CTO Realty Growth Stock Q4: Back In Growth Mode (NYSE:CTO)

Summary

In our last update on CTO (NYSE:CTO), we moved the shares from a Buy to a Hold primarily due to the near-term headwinds posed by the WeWork bankruptcy. The shares had remained rangebound since the last article, and we added to our position in the low-16s. The Q4 earnings report blew past our expectations and gave us confidence that the recent headwinds are behind us. Strong leasing activity, share repurchase activity, and the sale of the remaining subsurface interests drove a meaningful increase in our target price, and we are upgrading the common to a Buy. Given the hurdles to redemption and the presence of an attractive alternative in Gladstone Commercial’s Series E, we maintain the preferreds (NYSE:CTO.PR.A) at Hold.

Earnings Update

Disposition activity drove a ~10% decrease in GLA QoQ. Notably, CTO’s exposure to single-tenant properties is now <7% of GLA, and its office exposure has been reduced to <6% of GLA. Average ABRs across the portfolio improved by ~5.4%, and physical / leased occupancy improved by ~50bps / ~70bps, respectively, driven by strong leasing activity. CTO signed ~74k sqft of leases with a ~18% average leasing spread. We are glad to see the positive retail supply/demand dynamics finally showing up in the Company’s numbers.

These improvements drove strong revenue growth QoQ and YoY. As we saw with Alpine, mortgage and loan investments are becoming a material growth avenue for CTO as yields are competitive with equity investments in today’s rate environment. Core FFO and AFFO per share improved materially QoQ and YoY, aided by CTO’s well-staggered debt maturities (n.b., first maturity on April 25), reducing the impact of higher rates. Notably, our adjusted AFFO metric, which deducts TIs and LCs, finally caught up with the dividend rate – a promising sign for dividend sustainability.

CTO was active in the capital markets, repurchasing ~62k common and ~14k preferred shares for an average price of ~$15.7 and ~$18.4, respectively. Investment activity was limited to dispositions and loan origination. CTO sold ~$64MM of properties for an average cap rate of ~7.8%, ~90bps higher than the PQ, and originated one ~$15MM loan with a ~7.5% yield. CTO also sold off its remaining subsurface interests, a move that further cleans up the story and should help close the valuation gap.

With the bulk of the office portfolio now sold and leasing activity picking up, our previous concerns have been mitigated. The improvements in FFO and AFFO gave us further comfort around dividend sustainability and liquidity.

Valuation

CTO is now trading for ~10.8x / ~9.9x, the midpoint of the full-year 2024 guidance Core FFO / AFFO. It yields ~8.8%, and is trading ~28% below our updated NAV per share estimate (n.b., ~9.7% implied cap rate, excluding the market value of PINE).

Our target price reflects a 5% discount to NAV to account for the REIT’s small size and diversification across asset types (i.e., retail, office, mixed-use, loans). We see ~33% upside to our TP, which implies ~14.3x / ~13.1x ’24E Core FFO / AFFO. Our NAV estimate is based on ~$75MM of NOI, a 7.5% cap rate, and includes the market value of CTO’s stake in PINE and the FMV of its management agreement.

One major update to our valuation from the last report is the inclusion of the dilutive effect of the 2025 Convertible Note. Management has indicated their intention to pay the face value of the notes in cash and issue shares to pay the premium. Current prices imply the issuance of ~473k shares (n.b., ~2% of FDSO).

Despite the post-earnings rally, we see good value in the common shares. The ~9% yield is attractive compensation while we wait for a re-rating.

Preferred Stock

We are maintaining CTO’s preferred stock at a Hold. In the last 2 quarters, management has repurchased ~1% of the outstanding Series A. While this is not much, it shows a clear intention to reduce the outstanding balance. In the Q3 earnings call, management confirmed that the prefs are treated as equity in their leverage covenants, but the pref dividends are included in the FCCR calculation. While pref buybacks below $20 per share make obvious sense for the company from a capital allocation perspective, management might be looking ahead to the 2025 Convert maturity. Given their intention to pay the face value in cash and the premium in shares, CTO will need to refinance this with another convert or term loan. Unwinding the pref is one way to improve their credit metrics ahead of that refinancing process.

To determine the likelihood of a full redemption of the Series A in July-26, we must consider the debt maturity profile. Following the 2025 Convert, the next maturity is the 2026 TL due in March-26 (n.b., ahead of the pref redemption date). As mentioned earlier, the pref is treated as equity in the leverage covenants. If CTO refinanced and upsized the 2026 TL to take out the pref, it would run into three issues: 1) willingness of lenders to lend through ~58% LTV vs ~51%, 2) a higher spread if the answer to 1 is yes, and 3) pricing on the higher end of its grid. How these factors play out will determine whether or not management can and would redeem the pref. If they can buy in more of the pref prior to negotiating the 2026 TL refi, this may mitigate the impact of these issues and make them easier to redeem.

For REIT prefs, we see a better opportunity in Gladstone Commercial’s Series E, which offers a ~37% IRR (vs ~16% for CTO’s Series A) with a more straightforward path to redemption.

Conclusion

CTO’s Q4 earnings report demonstrated strong leasing dynamics, driving meaningful improvements in key operational and financial metrics. With only one remaining office property and critical vacancies backfilled, our previous concerns have been mitigated. We have revised our target price upward by ~9% and returned to a Buy rating. We continue to see a difficult path for the Company to redeem the prefs, and maintain our Hold rating.