Investing In Property Through Seritage Growth Properties (NYSE:SRG)

Seritage Growth Properties is a US$2.5b mid-cap, real estate investment trust (REIT) based in New York, United States. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how SRG’s business operates and also how we should analyse its stock. In this commentary, I’ll take you through some of the things I look at when assessing SRG.

View our latest analysis for Seritage Growth Properties

REIT investors should be familiar with the term Fund from Operations (FFO) – a REIT’s main source of cash flow from its day-to-day business activities. FFO is a higher quality measure of earnings because it takes out the impact of non-recurring sales and non-cash items such as depreciation. These items can distort the bottom line and not necessarily reflective of SRG’s daily operations. For SRG, its FFO of US$55m makes up 41% of its gross profit, which means over a third of its earnings are high-quality and recurring.

NYSE:SRG Historical Debt, March 8th 2019
NYSE:SRG Historical Debt, March 8th 2019

Robust financial health can be measured using a common metric in the REIT investing world, FFO-to-debt. The calculation roughly estimates how long it will take for SRG to repay debt on its balance sheet, which gives us insight into how much risk is associated with having that level of debt on its books. With a ratio of 3.4%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take SRG 29.11 years to pay off using just operating income, which is a long time, and risk increases with time. But realistically, companies have many levers to pull in order to pay back their debt, beyond operating income alone.

I also look at SRG’s interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it’s better to use FFO divided by net interest. With an interest coverage ratio of 0.61x, SRG is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.

I also use FFO to look at SRG’s valuation relative to other REITs in United States by using the price-to-FFO metric. This is conceptually the same as the price-to-earnings (PE) ratio, but as previously mentioned, FFO is more suitable. In SRG’s case its P/FFO is 45.54x, compared to the long-term industry average of 16.5x, meaning that it is highly overvalued.

Next Steps:

Seritage Growth Properties can bring diversification into your portfolio due to its unique REIT characteristics. Before you make a decision on the stock today, keep in mind I’ve only covered one metric in this article, the FFO, which is by no means comprehensive. I’d strongly recommend continuing your research on the following areas I believe are key fundamentals for SRG:

  1. Management: Who are the people running the company? Experienced management and board are important for setting the right strategy during a volatile market. Take a look at information on SRG’s executive and directors here.
  2. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

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