Welcome to the 2CHYP quarterly analytics. Each quarter we analyze our holdings both at a portfolio level and at a company level.
PDF link: 2CHYP 3Q17
For information and analysis on each company within the portfolio, click the links below to open 2 page profiles. Each profile contains our price target, company information and an elevator thesis.
Brandywine Realty Trust (BDN)
Brandywine Realty Trust (BDN) is one of the growthier names in our portfolio with a massive development pipeline. Beyond the increased cap rates that come from development, BDN can capture the synergies of these properties coming online in submarkets where they already have dominant market share. Historically, this has afforded outsized returns from both higher rental rates and lower occupancy costs. Brandywine is also one of the more established names in the portfolio with a long track record and consistent performance. In this case, we are willing to accept the relatively lower current dividend yield in exchange for the value creation potential.
CatchMark Timber (CTT)
CatchMark Timber just increased its acreage in the southeast through a substantial purchase of high quality timberland. The market has responded with a slight rebound in price from the issuance of shares but has not recovered to its former $13. We see this neutral response as inadequate to address the accretion of the deal. Specifically, I think the market is not fully anticipating the synergy benefits that come from the location concentration. Timber sells for somewhere between $8 and $35 per ton depending on the type of wood and quality, so the cost of transporting something that heavy is quite substantial relative to overall revenues. This means that the closest supplier of timber to a mill is going to be the best supplier and the timberland can charge a bit more for their product if there are no other suppliers in a viable radius. CTT already gets above market realizations, but we expect this to increase with the larger market concentration.
CBL Properties (CBL)
Since we have previously detailed our deep value thesis on CBL & Associates, I will instead focus this update on what has changed, or rather what hasn't. With all this talk of retailer bankruptcies and store closures, one might think vacancies have shot up, but the actual statistics show steadiness. The 10/4/17 Wall St. Journal provides updated national retail data with vacancy flat at 10% and asking rental rates up 0.4% quarter over quarter. CBL's numbers show the same thing with stability across the board. It is very easy to get lost in all the media hype, but I would encourage stepping back to consider the actual numbers. CBL's business is difficult at the moment, but still quite profitable. Its market price does not reflect the stability.
Core Civic (CXW)
Core Civic (CXW) flies under the radar of most investors as its fundamentals lie outside the realm of most REITs. Its investor base is further eroded by the politically charged debate of public vs. private prisons. These characteristics have caused CXW to be chronically underfollowed and therefore undervalued. While these problems will likely persist, the superior FFO yield that results will eventually lead to strong returns as long as fundamentals hold up. At 2nd Market Capital, we express no opinions on the political debate of this subject, instead only caring if the stock makes financial sense to own. Since the stock trades at a low FFO multiple and has significant upside through leaseup potential, we think it is worth a moderate position size.
Global Net Lease (GNL)
Our investment thesis on Global Net Lease (GNL) has not changed because its fundamentals have not changed. This is how it should be with an NNN REIT. The properties cashflow and they use those cashflows to pay investors a big dividend. We anticipate this being the case for the foreseeable future as GNL has a roughly 10 year average remaining lease term with high quality tenants. It is not exciting and it is not supposed to be.
Valuation has changed a bit in that GNL has gotten even cheaper relative to its peers. I believe this pricing is related to an enduring stigma from its affiliation with ARCP, but as far as I can tell this will have no bearing on fundamental performance.
Gramercy Property Trust (GPT)
Gramercy Property Trust (GPT) has successfully transitioned from a mixed portfolio of office and industrial of varying quality to a mostly industrial portfolio of institutional quality. In the process, it has picked up investors from the REIT mafia which has afforded a higher trading multiple and solid total returns to investors who have been long. Even with the price appreciation, it is still discounted to industrial peers so there could be a bit more room for upside. That being said, GPT is one of the REITs on our chopping block if we need to free up capital for another holding. Quite simply, the price appreciation has taken it closer to fair value than where most of our other REITs sit.
NexPoint Residential Trust (NXRT)
NexPoint Residential Trust (NXRT) has freshly re-entered the portfolio due to a recent pricing stumble related to surprise weakness in the 2nd Quarter numbers. This tax issue appears to be 1 time in nature and potentially recoverable, so we do not think it presents a serious impediment to what is otherwise an impressive growth story. At a property level, NXRT's performance is among the best as its refurbishments have resulted in significant rate increases. More recently, NXRT was able to go full cycle on refurbished properties, disposing of the assets at profit margins around 60% by my calculations. The proceeds were already placed into other assets through a reverse 1031 exchange and we anticipate a similar value-add approach to the new properties.
Jernigan Capital (JCAP)
We have already discussed Jernigan Capital (JCAP) extensively, so rather than rehashing, let us cover a more inside scoop. Highland Capital has expressed a vote of confidence in JCAP through its 100% ownership of the preferred which will expand to a minimum of $50mm by the end of 2018. We know Highland Capital through Matt Mcgraner and Brian Mitts who are guys that run NXRT. Admittedly, mREITs are a bit outside our wheelhouse as the cashflows are a bit murkier than the contractual cashflows of equity REITs. So while we like the valuation and business model of JCAP, there have always been larger error bars around our estimates than we would typically have. The Highland Capital guys are quite adept at what they do, so we feel a bit more comfortable holding the stock with their vote of confidence.
Kite Realty Group (KRG)
It is rare to find a disparity of the magnitude of that between Kite Realty's fundamentals and the narrative surrounding it. KRG is growing at a solid clip at both the property level and the REIT level, but its market price only reflects the doom and gloom of the death of retail. I don't think the entrance of Amazon into the grocery space is going to have a material impact on KRG. People like to see their food before they buy it. Through an online purchase, how does one test the ripeness of a banana or pick out the milk in the back that has not been oxidized by the light?
The grocery anchors of KRG should help to bring foot traffic to the rest of the shopping centers, making the portfolio more resistant than average to e-commerce. This has so far been reflected in the excellent quarterly numbers and we have seen no signs of abatement.
Sotherly Hotels (SOHO)
Our SOHO thesis is quite straight forward as it is just a deep value play. The double implied by our target price of $12 may seem outrageous, but that is our honest assessment of NAV. Hotel cap rates vary from maybe the mid 5% range for trophy assets to 9% or even 10% for junky assets. SOHO's assets are well above national average in terms of RevPAR and are in many cases the premier hotel of their submarket. These assets are not trophies, but they are historic and well respected. Ask anyone in Savannah what the DeSoto is and they will know the property. The Whitehall is the first 5 star hotel in Houston and the Georgian Terrace stands as the centerpiece for downtown Atlanta. Given the property quality and name recognition, I would propose a 7.5%-8% cap rate which results in an NAV of above $12.
STAG industrial (STAG)
STAG has been a consistent performer and earned a reputation as a well-run REIT. It started with an unproven business model and was viewed as risky. Now, it is considered to be one of the best industrial REITs and it has made significant money for many people in its run up from low double digits to around $28. With a vastly expanded property portfolio, STAG is well diversified. Talk has shifted from STAG's risk to STAG's valuation with some saying it is getting expensive. As a value investor, I too am leery of valuations after such a large increase in market price, but in this case, I think STAG sill has a bit of runway. While not as cheap as it used to be it is still among the cheapest in the industrial sector. I would not mind trimming it at these prices if a strong replacement opportunity comes along, but I am in no hurry to exit STAG.
Plymouth Industrial (PLYM)
PLYM is perhaps one of our more controversial stocks as there is significant fundamental risk here. PLYM operates at quite high leverage with debt to capital in the mid 70% range after accounting for the new preferred. Its business model is even more aggressive than STAG's as PLYM is going for B assets with very short remaining lease terms. They consider themselves operators with an aim to re-lease properties at a substantial markup to existing rent. The dividend is depending on their ability to execute this as current FFO does not cover the yield. We deem their success likely for 2 main reasons: 1) they are the only major operator in the space which gives them a competitive advantage, and 2) industrial fundamentals are so strong right now that there are significant re-leasing tailwinds. If they succeed, PLYM could be the best performer in the industrial sector.
UMH Properties (UMH)
Manufactured housing REITs are the top growing REIT sector in terms of AFFO/share growth. Equity Lifestyles (ELS) just reported 3Q numbers which looked quite strong, indicating the sector will continue its streak of performance. The problem is that ELS and Sun Communities are simply too expensive. Current pricing is already accounting for rapid growth rates. UMH Properties has access to the same manufactured housing fundamentals but without the price tag. It is a rapid growth REIT at a middle of the pack valuation. Through the continued expansion of its renting program as well as the use of excess land, UMH is positioned to grow at a fast pace for the next 5 years. There is some risk here as the rust belt geographic focus requires the economy to remain tepid or better, but in my opinion, the weighted average outcome is far better than indicated by UMH's market price.
Uniti Group (UNIT)
Uniti Group (UNIT) can be considered the hipster REIT because it started buying fiber before it was cool. Back in the day, UNIT was the only REIT with significant fiber holdings, but now others are following suit with CCI making large fiber acquisitions. As more parties get interested in the asset, the value increases so we think UNIT's assets are worth more, not less. Originally the idea was that the rollout of 5G would greatly increase the demand for fiber assets allowing existing fiber to have additional revenue streams. Uniti's fiber is only partially utilized, with capacity to take on more data load. This story remains fully intact, but unfortunately, it has been lost in market chatter which obfuscates the underlying fundamentals. With the Windstream legal stuff going on, everyone is focused on the next development rather than the bigger picture. Simply put, UNIT's assets are quite valuable and can generate enough cashflows to sustain its 15+% dividend whether or not WIN survives. The outcome of WIN may cause some bumps in the road for UNIT's market price, so holders should be prepared for capital loss, but if my analysis is correct, the long run looks much prettier.
Washington Prime Group (WPG)
Washington Prime Group is battling a challenging fundamental environment as are most of its peers. We are bullish on retail generally as I think the headwinds are fully or more than fully priced in, but I still prefer to pick and choose the best of retail. While some retail REITs are getting caught up in what wall street wants which is overly focused on sales per square foot, WPG is taking a more functional approach. They analyze their assets case by case and take action appropriately. In some cases it makes sense to keep the low sales per square foot asset due to its profitablity and in others it makes sense to sell the high sales per square foot asset due to the price it can fetch in the market. This rational approach, in my opinion, will help WPG maximize value and come out of this challenging environment with strong FFO.