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Morningstar | Macerich Displays Strong Fundamentals; 2018 Guidance Reduction Indicates Long-Term Optimism

Macerich showed very strong fundamentals in the second quarter but missed our funds from operations estimate due to an issue that we believe is nonrecurring, leading us to maintain our $58 fair value estimate and no-moat rating. Sales per square foot for inline tenants at Macerich's malls were up 7.1% for the quarter, outperforming the strong sales growth seen at other public A-mall owners for the quarter. Occupancy for the total portfolio was down only 10 basis points to 94.3%. Releasing spreads were up 12.3%, outperforming our 10% estimate but continuing a trend of decelerating spreads over the past three years. As a result, base minimum rent per square foot was up 4.0%. Same-store net operating income was down 1.6% year over year. However, the 2017 same-store NOI figure benefited from a high level of lease-termination income and excluding this income from the calculation results in same-store NOI growth of 1.4%, closer to our estimate of 2.2%.

Funds from operations came in at $0.83 for the quarter, 13 cents below our estimate, but the difference is entirely explained by a $19.4 million charge the company took to deal with shareholder activism. Excluding this nonrecurring item, the company reduced 2018 FFO guidance by 10 cents to a new range of $3.82 to $3.92, which we actually view positively. Half of the reduction is from the sale of noncore power centers in the quarter that was not previously in guidance that should allow the company to continue to focus on its strategy of owning and operating Class A malls. The other half of the reduced FFO guidance is due to lower-than-anticipated lease-termination income. Tenants are doing much better than Macerich had originally predicted, so far fewer are looking to break their leases, which portends that Macerich will have more leverage in upcoming lease negotiations. We think some short-term cash flow dilution is more than made up for in higher occupancies and higher releasing spreads in the future.

The $19.4 million charge Macerich recorded in the second quarter was to pay for legal and advisory fees in relation to a number of activist shareholders. The company said the legal services they took on began in November 2017 when activist shareholders acquired a significant position in Macerich. Hedge fund Third Point Management collected a 5% ownership stake in Macerich in November, and according to reports by Bloomberg News, was looking to call for a sale of the company. The Ontario Teachers' Pension Plan board, which held a 16.5% share of the company in January when the report came out, was said to have been considering the option of forcing a sale, but members later said that they only sought a position in Macerich as a long-term investment. Another hedge fund, Starboard Value, bought a small position in November of 2017 and then brought a list of its own nominees to replace the majority of Macerich's board. Despite the recent departure of long-time CEO Arthur Coppola, we don't believe that Macerich is trading at a significant enough premium to its fair value estimate that would warrant a sale of the company and don't think replacing the board to consider a sale is necessary. Macerich believes that both matters are now closed and thus recorded the full expense for the legal services it needed to address both issues.

Macerich's portfolio continues to show evidence that Class A malls are outperforming lower-quality malls. Macerich breaks up its portfolio into buckets sorted by sales per square foot. The trophy-level assets in the top 10 bucket produced sales per square foot growth of 10.5%,and the Class A malls in the top 11-20 bucket produced sales per square foot growth of 4.9%. Meanwhile, the Class B malls in the top 31-40 bucket were down 0.7%, and the Class C malls in the bottom 5 bucket were flat year over year. Macerich shed much of its lower-quality portfolio over the past five years to focus more on the top assets it owns, and we think the continued outperformance of these assets have proved out this strategy over time.