors that support grocery-anchored shopping centers due to low news supply, creating a scarcity of value. Furthermore, according to Coresight ResearchAfter several years of investment in e-commerce, the trend is moving back towards physical, as retailers look to capitalize on the renewed demand for in-person shopping experiences.
The most prolific of these includes discount retailers like Nordstrom Rack (JWN), Ross Stores (PINK) and Dollar General (DG), which disproportionately benefits REITs like REGs with high-quality locations. This is also supported by the addition of Urstadt Biddle locations in the densely populated Northeast (primarily the areas surrounding New York City). Management continues to target $200 million to $250 million in annual development and redevelopment costs to support the necessity of its last mile centers, as outlined in the last conference call:
We remain very encouraged by the structural trends in supply and demand that support our business today. Our tenants continue to invest in profitable brick-and-mortar stores as a last-mile distribution channel, and our suburban retail areas continue to thrive. And while we continue to create value through bottom-up development, overall very little new retail space is being added in the United States, supporting the value and scarcity of existing spaces.
Risks to this thesis include economic uncertainty heading into 2024, as household spending increases but slow motion this holiday season, according to Mastercard (MY). Additionally, while the Federal Reserve has signaled three-quarter point rate cuts in 2024, when it last meets, interest rates remain high compared to the previous decade, introducing refinancing risk via higher borrowing costs.
Nonetheless, REG maintains a BBB+ investment grade credit rating from S&P and a strong balance sheet, which contributed to REG not cutting its dividend during the 2020 pandemic, when many of its peers had to reduce theirs.
REG also has safe leverage with net debt and preferred stock EBITDA to operations of 5.0x, well below the 6.0x generally considered safe for REITs, and has strong fixed charge and interest coverage ratios of 4.7x. and 5.2x, respectively. As shown below, REG’s debt maturities are well-staggered between 2024 and 2026.
Importantly for dividend investors, REG currently has a forward yield of 4.0%, after the company raised its quarterly dividend rate of 3.1% in November. The dividend is also well covered by a payout ratio of 63%, leaving enough retained capital to fund developments and future dividend increases.
As for valuation, I continue to find REG attractive at the current price of $67 with a forward P/FFO of 16.2, sitting below its normal P/FFO of 18. Analysts also expect that mid-single digit annual FFO/stock growth over the long term, which, combined with the current dividend yield, could equal the 9-10% long-term total return of the S&P 500, but with a cash flow much higher than the yield of 1, 4% of the SPY. currently paying.
It’s worth noting that REG is currently a bit more expensive than its two major peers, FRT and Kimco Realty (KIM), with an EV/EBITDA of 20.1, higher than FRT’s 19.1 and KIM’s 18.9. However, there’s nothing wrong with owning a basket of stocks, as REG has greater exposure to the grocery sector than FRT and a better balance sheet than KIM.
Takeaways for investors
Overall, REG is a solid choice for investors looking for reasonable growth and reliable dividend income from the shopping center space. The company has consistently generated strong operating results, while protecting its dividend in good times and bad. With continued tailwinds supporting shopping centers with grocery stores and a well-positioned balance sheet, REG should continue to deliver long-term value to shareholders. Although REG is no longer cheap, I continue to find value in the stock at this time and maintain a “Buy” rating on the stock.