Vornado Realty Trust OUTPERFORM ZACKS CONSENSUS ESTIMATES (VNO-NYSE)

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1 January 23, 2015 Vornado Realty Trust Current Recommendation Prior Recommendation Neutral Date of Last Change 01/23/2015 Current Price (01/22/15) $ Target Price $ OUTPERFORM (VNO-NYSE) SUMMARY We are upgrading our recommendation on Vornado to Outperform from Neutral due to the positive synergies coming out from the recent spinoff. The spin-off of Urban Edge Properties is a part of Vornado s efforts to streamline its business and will help the company to focus exclusively on office properties and retail assets in Washington and Manhattan. In fact, this spin-off is an outcome of Vornado s decision to separate two businesses, which remained together for legacy reasons but with no real operating synergies. Moreover, helped by better strategic portfolio repositioning and leasing activities, Vornado s third-quarter 2014 FFO per share came ahead of the Zacks Consensus Estimate. Also, the New York portfolio is projected to grow which is encouraging. SUMMARY DATA 52-Week High $ Week Low $90.20 One-Year Return (%) Beta 1.01 Average Daily Volume (sh) 774,997 Shares Outstanding (mil) 188 Market Capitalization ($mil) $21,560 Short Interest Ratio (days) 3.98 Institutional Ownership (%) 89 Insider Ownership (%) 10 Annual Cash Dividend $2.52 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) -0.7 Earnings Per Share (%) -2.8 Dividend (%) 2.8 using TTM FFO/Share 21.7 using 2014 Estimate 23.7 using 2015 Estimate 22.3 Risk Level * Low, Type of Stock Large-Growth Industry Reit-Eqty Trust Zacks Industry Rank * 50 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) A 678 A 703 A 687 A 2,737 A A 671 A 669 A 673 A 2,732 A A 667 A 671 A 669 E 2,668 E ,702 E Funds From Operations (FFO) per Share (FFO is operating earnings before non-recurring items) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2012 $0.98 A $1.06 A $1.03 A $1.11 A $4.18 A 2013 $1.13 A $1.27 A $1.23 A $1.33 A $4.96 A 2014 $1.20 A $1.44 A $1.31 A $0.88 E $4.83 E 2015 $5.14 E Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page Projected FFO/share growth - Next 5 Years% Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 OVERVIEW NY-based Vornado Realty Trust, a real estate investment trust (REIT), is the owner and manager of commercial real estate in the United States, with a portfolio that is mainly located in the New York City and Washington D.C. areas. The company's core business segments include New York (comprising retail and office properties mainly in Manhattan); Washington D.C. (office properties); and retail properties primarily in California and Puerto Rico. Apart from its properties, the company has investments in other REITs, residential and industrial buildings and Toys R Us. Notably, in Jan 2015, Vornado completed the spin-off of Urban Edge Properties ( UE ). This new, independent, publicly traded company has started regular trading under the ticker symbol UE on the NYSE. UE has stake in 79 strip shopping centers, 3 malls and one Warehouse Park that were previously under Vornado s ownership. On the other hand, Vornado is left with high-quality office properties and retail shops in Washington and Manhattan. The move came as part of Vornado s efforts to streamline its business. REASONS TO BUY Recently, Vornado completed the spin off its shopping center business into a publicly traded REIT named Urban Edge Properties. This spin-off is an outcome of Vornado s decision to separate two businesses, which have been together for legacy reasons but with no real operating synergies. We believe the creation of two focused REITs would help in efficiently leveraging the improving fundamentals of each asset type. Vornado, which has been subject to criticism for venturing into too many sectors, would now be able to focus exclusively on office properties and retail shops in Washington and Manhattan. Vornado s Class A office properties are concentrated in a few select high-rent, high barrier-to-entry geographic markets. The company, focused on improving its core business, is making strategic acquisitions and divestitures in addition to business spin-off. It made three investments during the third quarter and closed its previously announced purchase of the St. Regis retail for $700 million. Moreover, strategic sell-outs provide the company with dry powder to invest in opportunistic acquisitions. These initiatives will go a long way in enhancing its profitability. Also, Vornado has a strong and dedicated management team, which is one of the most respected and accomplished in the industry. The company benefits from its reputation, and relationship of its key personnel with the industry as a whole. The company has a diversified tenant base that includes the U.S. government, as well as several industry bellwethers such as Bank of America, Macy s, AXA Equitable Life Insurance, NYSE, AOL, Wal-Mart, JCPenney and The Home Depot. The diversified high-end tenant base is encouraging and assures steady rental revenue growth, going forward. On the leasing front, the New York business continues to put up a solid performance with growth in occupancy and same-store earnings before interest, tax, depreciation and amortization (EBITDA). The company also continues to be positive on the New York Office market, submarket-by-submarket. Vornado has a solid balance sheet. At quarter end, the company had $4.3 billion of liquidity comprising $1.9 billion of cash, restricted cash and marketable securities and $2.4 billion undrawn under a $2.5 billion revolving credit facility. The company, on the first day of the fourth quarter, used $450 million of cash to pay off the unsecured notes due in Moreover, with a FFO payout ratio (based on FFO as adjusted for comparability) of 55.7% in third-quarter 2014, the company has sufficient scope to increase shareholders return, going forward. Equity Research VNO Page 2

3 RISKS For Vornado, the Washington D.C. market remains a concern as the business continues to be impacted by the sluggish leasing environment. Both occupancy and EBITDA continues to be low and the company expects Washington's 2014 full-year comparable EBITDA to be lower than Vornado faces intense competition from developers, owners and operators of office properties and other commercial real estate, including sublease space available from its tenants. This influences the company s ability to attract and retain tenants at relatively higher rents than its competitors, thereby adversely affecting its long-term profitability. Also, persistent office space efficiency trends continue to limit any robust recovery in office sector fundamentals. Moreover, as part of its portfolio-repositioning efforts, the company is aggressively disposing its assets. This, in turn, creates a dilutive impact on the company s results. Though a low interest rate environment is expected to continue in the near term, we believe that with an improvement in economy and job growth escalations, rates would rise in the long term and this can pose a challenge for Vornado. This is because the company s ability to refinance existing debt would be restricted, while the interest cost on new debt would increase. This could adversely affect the company s financial results and consequently dent its dividend payout. Moreover, amid rising rates, not only the financing costs will increase, but the common stock buyers usually demand a higher dividend yield and this may negatively impact the market price of the common stock. RECENT NEWS Vornado Q3 FFO and Revenues Beat Estimates Nov 3, 2014 On an adjusted basis, Vornado s FFO per share came in at $1.31, higher than the year-ago figure of $1.23 and ahead of the Zacks Consensus Estimate of $1.15. The results were aided by improving strategic portfolio-repositioning and leasing activities. Also, reported FFO per share of $1.15 in thirdquarter 2014 came above the year-ago quarter figure of $1.12. Total revenue rose 0.3% year over year to $670.9 million in third-quarter 2014 and exceeded the Zacks Consensus Estimate of $662 million. Quarter in Detail In the New York City portfolio, Vornado leased 556,000 square feet of office and 33,000 square feet of retail spaces. At quarter-end, same-store occupancy in the portfolio was 96.7%, reflecting an increase of 60 basis points (bps) year over year. Same-store EBITDA, on a GAAP basis, rose 4.6% year over year in this portfolio. In the Washington D.C. portfolio, Vornado leased 450,000 square feet of office space. At quarter-end, same-store occupancy in the portfolio came in at 83.4%, down 20 bps year over year. Same-store EBITDA on a GAAP basis declined 2.7% year over year in the portfolio. In the Retail portfolio, Vornado leased 243,000 square feet of Strips and 25,000 square feet of Malls spaces. At quarter-end, same-store occupancy in the total portfolio was 94.6%, reflecting a decrease of 30 bps year over year. However, same-store EBITDA on a GAAP basis climbed 1.1% year over year in the total portfolio. Equity Research VNO Page 3

4 During the third quarter, Vornado bought a land parcel under its 715 Lexington Avenue retail property in Manhattan for $63 million. On the other hand, the company sold Beverly Connection power shopping center in Los Angeles, CA, for $260 million and recognized a net gain of $44.2 million. Subsequent to the third quarter, in October, Vornado closed the buyout of the retail condominium of the St. Regis Hotel and the nearby retail townhouse for about $700 million. Also, the company disclosed that it has inked a deal to vend an office building, 1740 Broadway, in Manhattan for around $605 million. As of Sep 30, 2014, Vornado had $1.7 billion of cash and cash equivalents, up from $1.4 billion as of Jun 30, Moreover, at the end of the quarter, total outstanding debt was $14.8 billion, up from $14.5 billion at the end of Jun The FFO payout ratio (based on FFO as adjusted for comparability) in the quarter was 55.7% as against 59.4% in the year-ago quarter. Shopping Centers Spin-Off Update Vornado named the to-be-spun-off U.S. shopping center business as Urban Edge Properties ( UE ), which will be a new publicly traded REIT. Notably, in the second quarter, the company had disclosed its plan to spin off 80 strip shopping centers, 4 malls and a warehouse park. The transaction is targeted to be accomplished by the end of this year. Additionally, the company planned to keep hold of 20 small retail assets (that did not fit UE s strategy) and divest them in the near future. As per the plan, in the third quarter, Vornado sold two of the 20 assets for $15 million and reaped a gain of $13.6 million. Dividend Update On Jan 21, 2015, Vornado declared a regular quarterly dividend of $0.63 per share. The dividend will be paid on Feb 17, 2015 to shareholders of record as of Feb 2, The REIT has decreased its dividend by 13.7% to $0.63 per share from $0.73 paid earlier, as a result of the spin-off of Urban Edge Properties. However, this dividend, as the company noted, when pooled with expected Urban Edge dividend, remains the same at $2.92. Recent Developments Vornado Closes Urban Edge Properties Spin-Off Jan 15, 2014 Vornado has finally accomplished the spin-off of Urban Edge Properties ( UE ). This new, independent, publicly company started regular trading under the ticker symbol UE on the NYSE. UE holds stake in 79 strip shopping centers, 3 malls and one Warehouse Park that were previously under Vornado s ownership. Shareholders of Vornado received one share of UE for every two units of Vornado held, as on the close of business on Jan 7, For fractional shares, the distributions would be made in cash. Notably, UE shares have traded on a when issued basis on the NYSE under the symbol UE WI since Jan 5, 2015, allowing shareholders the right to receive UE shares in this distribution. Vornado will, however, continue to trade under the same ticker symbol, VNO. The move comes as part of Vornado s efforts to streamline its business. The company, which has been subject to criticism for venturing into too many sectors, would now be able to focus exclusively on office properties and retail shops in Washington and Manhattan. Equity Research VNO Page 4

5 On the other hand, UE is expected to unleash its potential of shopping centers and malls spanning over 15 million square feet across 10 states and Puerto Rico, with concentrations in New Jersey, New York and Pennsylvania. Vornado Realty Closes 1740 Broadway Sale, Gains $605M Dec 19, 2014 Vornado accomplished the sale of 1740 Broadway for $605 million. The move comes as part of the company s effort to reposition its portfolio. The company had announced this disposition move early last month. The sale of this 601,000 square feet office building in Manhattan at the rate of $1,000 per square foot would result in a financial statement gain of $439 million for the company that would be recognized in the fourth quarter. However, there would be a deferral of tax gain of around $484 million, thanks to a similarkind exchange as part of the company s previously disclosed buyout of the St. Regis Fifth Avenue retail. Vornado Closes $575 million Refinancing of Manhattan Building Dec 9, 2014 Vornado completed refinancing of the Manhattan-based 1.6 million square feet office building, Two Penn Plaza, for $575 million. It is an interest-only loan at LIBOR plus 1.65%, with a maturity date of 2019 and option for two one-year extensions. Vornado realized net proceeds of around $143 million. Vornado to Acquire Center Building in Long Island City Nov 24, 2014 Vornado penned a deal to acquire an office building in the Long Island City, NY for around $142 million, including the assumption of an existing $62 million mortgage. The move reflects the company s efforts to boost up its portfolio with quality office assets. Named as Center Building, this 8-story property encompasses 437,000 square feet of space. This office asset, positioned at Northern Boulevard in Long Island City, is 98% leased, denoting solid demand among customers for space in this building. The acquisition is projected to be accomplished in the first quarter of 2015, provided certain customary closing conditions are fulfilled. Notably, the 4.43% mortgage worth $62 million is scheduled to mature in Oct According to a report from commercial real estate advisory firm, Newmark Grubb Knight Frank (NGKF), Long Island City office market continues to experience growth in demand for space from the creative and tech firms. As a result, this demand, amid a limited supply, has pushed the asking rents up, while overall availability continued to fall. Vornado Leases Office Space to Amazon in NYC Nov 20, 2014 Vornado disclosed a 17-year lease agreement with Amazon.com Inc. for 470,000 square feet of space in an office building in Manhattan, NY. The building is basically located at 7 West 34th Street in the Penn Plaza District, where Vornado owns 9 million square feet of commercial space. The transaction is in sync with the company s aim of improving its leasing business. Also, it will boost Vornado s diversified tenant base comprising several industry bellwethers. With limited near-term lease expirations, the diversified high-end tenant base is encouraging and assures steady rental revenue growth for the company, going forward. Equity Research VNO Page 5

6 Note: FFO, a widely used metric to gauge the performance of REITs, is obtained after adding depreciation and amortization and other non-cash expenses to net income. VALUATION The shares of Vornado currently trade at 23.7x the Zacks Consensus Estimate for 2014 FFO per share, a 44.5% premium to the industry average. On a price-to-book basis, the shares trade at 3.8x, a 65.2% premium to the industry average. Given the solid fundamentals, the premium is justified. Our 6-month target price of $ equates to 28.6x the Zacks Consensus Estimate for 2014 FFO per share. Combined with a quarterly dividend of $0.63 per share, this price target implies an expected total return of 21.4% over that period. This is consistent with our Outperform recommendation on the shares. However, the stock currently has a Zacks Rank #3 (Hold). Key Indicators F1 F2 Est. 5-Yr FFO Gr% P/CF 5-Yr High 5-Yr Low Vornado Realty Trust (VNO) Industry Average S&P Ventas Inc (VTR) Health Care REIT, Inc. (HCN) Boston Properties Inc. (BXP) HCP, Inc. (HCP) TTM is trailing 12 months; F1 is 2014 and F2 is 2015, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Vornado Realty Trust (VNO) Industry Average S&P NA 2.0 NA Equity Research VNO Page 6

7 Earnings Surprise and Estimate Revision History Equity Research VNO Page 7

8 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of VNO. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1114 companies covered: Outperform %, Neutral %, Underperform 6.0%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Coverage Team QCA Lead Analyst Analyst Copy Editor Content Ed. 11C Kalyan Nandy Moumita C. Chattopadhyay Sanjoy De Anuja Mitra Moumita C. Chattopadhyay Equity Research VNO Page 8