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Morningstar | Despite Store Closings, Solid 3Q Growth for Kimco Realty

We are maintaining our $17.70 fair value estimate for no-moat Kimco Realty as the company reported an in-line third quarter. While anchor occupancy was down 50 basis points to 97.6% due to the previously announced closure of Toys 'R' Us stores, small-shop occupancy set another all-time high for the company at 90.8%, besting the prior high set last quarter by 60 basis points. Total re-leasing spreads of 8.9% in the quarter lead to same-store revenue growth of 3.3%, though same-store expense growth was up 6.3% due to a large growth in real estate taxes and credit losses so net operating income was only up 2.3% for the quarter. Still, the results were strong enough for management to increase their same-store net operating income growth guidance for 2018 to a midpoint of 2.5% from 2.25%. The company sold 10 shopping centers and two land parcels for total proceeds of $156.8 million, slightly more than we assumed they would execute in the quarter. Funds from operations as adjusted came in at $0.36, in line with our assumption, and the company raised the low end of adjusted FFO 2018 guidance by a penny. Despite recent store closings, we like how Kimco has been able to produce solid positive fundamental growth.

Kimco is exposed to several retailers that have recently announced store closings, but we think there are positives to take away from each case. Kimco is currently in the process of releasing the 21 Toys 'R' Us boxes that it had in its portfolio, and it seems to have made great progress in finding new tenants for those spaces. Thirteen of the 21 boxes have new tenants lined up, with six of the assets finding tenants who bought the leases at auction, creating no downtime in rent payments, and seven more under contract to new tenants at mid-single-digit re-leasing spreads. Six of the remaining boxes are under negotiation, with Kimco having received letters of intent from prospective new tenants. Only two of the boxes do not have tenants lined up, but those assets are under contract for disposition and should come out of Kimco's portfolio when they close. Of the 19 under contract, only four have had to break up the box into smaller spaces (which creates additional capital expenditure and tenant improvement costs for Kimco), so Kimco has successfully found many large tenants to fill the spaces. While the third quarter saw a drop in revenue due to Toys 'R' Us vacating the space, it appears that Kimco has solved this issue and should have new tenants paying rent in these spaces by the start of 2020.

Sears' recent announcement that it would close 65 Kmart and 77 Sears locations across the U.S. has affected Kimco's portfolio, but Kimco has been eagerly anticipating this development for several years. Kimco has 14 total boxes exposed to the announcement, with three leased to Sears, 10 leased to Kmart, and one store leased to Kmart but then subleased to tenant At Home. While these stores represent 1.9% of Kimco's total gross leasable area, they only pay 0.6% of Kimco's total annual base rent. On average, these stores only pay $5.25 per square foot, significantly below the company's anchor average of $12.24 and portfolio average of $16.08. Being able to re-lease those boxes to new tenants represents a significant opportunity to generate higher revenue as the leases are marked to market. While there will be a drop in occupancy in 2019 while Kimco searches for new tenants, the long-term impact should be significant once healthier tenants move in, as they can support higher rent payments and will drive more traffic to the properties than Sears or Kmart.

Finally, the Mattress Firm bankruptcy also has the potential to affect Kimco. Kimco has 62 leases with Mattress Firm, eight of which were on locations that were listed as a site to potentially close as part of the bankruptcy proceedings. While those locations pay rents that are higher than the portfolio average, Kimco says the leases are at market and there would likely be little impact if the firm had to re-lease them to new tenants. Additionally, Mattress Firm would owe a full year of rent on any lease it ends, so Kimco would be covered in the short term as it looks to bring in a new tenant. As a result, we think this will end up having a very minimal impact on Kimco's bottom line, whether Mattress Firm keeps the stores open or Kimco re-leases the locations to new tenants.