Forest City Enterprises, Inc. (FCE-A): Don’t Miss This Forest for the Trees

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In the search for yield, it is all too easy to miss out on attractive non-REITs and non-dividend paying real estate stocks. Forest City Enterprises, Inc. (NYSE:FCE-A), an owner and developer of real estate across the country specializing in executing complex mixed-use urban developments, is one stock to watch. Concerns over its high gearing are overblown, as Forest City has a high proportion of non-recourse debt. In addition, its balance sheet is expected to be further strengthened from future sales proceeds of non-core assets going forward. It is now attractively valued at 2.3 times P/B, at a discount to its peers.

Efficient tax strategies minimize cash taxes paid

Forest City Enterprises, Inc. (NYSE:FCE-A) has its own set of tax strategies to minimize cash taxes paid. For example, its latest project B2 At Atlantic Yards, a new residential tower, was financed with tax-exempt bonds and low-income housing tax credits. These are common tax and financing incentives that local governments dish out to developers of urban mixed-use projects like Forest City. As seen in this Reuters article, critics have argued that the local governments cede too much ground in these kinds of urban redevelopment projects at the expense of public funds.

However, it is likely that such arrangements will remain in place going forward, as the cities and communities eventually reap the benefits of improved living standards and higher tax revenue post-redevelopment. This is just one component of Forest City Enterprises, Inc. (NYSE:FCE-A)’s tax strategies, which include the utilization of charitable contributions, general business credits and state net-operating losses to reduce cash taxes paid.

Not all debts are created equal

While a gross debt-to-equity ratio of 321% appears daunting, it is important to differentiate between recourse and non-recourse debt. In the event of a default on non-recourse debt, the lender is only able to recover its debt from the sale of the property secured as collateral; the borrower is not liable to repay the debt from cash flows generated the business or the sale of other properties.

Only slightly more than 10% of Forest City Enterprises, Inc. (NYSE:FCE-A)’s debt is recourse debt at the corporate level, with the remaining debt is non-recourse in nature and secured by individual properties, according to its most recent 10-K. As a result, Forest City is able to walk away from failed property ventures easily without incurring any loss beyond the capital investing in individual projects.

Becoming more investor friendly

Last year, Forest City rolled out a series of initiatives to make itself more shareholder friendly. First, in February 2012, it reduced the number of directors on the board from 15 to 13 with the aim of increasing the proportion of independent directors. Second, in the same month, it also announced it will focus on core markets and products going forward with the intention of repaying debt from sales proceeds of non-core assets. Such efforts are ongoing, with the disposal of two properties in non-core markets at the start of 2013.

Last, although Forest City Enterprises, Inc. (NYSE:FCE-A) has suspended dividends on its common stock since 2009, it announced that its board of directors approved a new $100 million share-repurchase program in December 2012.

With Forest City’s share price up 15.9% since the share-repurchase announcement, slightly outperforming the S&P 500 over the same time period, it might not have found its own company sufficiently attractive vis-à-vis other investment opportunities. To date, no shares have been purchased under this program.

Peer comparison

Forest City Enterprises, Inc. (NYSE:FCE-A)’s peers include Boston Properties, Inc. (NYSE:BXP) and Vornado Realty Trust (NYSE:VNO). On a P/B valuation basis, Forest City is the most undervalued of the three with a P/B of 2.3. In contrast, its peers Boston Properties and Vornado Realty Trust (NYSE:VNO) trade at P/B ratios of 3.3 and 2.6, respectively.

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