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Morningstar | Initiating Coverage of Shopping Center REIT Regency Centers; Shares Appear Undervalued

We are initiating coverage on no-moat Regency Centers, the largest shopping center REIT, at a fair value estimate of $74. Regency's portfolio is built around e-commerce-resistant tenants, which has produced same-store net operating income growth higher for Regency than its average peer over each of the last seven years and is a trend that should continue for the foreseeable future. Over 80% of the properties in the portfolio feature a grocery anchor and nearly 20% of the annual base rent comes from grocery tenants. Another 20% of the annual base rent comes from restaurants, another type of tenant insulated from the pressures of e-commerce, and other service-oriented tenants like fitness centers and pharmacies make up a significant portion of the portfolio. As a result, we expect Regency's portfolio to see low but steady growth over the next decade and outperform other retail that will lose market share to online purchases. Regency currently trades at a moderate discount to our fair value estimate as we believe that the market doesn't fully appreciate how Regency's tenant mix is naturally resistant to retail disruptors.

Regency became the largest shopping center REIT in early 2017 after its merger with Equity One. The merger combined two similarly grocery-anchored portfolios in strong demographic markets that allowed the combined entity to operate with a significantly lower general and administrative cost burden. The merger also further increased the quality of Regency's average anchor and increased the company's exposure to many affluent metropolitan areas like New York, Boston, San Francisco, and Miami. Since the announcement of the deal, Regency has reported adjusted funds from operations growth well above the shopping center average and is one of only two shopping center REITs that produced positive growth in 2018. This has allowed Regency to continue to drive annual dividends higher each year while maintaining a steady dividend payout ratio.

One area where we see Regency lagging some of its peers is in the company's development pipeline. While the company currently has a little under $400 million in projects spread between its development and redevelopment pipelines and projects $150 million to $250 million in starts in 2019 and $1.25 billion to $1.5 billion in starts over the next five years, all of those figures are smaller than what some of their smaller shopping center peers either have underway or are aiming to achieve. As a result, the company's planned external growth won't move the needle nearly as much for Regency as it will for other retail REITs. Additionally, Regency is starting to look into adding office buildings and apartment complexes into their redevelopment plans. While these should add more rent to Regency's portfolio that is resistant to e-commerce, the company seems to be only dipping their toe in this type of development while their peers already have several high-yielding mixed-use projects underway or completed at this point. We see Regency's internal growth and external growth as being far more measured and steadier and thus less risky than their competitors, but they also risk seeing less overall growth than their competitors over the next few years.