Piggy bank in glasses, investment and saving concept
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In the world of investing, sometimes the hardest thing to do is to ‘not’ follow the herd. While that sounds easy, most investors seem to buy or sell stocks when the majority of them are stampeding to the trading desk.
Ultimately, it’s the smart investors who buy or sell at the most opportunistic time, or as Warren Buffett explained
“Be fearful when others are greedy and be greedy when others are fearful.”
Whenever I see quality stock on sale, I react by examining the reasons for the bargain. I first try to determine the catalysts for the price reduction, with a critical eye on dividend safety, as I ask myself,
“are the sources of income sustainable?”
“what are the competitive advantages?”
“can the dividend keep growing?”
“is the management team performing to expectations?”
“what is the intrinsic value of the company?”
If these questions can be answered to my satisfaction, I then examine the valuation of the shares, with an emphasis on earnings sustainability and dividend safety. The company must enjoy a superior moat and the most important test is that the company must have a wide margin of safety. Ben Graham famously wrote,
“You are neither right nor wrong because the crowd disagrees with you. You are right because the data and reasoning are right.”
In December 2018 I decided to upgrade shares in Essential Properties (EPRT) to a Strong Buy. After carefully researching the company, I determined that the shares were trading at a wide margin of safety and that there was potential for significant price appreciation.
Since that time, shares in EPRT have returned over 100 percent (in less than one year), illustrating the fact that it’s the value investor’s purpose is to capitalize upon “a favorable difference between price on the one hand and indicated or appraised value on the other.”
3 Strong Buys
My first Strong Buy is Tanger Outlets (SKT), a REIT that has returned -13 percent in 2019. Keep in mind, all mall REITs have underperformed this year, due to continued store closures; however, Tanger is best-positioned to manage through the cycle by maintaining strict discipline.
Tanger has been able to maintain strong occupancy that has never dropped below 95% in more than 25 years. In Q3-19, Tanger’s consolidated portfolio occupancy rate was 95.9% compared to 96% in Q2-19 and 96.4% in Q3-18.
Also, Tanger has a strong balance sheet that includes an unused $600 million credit line and 94% of consolidated square footage unencumbered by mortgages. The company maintains strong leverage metrics such as 4.3x interest coverage and 5.8x net debt to EBITDA, and also maintains investment grade ratings of BBB and Baa1 from S&P and Moody’s.
As referenced previously, dividend safety is important to the Strong Buy rating, and Tanger has an enviable record of paying and increasing dividends for over 25 years in a row. And after dividend payments, Tanger has just under $100 million of free cash flow which means that the payout ratio is healthy (around 71% as of Q3-19).
Shares now trade at $16.27 with a dividend yield of 8.73%. Based on out Strong Buy rating, we believe that the shares could generate annual returns of 25 percent.
The next Strong Buy pick is Park Hotels & Resorts (PK) that has returned -6.7 percent year-to-date. This REIT is now the second-largest lodging REIT (behind Host Hotels) and is among the Top 25 Largest REITs in the US.
Park’s portfolio includes 66 hotels in 17 states and D.C. with an enterprise value of around $9.6 billion and the company focuses on owning hotels and resorts in the Luxury and Upper Upscale segments, with brads such as Hilton, Marriott, and Starwood.
Like Tanger, Park also maintains a disciplined risk management profile with 50 unencumbered hotels (or 62% of Adjusted EBITDA) with a targeted leverage ratio of 3x – 5x. (Note: The Chesapeake deal results in a modest increase in leverage with net debt to adjusted EBITDA increasing to 4.6x from 3.9x).
Park and its JV partner recently sold their interests the 192-room Conrad Dublin hotel located in Dublin, Ireland, for €116.4M. The gross proceeds equate to ~$128M ($667K per key) and Park’s share of the gross proceeds is $61 million. The sale price represents a 3.9% capitalization rate on the hotel’s projected 2019 NOI.
Park continues to utilize an active capital recycling program, expanding presence in target markets, with a focus on br
and and operator diversification, while also reducing exposure to slower growth markets. Capital recycling (i.e. Conrad in Dublin) further reduces leverage and provides adequate liquidity (around $1.2 billion).
Park’s dividend is well-covered and ranks as one of the safest in the Lodging REIT sector (around 70 percent) and the company plans to reduce leverage by selling around $550 million of assets over the next six months. Shares now trade at $22.62 with a dividend yield of 7.97 percent.
The final Strong Buy pick is Iron Mountain (IRM), a storage REIT that focuses on records and information management, as well as data management, data centers, and secure shredding services. This REIT is one of the most diversified as evidenced by the more than 225,000 organizations around the world that utilize its services.
The company recently said it was reducing its staff in a restructuring known as “Project Summit”. The company said it plans to combine its core records and information management (or RIM) operations under a single global leader to eliminate “unnecessary work in rebalancing resources.” By streamlining its support structure (condensing layers by reducing VP-level positions by ~45%) Iron Mountain is set to eliminate ~700 positions.
Project Summit will begin in the fourth quarter (of 2019) and should be substantially completed by the end of 2021. The cost is estimated to be ~$240 million and is supposed to deliver $200 million in annual run rate adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) benefits by the end of 2021.
We view this news as a positive (and much needed) catalyst for Iron Mountain and if the plan is executed, we target 9.5 percent of adjusted EBITDA in 2020 (4% expected growth and 5.5% related to Project Summit). This also means that the company should generate more free cash flow to deleverage, with plans to get leverage down to 4.5x to 5x overtime.
Iron Mountain’s shares now trade at $33.58 with a dividend yield of 7.37 percent (the payout ratio based on AFFO is 82 percent).
I own shares in SKT, PK, and IRM.