When we last covered Brookfield Property Partners (BPY), we made a compelling case to use the safer route to get a 10% yield.

If you do believe that malls will never be the same again and office properties will be rendered obsolete by working from home, then there are absolutely no investments you should own, as the economy has much further south to go. But if you do think that the pandemic will end at some point and we will reach even 95% of the pre-pandemic GDP, then BPY makes a lot of sense. BPY preferreds are an even more compelling option for those who want the yield with less risk.

Source: Brookfield Property Partners: A Bulletproof 10% Yield

BPY has reported three quarters’ worth of financial information since then. The stock has had a strong move as well.

ChartData by YCharts

With the stock now near the top end of what we thought it could achieve, we look at the thesis to see if it is time to take profits.

The Assets

The case for BPY has always been underpinned by its premier office properties in key locations.

Source: Q3-2020 Supplemental

This has been supplemented by strong retail locations and opportunistic investments through which BPY has successfully recycled capital. Of course, the hit of COVID-19 called into question all three prongs of that approach.

Q3-2020

BPY’s recent results showed the strain of COVID-19 as funds from operations (FFO) declined by more than 50% from last year.

Source: BPY Q3-2020 press release

Year to date the results have been better, thanks to Q1-2020. But even here the lack of realized gains is showing up. Looking at the different segments within BPY, we see that office was relatively steady this quarter, although the lack of fee revenues showed up in the year-to-date results.

Source: Q3-2020 Supplemental

Retail, as expected, was far worse and Q3-2020 showed a 50% plus FFO decline.

Source: Q3-2020 Supplemental

Finally, the LP segment, hurt by the hospitality investments declined by almost 70%.

Source: Q3-2020 Supplemental

READ ALSO  Blackstone seeks $5 billion for second Asia buyout fund: source

The Leverage, Like the Empire, Strikes Back

One of the cautionary flags for BPY has always been its extraordinary leverage. Running double digits of debt to EBITDA multiples is something that is scary for most companies. Anyone who went into the pandemic leveraged to the hilt, has been decimated by that decision. We can see the impact of BPY’s leverage on the decline in FFO. Even though interest expense has trended down, thanks to rate cuts and floating interest rate structure, BPY has seen big FFO drops.

Source: Q3-2020 Supplemental

We draw attention above to the fact that interest coverage by segment ranges for just over 1.0X (LP Investments), to barely near 2.0X (Office). On the bright side, these are all property specific mortgages so BPY can walk away from a property, should it choose to. Nonetheless the leverage is sky-high.

Dividend

BPY had always had a high payout ratio on its basic funds flow and relied heavily on its realized gains to pay the dividend. In the last 12 months, even this ratio has gone whizzing past 100%.

Source: Q3-2020 Supplemental

In the most recent quarter, we are at a 200% payout ratio. Can this go on indefinitely? We believe not. While BPY and Brookfield Asset Management (BAM) are incentivized to keep the dividends flowing, there are limits here. A key factor that comes into play is the fact that realized gains and capital recycling will be muted over the next 1-2 years even if things normalize rapidly. Based on all the information, BPY has been moved to a higher level of danger on our proprietary Kenny Loggins Scale.

This rating signifies a 33%-50% probability of dividend cut in the next 12 months.

But The NAV?

BPY does release a NAV as it follows IFRS.

This often causes plenty of confusion as investors running price to book metrics find BPY is cheaper than all comparative US REITs.

ChartData by YCharts

Investors should not compare IFRS and US GAAP as that is about as “Apples and Oranges” as it gets. But getting back to BPY’s big discount to NAV, it is likely a symptom of BPY using very optimistic capitalization rates.

READ ALSO  Small-Caps Keeping Large-Caps Afloat (Technically Speaking For 11/23)

Source: Q3-2020 Supplemental

Barring a real estate investor who went into a coma in early February and woke up just now, no one believes those numbers on retail are realistic today. What exactly is BPY’s NAV? That falls somewhere in the dominion of “how many angels can dance on a pin?” category. The Bid-Ask spread on properties is incredibly wide and selling into this market would mean BPY would struggle significantly.

The Real Choices: Preferred Shares

Based on the information above, we believe that BPY has its work cut out for it, but we think it does make it. We still like the preferred shares as they provide a better risk-adjusted yield. While most companies think that 3-4 preferred shares would be quite a lot, BPY aims to have one for each letter for the alphabet.

In the US it has Brookfield Property REIT Inc. 6.375% PFD A (BPYUP).

Source: Seeking Alpha

It also has Brookfield Property Partners L.P. 5.75 CL A PF SR3 (BPYPN).

Source: Seeking Alpha

Both the above yield over 7%.

In addition, it has a smattering of these listed on the TSX.

Source: Q3-2020 Supplemental

All are above the common shares and rank equally in preference for dividends. They are also insulated from single property issues and BPY can just walk away and carry on as if nothing happened. They offer a range of yields from 5% to over 9%. Some are floating while others are fixed. The entire set of merits and disadvantages of various classes is beyond the scope of this article. What we want to say here though is that these are in general, a safer option for speculating on the viability of BPY. We want to add that the TSX listed ones “float” with interest rates and they may also be a great play for those bullish on interest rates.

Conclusion

BPY has got its work cut out for it and while we expect a return to normalcy soon, the company may still not be able to generate its historical returns. BPY and BAM showed faith in the shares and retired a decent portion through buyback. But from our perspective, the interest coverage ratios are still extremely slim and Brookfield’s focus needs to shift there. We think BPY can still deliver positive returns from this point, but we think the relative case for the preferred shares has become stronger today than it was 7 months back.

READ ALSO  SE: Goldman Sees 18% Total Returns for Asian Stocks in 2021

If you enjoyed this article, please scroll up and click on the “Follow” button next to my name to not miss my future articles. If you did not like this article, please read it again, change your mind and then click on the “Follow” button next to my name to not miss my future articles.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

Are you looking for Real Yields which reduce portfolio volatility and outperform in bear markets?

Conservative Income Portfolio targets the best value stocks with the highest margins of safety. The volatility of these investments is further lowered using the best priced options. Our Cash Secured Put and Covered Call Portfolios are designed to reduce volatility while generating 7-9% yields. We focus on being the house and take the opposite side of the gambler.

Learn more about our method & why it might be right for your portfolio. We are offering the next 20 subscribers a 20% discount to try our method risk-free!
tets

Disclosure: I am/we are long BPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Via preferred shares



Via SeekingAlpha.com