CBL's 17% Dividend Yield And What Investors Should Make Of It

By Jonathan Weber for Sure Dividend

CBL & Associates Properties (CBL) currently offers a very high 17% dividend yield to investors, but the future of the REIT is highly doubtful. There are not many securities with yields near that of CBL’s. You can see the full list of all 402 securities with 5%+ yields here.

In this article I will lay out why I believe that CBL may not be a good choice for conservative income focused investors. For adventurous investors CBL offers some chances though, as the valuation the REIT is trading at is extremely low.

Company Overview

CBL, which was founded more than 50 years ago, owns a large portfolio of grade B malls and other real estate assets that it operates throughout the US.

Source: (CBL’s 10-K filing)

Despite the struggles in the mall industry CBL’s performance through 2016 has not been bad at all:

Source: (CBL’s 10-K filing)

CBL had managed to grow its sales per square foot whilst at the same time reducing its debt levels significantly.

Retail trends such as shoppers moving from malls to online shopping avenues has hurt brick and mortar retailers in the recent future, and has had an impact on retail REITs as well:

Source: ^DJUSRL data by YCharts

Over the last three years the Dow Jones Retail REIT index is down 25%, but CBL’s performance has been significantly worse over the same time frame; Shares dropped by more than 75%.

CBL Looks Like It Is Priced For Bankruptcy

This deep decline in CBL’s share price has brought down the REIT’s valuation, and it currently looks like the market is pricing CBL as if it would go bankrupt in a couple of years.

Source: CBL Price to Book Value data by YCharts

CBL trades at 0.7 times book value right now. This indicates a steep undervaluation by the market, assuming that CBL’s stated book value is what it would receive if it sold its assets.

Source: (CBL 8-K)

More than 90% of the company’s assets are made up of real estate, and those values already include $2.5 billion of accumulated depreciation. Depreciation rules do not necessarily reflect the exact real world worth of a building, though. It is possible that the buildings CBL owns, which were originally valued at $6.7 billion, have a current worth of more than the $4.2 billion they are valued at in the balance sheet.

These so called hidden reserves are something we see regularly among assets such as real estate and other long-lived assets. Balance sheet values for short-lived items such as inventories usually have to be adjusted downwards to get their real values.

In CBL’s case, since the majority of its assets consist of buildings and land, the true value of its assets is likely higher than what is stated on the REIT’s balance sheet. A scenario analysis gets us to this picture:

Depreciation overstated by

Adjusted book value of Real Estate

Adjusted book value of equity

Price to book ratio

$5.16 billion

$1.24 billion

0.72

5%

$5.29 billion

$1.37 billion

0.65

10%

$5.42 billion

$1.49 billion

0.60

15%

$5.54 billion

$1.62 billion

0.55

20%

$5.67 billion

$1.74 billion

0.51

It is obvious that past depreciation being too high has a large impact on CBL’s price to book valuation. This is due to the fact that CBL is very highly leveraged (its debt to equity ratio is about four) — small changes in book value therefore have a big impact on the price to book multiple.

The high depreciation expenses CBL accounts for have another big impact. CBL’s net earnings are negligible, but since depreciation expenses are a non-cash item we can add those back to get to the REIT’s funds from operations.

Source: (CBL 8-K)

CBL trades at 2.2 times last year’s FFO, and at 2.3 times last year’s adjusted FFO (using a market capitalization of$816 million). CBL’s funds from operations have declined by about fifteen percent over the last year, and the market currently prices CBL as if this trend would not only continue, but accelerate:

Year

Adjusted FFO

Present value of FFO

Accumulated present value of FFO

2017

$355 million

$355 million

not included

2018

$308 million

$280 million

$280 million

2019

$268 million

$221 million

$501 million

2020

$233 million

$175 million

$676 million

2021

$202 million

$138 million

$814 million

2022

$176 million

$109 million

$923 million

I discounted all future FFOs by 10% annually to get to the present value number in the above table. We see that the present value of the funds from operations over the next five years is higher than the current market cap even if FFO continues to decline by a whopping 15% annually.

The current price of CBL’s shares thus only makes sense when we assume that the market believes that either FFOs will drop at an even faster pace going forward, or that the REIT will go bankrupt in the not too distant future.

Dividend Investment And What Management Should Do With The REIT’s FFO

Like all REITs CBL uses parts of its FFO to pay dividends to its shareholders. After a dividend cut in 2017 CBL currently pays out $0.20 per share per quarter, which means a dividend yield of 16.7% with shares trading $4.80.

CBL’s payout ratio (relative to its FFO number) is rather low at 45%, which means that CBL has a lot of excess funds that it can utilize elsewhere. When we look at CBL’s cash flows this becomes even more apparent:

Source: (CBL 8-K, page 19)

CBL has produced $423 million in cash flows during the last year, this means that cash flows after dividends total $264 million annually (all else equal). CBL has been using the majority of these cash flows to pay down debt and to upgrade its malls over the last quarters. Both of these actions imply that CBL plans to remain in business for a long time — otherwise upgrading malls would not make any sense.

Since the market seems to have the opinion that CBL will not remain a going concern forever, another approach could be more beneficial for shareholders. If CBL chose to return all of its cash flows to its owners via dividends and / or buybacks investors would very likely get much more than $4.80 over the coming years.

At the same time CBL could try to drive its cash flows further by selling off properties wherever possible. This approach would, in the long run, result in the shutting down of the REIT, but investors would at least receive a substantial amount of cash during the process.

The current approach (investing a lot of cash back into the business) is not showing a lot of success yet. Rent per square foot and other operating metrics continue to decline, and the market is not putting a lot of value on CBL’s shares.

What does this mean for income investors? Currently they receive a very high dividend yield (17%), and CBL can very likely continue to pay this dividend for the next couple of years even if its FFOs decline further. It is doubtful whether management is planning to do that though, currently it looks like the focus is being put on investing for the future to keep the REIT going.

This approach, which leads to a lot of cash being deployed into property improvements, could make management cut the dividend again in the future. CBL thus will very likely not be forced to cut the dividend in the next couple of years (due to the payout ratio being so low), but the REIT might still announce another cut. That is, if management comes to the conclusion that it is in the REIT’s best interest to invest for the future rather than to return more cash to its owners.

Management has an incentive to prioritize the long term survival of the REIT (their income depends on it) over total shareholder returns, more dividend cuts could therefore be coming in the near future.

Due to these reasons I believe that CBL might not be a very good income investment at the current level, even though its dividend yield is very high. The very low valuation and the price to book discount (which does not yet include any hidden reserves) make CBL a value play that could be interesting for adventurous investors though.

Final thoughts

CBL has operational problems and it is unlikely that this will completely reverse. Due to a very low valuation shareholders could see positive total returns even if things do not improve going forward, though — right now CBL is priced as if the REIT would go bankrupt in a couple of years.

Investors can get a very high income yield if they buy here, and the payout ratio looks quite low. Operational problems and management’s strategy of trying to turn the ship around via investments into its properties could lead to more dividend cuts.

CBL is not necessarily a bad investment, but it is more likely suitable for adventurous investors that want to speculate that CBL’s equity is undervalued. For conservative income investment there could be significantly better REIT choices, but with lower yields than CBL’s.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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