Thursday, March 26, 2020

What I've Been Buying, Coronavirus Edition

I hope everyone is staying safe and healthy, but if you're interested, here are some thoughts on a few current positions where I've added in recent weeks, some I've bought above where we're trading today, some below.  I probably started averaging down in some of these too soon, eaten some humble pie and have slowed my activity down significantly.  I assume we'll have more opportunities as it'll take awhile for the new economic reality to work its way through our system, credit agreements will need to be amended, etc.  There will be pot holes and bankruptcies, one change from recent years is we're likely to start to see bankruptcy reorgs that are the "good business, bad balance sheet" type that have been rare lately.  Things will likely get worse, so treat this more as a watchlist than a buylist.

Howard Hughes Corporation (HHC)
I'm a long time HHC bull, my pride is hurting here at the moment, 4 of 5 of HHC's primary markets have significant near term challenges: 1) NYC is front and center of the pandemic in the U.S., likely further pushing back (I've lost count how many times now) the stabilization date of the Seaport development; 2) Houston is dealing with yet another crash in oil prices just weeks after HHC made what they describe as the "largest acquisition in the company's history" by buying Occidental Petroleum's office buildings; 3) Nevada casinos are closed indefinitely, that will have its ripple effects through the Las Vegas service based economy and slowing the development of Summerlin; 4) Similarly but maybe less impacted, Honolulu will see significantly less tourism in 2020 than it did 2019, but more importantly a fall in financial markets doesn't lead to more wealthy people purchasing vacation beach condos.  Only Columbia, MD is mostly spared due to its connection to government services jobs.

The stock has bounced back slightly, but for a while there was trading below $40 which is where it was following the spin-off from GGP almost a decade ago, I was able to add a bit there, but still find the shares incredible cheap around $50.  In early 2019, I pegged the value of the land at ~$2.35B after subtracting out land level debt using a straight line NPV approach with a 10% discount rate, sure the near term sales might be low, but the nature of raw land is long term and Nevada and Texas remain attractive states for corporate relocations due to low/no taxes and friendly regulations.  HHC has $1B in corporate level debt, so just the land portfolio is worth ~$1.35B or about $35/share, obviously this is a somewhat silly back of the envelope valuation exercise that doesn't include overhead, etc.  But sort of thinking about what has happened since the spin-off a decade ago, HHC lays out the development activity in aggregate since then in their 10-K:
We have completed the development of over 5.2 million square feet of office and retail operating properties, 2,516 multi-family units and 909 hospitality keys since 2011. Excluding land which we own, we have invested approximately $2.0 billion in these developments, which is projected to generate a 9.5% yield on cost, or $192.7 million per year of NOI upon stabilization. At today’s market cap rates, this implies value creation to our shareholders in excess of $1.0 billion. Our investment of approximately $444.9 million of cash equity in our development projects since inception, which is computed as total costs excluding land less the related construction debt, is projected to generate a 25.5% return on cash equity assuming a 5.0% cost of debt, which approximates our weighted-average cost. These investments and returns exclude condominium development as well as projects under construction such as the Seaport District. We exclude condominium developments since they do not result in recurring NOI, and we exclude projects under development due to the wider range of NOI they are expected to generate upon stabilization. In Ward Village, we have either opened or have under construction 2,697 condominium units, which have approximately 89.8% units sold as of December 31, 2019 at a targeted profit margin, excluding land costs, of 23.6% or $747.3 million.
If we go back to 2015 and early 2016 when oil collapsed from around $100, there was a lot of anxiety about Houston office space and HHC dropped from ~$150 to ~$80 in a few months, but in the aftermath of the drop, HHC's Woodlands sub-market performed fairly well, their last speculatively built office property (Three Hughes Landing) still hasn't reached stabilization 4 years later, but the bottom didn't fall out either.  Not to directly compare the two time periods, this oil route seems worse for U.S. producers as it coincides with a demand shock due to coronavirus, but Houston is a major metropolitan market (it's not say, Midland TX or OKC) and the economy will evolve over time.  The Occidental office property buy certainly looks like unfortunate timing, but the bulk of the purchase is centered in the Woodlands giving them additional control over the sub-market, the Houston Energy Corridor former OXY campus was only ~10% of the purchase price and not a significant drag if they can't sell it in a year or three.  OXY's equity is certainly in question, the company signed a 13 year sale leaseback with HHC when the transaction happened, but even a reorged OXY will need office space, and HHC recently leased some empty space in the second office tower in the Woodlands to OXY's midstream company, WES.  HHC is taking a portion of the remaining space for themselves as they move their corporate headquarters to Houston, so in reality, there isn't a lot of current vacancy in HHC's Houston offie portfolio.

I'm less worried about Ward Village in Honolulu or Summerlin in Las Vegas, Summerlin is likely to have a terrible year, coronavirus feels temporary to me when you take a longer view, whereas domestic oil production might not be viable for many years.  The Seaport has always been a bit of a clown show, it was former management's pet project, there might be more willingness now to part with it for a reasonable offer that eliminates much of the risk/earnings volatility from HHC results.

Par Pacific Holdings (PARR)
Similarly, owning a refining business is tough here, if we just had the supply shock due to the OPEC+ breakup then refiners might be sitting pretty with cheap crude and strong gasoline demand, but with everyone staying in their homes and not commuting to work or traveling, gasoline and jet fuel demand have dropped almost as much as hotel occupancy.

Quick recap, Par Pacific is part of Sam Zell's empire, he doesn't technically control the company or sit on the board, but he owns a significant stake and the PARR management team is made up of former members of his family office - Equity Investments.  Over the last several years they've bulked up their operation to include three refineries, related logistics and a growing retail presence, focusing on niche/isolated markets.  Following a small tuck-in acquisition, they're the only refining presence in Hawaii and thus exposed to their tourism market via jet fuel sales.  They've got a turnaround scheduled for later this year in Hawaii which could be a blessing in disguise as it takes supply offline in that market just when there is a lack of demand.  But in a normalized year, Par Pacific should have a current run rate of approximately $225-250MM (after the next 12 months, PARR won't have a scheduled turnaround for several years), below is the breakdown of EBITDA between their business lines and sort of a reasonable, more rational market multiple for each.  It could take us a while to get there, but management on their last call (guessing there will be a lot of cringing across many management teams when they play back their comments on Q4 earnings calls) said that PARR is "today" a $3/share free cash flow business.  Obviously it won't be this year, but that's how the owners/managers of the business think of the earnings power.
It currently trades for $7-8/share, so that looks like a silly price and maybe it is because things are really different this time.  PARR also has ~$1.5B in NOLs that should shield it from ever paying cash taxes in the foreseeable future (not that it'll be an issue this year) and a stake in a natural gas E&P, Laramie Energy, but I mentally wrote off that investment a long time ago.  Given the natural gas price environment, Laramie has no active rigs, is reportedly cash flow positive and won't require additional investment from PARR to keep it a going concern, so we can sort of sidecar it.

PARR is a small cap and thus only has a relatively short term option chain with the latest expiration being in September.  Moving up market cap, Marathon Petroleum (MPC) is a similarly constructed downstream business with refining, midstream and retail operations that has January 2022 LEAPs available.  Marathon has been under pressure from activist investor Elliott Management to abandon their conglomerate structure and separate into three businesses: 1) retail (which operates the Speedway brand of gas stations/convenience stores); 2) midstream (which is publicly traded as MPLX, MPC owns 63% of MPLX and owns the general partner); 3) and the remaining refining operations.  The company recently rejected the idea of converting MPLX into a C-Corp and spinning MPC's MPLX units out to investors, but they are still committed to separating the Speedway retail business off by year end.  Convenience store 7-Eleven's owners, Seven & i Holdings, recently scrapped a deal to buy Speedway for $22B citing coronavirus and valuation concerns.  If you assume a $15B valuation for Speedway and back out the MPLX shares and consolidated debt, the remaining refining business is something like a $9B EV (with no value given to the MPLX GP) for a ~$5B EBITDA business in normal times.  There's also reason to believe (well maybe) that MPLX is undervalued as well as they're exploring selling their gathering and processing business segment for $15B which represents 1/3 of EBITDA.  The EV of MPLX is ~$34B, and the remaining logistics and storage business should fetch a considerably higher multiple.  I threw some speculative money at out of the money calls, maybe by early 2022 the world is a little more sane, until then I don't really plan on following the day-to-day swings in MPC's share price.

Five Star Senior Living (FVE)
Five Star is debt free (besides a small mortgage on the owned facilities), has a significant net cash position for its size and receives what should be a reliable management fee off of revenue.  Even if we do see small changes in occupancy (for morbid corona related reasons), FVE isn't as exposed to the high fixed cost structure of owning the senior living properties or leasing them.  FVE shares are trading below where they sold off when it was dumped following the distribution to DHC shareholders.  While there is certainly some operational or reputation risk associated with operating senior living facilities during such a high-risk time for the elderly, if Five Star can avoid a Kirkland WA style outbreak, their business should be positioned well and is extremely cheap.  We're still dealing with swag proforma estimates from management as the new structure is only a few months old, but at the EBITDA midpoint of $25MM, that should generate somewhere in the neighborhood of $14MM in FCF for about a 6.4x multiple at the current price of $3, plus you get the owned real estate and $30+ million of cash on a $90MM market cap company.

Wyndham Hotels & Resorts (WH)
Wyndham Hotels generates sales primarily on franchise fees based on hotel revenues (93% of their business) compared to their upscale hotel brand peers like Marriott (MAR) or Hilton (HLT) which have significant hotel management businesses where they get paid a percentage of hotel level profits and employ the workforce.  During good times, the management company model is better but during bad/terrible, I'd rather have the franchise model, hotel revenues will certainly be a fraction of what they were last year, but they won't be negative like profits.  Wyndham's typical hotel is an economy or midscale hotel with limited business or convention business and less reliance on food & beverage -- convention/conference business might take a while to recover as people stay cautious on large events, and if business travel does pick back up, maybe business travelers move down in hotel segment for a period of time.  Additionally, the typical Wyndham branded hotel owner is a mom or pop who owns just the one hotel, they likely got their financing from a local bank or the SBA who might be more willing to work with them on amendments/forbearance versus a large syndicate of lenders like the larger lodging REITs.  They do have a financial covenant of 5x EBITDA that is at risk, maybe other credit folks could chime in here, but I imagine by the time the TTM month EBITDA trips that covenant we might be back on the other side and WH could work with their creditors.  I did buy a little bit of shares, but also calls as to limit my downside if things do go south with their balance sheet.

My watchlist - quick blurbs, maybe turn into full posts if I buy:
  • Exantas Capital (XAN): This is the former Resource Capital (RSO) that I owned for a couple years after C-III took over the management, cut the dividend, and reorganized the assets to a cleaner mortgage REIT.  XAN funds its assets in two ways, one is through repurchase agreements and the other is through CRE CLOs.  CRE CLOs are term financing and not mark-to-market, however the repurchase facilities are mark-to-market and Exantas failed to meet margin calls on their CMBS portfolio this week, sending the preferred and common cratering.  I'm maybe too optimistic on the commercial real estate market (HHC bull) but I think a lot of these loans get amended and Exantas might find its way out of this mess, however it won't be without some pain.  The CRE CLOs might end up tripping their OC tests and shutting off cash flows to the junior notes and equity which is owned by Exantas, so I'm on the side lines for now.  Additionally, like most CRE CLOs, these are "transitional loans" meant to fund a development project, say renovate an apartment building and move it up market, something like that.  So if the market shuts down, the borrower might not be in a financial position to complete said project or refinance into longer term financing, sticking XAN with the exposure longer than expected.
  • iStar (STAR): I want to revisit another former holding in iStar, their SAFE ground lease business has grown far larger than I imagined (although likely very overvalued), taking SAFE at market value you could make a case that the legacy business that I originally liked is very cheap.  But they do have a CRE finance arm similar to XAN, but more concentrated on construction lending in major markets (NYC and Miami IIRC) that could be a problem.  Worth looking into given the SAFE stake and the management contract associated with SAFE.
  • NexPoint Residential Trust (NXRT):  Another former REIT holding of mine, this is one that sort of got away, I'll get the exact numbers wrong but it spun off from a closed end fund at ~$11 and I sold somewhere around $22, not too far from where it is trading today at $25, a few months ago it was $52.  I love the strategy, they acquire garden style Class B apartments in the sun belt, put a little money into them to move up market a touch, maybe "B+", this investment is very high return on invested capital and then they'll sell, recycle the funds and do it all over again.  Sure their tenant base might have some credit issues in the next year, but demographic trends are still in the sun belt's favor, working class people will need reasonably affordable housing in the future, supply is relatively constrained, and this management team (it is external) has proven they can execute on their strategy.
Disclosure: I own shares of HHC, PARR, FVE, WH (and calls) and MPC 2022 LEAPs

5 comments:

  1. Thanks for the write-up. What do you make of HHC raising equity at these prices?

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    1. Thanks, my thoughts might evolve on it, but initially:

      - I wish I would have waited a few hours to post this! Facepalm emoji this morning

      - It is a bad look if 4-5 months ago you outline a plan to sell non-core assets and use the proceeds to buyback stock at ~$90-100 IIRC at the time of end of sale process call. Then you go buy OXY's office properties, forgivable, then you raise equity at $50, maybe they do really need the cash but have always claimed and proved out in their supplementals and/or filings that they can meet their current construction schedule with available liquidity.

      - It's either things are worse than they appear for the company and they need to raise cash and/or Ackman just made his big hedge score and wants to double down, can't through the public markets and does the secondary to benefit himself while potentially (if I'm right about the value of the company) severely dilute the outside shareholders. Not sure if a rights offering would make sense here, his fund could backstop it and still increase their ownership, and all shareholders could choose to participate or not.

      Might come back later with more thoughts, but that's my current take.

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  2. Hadn't heard of Par Pacific Holdings. Thanks for sharing. You should take a look at Tidewater Midstream. They own a refinery which has had average crack spreads of 44 CAD over the past 7 years. Management team is top notch.

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  3. On NXRT, the Dondero sales are pretty concerning. He was taking up a ton of shares in 2015 when it was $11-12 and now he's selling almost daily.

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    1. I don't believe he's a willing seller here, more of a forced one given his other business matters. He's a litigious guy, I'll just leave it at that.

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