Research Associate: Tanuka De, M.Comm.,MBA

Research Associate: Tanuka De, M.Comm.,MBA

June 04, 2007

Research Associate: Tanuka De, M.Comm.,MBA

Editor: Christopher R. Jones, CFA

Sr. Editor: Ian Madsen, CFA 1- 800-767-3771 x9417

N.Canal Street, Suite 1101Chicago, IL 60606

Developers Diversified Realty Corp. (DDR - NYSE) $61.93

Note: This report contains substantially new material. Subsequent reports will have new or revised material highlighted.

Reason for Report: 1Q07Results with new reports (Previous: 4Q06 and FY06 Results, Mar. 8)

Recent Events

On May 10, 2007 DDR filed its 10-Q reported with the SEC.

On April 26, 2007, DDR announced its 1Q07 results. FFO in the reported quarter increased 16.7% to $0.91 per share from $0.78 per share in 1Q06.

On April 26, 2007, DDR announced the formation of a joint venture with Dividend Capital Total Realty Trust to sell a portfolio of three assets having 1.5 million square foot of area for a price of $161.5 million. The company will have 10% stake in the newly formed joint venture.

On March 19, 2007, DDR announced its inclusion to the S&P 500 index replacing Caremark Rxafter the close of trading on Tuesday, March 20, 2007.

On March 16, 2007, the company’s Board declared 1Q07 Preferred stock dividends at $0.460938 per Preferred Class H stock and $0.46875 per Preferred Class I stock. The preferred dividend was paid on April 16, 2007 to shareholders of record on March 30, 2007.

On March 12, 2007, the company announced the appointment ofDavid Oakes as Executive Vice President of Finance and Chief Investment Officer of the company.

On March 7, 2007, DDRannounced pricing of its offering of $600 million aggregate principal amount of convertible senior unsecured notes due 2012. The notes will pay interest semiannually at a rate of 3.00% per annum. The company also announced the repurchase $117.0 million of its common shares.

Overview

Cleveland, Ohio-based Developers Diversified Realty Corporation (DDR) operates as a real estate investment trust (REIT). The company, through its subsidiaries, is engaged in the acquisition, development, ownership, redevelopment, leasing, and management of shopping centers and business centers. Currently, DDR owns or manages approximately 800 retail properties in 45 states, Puerto Rico and Brazil, comprising approximately 162.1million square feet of real estate. The company, as a REIT under the Internal Revenue Code, will not be subject to income tax, provided it distributes 90% of its taxable income to its shareholders. More information is available at its website DDR’s current dividend rate is $2.43 per common share.

On April 26, 2007,DDR announced 1Q07 FFO of $0.91, which was $0.06above the Street Consensus of $0.85. Management reiterated itsFY07guidance of $3.74–$3.80.

Key Positive Arguments / Key Negative Arguments
  • Operating results –Strong operating results led by a solid operating margin and a strong management team.
  • Treasury Rates–Treasury rates continue to stay low, which enables the REIT to perform strongly.
  • Business–The shopping center business is entering a period of consolidation, which will act as a positive catalyst for DDR.
  • Development and rent growth–Robust development pipeline and rent growth in the next 12–24 months.
/
  • Demand– Deterioration in consumer spending and lower demand pose risks for DDR.
  • Supply – Increased new supply of shopping centers can pressure occupancy and rental rates.
  • Economic– An economic downturn can limit internal growth of the company.
  • Material Costs – Higher raw material and labor costs can negatively impact investment.

Note: DDR’s Fiscal Year ends on December 31.

Revenue

Total Revenue( in million) / 4Q06A / 1Q07A / 2Q07E / 2006A / 2007E / 2008E
Digest Average / $214.5 / $230.6 ↑ / $245.2 ↑ / $823.3 / $956.6↑ / $990.9↑
Digest High / $215.9 / $233.8 ↓ / $270.3↑ / $829.3 / $1,040.7 ↓ / $1,128.1↓
Digest Low / $213.5 / $228.7↑ / $229.9↑ / $818.0 / $911.8 ↑ / $925.2↑
YoY Growth Rate / 15.7% / 22.0% / 13.2% / 16.2% / 3.6%
Sequential Growth / 4.2% / 7.5% / 6.3%

In 1Q07, revenue was $230.6 million, 15.7% higher than $199.3 million in 1Q06 primarily attributable to partial quarter ownership of Inland. A year over year increaseof 15.6% in Rental revenue, 15.6% year over year increase in Recoveries from Tenants, 7.9% year over year increase in Ancillary Income and 59.4% year over year increase in Management feeincome also attributed to the improvement in total revenue.

On a sequential basis, revenue in 1Q07 was 7.5% higher than $214.5 million posted in 4Q06.

One analyst (RBC Cap.) anticipates management fee income to increase by 56.4% attributable to theIRRETI acquisition for FY07. Another analyst (Citigroup) expects management fee income of $44.5 million while management expects it to be $50.0 million for FY07. Ancillary income of $21.2 million for FY07 is expected by one analyst (Citigroup).

During the reported quarter, the companycompleted 155 new leases and 272 renewal leases totaling 0.7 million and 1.7 million square feet respectively. Rental rates increased 24.1% on new leases and 10.7% on renewals.Average annualized base rent per occupied square foot, including those properties owned through joint ventures and excluding the impact of the Mervyns assets, was $12.36 as at 1Q07, versus $11.50 as at 1Q06 and $11.75 in 4Q06.

Core portfolio (which excludes the impact of the Mervyns, Brazil, and Inland assets) occupancy was flat year-over-year. Overall occupancy during the reported quarter was 94.8%, a decrease of 20 basis points from 95.0% in 1Q06 and 140 basis points from 96.2% in 4Q06.

One analyst (RBC Cap.) expects occupancy to increase to 96.5% by FY07.

Analysts expect revenue to be $956.6 million, $990.9 million and $1,078.2 million in 2007, 2008 and 2009respectively, indicating y-o-y growth rates of 16.2%, 3.6% and8.8% respectively.

Please refer to the Zacks Research Digest spreadsheet on DDRfor specific revenue estimates.

Margins

Margins / 4Q06A / 1Q07A / 2Q07E / 2006A / 2007E / 2008E
EBITDA margin / 71.0% / 70.9%↓ / 86.5%↓ / 73.0% / 77.5%↓ / 80.9%↓
Net Margin / 22.5% / 21.1%↓ / 35.0%↑ / 24.1% / 32.3%↑ / 29.4%↑

G&A expense in 1Q07 was$20.9 million; itincreased35.9% compared to $15.4 millionin 1Q06. 1Q07 GA expense includes one time costs related to the Inland acquisition. Oneanalyst (Hillard, Lyons) expects considerable year over year increase in G&A expense. One analyst (RBC Cap.) expects a 14.5% increase in G&A expense for FY07. Another analyst (Citigroup) anticipates a G&A expense of $75.9 million while management guided it to $73.0 million-$76.0 million for FY07.

Interest expenseincreased 22.9% year over year to $65.5 million in the reported quarter. 1Q07 interest expense reflected one month of the added debt for the Inland transaction.

Same-store NOI rose 2.3% in 1Q07 versus an increase of 3.0% in 4Q06.

One analyst (Goldman) expects same store NOI to grow over the remainder of the year while management expects an increase of 2.5% in same store NOI for FY07.

EBITDA in1Q07 was $163.6 million, an increase of 14.2% from $143.3 million posted in 1Q06,and7.4% higher than $152.3 million posted in 4Q06. EBITDA margin in1Q07was70.9%, down from 71.9% in 1Q06 and71.0% in 4Q06. Analysts expect EBITDA margin to be 77.5%, 80.9% and76.2% for 2007, 2008 and 2009 respectively.

Net income in1Q07 was $48.7 million, an increase of 35.7% from $35.9 million in1Q06 and1.1% from $48.2 million posted in 4Q06. Net margin inthe reported quarterwas21.1%,higher than 18.0% reported in 1Q06,but lower than22.5% reported in 4Q06. Analysts expect net margin to be 32.3%, 29.4% and27.0% for 2007, 2008 and 2009 respectively.

Please refer to the Zacks Research Digest spreadsheet on DDR for more details on margin estimates.

FFO per Share

FFO per share / 4Q06A / 1Q07A / 2Q07E / 2006A / 2007E / 2008E
Digest Average / $0.82 / $0.91 ↑ / $1.17 ↑ / $3.41 / $3.79↔ / $4.15↓
Digest High / $0.82 / $0.91 ↑ / $1.22 ↑ / $3.43 / $3.84↑ / $4.21↓
Digest Low / $0.82 / $0.91 ↑ / $1.06 ↑ / $3.41 / $3.71↓ / $4.09↓
YoY Growth Rate / 16.7% / 17.7% / 6.3% / 11.0% / 9.5%
Sequential Growth / -1.2% / 11.0% / 28.1%
Zacks Consensus / $1.15↑ / $3.79↓ / $4.15↓

FFO in 1Q07was $0.91, 16.7% higher than $0.78 posted in 1Q06. 4Q06 FFO was $0.06above the Street consensus of $0.85. The upside was attributable to a deferred tax benefit ($0.13 per share tax) partially offset by less than expected merchant building gains ($0.04 per share) and smaller contribution from Inland transaction ($0.06 per share), as per the analysts. On a sequential basis, FFO in 1Q07 was 11.0% higher than $0.82 posted in 4Q06.

Following the 1Q07 results, one analyst (Deutsche Bank) reduced the estimate for 2007 from $3.81 to $3.76, and for 2008, from $4.21 to $4.16 to account for promote from new JVs, net impact of deferred tax benefits, preferred redemption charge, increased G&A assumption and lower run rate for Inland. However one analyst (MorganStanley) raised the estimate for 2007 from $3.80 to $3.82 to reflect higher gains, and reduced the estimates for 2008 from $4.25 to $4.21.

One analyst (Hilliard, Lyons) expects 2Q07 earningsto be positively impacted by the merchant building gain and the promote fee, partially offset by the charge for redemption of the Series F preferred stock andhigher G&A expense.

Analysts expect FFO to be $3.79, $4.15and $4.46 for 2007, 2008 and 2009respectively, indicating y-o-y growth rates of 11.0%, 9.5% and7.5% respectively.

Please refer to the Zacks Research Digest spreadsheet on DDR for more extensive FFO figures.

Target Price/Valuation

Of the 11 analysts included in this report, 5gave positive ratings,4gave neutral ratings, and 2 gave negative ratings. The target prices range from $60.00 (3.5% downside from current price) to $80.00 (28.6% upside from current price), with an overall average of $71.00 (↑ from previous target price; 14.2% upside from current price). The most common valuation method used by analysts involves the application of a multiple to FFO and NAV estimates. Following 1Q07 results,one analyst (MorganStanley) reduced the price target and one analyst (Deutsche Bank) upgraded the rating.

The ratings and price target distribution are as follows:

Rating Distribution
Positive / 45.45%
Neutral / 36.36%
Negative / 18.19%
Avg. Target Price / $71.00↑
PriceRange / $60.00-$80.00
Number Targets/Analysts / 8/11

Risks to the price target include volatility of real estate gain income, unexpected vacancy, lower than expected market rents, expense inflation, inability to access capital, and weaker than expected external growth opportunities.

Please refer to the Zacks Research Digest spreadsheet on DDR for further details on valuation.

Capital Structure/Solvency/Cash Flow/Governance/Other

Acquisitions: During 1Q07 the company's joint venture in Brazil acquired an additional 73% interest in ShoppingMetropoleCenter with the joint venture currently owning 83% in this shopping center. The company's proportionate share was $24.7 million in this acquisition.

The company also acquired the remaining 25% minority interest in Coventry I during the reported quarter owning 100% of this entity. The aggregate purchase price was approximately $13.8 million.

Including the $6.2 billion IRRETI portfolio, one analyst (RBC Cap.) expects acquisitions of $6.8 billion in FY07 and $1.4 billion in FY08.

Dispositions: The company sold six shopping center properties, including one shopping center that was classified as held for sale during 4Q06 aggregating 0.7 million square feet for approximately $51.9 million during 1Q07. These dispositions generated non-FFO gain of approximately $2.8 million for the company.

One analyst (J.P. Morgan) expects considerable ramp up of asset disposition for the remainder of FY07. Another analyst (Citigroup) expects disposition of $1.9 billion in 3Q07.

Expansions/Redevelopment: During 1Q07, the company completed a redevelopment project located in Ft. Union, Utah for a cost of $26.4 million. The company is currently expanding/redeveloping ten shopping centers in Gadsden, Alabama; Crystal River, Florida; Plantation, Florida (acquired in the merger with IRRETI); Ottumwa, Iowa; Chesterfield, Michigan; Gaylord, Michigan; Hamilton, New Jersey; Olean, New York; Stow, Ohio and Brookfield, Wisconsin at an estimated cost of approximately $71.7 million. $16.5 million of costs had already been incurred in relation to these projects during 1Q07. The company expects to start construction on eleven additional expansion and redevelopment projects at shopping centers located in Tallahassee, Florida; Louisville, Kentucky; Gulfport, Mississippi; Huber Heights, Ohio; Amherst, New York; Fayetteville, North Carolina; Allentown, Pennsylvania; Bayamon, Puerto Rico (Plaza Del Sol); Hatillo, Puerto Rico; San Juan, Puerto Rico and McKinney, Texas.

Seven of the company's joint ventures are currently expanding/redeveloping their shopping centers located in Phoenix, Arizona; Buena Park, California; Lancaster, California; Benton Harbor, Michigan; Kansas City, Missouri; Cincinnati, Ohio and Macedonia, Ohio for an estimated cost of approximately $559.8 million (which includes the initial acquisition costs for the Coventry II redevelopment projects located in Phoenix, Arizona; Buena Park, California; Benton Harbor, Michigan; Kansas City, Missouri and Cincinnati, Ohio).$443.1 million of costs had been incurred in relation to these projects during 1Q07. Two of the company's joint ventures expect to start expansion/redevelopment projects at their shopping centers located in Deer Park, Illinois and Kirkland, Washington.

Development: At 1Q07 end, the company had ten shopping center projects located in Brandon, Florida; Miami, Florida; Douglasville, Georgia; Nampa, Idaho; McHenry, Illinois; Seabrook, New Hampshire; Horseheads, New York; Apex, North Carolina, and San Antonio, Texas, under construction with completion scheduled during FY07 through FY09 at anestimated cost of approximately $716.9 million creating an additional 4.5 million square feet of gross leasable retail space. These projectsinclude three projects acquired in the merger with IRRETI.

The company also expects to start construction on five additional shopping centers located in Ukiah, California; Homestead, Florida; Wesley Chapel, Florida; Union City, Georgia and Gulfport, Mississippi with an estimated cost of $342.7 million creating 2.1 million square feet of additional gross leasable retail space. These projects include two projects acquired in the merger with IRRETI. During 1Q07 $456.4 million of costs were incurred in relation to these projects.

Three of the company’s joint ventures have shopping center projects under construction located in Merriam, Kansas; Bloomfield Hills, Michigan and Allen, Texas. These three projects are being developed through the Coventry II program with completion scheduled during FY07 through FY09. These projects have an estimated cost of $526.7 million and $130.7 million of costs had been incurred in relation to these development projects during 1Q07.

One analyst (RBC Cap.) estimates development deliveries in FY07 to increase by $165.0 million and in FY08 by $170.0 million. Another analyst (Citigroup) expects development deliveries of $350.0 million in FY07.

Financing: During 1Q07 the company amended its secured term loan agreement with one major multinational to increase the loan to $550 million, and at the company's option, up to $800 million, to extend the maturity date to February 2011 and to reduce the interest rate to LIBOR plus 0.70% based on the company's current credit rating. The company also entered into a $750 million Bridge Facility with a major multinational during the reported quarter.

Merger: During 1Q07, the Company merged with IRRETI and acquired all of the outstanding shares of IRRETI for a total merger consideration of $14.00 per share, of which $12.50 per share was funded in cash and $1.50 per share in the form of DDR common shares. The company issued 5.7 million of DDR common shares to the IRRETI shareholders for a total consideration of approximately $394.1 million in relation to the merger. In conjunction with the deal the company closed on a JV with TIAA-CREF.

Others: As of1Q07, the company’s total debt outstanding was $6.1 billion;it increased from $4.2 million at 4Q06 end attributable to Inland acquisition. Debt to total market capitalization of $15.3 million was 40.2%, up from 34.3% in4Q06, and 37.6% in1Q06. Interest coverage ratio was 3.0x in 1Q07 versus 3.1x in 4Q06 and flat versus 1Q06,with fixed charge coverage ratio of 2.7x in 1Q07 versus2.2x in 4Q06 and 2.1x in 1Q06.

During 1Q07 the company issued $600 million of Senior Convertible Notes due 2012.

Subsequent to 1Q07, the company redeemed all outstanding shares of its 8.6% Class F Cumulative Redeemable Preferred Shares, aggregating $150 million, at a redemption price of $25.10750 per Class F Preferred Share.

Potentially Severe Problems

There are none other than those discussed in other sections of the report, in any.

Long-Term Growth

Long-term growth rates by the analysts average 7.5%.

Management indicated though the Coventry II venture is now full, DDR will likely continue to acquire value added opportunities in joint venture structures in the coming years.

DDR's international expansion plans will continue to gain momentum in 2007. Analysts have projected the joint venture investment in Brazil will double over the next three years. Brazil has been a hot topic among retail REITs,and it is expected Brazilwill remain a hotbed ofactivity for U.S. retail REITs over the coming several quarters. Management indicated a letter of intent has been signed with a partner for a new development joint venture focused in Eastern Europe.

Over a longer term one analyst (Hilliard, Lyons) expects a dividend increase of 4%-8%. The analyst also believes going forward the integration of Inland’s portfolio into DDR and the sale of non-core assets will help in higher growth.

Management found out several development sites in its pipeline that could generate more than $1 billion over the next several years.

Upcoming Events

July 26, 2007: The company is expected to release its 2Q07 Earnings.

Individual Analyst Opinions

POSITIVE RATINGS

AG Edwards – Buy ($74.00) – (05/02/07): The analyst has maintainedthe price target of $74.00,and a Buy rating. INVESTMENT SUMMARY: The analyst believes that the company is enhancing its portfolio byincluding attractive assets while disposing lessdesirable ones, without substantially altering its balancesheet.

Deutsche Bank – Buy ($70.00) – (05/29/07):The analyst maintains a price target of $70.00, andupgraded the rating from Hold to Buy. INVESTMENT SUMMARY: The analyst believes the company’s strategy of selling non-core assets will help the company improve its growth profile.

Lehman – Overweight ($74.00) – (04/30/07):The analyst maintained the price target of $74.00 andan Overweight rating. INVESTMENT SUMMARY: The analyst believes the company, through a combination of solid internal growth, development, acquisitions, and joint ventures, should be able to generate high earnings growth.

RBC Cap. – Outperform ($80.00) – (05/01/07): The analyst maintained the target price of $80.00,and an Outperform rating. INVESTMENT SUMMARY: Based on the US joint venture, international ventures, development pipeline and operating portfolio, the analyst expects the company to deliver double digit FFO in FY07and FY08.

UnionBankSwitz. – Buy ($72.00) – (04/30/07):The analyst maintains a price target of $72.00 and a Buy rating.

NEUTRAL RATINGS

Hilliard, Lyons – Neutral– (04/30/07): The analyst maintains aNeutral rating. INVESTMENT SUMMARY: The analystbelieves FY07 results will be positively impacted by the integration of Inland’s portfolio into the company and the selling of non-core assets will help pay down the credit line.

Goldman – Neutral ($71.00) – (04/29/07): The analyst maintained the price targetof $71.00 anda Neutral rating. INVESTMENT SUMMARY: The analyst believes that the company should trade at a premium based on its ability to create value through its additional businesses and opportunistic ventures.

J.P. Morgan – Neutral – (05/29/07): The analyst maintains a Neutral rating. INVESTMENT SUMMARY: The analyst believes the company’s earnings could be enhanced by its robust development pipeline.

Merrill – Neutral – (05/15/07):The analyst maintains a Neutral rating.

NEGATIVE RATINGS

Citigroup – Sell ($67.00) – (05/02/07): The analyst maintains a price target of $67.00 and a Sell rating. INVESTMENT SUMMARY: The analyst believes the company was successful in focusing on open-air market dominant community centers anchored by the country's largest and growing retailers including Wal-Mart, Target, Home Depot and Lowe's and building a network of joint venture capital partners meeting different goals and needs. The analyst also believes the company has superior dividend growth relative to its peers based on a low dividend payout and FFO growth.