Kite Realty Stock: Fly High With This Discounted REIT (NYSE: KRG)

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Investing for income has been much easier over the past two months as the price rout of many REITs has pushed up their dividend yields. However, looking at yield alone is not enough, as some REITs currently have low payout ratios. As thus, valuation also matters, and that brings me to the beaten group Kite Realty (NYSE: ARK). This article explores why KRG is a good investment to increase income, so let’s get started.

Why the ARK?

Kite Realty Group is an Indianapolis-based REIT with 60 years of experience developing, acquiring and operating real estate. It has been public since 2004 and currently has outdoor shopping malls and mixed-use assets primarily centered around the growing Sun Belt region of the United States.

As shown below, 67% of KRG’s annual base rent comes from the Sun Belt region, while the remaining 33% comes from major gateways and Tier 1 markets such as New York, Washington DC and Seattle.

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ARK locations (Investor Presentation)

Like some of its mall counterparts, such as Kimco Realty (KIM), KRG has increased its exposure to grocery-anchored malls, which are more economically essential and resilient to e-commerce growth. Currently, 75% of ARK’s annual base rent comes from grocery-anchored centers, putting it just below the 80% of its peer Kimco Realty.

Additionally, management continues to evolve the profile of tenants towards stores that resonate with today’s consumers. Its top 5 tenants include well-known companies TJX (TJX), Best Buy (BBY), PetSmart, Ross Stores (ROST) and Michaels Companies (MIK). Beyond groceries, the tenant base is also well-diversified across drugstores, electronics, quick-service restaurants and discount retailers, as shown below.

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Main ARK tenants (Investor Presentation)

Additionally, recent additions to the tenant roster include discount grocers like Aldi and trendy offerings like Total Wine, Five Below (FIVE) and Ulta Beauty (ULTA), replacing outdated brands like Office. Depot and Pier 1.

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New ARK tenants (Investor Presentation)

In the meantime, the ARK portfolio has performed quite well, with a good occupancy rate of 93.6%. It also increased net operating income from the same properties by 5.9%, including legacy RPAI properties, which it acquired in the fall of last year.

This was driven by strong leasing trends, reflecting strong demand for KRG properties, with a blended spread of 16.1% on cash leases (new leases and renewals combined) over the of the first trimester. Given the strong trends, management now expects full-year FFO per share of $1.77 at the midpoint, down from $1.72 previously.

Going forward, ARK appears to be well positioned to fund its acquisition and development portfolio, as it maintains close to $1 billion in cash on hand and benefits from safe leverage with a net debt to EBITDA of 5.7x. This also comes with investment grade credit ratings of BBB- and Baa3 from S&P and Moody’s (MCO).

Additionally, shopping center REITs are often referred to as “land banks,” given the large amount of undeveloped land they have in their parking lots. Management intends to use these assets, as indicated in the recent conference call:

We have also made progress on the development front, with all of our active development running on time and/or under budget. This is for the authorized land reserve, we have unearthed additional value propositions as promised, and we are taking a bespoke approach to each parcel. During 2022, we look forward to sharing our creative vision to maximize value and minimize risk. The best thing about Authorized Land Banking is that the investment community has historically placed very little value on land. And we certainly didn’t put a price tag on that when we underwrote the merger, but we see great opportunities ahead.

Meanwhile, KRG recently increased its dividend by 5% to $0.21 per share, which translates to an expected payout ratio of 47% based on the midpoint of its 2022 FFO/share forecast. as such, I see plenty of room for ARK to return to its pre-pandemic dividend rate of $0.3175, which would still equate to a modest 72% payout ratio.

Risks for KRG include higher interest rates, which could increase the cost of its debt. In addition, a short-term recession could put pressure on KRG tenants. It looks like these risks are more than priced into the stock price, as KRG appears to be cheap at the current price of $18.03, with a forward P/FFO of 10.2.

This translates to an earnings yield of 9.8%. Management appears to agree on the stock’s undervaluation, as it increased its share buyback program from $150 million to $300 million. This sentiment is perhaps best expressed by CEO John Kite on the recent conference call:

Finally, I want to talk about the modification of our share buyback program. The primary objective is to properly size this critical capital allocation tool in light of our post-merger market capitalization. That said, we are acutely aware of the disconnect between our stock price and our underlying fundamentals. We have excellent real estate on a top-notch platform, and we will continue to outperform until this disconnect resolves. Whether you’re a value investor or a growth investor, I can’t think of a name in our space that’s more appealing.

Analysts on the sell side have a consensus Buy rating on KRG with an average price target of $26.30. This translates to a potential total return of 51% over one year, including dividends.

Key takeaway for investors

Kite Realty Group is a well-managed REIT with strong portfolio fundamentals. It has a strong tenant base and maintains balance sheet flexibility to continue to grow in the portfolio. Meanwhile, KRG is posting a growing dividend supported by a low payout ratio. Recent share price weakness makes KRG a solid buy for revenue growth.

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