ATG Take on American Realty Capital Properties(ARCP)- Eat that Lobster!

moMANon is pushing for an ATG position in American Capital Realty (ARCP), a large REIT focused on single tenant properties (including 500 Red Lobster locations) that has been at the forefront of scandal allegations over the past few weeks.  Two weeks ago the stock started tanking on news that the FBI and SEC were investigating reports of accounting errors and potential fraud.  The resulting drop in stock price has been dramatic- at one point the stock fell 37% to $7.85/ share from a price of $12.48/ share at the end of October before settling at $8.66 as of today.  While nothing definitive has been announced, early indications are that the investigation centers around “improper accruals related to executive bonuses” as reported by none other than Ed Rendell, former Pennsylvania Governor and ARCP board member.  At a minimum, it appears that some heads of ARCP management are likely to roll.

I’ve looked at ARCP before, but never had a good feeling about Nicholas Schorsch and his basic strategy of simply gobbling up as much single tenant real estate as humanly possible to package into a diversified alternative real estate investment vehicle.  As of a few months ago, the 10%+ dividend offered seemed thin compared with the 7% cap rates he was paying for recent acquisitions, and I was convinced that rates would start ramping up (which clearly did not happen).  The Red Lobster lease-back transaction helped boost his yields, but I don’t exactly see people flocking to Red Lobster in droves (aside from those few seeking the nostalgic euphoria of Cheddar Bay Biscuits).

moMANon’s suggestion to go long on ARCP amidst the current controversy is ballsy and contrarian, to say the least.  Here’s a quick snapshot of the equity’s current ratings as reported by Schwab:

ARCP Ratings

“F”, “Sell”, “Hold”, “Avoid”, you get the picture.  After a quick gut check, however, I’m with moMANon on this one- ARCP appears oversold and ATG is going long on this REIT.  Here’s a quick summary of what I like about it:

  1. The stock trades at a material discount to book value at 0.74. In today’s environment it is very difficult to find a REIT trading at a discount to book value, particularly one with a portfolio that is 99% leased with an average remaining lease term of 12 years.

 

  1. The REIT appears appropriately leveraged at approx. 55% loan to value with ample debt service cushion and an average interest rate of 3.55%.

 

  1. The current scandal might actually turn into a positive situation for shareholders, preventing management from aggressively pursuing further growth in a frothy real estate market.

 

  1. A monkey can manage a portfolio of singe tenant, triple net properties. Assuming no further acquisitions, it would be very, very difficult for management to screw up the management of a well-diversified, 99% leased portfolio of single tenant properties that have long lease terms.  While it’s challenging to find a talented management team to execute an accretive growth strategy, it’s not challenging to find talented management to oversee a portfolio of low-maintenance assets trading at a discount to their intrinsic value.  Any growth beyond responsible management is icing on the cake.  (I think I just spent three sentences re-iterating the exact same point- at least it’s an important one 🙂

 

  1. ARCP’s current forward dividend is 11.40%. The sustainability of this dividend is certainly questionable when looking at recent financials, but my rough back-of-the –envelope calculation for current cash flow yield is a very respectable 11% (Q2 2014 Earnings (with nominal sale activity) before depreciation/ amortization of $215 million, annualized against a current market cap of $7.81 billion).  It appears that a substantial potential dividend drop despite ample cash flow support has been priced into the stock.

 

At a very rough gut-check level, I agree that the market value of ARCP’s portfolio materially exceeds the current enterprise value of  $17.7 Billion ($178 psf on 99 million sf).  $178 psf feels pretty cheap for a well-diversified, strong credit and fully leased portfolio with an average remaining lease term exceeding 12 years.

ARCP Portfolio Overview

At the end of the day I think this is an opportunity to invest in a portfolio of stable, cash-flowing real estate assets that are worth more on the open market than the stock price suggests.  Shady/ potentially unethical management has scared investors away in droves to the point where all it takes for this investment to succeed is some house cleaning at the front office and a new management team that can clip coupons and manage the debt side effectively.  I’ll take that risk… and a double order of Cheddar Bay Biscuits!

-Maverick

Advertisements

ATG Portfolio 6 Month Check-up

I suppose it’s my turn to provide a quick take on the current make-up of ATG’s portfolio and thoughts on specific equities.  While I have a few regrets (such as not buying Royal Caribbean at moMANon’s behest in hopes of buying a little cheaper and not picking up a larger entry position of Whitewave Foods), overall I’m happy with the current makeup of our portfolio and the various trades over its first 6 months.

ATG Snapshot 10-30-14

 

  1. OZM- At 16% of invested capital, Och-Ziff is our largest holding in the portfolio, more as a result of picking up more shares on weakness than overt confidence. I am extremely interested to see how their third quarter earnings pan out on November 4- the beauty of this stock is that they distribute most of their earnings as a dividend and it’s priced so cheap that their funds only need to gain a few ticks above 0% to generate adequate profits.  The downside is that that they primarily play in international alternative investments, an area where getting a few ticks above 0% is no easy task in today’s environment.  I’m a HOLD on this one.

 

  1. ESV- Admittedly, I keep getting this stock wrong. It has been the worst performer of the ATG portfolio, with an unrealized loss of 13.5% to date.  Plummeting oil prices coupled with concerns about over supply in the offshore rig industry have outweighed positive earnings results, a stable balance sheet, attractive dividend yields, and continued backlog of revenue for the company.  Perhaps this is my version of the Ackman-Herbalife complex, but I’m convinced that ESV is destined to turn around- today’s earnings announcement of a solid beat and 3.2% gain is a good start.  It’s hard to find a best-in-class company that generates ample profit, cash flow, and trades at a price below net book value of assets, even after excluding intangibles.   I’m a believer in Ensco, but keeping a HOLD rating relative to the ATG portfolio given our large position.

 

  1. GOOGL- I like monopolies, low leverage, strong revenue growth, and cutting edge technology investments at a price equal to the average S&P P/E ratio. STRONG BUY.  We’ll be adding more soon.

 

  1. VNM- Vietnam index, this is a tough one. I like this play a lot in the long run, but I’m annoyed by  the nature of emerging market ETF’s like this where  local players can anticipate the ETF buys for particular stocks in advance and move the market (increasing the ETF basis);  I’m also cautious about emerging markets in general over the next couple of years.  I think we’ll see a lot of volatility here and will need to buy on dips/ maybe sell on big upswings over the next year or so, hence the HOLD/ WATCHING WITH CAUTION rating.

 

  1. HTZ- Hertz is a fascinating story, not too dissimilar to WTW: incredible overall market demand drivers for the industry but company-specific misteps and under-performance.  If you missed my prior post on Hertz, check it out for more detail on why I’m intrigued, including how Carl Icahn bailed my ass out of the initial trade.  We’re back in now that the stock has plummeted from $31/ share to around $20 share and has removed their CEO.  While there may be some short-term turbulence as they eventually re-state their earnings and name a new permanent CEO, I’m extremely bullish on this stock over the next 12 months.  STRONG BUY.

 

  1. DE, PHM, DNOW, CLNY- I’m going to pull a Bill Simmons and group all these stocks together because (i) I’m lazy and (ii) they all share the similar characteristic of being what I consider relatively safer, industry leading stocks at attractive P/E ratios that I don’t lose any sleep over. We’ll buy on dips but they also aren’t likely to sky-rocket any time soon.  The overall theme is increased importance on agricultural equipment/ farming efficiency, eventual millennial movement towards starting families and moving into new homes, continued energy/ oil industry growth in the US via a Warren Buffet supported spin-off, and attractive risk-adjusted real estate returns via a super smart shop that plays in both debt and equity (including rental residential).

 

  1. WTW- In the last 3 months, Weight Watchers notched a staggering 53% gain from $19.25/ share to $29.42/ share before dropping 13% today despite a healthy earnings and revenue beat (but a 12% reported loss in overall membership). We’ve done well on this stock, and any reader of this blog knows that I’ve been cheer-leading it for over a year (admittedly more in bad times than good).

 

After reading the earnings transcript, the clear strategy set by new CEO Jim Chambers,  and witnessing the measureable improvement of Weight Watcher’s technology presence (app integration with fitbit, iphone6, jawbone, etc.) I remain a steadfast  believer in the stock.

 

The only caveat is that I actually did a little “gonzo investment research” and joined a new weight watchers group through my company to see what the program was like from the inside.  I lasted one meeting- out of the total 18 people in attendance, there were literally 17 women staring down the 1 man with total disdain.  I knew that Weight Watchers was overwhelmingly women, but I never fully appreciated the company’s challenge in attracting men to their onsite meetings until being there in person and feeling the awkwardness.  I was very impressed by the initial Simple Start program and could immediately see the benefit of their group weight loss approach, but I think the programs need to be separated by gender if they ever hope to gain critical mass from the dudes.  They also need a dude sponsor that men can actually relate to: Jonah Hill or Seth Rogan need to get fat again!!

 

-Maverick

Navigating Choppy Waters (in Luxury)

Cruise Line Pic

 

The market is a vengeful mistress. After 8 relatively strong months and a 2014 YTD return of just under 9% through August, the S&P took a wicked left turn, wiping out almost all of that gain over the course of September and early October.

 

It can be hard to remember that a responsible investing time horizon should be measured in years and not weeks or days, especially when headlines of eminent collapse are a daily occurrence. And it’s hard to stomach daily moves when volatility ramps up; no one enjoys losing more than 1% of their wealth in a day unless it involves a really, really good time in Vegas.

 

The good thing about volatility is that it often creates options. If stocks are popping, you can take some off the table, and if they are collapsing, you might pick up a favorite name.  That’s why we always have dry powder available.  If you are all-in from the get go, there’s neither margin for error nor the opportunity to capitalize on bargains.  Being 100% invested in any one thing (including a diversified equity portfolio) is risky business*.

Maverick and I have been discussing the benefit of low oil prices. While energy stocks take a hit, there are plenty of industries in which gas prices are one of their biggest expenses.

I’m looking at Royal Caribbean Cruises (RCL) in particular. While fuel is only ~12% of costs, and the company hedges much of their near term volatility, over the long term, lower oil prices can add a couple points to their margins, driving a large improvement in the bottom line.

In other words, low fuel = bueno.  All things aside, RCL’s stock has tanked in the last month in lockstep with oil prices despite their inverse relationship:

RCL vs OIL

Now I have plenty of issues with the cruise business: They don’t pay taxes because they operate offshore.  Every dollar they make gets dumped back into new ship construction (though RCL is paying out a tidy 2% dividend).  And shareholders rarely see the cash being produced by the business.  For a trade, however, I’m comfortable owning the group, and if we find a down day we might pick up a little for a short term play.

RCL Chart

 

It’s important to note that RCL has also bounced back off its lows the past three days. If the bounce continues, we’ll probably let this one go and wait for the next opportunity.  If not, ATG may be throwing on the flip flops for a quick sea-faring expedition.

-moMANon

*not the good kind with a young Tom Cruise

Spin-offs, Continued… The time is NOW

spin-off pic

 

As discussed in last week’s blog about spin-off opportunities, ATG will be taking a position in a recent spin-off company.  That company is NOW Inc., (ticker DNOW), a $3 billion market cap oil services distribution company based out of Houston that spun-off from the $30 billion market cap National Oilwell Varco (NOV) back in May 2014.

When looking at spin-offs, the first question to ask is this- who’s likely to win from a spin-off… the former parent company or the new spin-off??  While not always a zero-sum game, it’s the question that I suppose separates the men from the boys in the world of special situation investing.  In this case, I have a hard time coming to any strong opinion on the matter- National Oilwell Varco has been one of my favorite personal stocks for a while.  After all, NOV’s long-term dominance in providing equipment and components to all phases of the oil and gas industry has earned them the nickname of “NOV- No Other Vendor”.  Market leader, attractive P/E (10.5), low leverage, good return on equity (12%), solid earnings history… it has virtually all the traits that I covet when owning a stock.

According to the Form 10-12B filed in February, 2014 (Form 10’s are the formal notification documents when public companies intend to issue additional securities via IPO’s, secondary offerings, spin-offs etc.), NOV decided to spin their $3 Billion distribution arm off so that the separate entities could better focus on their particular niche and respective specialties- NOV as a drilling rig parts supplier and DNOW as a supply chain/ distribution provider to the oil and gas industry.

DNOW’s distribution arm has tended to be a lower margin business as compared with NOV’s main operations- by shedding DNOW they can improve their margins in hopes of getting a higher multiple on their stock.  On the flipside, a separate distribution company for DNOW allows them to leverage dominant distribution channels and market product for new suppliers in addition to NOV.

Since the spin-off, both NOV and DNOW have had a similar trajectory, albeit that DNOW has been a tad more volatile, reaching gains north of 25% before dropping to 5% below their spin-off price in light of the recent oil price slide:

NOV vs DNOW 10-2-14

While I have a hard time coming up with reasons to knock the long-term opportunity of NOV, ATG ultimately made the decision to buy DNOW instead of NOV for the following reasons:

  1. Merill Miller, the long-time CEO of NOV primarily responsible for their evolution into the dominant market leader for oil services stepped down from NOV in November 2013 in order to lead and serve as executive chairman of DNOW.

 

  1. DNOW has effectively no debt on its balance sheet despite a well-established, profitable business. There is tremendous opportunity for accessing cheap capital to pursue growth opportunities.

 

  1. As a $3 billion company (vs. NOV at $30 billion), DNOW has a larger runway for long-term growth prospects, particularly given the opportunity for them to market product from new suppliers.

The cyclicality of oil-related businesses and the glut of oil supply in the world today are serious risk factors in the near and medium term, but NOW feels like a good time to pick up a quality spin-off opportunity in DNOW for the long haul…

Maverick

 

 

The “Spin-Off” Play

stock market genius

 

Despite the terrible title, “You Can be a Stock Market Genius” by Joel Greenblatt is on the short list of best investment books out there- probably my favorite. Joel is the founder of Gotham Capital and one of the most influential value and special situation investors around.  I often use his value stock screening website for ideas (www.magicformulainvesting.com) and have been heavily influenced by his investment philosophy and approach to finding opportunities.

In the “Stock Market Genius” book, Joel spends a great deal of time discussing the general investment attraction of spinoff companies, which are companies that break off from larger public companies and operate as a stand-alone public company. A couple of irritating consequences of spin-offs create a source of opportunity in Joel’s view:

  • When people own a company that effects a spinoff, they tend to sell their spinoff company shares because they don’t want to take the time to evaluate a new stock and it’s usually a small position relative to their holdings in the former parent company.

 

  • Large money managers usually don’t focus on spinoffs simply because they are smaller in size and may fall outside of their index parameters.

 

  • Logically a parent company wouldn’t spin off and sell a piece of their business unless it was in their best interests- most investors are very hesitant to buy something that the insiders (who have way more information and insight into the business) are selling.

 

Joel boils it down to the idea that unlike an IPO, spinoffs are designed to give shares in a new company to people who probably don’t even want them, creating an initial negative price pressure on spinoffs that has nothing to do the quality of the company itself.

Now for the generalized bull case on Spinoffs:

  1. Spinoffs often give executives a more direct opportunity to have their personal compensation relate to the success of the company itself. (An example might be if the dude who runs Frito Lay underneath Pepsi was given huge stock options in Frito as potential compensation as part of a spinoff).
  2. Unburdened by a larger corporate environment, spinoffs often can be more nimble in decision making, capital allocation, and growth initiatives.
  3. Parent companies usually retain a decent minority chunk of the spinoff company and have a vested interest in seeing the new company succeed. (Think of it like having a big brother that looks out for you as you start high school).

 

Every situation is unique and must be evaluated in earnest, but I agree with Joel that there are structural elements of spinoffs that have the potential to create outsized returns. His book cites research indicating that from 1963-1988, stocks of spinoff companies outperformed their industry peers and the S&P500 by about 10% per year in their first three years of independence.  In looking how they might have performed as a group relative to the broader index more recently, I pulled up a chart of the Guggenheim Spin-Off ETF (CSD):  Sure enough, the Spin-Off ETF handily beat the S&P 500 return over the past 7 years (about 80% gain vs. 45% for the S&P 500), although it should be noted that the superior performance of the ETF didn’t really start kicking in until 2013:

spinoff

One of ATG’s holdings, White Wave Foods Company (WWAV), is a recent spinoff success story. Since parking from Dean Foods back in May of 2013, they have more than doubled their market cap through strong growth and investor appetite to pay a premium for companies that specialize in the organic food arena.

What’s the POINT of all of this?? A stock pick, of course!   Stay tuned for Part II where we analyze an interesting spinoff that’s a strong contender for the portfolio.

Maverick

 

Another Take on ESV and OZM

Below is moMANon’s response to my last post on ESV and OZM.  Since I wrote my last post praising ESV and questioning OZM, ESV has dropped another 4% and OZM has gained 4%, so I have to give some credit where credit is due (at least for now).  🙂

“The call out is well deserved.  But such a thing demands a response:
  • ESV and oil rigs.  These are very cyclical businesses.  Drilling rates go up, the industry builds more rigs, drilling rates go down, repeat as needed.  The timing of the cycles changes, the upswing can last longer than expected and the downturn can be worse than you planned.  While you earn a nice dividend you need to insure a lot of volatility.  While I too have little idea what will happen to oil prices they need it to rebound so drilling activity picks up and rig rates stop falling.  I too hope we’ve seen the bottom, and will support a Maverick purchase (but still no full position).   There’s still plenty of downside available.
  • OZM.  I’ve been trading around OZM for a while admittedly have position bias.  The downside is all true: performance sucks, management is bribing people, and hedge funds are under fire in the news.  But I don’t think OZM and BX are the same play.  Blackstone is a bull market winner; more deals, more inflows and more asset appreciation.  OZM on the other hand will do well in a flat and choppy economy with lower risk and steady performance.  Don’t get me wrong- I like Blackstone.  It is the benchmark in financial services, and buying a best of breed always seems to work out well.  OZM is a cheap way to play hedge funds, which have had a tough run, but the fees have held up, and the market can always shift to a more hedge fund friendly trajectory.  I like them both.  As long as assets under management keep growing, OZM is a better business going forward then it was yesterday.  For now they keep adding dollars even with the headwinds.  Some performance boost would go a long way but I have not lost faith.  Buy OZM.”
-moMANon

Dealing with Losers

Stocks are Down

 

Overall I’m pretty pleased with the ATG portfolio’s performance since inception 5 months ago.  We’ve stuck to our guns of investing in 8-10 stocks with a patient deployment schedule (we’re still over 50% in cash), taking some gains in response to quick abnormal up-ticks as well as adding to positions on down movements.  For the most part we’ve been able to stay ahead of the major index returns without taking too much risk, carrying responsible diversification without watering down our best ideas, and I believe we’ve done a good job of sticking with the principals of the ATG investment philosophy which I provided in the very first ATG blog post:

  1. Look for companies that are the best or near the best at what they do and have “moat-like” characteristics.

 

  1. Ask yourself if this is a company that you would be willing to invest in for 15 years based on their product, industry, and reputation.

 

  1. Pay close attention to a company’s balance sheet and capital investments.  A High amount of leverage is not necessarily a bad thing, but make sure you believe the company is properly capitalized to execute their business plan and that they adequately invest in growth and development.

 

  1. Once you have identified companies that fit criteria 1-3, filter out the companies that appear to be undervalued relative to their peers and the general market based on factors such as P/E ratio, return on equity, and price to book.

 

  1. Pay more attention to how companies perform and the hard numbers than what their executives say or the guidance they provide.  As an example, I love buying companies that dip on disappointing guidance and profit beats for the current quarter.

 

  1. Once you have picked your investments, track them closely and don’t be afraid to either take gains or cut losses based on the movements of the market.  I don’t necessarily advocate short-term trading, but taking advantage of quick, abnormal movements in specific equities is an advantage the individual investor has over institutional investors and mutual funds.  I truly believe a disciplined active management approach to specific equities can help an investor mitigate the impacts of larger adverse macro movements and help take chips off the table in a bubble environment.

 

Having said all of this, the portfolio has taken a major hit the past month, primarily due to two stocks:  Enseco (ESV) and Och-Ziff (OZM).  Below is a chart showing the performance on these two stocks over the last few months:

ESV, OZM

 

It has been a rocky ride- at one point ATG was actually up over 10% in both stocks before they started their painful descent.

Naturally the question comes down what we should do about it.  There are three choices:

  • sell and move on,
  • double down and buy more, or
  • do nothing and see if comes back. Let’s break it down individually:

Ensco, PLC (ESV).  This is company that owns and operates offshore drilling rigs around the world.  They are generally recognized as one of 2nd or 3rd the largest rig providers and pride themselves as having the newest fleet of rigs amongst their competitors.  Along with all the offshore rig companies, ESV’s stock has been under pressure lately due to concerns about over-supply of rigs through 2016 which could impact their utilization combined with a dramatic drop in oil prices over the past month.  What attracted me to ESV in the first place was their market-leading position combined with a great dividend (6%) and cheap P/E ratio around 9% due to negative buzz on the rigs in general as highlighted below.

I’m not smart enough to know where oil prices are going.  They may continue to lag due to international events and the fracking boom, but history suggests a bounce back up.  As for the company, I don’t see any negative developments- their utilization rates remain high, an impairment of older fleets on their balance sheet is behind them, and I don’t see any financial burden that would leave me to believe that would force them to cut their 6.9% dividend.  At a forward P/E of 7.59, there is plenty of room for slack as supply risk on the rig-side plays out over the next few years.  In fact I see this dynamic playing into ESV’s favor over the long run as competitors are currently discouraged from building new rigs and putting long-lead capital dollars to work.   To put a long story short, we’re doubling down on ESV.

Och-Ziff (OZM).  Och-Ziff is one of the largest alternative asset management firms in the world.  In simple terms, they invest billions of dollars in various vehicles on behalf of large institutional investors and charge both asset management fees and performance fees.  Their recent drop has been due to:

  • Negative publicity surrounding a lawsuit involving bribery and fraud (see moMANon’s prior post detailing the issue);
  • Calpers’ recent announcement (Calpers is the largest pension fund in the country) that they are exiting the hedge fund arena due to excessive fees and monitoring costs and
  • Lackluster fund performance. Through August, their three funds have reported paltry YTD returns of 2.57%, -1.47%, and -4.25%.

Despite all the bad news above, OZM is still making money and attracting fund inflows ($400 million in the last month alone).  Last quarter’s earnings surprised to the upside, there’s excess cash flow to cover their 6.6% dividend, and if they can improve fund performance over the  remainder of the year there could be additional performance fee distributions at the end of the year.  In fact, the consensus forward P/E ratio for OZM is an astounding 6.75, which is less than half of what the overall S&P is valued at currently.

When faced with disappointing stock picks and what action to take, I try to step back and apply the investment principals at the top of this post before making a decision.

In this circumstance it has led me to hold my faith in ESV (passed all 5 criteria) and question whether OZM belongs in the portfolio.  Given OZM’s weak fund performance and negative publicity, I question whether they can sustain their position as a market leading money manager with moat-like characteristics.  There is a decent chance their performance and reputational issues are a temporary blip and this is the perfect time to buy into their stock, but I’m strongly considering pulling the rip-chord and switching them out for a group like Blackstone (BX).

moMANon- speak now or forever hold your peace!

-Maverick