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As Chris Zook and James Allen wrote in Repeatability: Build Enduring Businesses for a World of Constant Change, “the power of a repeatable model lies in the way it turns the sources of differentiation into routines, behaviors, and activity systems that everyone in the organization can understand and follow so that when a company sets out on a particular path, it knows how to maintain differentiation that led to its initial success.”
As the co-authors explained, that differentiation is the “prime source of competitive advantage” and the really successful “companies learn how to sustain differentiation over time through constant change.” They summed it up by saying that
…the strongest source of differentiation in a company’s business are its crown jewels.
Differentiated By Geography
Retail Opportunity Investment Corporation (ROIC) got its start from cash raised through a special purpose acquisition company (or SPAC); in essence, a blind pool with $400MM of cash at the trough of the real estate market. The company’s CEO, Stuart Tanz, took advantage of the opportunity to assemble shopping center properties as the Great Recession was ending.
Since the company's listing on NASDAQ in November 2009, ROIC has delivered robust earnings growth to its shareholders while maintaining a conservative balance sheet. Based in San Diego, ROIC acquired and operates a portfolio of 61 shopping centers encompassing approximately 7.3 million square feet.
ROIC's portfolio of 61 shopping centers is concentrated exclusively in 4 core West Coast markets including Seattle, Portland, Northern California, and Southern California. Accordingly ROIC is the only shopping center REIT that focuses in these densely populated west coast markets with above-average household income levels.
Coastal markets are most attractive as most investors do not want to own shopping centers in the middle of the Country. The competitive advantage for ROIC is the fact that the company only invests in strong economic markets with exceptional demographics and growth characteristics that provide stable income and long-term growth.
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Differentiated By Tenant Base
Grocery and service-oriented tenants are becoming increasingly important in the retail sector as e-commerce takes market share from other areas of retail. ROIC offers a necessity-based strategy in which the company derives around 85% of its revenue from a grocery component. When including drug stores, ROIC has the largest composition of grocery revenue in the shopping center sector.
ROIC has a growing number of necessity-branded tenants (the top tenant has less than 5% of revenue concentration) including
Differentiated By Balance Sheet
ROIC maintains a flexible and conservative balance sheet that provides the financial strength to execute the company's investment program taking full advantage of market opportunities.
The company has one of the cleanest balance sheets in the shopping center sector , and one of the most flexible as well. The company has above-average interest and fixed-charge coverage ratios as well as an in-line debt/EBITDA ratio. Perhaps more importantly, the debt structure (31.6% debt to total is largely unsecured, with 90% of the NOI unencumbered. This allows management more flexibility in recycling its portfolio and arguably makes the company a more attractive acquisition candidate.
Additionally, Q4 finally closed the book on the company's drawn-out warrant conversions, leaving a clean, conservatively-levered balance sheet (4.0x interest coverage ratio and 32% debt/market cap), with only $81M of debt maturities in the next three years. ROIC is rated BBB-by S&P and Baa2 by Moody’s.
Differentiated By Dividend Growth
Recently ROIC announced a 6.3% increase in its quarterly dividend to an annualized rate of $0.68/share. Factoring in the new dividend run-rate, ROIC shares are currently yielding 3.9%. While the yield is not as impressive as some of the peers, the growth has become most predictable – average growth over the last 5 years of 12.6%.
ROIC grew its revenue by 83% in 2014 and with a robust pipeline of deals 2015 is expected to be another solid year. Since formation (in 2009) ROIC and its management team have averaged almost $300M in acquisitions annually, and the last two years have reached over $400M. Management's strategy specifically targets off-market deals where the REIT can add value, boosting acquisition cap rates by 100-150bps through 3.0% - 5.0% internal growth.
Differentiated By Discipline
ROIC’s CEO and senior-level executives have a track record for creating shareholder value. The core management team consists of its current President and CEO, Stuart Tanz, and several other leading shopping center veterans. Tanz was the former CEO of Pan Pacific Retail Properties Inc. where, during his nine year tenure, he grew the company's market cap from $447 million to around $ 4 billion.
Through a series of consolidative acquisitions, PNP purchased around $2 billion of retail assets (over 18 million square feet) and later sold PNP to Kimco for around $4.1 billion (2006). As evidenced by the early enthusiasm with ROIC's IPO, Tanz's track record (at PNP) was fundamental to the success of the investment model. During the period of PNP's public ownership, the company provided a 529% total return, compared with 355% for shopping center REITs and 67% for the S&P 500 over the same period.
ROIC is currently trading at $17.42 per share, a premium to the peer group. However, the high-quality west coast assets and the company’s track record of solid operating results justify the rich share price. The company’s P/FFO (price-to-funds-from-operations) multiple is 18.9x.
In conclusion, ROIC is a “west coast gem” and based upon the company’s track record, Mr. Market knows this REIT has something special. Fortunately I established a position early and I remain bullish that this REIT will continue to deliver strong operating results, accented by sharp “high quality” differentiation.
I would not be surprised to see a bigger fish swallow up ROIC in the future . The industry is ripe for consolidation (18 shopping center REITs) and ROIC has one of the most sought after portfolios in the sector. In addition, the CEO (Tanz) has a track record for timing M&A deals and ROIC’s balance sheet (based on flexibility) offers a compelling and simple thesis for a bigger brand like Kimco Realty (KIM), DDR Inc. (DDR), or Brixmor (BRX).
The author owns shares in ROIC, KIM, and BRX.
Brad Thomas is editor of Forbes Real Estate Investor.
