Has A Major Tenant Bankruptcy Diminished Spirit?

chart01Spirit Realty Capital, a freestanding net lease real estate investment trust that competes with Realty Income and National Retail Properties, has experienced some head-scratching problems lately. They signed a sale-leaseback agreement with a major tenant that filed for bankruptcy just a few months after initiating the contract. The question for Spirit shareholders or potential shareholders remains: How should they view this situation?

During the first half of 2015, Spirit purchased the properties from Haggen Inc., which is a large regional food and pharmacy retailer in the Northwest. It just so happens that Haggen filed for bankruptcy in early September. By the end of November, Spirit negotiated the restructuring of a major portion of the master lease agreement in order to stem the tide and minimize revenue losses. You’ll be able to see the outcome by property below.

chart04Should this be considered a major event? Is there a major flaw with their due diligence process that emerged from this acquisition? Did the management act recklessly? Although we do not have a straightforward answer to any of these questions, we can certainly provide you with a few thoughts in order to flesh them out and avoid getting personal with their management team.

  1. Despite being a top tenant, Haggen Properties encompasses a minor percentage of Spirit’s square footage space that is available for rent. In fact, Haggen leased 1.0 million square feet out of the available 55 million square feet that Spirit owns. These figures equal 20 out of the 2,600 Spirit controlled properties with a 2.4 percent normalized revenues.chart05
  2. Haggen’s explosive rate of growth in 2014 should have raised some red flags. The company was once a small player in the industry, but grew their number of stores by a staggering 800 percent from only 18 to 164 in December 2014. This rapid growth came as a consequence of an agreement that occurred between the U.S. Federal Trade Commission (FTC) and grocery chains Albertsons and Safeway. The FTC approved the merger between both grocery store chains Albertsons and Safeway as long as they sold dozens of stores to their rivals, including Haggen. Spirit ended up purchasing 20 Haggen properties.chart02
  3. During the Q2 results conference call in August, when Spirit was questioned about the risk that Haggen posed, the company defended the acquisition by stating that they were able to ‘cherry pick the best assets that they wanted to keep long-term.’ In addition, they said that the assets not even cost 60 percent of the replacement cost.chart03
  4. Spirit brushed off the concerns regarding Haggen a month before they filed for bankruptcy. The company said that they were confident about Haggen’s ability to absorb the Albertsons stores. This would explain why they had signed a twenty-year master lease.
  5. Spirit disclosed the information in August that Haggen became a top tenant, although the agreement was signed in December 2014, on top of the fact that the properties rolled in during the first half of 2015. It is interesting that Spirit announced Haggen as a top four tenant during the second quarter results without providing any explanation in their Q2 10-Q. The word ‘Haggen’ was mentioned once.

To be continued tomorrow…

Source: Spirit Realty Capital (NYSE:SRC), Seeking Alpha, National Retail Properties, Inc. (NYSE:NNN), Realty Income Corporation (NYSE:O), Haggen

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.

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