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S&P Capital IQ


09/26/16 10:00:13 AM



This week's Focus Stock of the Week is Kite Realty Group Trust (KRG 29), whose shares carry S&P Capital IQ's highest investment recommendation of 5-STARS or Strong Buy. As a full-service, vertically integrated real estate investment trust, KRG owns, develops, leases and manages high-quality neighborhood and community shopping centers. As of June 30, 2016 Kite held interests in a portfolio of 120 retail properties totaling about 24 million square feet of gross leasable area. Kite's properties are located in 20 states but concentrated in Indiana, Florida and Texas. For KRG, location and the financial health and growth of its retail tenants are among the most important factors affecting the success of its portfolio, in our view. KRG has a diversified portfolio of tenants, which include many of the nation's major retailers. During 2015, no single tenant accounted for more than 3.4% of annualized rent; and the trust's largest tenants were Publix, Petsmart, TJX Companies, Bed Bath and Beyond, Ross Stores and Lowe's. Leases representing 6.5% and 10.8% of annualized base rents expire in 2016 and 2017.

KRG's primary business objectives are to generate increasing cash flow, achieve sustainable long-term growth and maximize shareholder value primarily through the development, acquisition and operation of well-located community and neighborhood shopping centers. It focuses on a dual growth strategy to grow its business. The first part of this strategy is to focus on increasing its internal growth by leveraging its existing tenant relationships to improve the performance of its existing operating property portfolio. The second part is to focus on achieving external growth through the expansion of its portfolio. It seeks to implement its business objectives and strategies by, among other things, completing the construction and lease-up of its development portfolio; continuing to selectively pursue land parcels in attractive markets that can support retail development while also focusing on conserving capital; selectively acquiring well located, high-quality retail properties or portfolios through its investment and market selection process; and maintaining a focused property management and leasing strategy by emphasizing and maximizing rent growth and cost-effective facilities.

Central to Kite's portfolio repositioning strategy is the planned divesture of non-core or (relatively) under-performing assets. Between 2008 and June 30, 2016, the size of the trust's operating portfolio grew from 50 retail properties to 120. Though total debt increased from $678 million at the end of 2008 to nearly $1.8 billion at June 30, 2016, KRG's debt-to-assets ratio improved from 61% to 47.2%. Most of this debt is mortgage debt secured by the trust's income-producing properties.

Following an acquisition-driven more than doubling of revenues in 2014 and a 33.7% rise in revenues in 2015, we expect more modest revenue growth of around 3% to 5% in 2016 and 4% to 6% in 2017. We expect margins to be aided by KRG's highly efficient and streamlined operating platform, and by an an occupancy rate that we expect will approach 96% in coming periods (up from 95.3% at June 30, 2016). We also expect KRG to benefit from relatively favorable industry supply and demand trends. Our positive view of retail REITs reflects our view that demand for top tier retail space has increased at a faster rate than the supply of new construction. Average retail vacancy rates are expected to be around 12% in the third quarter of 2016 (down from nearly 20% in 2011). KRG's average vacancy rate of less than 5% is far superior to industry averages. This very low vacancy rate should enable KRG to command above average rent increases from new and existing tenants.

Our 12-month target price of $35 is equal to 15.9X our 2017 FFO estimate of $2.20 per share. We think the multiple will expand from recent levels as KRG continues to post results that show that its retailer-dependent business, which is anchored by long-term leases, is continuing to improve.

Currently trading at 13.7X our 2016 funds from operations (FFO) per share estimate of $2.08 (versus a peer average of 17.1X) and at 13.0X our 2017 FFO per share estimate (versus a peer average of 16.1X) we view the shares (which currently yield 4.0%) as undervalued versus peers. We expect KRG successful execution of its growth strategy, coupled with steps it has taken to de-lever its balance sheet, should enable the shares to close their valuation gap versus peers..

Risks to our recommendation and target price include a sharp contraction in GDP and consumer spending and a surge in retailer bankruptcies. Also, because KRG (as a REIT) must distribute 90% of its taxable income to shareholders in the form of dividends, it relies on external sources of capital to fund growth. A sharp rise in interest rates could impair KRG's ability to fund growth.

S&P Global Market Intelligence'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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