I don’t often go to the mall. I tend to avoid them like the plague. But that’s nothing new. I will dislike the mall no more post-coronavirus than I did before.
I’m not alone. Americans are doing more and more of their shopping online. The coronavirus outbreak didn’t cause this shift, but it certainly helped to accelerate it. Once you get used to having packages magically appear on your doorstep, driving to a store feels cumbersome and inconvenient.
So, a lot of the market share gains by Amazon.com Inc. (AMZN) and others will likely be permanent once this is over.
Americans like their space, and our cities are less densely populated. So, it makes sense that we have a lot more square footage. But five times more?
But you can’t buy everything online, nor would you want to. We still need stores for showrooms and for services. I can’t order a haircut or a tooth filling from Amazon, after all.
But at the margin, this means less demand for malls and for big-box retail properties. I mentioned over the weekend that I liked REITs at current prices. But I’m sticking with high-traffic retail like convenience stores and pharmacies and steering clear of malls.
I also have no plans to buy the dip in department store stocks. Best in class department stores like Nordstrom (JWN) will survive and thrive, even if it takes them a while to recover.
But there were plenty of retailers that barely escaped the last recession intact, and it’s hard to see them surviving this one. I think it’s safe to assume JC Penny (JCP) is toast. It’s hard to believe, but Sears still has nearly 200 open stores. It’s hard to see those surviving. Research site Macroaxis puts the probability of Dillard’s (DDS) coming under financial distress at about 27% and Kohl’s (KSS) at 42%. But this was based on company data before the coronavirus crisis hit. You can bet those numbers will look bigger once new quarterly data comes in.
To say the coronavirus bear market has been hard on REITs would be an understatement. While the S&P 500 was down about 35% at its lowest point (thus far), the Vanguard Real Estate Index Fund (VNQ) was down 44%. And the damage in many individual REITs was far worse.
As an example, triple-net retail REIT VEREIT (VER) dropped 65%.
REIT prices should be lower. The next two quarters promise to be an unmitigated disaster for REIT earnings. Recessions have come and gone. But we’ve never had a situation where large swaths of the economy were shut down, virtually instantly, in an otherwise healthy economy. The shear strangeness of the entire exercise and the fact that there is no obvious end to it add to the difficulty of assessing the damage.
And as damaging as it would be to investor confidence, several REITs — including VEREIT — may end up having to reduce or eliminate their dividends, at least for a couple quarters. If tenants cannot continue making payments, eventually the REITs will have a hard time continuing to pay their investors.
All of that said, a 65% drop in the share price suggests more than an awful quarter or two. A decline of that nature in an otherwise boring and stodgy company suggests the property values are impaired and that rental revenues will be permanently lower.
For some REITs, that might very well be true. Mall properties were a tough sell even before the coronavirus scare, and they haven’t somehow become more attractive over the past six weeks. Even the office market might have long-term or permanent damage to demand as companies have been forced to make working from home feasible. Most work will return to an office setting once the dust settles. But some likely will not.
It’s harder to make that case for restaurants and high-traffic retail properties like the ones VEREIT owns. When your typical tenant is a dollar store, a pharmacy or a gym it’s pretty safe to assume your properties will still be in demand once life returns to normal. Tenants might skip a payment or two. But longer-term damage is unlikely.
A Look at the Portfolio
VEREIT has a portfolio of nearly 4,000 properties, the largest consisting of retail properties. It’s the 21% allocated to restaurants that seems to have Wall Street the most worried.
VEREIT’s largest single tenant is Red Lobster at 4.7%. Red Lobster is a junk-rated tenant that looked somewhat shaky even before the coronavirus panic. It certainly looks no less shaky now. Most Red Lobster locations are operating as carry-out only in response to stay-at-home orders. We have no visibility as to what sales or profits will look like, but we can assume it’s not good.
Digging deeper into the restaurant portfolio, the numbers are a mixed bag. Only 3.3% are rated investment grade. Rent coverage as of year end was good enough at 2.63 times. (Rent coverage defined as (EBITDA + rent) / rent.) Of course, those numbers are now meaningless until we see guidance coming out of the restaurant sector.
Rents collected from restaurants don’t go to zero. But it’s safe to assume that some — and maybe a large portion — of the rents get reduced or deferred over the next several months.
I’m a lot less concerned about the rest of the portfolio. Apart from Red Lobster and perhaps LA Fitness, the remaining top-10 tenants would seem relatively immune from disruption.
44.2% of VEREIT’s rents come from retail businesses (apart from restaurants). There will be rent deferrals and concession here, particularly in the 3.3% in entertainment properties, the 2.9% in home furnishing, and the 2.4% in auto-related tenants. But assuming stores are allowed to reopen within the next month, the long-term damage to this segment of the population would seem pretty minimal.
Office and Industrial properties make up 18.6% and 16.5% of rents, respectively. These segments will not be free of disruption, of course, and there may be a few tenants that get in financial trouble. But I’m not expecting much in the way of coronavirus-related rent deferrals or reductions here.
VEREIT’s risk mainly comes down to its restaurant portfolio and to how long the world remains locked down.
VEREIT Price/Book Ratio
After the share price swoon, VEREIT trades at a price/book ratio of 0.68. Now, REITs generally have understated price/book ratios as the value of their real estate portfolio isn’t regularly marked to market and is actually reduced by depreciation. But just for giggles, let’s assume assume that book value is a reasonable estimate for the value of VEREIT’s portfolio.
At current prices, you could write off the entire restaurant portfolio, giving it a value of zero, and VEREIT would still be worth more dead than alive, trading at a price.book ratio of less than 1.
Obviously, the restaurant portfolio is worth more than zero. Most of the restaurants are likely to continue business as usual and won’t miss as much as a single rent payment. But even if Red Lobster and a large minority of its restaurant tenants were to come under severe stress, VEREIT’s share price would seem ridiculously low.
What About Cash Flow?
We’re stabbing in the dark here. We don’t have great numbers to play with. But let’s say restaurant rentals go to zero in the second quarter and then recover to 70% in the third and fourth quarters. That’s obviously extreme and isn’t a realistic scenario. But, frankly, we’re all under quarantine and have nothing else to do, so humor me.
VEREIT had rental revenues of $1.2 billion last year, of which approximately $240 million came from restaurants. We’ll chop $60 million off for the second quarter and $18 million each for the third and fourth quarters. That reduces full year rental income to something in the ballpark of $1.1 billion.
Chopping ~$100 million off of adjusted funds from operations gets us something in the ballpark of $600 million for the year. That’s slightly below the $665 million paid last year in dividends on the preferred and common stock. But we’re also assuming that restaurant rental income literally goes to zero, which it won’t.
VEREIT also had approximately $1.35 billion available on its revolving credit facility that it could presumably tap as a short-term fix.
I’m playing fast and loose with the numbers here because, frankly, it’s an exercise in futility to try to be exact given the degree of uncertainty faced. But it’s fair to say that VEREIT isn’t facing insolvency even under very negative scenarios. I think it is possible they could reduce or delay their dividend for a couple quarters as an abundance of caution. But I don’t think they’ll necessarily need to.
Sentiment towards REITs is awful right now, and further declines can’t be ruled out. But if you have a time horizon of even a year or two, this would seem to be a good opportunity to accumulate shares.
REITs are normally a quiet corner of the market. Because they tend to pay high dividends, they’re a favorite of income-starved retirees.
Well, I’m not speaking in hyperbole when I say they got their heads bashed in last month. The Vanguard Real Estate Index ETF (VNQ), a popular way to track the sector as a whole, was down 44% at the lows. That’s bad, but individual stories get so much worse.
Consider Realty Income (O). This is as close to a bond as you can get in the stock market. The REIT owns a collection of high-traffic retail properties – things like pharmacies and convenience stores. There is nothing interesting or sexy about Realty Income or its properties, and that’s exactly the point. Its investors love the stock precisely because it’s boring and gives them no drama.
Realty Income — boring, stodgy, fuddy-duddy Realty Income — was down 55% at one point and is still down close to 50%.
This is a stock that has raised its dividend for the past 90 consecutive quarters — 23 years and counting — and sailed through the 2008 meltdown. And its shares were down by more than half.
I don’t expect widespread bankruptcies or long-term impairment across the REIT sector. Sure, some of the smaller, weaker players could fail, and I’d probably stay away from mall REITs given that malls were already in bad shape even before this crisis struck. I also believe a lot of these companies could end up having to cut their dividends, at least temporarily, if their tenants are unable to pay for a few months.
But the key here is temporarily. High-quality real estate that was in demand before the coronavirus blow-up will still be in demand a year from now.
If you’ve been waiting for your chance to snap up real estate at 2008-caliber prices, this is it. I don’t expect this volatility to disappear in a day, but if you’re willing to stomach it, you can buy a basket of solid REITs at prices we may never see again in our lifetimes.
Here’s a fun article by my colleague Bill Washinski to take your mind off of the coronavirus crisis for a while. Enjoy! — Charles
When Star Trek the Next Generation (“TNG”) first came on the air in 1987, it had high hopes and big shoes to fill from the original Star Trek. It also had a lot of detractors and even Sir Patrick Stewart refused to unpack as he doubted the show’s future. 15 years later it ended after 7 seasons, 18 Emmys and 4 feature films and spawned several spinoffs of its own. It also created one of the greatest villains of all time in the Borg with their memorable phrase “Resistance is futile.”
The legacy of Star Trek TNG is very much alive and well; perhaps even more so as much of the technology that was science fiction at the time the show was created actually exists today. Resistance to that change is definitely futile as it has had dramatic effect on industry and peoples lives. It continues to move fast – driving some areas of the economy skyward while others are forced to adapt or are “assimilated”.
8 Things From Star Trek You’re Using Today
8. Drones – In the first season episode “Arsenal of Freedom” the crew was attacked by an advanced weapon that was small in size but deadly in nature. Today, not only does the military utilize drones of the same size, but you can go to Amazon or Walmart and purchase one for your children.
7. iPad/Notebooks – Throughout the shows run, characters used a mobile computing device known as PADDs (Personal Access Display Devices) that bears a striking resemblance to the well-known Apple product These generally small, rectangular-shaped devices comprised largely of a screen allowed their users to take advantage of wireless computer networking as well as reading messages/books/schematics, recording logs, audio playback, writing of messages and even communicating with other PADDs. Rather astonishingly, the idea of the smooth, portable computing device was the result of imagination since the budget did not allow for switches, knobs or buttons – which leads us to the next item on the list.
6. Touchscreen – Not only did the PADD and iPad both make the use of touchscreen, but every computing terminal featured a touch-based interface. This has expanded to other computing terminals; the most common being your own laptop computer. There is much greater ease in taking online tests or placing orders. Even your car – your ability to operate the radio, answer a call or operate your A/C with a touch of a screen. Hard to believe 30 years ago, people wanting to listen to music would use a knob to find the frequency and a button to lock it in.
5. Smart Phones – The similarities of the flip phone to the original Star Trek communicator have long been observed. Consider now the similarities to the Tricorder to your smart phone – a handheld device that was used in data analysis, data sensing, recording and other multi-functional uses. Each day, we literally carry a mini-computer every day with accessibility to apps that can track everything from gathering biometrics, scanning the environment around you with GPS to get a picture of the building your are trying to find and see active weather patterns. And the irony of the math teacher saying you won’t be able to use a calculator when you grow up wasn’t exactly an accurate prediction.
4. Teleconferencing – Watching Captain Picard talking to Admirals in his ready room over a laptop sized device face-to-face became routine, but the ease of doing it now is amazingly simple. Through a series of methods like Webex or Zoom with webcams to conduct meetings or just using your Facetime to make a call and talk face to face on personal level, it happens you can be sure that it happens every day. Just make sure you use a secure channel when talking about sensitive topics!
3. The Cloud/Wireless Interface – How many times did Lt. Commander Data link up with a computer system from another planet to access their database while trying to solve the episodes mystery? It seemed very convenient, but with approved access, the ability to access that type of information has become ordinary – and not just granting access to another individual computer over the network, but to access the entire network and share files, make authorized changes and see your co-workers project progress is extremely commonplace and it’s even more so today and can maintain longer history (we all know the feeling of lost files and pictures when our old hard drive crashed and we didn’t back it up on an external device.)
2. AI/Artificial Intelligence– AI is definitely not an exclusive domain to Star Trek TNG, even existing in the original series. While we do not have fully functioning Androids like Lt. Commander Data – when I tell people that right now there are 150 self-driving trucks hauling to and from distribution centers there is usually a look of surprise. The concept of the autonomous car is familiar to most and while it’s not on the market yet, features of parallel parking, sensing impediments ahead and setting alerts when drifting lanes are becoming common in newer model cars. That doesn’t even begin to mention the assistants on our tricorders/smartphones like Siri/Google to ask questions is very reminiscent of accessing a database of information whether you are speaking to Data or if Captain Picard requested information from the computer; leading us to #1:
1. Voice Command Interface – This was one I had a hard time believing, but it’s amazing how Captain Picard could simply say “Computer, locate Commander Riker” or Data verbally requesting the computer for specific information or extrapolating a hypothesis. I can walk in the house and request lights be turned on or the oven to pre-heat. I even have a friend who configured his device to register as “Computer” so he can literally say “Computer, turn off living room TV” just because of his love for Star Trek. While you cannot yet expect to pick up your iPhone and ask Siri to extrapolate a theory, but you can have searches done and verbal answers to what is programmed in – but you can easily have functions performed and searches conducted.
One thing that Star Trek TNG has not accomplished: Economy using no Money
I always wondered how you could construct the Enterprise in a society that doesn’t use money – getting the raw materials just to construct it would be an enormous task. Of course, they did have Replicators that could materialize on command whatever was needed, be it a phase coupler or chicken sandwich and coffee. However, you come back to the paradox of who would design, build, program, test and maintain that device? It would obviously take years of learning and studying it’s a bit of a stretch to believe individuals would take that on without the incentive of greater financial gains and security. It would be a bit risky to work in space to build the ship – call me crazy but I would think you’d want to be compensated for that risk!
So until that paradox is solved, we can look at the advancement of the last 10 years in the DOW and the NASDAQ – while there are still investors and still people working on these projects it will matter – and Star Trek TNG will have to leave that question unanswered.
Macquarie Infrastructure (MIC) eliminated its dividend yesterday, sending the shares down sharply today. The shares closed down 24% at $18.25.
Interestingly, even after the post-dividend-cut run for the exits, the shares are still 46% above their March panic lows.
While I’m disappointed to see MIC slash the dividend, I understand their reasoning for doing so. No one knows how long quarantine conditions will last or how long it will be until life returns to something resembling normal. Hoarding cash isn’t an irrational strategy here.
Last month I did a quick and dirty look at Macquarie Infrastructure, noting that “The biggest risk to MIC shareholders is that the dividend gets reduced or eliminated for a couple quarters. That happened during the 2008 meltdown, and it could easily happen again. But the underlying infrastructure assets are solid and, once life more or less returns to normal, will be back in demand.”
I noted that even if the company’s aviation business went to zero — which is ridiculous — the stock was still worth at least $22 per share. That hasn’t changed post dividend. Adding any sensible value for its other businesses gets you a conservative value north of $40 per share.
At any rate, Jeff Middleswart of Behind the Numbers published a report on MIC drawing similar conclusions. Some of Jeff’s conclusions:
We initiate coverage of MIC with a BUY recommendation as we continue looking for more potential bargains from the sell-off wreckage. This is an infrastructure company that normally has very stable to growing cash flows, but it will be impacted by coronavirus in two of the three units. MIC has also been looking to unlock shareholder value by selling the entire company as a whole or in pieces. We believe the two units hurt by coronavirus will recover and trade on the normalized results. We believe the sum of the parts could be $43-$49 per share vs. the current price that is bouncing around the high teens to $22…
There are two issues looking at the dividend in the short-term. First, the company is in the middle of its heaviest year of planned growth capital spending. It was already planning to boost its net leverage by spending cash on hand to offset the impact of that growth investment. Second, the company wants to keep leverage under 4.5x EBITDA. The operating units were forecast to grow EBITDA and 1Q was shaping up well to offset net leverage rising via lower cash levels. Now, as 2Q and 3Q are impacted by the economy being turned off – not only is net debt increasing, EBITDA will be falling and driving up the ratio much faster. Retaining cash from the dividend offsets that problem.
We believe MIC will restore a smaller dividend later this year.
Behind the Numbers, April 3, 2020
Charles here. I agree that the company should be able to reinstate its dividend later this year. I also think it’s very possible they will opt to retain the cash instead since they are planning to sell the assets anyway to unlock value.
Either way, it’s not unreasonable to expect the shares to double from current levels and likely do a lot better than that. These are real assets supported by real cash flows. The economy doesn’t go to zero. This panic will end, whether that day comes in weeks or (more likely at this point) months. And when it does, cash flowing infrastructure assets will start to look good again.
The following is an excerpt from a piece first published on Money & Markets.
I’m the first to admit I don’t know what happens next to stock prices. You could make a credible case that, while the economy might be in for its worst recession since the 1930’s Great Depression, the S&P 500 could hit new all-time highs by year’s end due to the flood of Fed stimulus coming down the pipe. That’s not a crazy statement.
But you could also credibly argue that the market should take another major leg down, as buybacks will be off limits for large swaths of the market for the foreseeable future and earnings promise to be awful.
Rather than try to guess — and let’s face it, it’s a guess — let’s instead take a look at what the insiders actually running America’s largest companies are doing.
Company executives and board directors aren’t geniuses. They’re regular people like you and me. They do, however, generally have a pretty good grasp of when their company shares are undervalued. While not necessarily market timers, they tend to be pretty good value investors. And to say they saw value in March would be an understatement.
There is no disputing that the coronavirus is a social and economic catastrophe—as many as 47 million Americans could lose their jobs amid a crash some experts fear could rival the Great Depression. But like any crisis throughout history, some people are cashing in.
“In a nutshell, if people are able to use a company’s products or services from their home, then this is a field day for these companies,” Charles Lewis Sizemore, a Dallas-based investment advisor, told VICE over the phone from Peru, where he was stranded due to the country’s airports shutting down because of coronavirus. “Not only are those companies not affected, they actually benefit.”
Among others, we discussed the prospects for Campbell’s Soup and DocuSign. In one case, the benefits are likely to be fleeting. In the other, more or less permanent.:
With millions of people working from home, a company that lets you sign documents without leaving your front door or having to interact with people seems poised for massive gains. “Something like DocuSign is fantastic because it allows business to go on as usual,” Sizemore said. The company’s revenue is up 38 percent since last year and may keep growing even as the pandemic wanes. “Are you going to want to go back to printing out paper and signing it and Fedexing it?” he said. “That doesn’t really make a lot of sense.”
This company falls into the “unexpected windfall” category. A year ago, Campbell Soup posted a quarterly net loss of $59 million, in part caused by the longer-term trend of people wanting to eat fresh food instead of canned meals. But with all the panic-buying, hoarding and stocking up taking place because of COVID-19, the company’s fortunes are temporarily turning around, resulting in it recently posting net income of $1.2 million in its most recent earnings report. This is probably just a one-time bump, however. “When life gets back to normal we’re not going to be eating canned goods in our houses anymore,” Sizemore said.
As I sit down to write this, my pick in InvestorPlace.com’s Best Stocks for 2020 contest — pipeline giant Energy Transfer (NYSE:ET) — is smack-dab in last place and nursing losses of over 60%.
I’m not too thrilled about that, as you might imagine. But we’ve been here before.
In the Best Stocks for 2016 contest, Energy Transfer was my pick. It struggled at first, and toward the end of the first quarter I was down more than 70%.
But then, a funny thing happened. The stock finally hit bottom and proceeded to rocket higher. I finished the year with a 53% return.
Now, history never repeats itself exactly. I have no idea if ET stock is going to mount an epic rally over the next nine months of 2020. But I know that, given the stock’s valuation, it very easily could.
I’ll spare you yet another “Business Continuity Plan” email. You’ve no doubt gotten dozens of those by know from everyone from your banker to the local donut shop. You don’t need another one from me.
That said, the Covid-19 lockdowns have been an interesting experience in seeing an business continuity plan in action. It’s nice to know your plan actually worked when it needed to.
All About the Cloud
I moved all of Sizemore Capital’s critical functions to the cloud at firm inception. I was using the cloud before “the cloud” even existed as an expression. I simply couldn’t imagine running a company any other way.
Sizemore Capital was founded in 2008, and from day one all critical files were archived online. Today, I don’t archive online. The active files actually live online via Microsoft’s business version of OneDrive.
I can access my files from any computer in the world with an internet connection. If my hardware conked out on me today, I could have a new computer expressed delivered to me and be back in business in short order. Or, if that wasn’t possible due to coronavirus delays, I could even run the company for extended periods of time from my phone. It’s not ideal. But I could do it.
We’ve been calling clients, trading client accounts, meeting redemptions, wiring funds and doing all of the things you expect money managers to do… uninterrupted.
Communication With Key Personnel
As I write this, I’m stuck on a ranch in rural Peru and likely will be for another couple weeks. I was in Peru prospecting when all hell broke loose and they shut the country down. The airport is closed until after Easter.
It’s barely slowed me down. I’ve had minimal service interruptions and have been able to carry on remotely more or less as if nothing had happened.
My partners are geographically spread out. One is in Dallas, one is in Houston, one is in San Francisco and one is in Lima, Peru. We’re accustomed to communicating remotely, so this hasn’t been much of an adjustment.
I find face to face meetings to be a lot more valuable and productive. But if I get stuck on the ranch for months and my partners are stuck in their respective locations for months, we can keep this up. Indefinitely.
I haven’t had access to my office for a few weeks, and I know I have a few undeposited checks sitting in the office mailbox. It may be a while until I’m able to deposit those. But I would emphasize that those are not client checks. Client funds are deposited directly with the custodians we use, and that service has not been interrupted.
So, the worst that has happened is that I have been unable to pay myself a handful of checks.
I don’t have a lot of sympathy for firms that weren’t ready for this. Sure, few people saw coronavirus happening. I certainly didn’t. But it doesn’t matter. Look at the natural disasters that seem to be happening every other day: hurricanes, floods, tornados, etc.
If you weren’t already prepared for widespread business disruptions… what exactly were you waiting for? The tools have been around for over a decade now.
Clearly, there are industries that simply couldn’t prepare for this. If you’re a barber, a dentist, a bartender, a dry cleaner or another number of other professions that require face to face contact, there was really nothing you could do about this. Zoom and Skype aren’t particularly useful in these cases.
But to paraphrase an old Warren Buffett quote, now that the tide has gone out, it’s time to see who was swimming naked.