Kite Realty Group Trust

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Kite Realty Group (KRG) is a real estate investment trust (REIT) that focuses on owning, operating, acquiring and developing high-quality, open-air shopping centers and mixed-use properties in the United States.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Kite Realty Group Trust (KRG) operates as a real estate investment trust (REIT), concentrating on open-air shopping centers and mixed-use properties primarily located in suburban areas and high-growth regions in the United States. Its revenue is mainly driven by lease agreements with tenants, which are typically long-term, providing a stable cash flow. It operates primarily as a landlord. This strategy relies on both occupancy rates and the ability of the real estate locations to generate foot traffic and sales for their tenants.

  • Revenues: KRG’s income primarily comes from rental income generated from its properties (base rent, percentage rent, and recoveries). The majority of the revenue is from the tenant rental payments.
  • Industry Trends: The retail real estate market is undergoing shifts. Shopping centers need to be more than just collections of stores; they need to be “experiential,” offering a variety of services and attractions for people. Additionally, there is an increasing amount of e-commerce, and landlords have to adapt to these changing trends in order to stay competitive.
  • Margins: KRG’s operating margins have varied but show that while they do make good money they do not get sky high returns as the nature of their business is to be a landlord and the margins they have aren’t high compared to other industries. There is pressure from increasing interest rates which may further impact their margins.
  • Competitive Landscape: KRG operates in a competitive landscape with a number of large and small REIT competitors. In general, smaller REITs, unlike the behemoths in the space, are less insulated against fluctuations in the economy. They are more vulnerable to increasing interest rates due to their higher use of debt financing. They can achieve an advantage by focusing on specific property types, regions, and tenant types.
  • Differentiation: KRG sets itself apart through a focus on open-air shopping centers and mixed-use properties which they believe can be more resilient than enclosed malls in the changing retail landscape. They have also positioned their portfolio towards more high-growth regions with strong underlying economics. KRG attempts to create a higher-quality tenant base that brings more profitability to the locations and makes them more immune to the volatile changes.

Moat Analysis: 2 / 5

KRG’s moat is relatively weak, and is best described as a narrow moat, which is not very durable. Here’s a breakdown:

  1. Limited Differentiation: KRG primarily owns open-air shopping centers, a fairly common and replicable real estate asset. There are limited barriers to entry in this market, allowing new competitors to develop competing real estate locations over time.
  2. Location Advantage (Weak): While location is a factor, most of their properties lack very unique locations and are primarily in suburban regions and not densely populated areas. Some may be in prime locations that might attract other retailers, but KRG’s assets are not necessarily monopolistic by location and therefore this moat source is relatively limited.
  3. Lack of Brand Power: In general, most REITs lack brand power. For a shopper, it makes little difference if the same store is in a Kite property or some other place.
  4. Switching Costs (Low): Tenant leases are contractual which provide steady revenue, but they are generally long term. That means even if the company has difficulties, the business can’t immediately replace tenants in order to bring in more profitable ones, therefore they do not have high switching costs.
  5. Other: There may be a small benefit from scale in that larger REITs usually have a better cost structure because they can spread fixed costs across a larger number of properties. However, their scale isn’t big enough to make it a clear sustainable moat.

Risks to the Moat & Business Resilience

  1. Economic Sensitivity: The real estate market, and in particular commercial real estate, is extremely sensitive to economic cycles. Recessions, periods of low growth, and high interest rates have negative impact on REIT’s performance. During the COVID pandemic, the REIT suffered large losses, and this can be repeated if a similar economic contraction occurs.
  2. Interest Rate Risk: Since REITs rely on debt to finance acquisitions, increases in interest rates can lead to higher debt costs. Interest costs are their most important cost (aside from property costs), so they have less profit to show from their operations as interest rates increase.
  3. Competition: The retail space is competitive, and KRG’s tenants are not immune to losing business to other competitors. If some tenants go out of business or move out of a KRG property, this creates loss for KRG.
  4. Changes in Consumer Preference: The consumer’s move to e-commerce continues. If KRG’s tenants can’t attract enough people to their locations because they prefer buying online, this will cause declining sales and lower occupancy rates, thereby hurting their rental revenue.
  5. Acquisitions: The company has been relying on acquisitions to grow their revenue, but acquiring a business involves significant capital risk and it may not pan out as planned.
  6. Tenant defaults and bankruptcies: A lot of REIT performance relies on their tenants. If tenants can’t pay the rent due to their own economic struggles, this poses a major problem for REITs as they are a landlord first and foremost and have to collect their rent. A few large or many smaller bankruptcies can significantly impact their revenue.

Recent Concerns & Management Commentary

KRG has faced several concerns related to economic conditions and competition.

  • Interest Rate Impact: Rising interest rates have significantly increased the interest rates on their debt, leading to a decrease in profitability.
  • Tenant Issues They have mentioned some of their tenants have been having issues, especially small tenants who are experiencing headwinds.
  • Acquisitions: The recent acquisition of RPAI has been questioned by the market as the company’s debt load has become heavy, and more questions on synergies and the costs incurred have been raised. They claim the deal will still generate high returns on investment, and are positive regarding the transaction.
  • Property Vacancy: Due to some tenants having problems, some properties have lower occupancy rates than usual. They expect that these will be filled up over time.
  • Macro headwinds: They expect that the company faces headwinds, especially with regards to inflation and consumer spending habits. They will look to diversify into different geographical regions in order to offset some risk.

Despite the headwinds, they are confident in their long-term growth plan. They plan to focus on the strongest performing assets, improve properties, and attract high quality tenants.

Financials Deep Dive

KRG’s financials reveal a consistent pattern but have seen some volatility:

  • Revenue: KRG’s revenues have been steadily growing over the last few years, but it has flattened out with some declines. Most of their revenue is from tenants, so their performance is highly related to how they are doing. The company reported Total Revenues of $627 million for the last three quarters of 2023, compared to $575 million for the same period in 2022.
  • Net Income: Their profitability has fluctuated over time as they are affected by macroeconomic situations. For the three months ended September 30, 2023, they had a net income of $14 million but compared to that, in 2022 same period, it was $51 million.
  • Leverage: A major financial issue is the companies very high debt levels, with its Debt-to-Market Cap Ratio being around 80% and Debt-to-EBITDA of around 10x. They rely on a lot of debt to finance their acquisitions and have a very large amount of liabilities compared to the assets they hold.
  • Cash Flow: Cash flows from operating activities for the nine-months ended Sept 2023 stood at $280 million compared to $320 million in the same period in 2022. They have a negative cash flow from financing, meaning the debt financing portion of the company is bigger than the positive cash flow generating operations.
  • FFO and AFFO: Funds from Operations (FFO) which removes depreciation and amortization from net income was $212 million in 2023 for the last three quarters, whereas Adjusted FFO was $207 million in the same time period. They did increase their FFO per share but it was at a low single digit growth rate.

Understandability: 2 / 5

KRG is not particularly difficult to understand as a business. There are some nuances that require understanding but its core operations are quite simple. Here’s why the understandability is not rated higher:

  1. Complex Accounting: Like most REITs, KRG has very complex and opaque accounting and their reports don’t provide an easily understandable view of their operations. Their reports are filled with accounting and finance jargon that require knowledge to understand, and they often don’t follow normal operating results in their reports. The use of terms like FFO and AFFO along with non-cash adjustments make it difficult to analyze their reported earnings.
  2. Capital intensive business: REITs are very capital-intensive businesses because they need a large amount of capital to acquire real-estate. If there are no tenants to occupy their properties then the company is left with huge losses and the business is affected severely. The business performance fluctuates widely based on economic conditions.
  3. Debt Structure: Due to using a lot of debt to finance operations, their performance is linked closely to the cost of debt, therefore, understanding that aspect is very important.

Balance Sheet Health: 3 / 5

KRG’s balance sheet health is concerning due to high levels of debt, but it’s also not extremely problematic:

  1. High Leverage: They have a total debt around 5.6 billion which dwarfs their equity value. This makes their financials more volatile and susceptible to rate hikes and economic contractions.
  2. Decent Asset Quality: Although it does seem like their properties are well maintained and are generally in good shape, it remains hard to evaluate their long term value.
  3. Recurring Revenue: As they have contracts for several years, they have a clear view of future revenue which protects their cash flow to some extent.
  4. Financial Covenants: Their debt covenants are good but also not very strong which is a slight weakness.
  5. Large Intangibles: The combined amount of goodwill and acquired intangibles are high which make the asset side of the balance sheet bloated and may impair true profitability calculations.