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S&P Capital IQ


01/09/17 10:00:12 AM



This week's Focus Stock of the Week is Mack-Cali Realty (CLI, $29), which carries S&P Capital IQ's highest investment ranking of 5-STARS, or Strong Buy. We think CLI is a leading equity real estate investment trust (REIT) with a premier position mostly in the New York and Boston metro markets.

We view CLI as a turnaround story with focus to improve the quality of its office portfolio by disposing less attractive assets and acquiring new properties in strong sub-markets such as Hoboken and the Jersey City waterfront, and other key areas of NJ. While there have been concerns about the Manhattan office market beginning to soften, CLI is confident its premier office locations in NJ will not experience a decline in rental rates or higher rental incentives in signing up tenants, either new or renewal leases.

We estimate mid-single digit growth in 2017, with increased rental rates, higher occupancy and net acquisitions of more attractive properties in its portfolio. Capital spending on redeveloping existing properties may continue to be a near-term drag on performance, driving higher expenses that we believe will lead to higher rental rates into 2017. CLI is seeing a pickup in rental rates in Jersey City waterfront and suburban locations like Short Hills, Metropark and Monmouth locations.

We think CLI will focus new investments on the multi-family sector as part of its strategy to expand into the residential rental market. CLI's Roseland Residential Trust had 97.7% lease occupancy in the third quarter, up from 95.5% in early 2016. Major new apartments are beginning to be leased in the Jersey City waterfront area.

We estimate FFO per share of $2.15 in 2016 and $2.35 in 2017. CLI's same-store cash NOI is targeted for 5.0% to 6.0% growth on a cash basis in 2016. As CLI begins to drive higher lease rentals on individual properties, we believe this will lead to improvements in overall financial metrics ahead.

As of November 2016, management is one third of the way through its 39-month transformation plan. CLI continues to execute on its strategy with the sale of $750 million of less attractive properties, the purchase of $400 million of class A properties and $560 million in refinancing higher-cost debt in 2016.

Plans in 2017 are to sell the remaining non-core assets with a goal of $500 million to $600 million in gross proceeds, drive operating margins to a goal of 62% in 2017 and 65% in 2018 from the low 50% in 2015 and improve the balance sheet with paying down high cost debt and adding new term loans of $250 million and raise $250 in equity for its residential unit called Roseland which is less than 20% of its property portfolio.

CLI has expanded its property portfolio primarily through an active acquisition program. In addition, the company owns land parcels with an aggregate development potential of 12.3 million sq. ft. This includes 4.3 million sq. ft. on the Hudson River waterfront in Jersey City, NJ, which is on its way to becoming the largest city in NJ.

At September 30, 2016, CLI owned interests in 214 properties, totaling about 23.3 million sq. ft. Real estate holdings principally include office and office/ flex buildings leased to a diverse base of tenants. The properties are located in five states in the Northeast, and in the District of Columbia.

Over the next 12 to 18 months, CLI has targeted an increase to its overall occupancy from 87.7% at September 30, 2016 to 90% by year end 2016 compared to 86.2% at the end of 2015. For CLI, occupancy rates are likely to get to close to 90% in 2017 for the new residential properties on the waterfront in Jersey City.

Our 12-month target price of $31 is based on a multiple of 13.1X our 2017 FFO per share forecast of $2.35. This target multiple is still at a discount of about 21% to the office REIT average at 16.5X to reflect our view of execution risks CLI may face in the company's turnaround. We believe CLI's valuation will close the gap as it reaches its milestones to improve the business.

Risks to our recommendation and target price include slower-than-expected economic growth and new job creation. A significant rise in interest rates could also decrease the value of commercial real estate holdings or increase vacancies.

S&P Capital IQ's views on stocks are constantly re-evaluated. Please refer to our most recent publication on this stock to see our current view.


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