Betting big on Amazon and selling the shares of traditional retailers has been a blockbuster trade for some time.
Now, a small but growing number of hedge funds are wagering that the next leg of the woes afflicting bricks and mortar retailers in the US will unfold dramatically for those shopping mall owners who have largely so far been considered immune.
The level of bets against some of the largest US mall operators has been rising steadily this year. Simon Property Group, the biggest US real estate investment trust with a market capitalisation of $52bn, for example, has the largest amount of shares lent out to short sellers since 2011, according to Markit data. While SPG’s share price has fallen 5.5 per cent this year, the level of short interest — anticipating a pronounced drop in value — represents a bet worth just over $1bn. Here the Financial Times dissects the anatomy of this trade.
Aren’t investors already aware of the difficulties of US mall operators?
For some yes, but for others far less so. Concern about the health of smaller regional mall operators has seen their share prices already fall sharply.
Recent data on the US retail sector has been bleak, with the number of bankruptcies during the first quarter of 2017 already eclipsing the total for 2016, according to the restructuring adviser AlixPartners.
Shares in Washington Prime Group, a small US-listed shopping centre and mall operator, are down by a third since September and currently trade at a dividend yield of over 10 per cent, implying the market believes it may not be able to sustain its payout.
But the troubles of smaller operators contrast sharply to the share price performances of the largest prime mall owners in the US, Simon Property Group and GGP. That reflects an assumption that their businesses should remain largely immune from the malaise affecting large parts of the country’s retail sector. At the same time, investors have been attracted by the dividends paid out by large Reits.
Russell Clark of the London-based hedge fund Horseman Capital told his clients in March that he had begun to sell short US mall Reits, calling them “mall rats” and noting that there appeared to be a growing disconnect between their share prices and concerns about the state of US retailers.
“Back in the lead-up to the financial crisis we found that the share prices of Reits and their tenants were very closely related,” he wrote. “Recently we have seen tenants share price weaken again, but Reits remain relatively strong”.
Shares in the very largest shopping mall owners, who operate prime malls known in the industry as “A” malls, have remained resilient even as some of their largest tenants suffer slowing sales. Simon Property shares currently yield 4.2 per cent, not much higher than the 3.5 per cent level from 2014. Indeed, Wall Street analysts remain optimistic about the company’s fortunes. Of the 24 that cover it, 17 rate it as a “buy”, seven as a “hold” and none recommend selling it, according to Bloomberg.
Consultants in the sector appear to believe that “A mall” operators such as Simon are a distinct category that means investors need not worry. ”The non-commoditised nature of ‘A’ malls is likely allowing these properties to play by a different set of market rent rules,” wrote the consultant Green Street Advisors in a note.
Some hedge funds are betting that this widely held conviction is wrong.
Why are funds starting to bet against the largest mall operators?
Over the past year there has been a growing amount of evidence to suggest that the financial health of the large tenants of the bigger Reits such as Simon Property and GGP is also dereriorating. Tenants of these large mall operators are generally split between their large “anchor” retailers, big name retailers such as Macy’s and Sears, and then smaller so-called “in-line” tenants who tend to pay higher rents than the flagship stores.
Mr Clark of Horseman notes how the rent per square foot paid by the specialty “in-line” retailers can sometimes be as much as 30 times that paid by anchor tenants, meaning the fate of these smaller retailers is crucial to the fortunes of the mall operators.
While like-for-like sales have been slowing at many large US retailers, it is the smaller in-line retailers who appear to be hurting more. Shares in Ascena Retail Group, which is Simon Property’s second largest in-line tenant with 493 stores, equivalent to 1.5 per cent of the Reit’s total US square feet, have fallen by more than 35 per cent since the start of the year. Shares in L Brands, owner of brands such as Victoria’s Secret and Simon Property’s third largest in-line tenant, are down by almost a quarter since January, while shares in Signet Jewelers, who ranks fourth, have fallen by 30 per cent over the same period.
So what are the hedge funds hoping for?
The logic of the trade is simple: the financial health of mall operators is ultimately decided by their tenants and eventually the wider market will wake up to this. It hinges on one fairly simple idea — that the broadly held belief that “A” malls are different to other malls is a fallacy. The hedge funds believe that, when reality dawns that many of the largest tenants of prime malls are also experiencing difficulties, their shares will experience a violent downward re-rating.