by Travis Johnson, Stock Gumshoe | August 3, 2016 11:23 am
I won’t be able to post our regularly-scheduled Friday File for you this week, since I’ll be preparing for my ride this weekend (thanks again to the many of you who have sponsored me![1]), and Stock Gumshoe will be very quiet next week because I’ll be on vacation with my family (and recuperating, I imagine), so I’m trying to get some quick thoughts out during this week to make up for it… particularly as earnings releases of note catch my attention.
AIG (AIG) reported what looks like an excellent quarter yesterday, which is good news for AIG shareholders and warrant holders (I hold the warrants on this one) — book value per share grew by 6%, but, more importantly, their “turnaround” moves to dramatically improve efficiency and continue clearing out their “legacy” assets (that’s seems to be the generally accepted polite term for “the crap previous management teams invested in that got us in trouble”), and their return on equity and income were both better than anticipated. It’s still not the best insurance company around, but it’s at least becoming an average one with the potential to be better than that, and it’s still trading at a meaningful discount to book value — book value per share is $83.08, the shares opened this morning, post earnings, at around $57, which is roughly 70% of book value.
I went into those AIG warrants in a bit more detail last month here[2] if you want some background — the key, really, is that returns from the warrants should be somewhere between half again as good and twice as good as returns from the common stock IF AIG goes up by at least 30-60% over the next five years (which it could easily do if it just had stable and mediocre performance and traded up to near book value), and I have a hard time resisting long-dated warrants that price in too much pessimism. That may just be my rose colored glasses at work, we’ll see. In the short term, the leverage is working as expected — AIG up about 6%, AIG-WT up about 10% today, I think AIG is a decent bet here if you want some exposure to the financial sector, with the general backdrop being that rising rates (if they ever come) should benefit insurance companies, but I’d still choose the warrants because I think low interest rates and a bit of a veil of pessimism are exacerbating the market’s tendency to downplay the power of long-term leverage.
Markel (MKL) is my largest personal insurance holding, if you don’t count Berkshire Hathaway (BRK-B), which isn’t really primarily an insurance company anymore. They released earnings yesterday and are continuing to do just fine, I just remain uncomfortable with the relatively lofty valuation they’re carrying at more than 1.5X book value. Book value is now $603 per share, and it is growing (it was $561 at the end of 2015, $590 last quarter), and they had a great operational quarter with a combined ratio of 90 (meaning they spent 90 cents on expenses and claims for every dollar in premiums they brought in), so I’m happy to hold Markel, which is a stock I’ve had in my portfolio for over a decade and may never sell… but we’re not at a particularly exciting buy price here at $925.
I’ve gotten more expansive in my willingness to pay up for Markel of late, but my view hasn’t caught up with the market’s — I’d bump up my “buy” price to 1.3X book value (I used to say 1.2X book, but it hasn’t been there in ages), which would mean buying around $780. Maybe we’ll get there, maybe not — Markel is worth more, and I wouldn’t argue that $925 is an unfairly high price for a great company in the abstract, but I’m mindful that the market has historically not let Markel keep this high a valuation for very long, and the share price has grown dramatically faster than the book value per share over the last year and a half (though both have grown at about the same rate so far in 2016)… which tells me that if we’re patient we may see a better price over the coming years, either because the business gets worse (we keep getting gold that insurance is a tough business right now, but Markel is not showing) or because the market takes a big hit.
Douglas Dynamics (PLOW) was the real outlier this week — their earnings report (press release here[3]), which doesn’t even include the latest non-seasonal addition to the business (that’s their Dejana acquisition, which closed a few weeks ago after the end of the quarter), was a clear blowout — and they not only reported record sales and earnings despite a weak snow year, they raised their guidance for the remainder of the year (yes, even with the anticipated loss of a few cents a share that they expect from Dejana in their first six months of ownership). Wall Street loves “beat and raise” quarters, and investors love dividends these days, so those two forces joined together to rocket PLOW up by better than 15% after the report came out. That makes me happy that I added to my PLOW holdings to build them back up in the post-Brexit dip (it was a small dip indeed, but you take what you can get), but it is hard to trust a big move like this when investors seem to suddenly be re-rating a stock and giving it a higher margin of safety. Probably the most important thing hidden in the great numbers is that yes, they have already started to improve operations at Henderson, their previous big acquisition (highway plow trucks, mostly), which gives additional confidence that they can keep applying their efficiency-focused “DDMS” (Douglas Dynamics Management System) to new companies to improve operations.
I wouldn’t rush into the shares above $31 here, it’s still a cyclical company even if if will be a little less of a snow-dependent one, but if investors are really starting to believe in management’s ability to continue this “roll up” strategy and keep acquiring smallish truck service/upgrade/accessory companies it could certainly stick at this higher valuation. Their guidance for full year earnings per share now, including Dejana, is between $1.36-1.79, which, if you go by the midpoint, is 17% higher than their guidance had been back in March (it was $1.05-1.65 then)… so it’s not shocking that the stock went up about 17% yesterday. The dividend yield is now down to 3%, which is very reasonable for a growing manufacturing company, and the PE for the current year (now half done) is about 20… which is not terribly expensive, but it’s also not compellingly cheap. Any big upside possibility from here over the next six months would really have to be seasonal, probably — like a really snowy winter as we finish up the fourth quarter, but I really like their performance so far and it’s not a crazy expensive valuation, I think it’s a great hold here and might consider adding if the shares dip back down by 10-20% when the excitement of the earnings beat wears off (or when the whole market softens).
Criteo (CRTO), which we covered in some detail on Monday[4]because it was the subject of a teaser pitch from Investing Daily, also reported earnings this week — at the time I noted that I like and am exposed to the company, but you never know what can happen with a quarterly report… and after this quarter, you can now buy CRTO cheaper if you’re so inclined, the stock is down about 7% as I type, right around $40. I’ve sold puts at $40, so I may end up owning shares again if it drops a little further over the coming months (or hours, even) — and that would be fine with me. The performance is still solid, they are still growing revenues at 30% and earnings at about 60%, but they downplayed forward guidance a little bit — and as much as Wall Street loves increased guidance (see PLOW, above) they panic about “softer” guidance.
It’s still the best small “ad tech” company in my mind, it’s still quite profitable and growing very fast (in the right ways, without a lot of churn — they’re both adding huge numbers of clients and boosting business with existing clients by almost 15% annually), and it’s still reasonably priced. I think it’s a buy at $40 (obviously, that’s why I sold puts at $40 a while ago), with very real potential to double in two or three years, and there’s always that rumored possibility of a buyout that would likely come at a stiff premium if it happens… but that doesn’t mean it can’t also go back to $30 if investors stop being excited about future growth or there’s some existential crisis with the company (like losing access to Facebook or Google traffic, for example).
In REIT World, this is the week to watch our healthcare REITs — Medical Properties Trust (MPW) doesn’t report until tomorrow morning, but Omega Healthcare (OHI) and Physicians Realty Trust (DOC) have now both reported.
Omega Healthcare (OHI), which is primarily an owner of skilled nursing facilities and generally gets discounted a bit because of their exposure to government reimbursement vicissitudes, keeps showing us that we’re overstating the risk — their operators continue to perform well, and their earnings and cash flow keep rising, and the dividend keeps going up quarter after quarter. This last quarter was, again, a very small beat on revenue, earnings and FFO, and they raised the forecast adjusted FFO for the year to a range of $3.36-3.40 — the dividend bumped up another penny to 60 cents. At current increase rates (a penny per quarter), that would be $2.46 in dividends for the coming year for a 7% yield (the trailing yield is about 6.5%). [I used the wrong number in my first published version of this comment, sorry — their payout ratio is not as high as I implied earlier]
That’s where the real risk lies, I think, that the expectation they’ve built up for a raise in the dividend every single quarter is too much to handle if they can’t keep the top line growing, but so far they’re able to handle it pretty well — even integrating a major acquisition (Aviv) last year. OHI will likely continue to be volatile, primarily because of the fear that washes through the industry whenever there’s talk of an operator in trouble or a change to reimbursement policies, so I’d be patient and look for better prices to buy big on this one (and I’d always be mindful of staying diversified even within the healthcare REIT segment, you want office buildings and hospitals and labs, not just skilled nursing facilities), but I’d probably be willing to nibble at $35 with a 7% yield and I’d keep an eye out for those panic buying points 10-20% lower, like that dip back in February that inspired me to add several healthcare REITs to my portfolio. This is a REIT, so it’s not a scalable business — it’s not likely to cut costs or become more efficient, but they’ve been able to slowly and steadily grow by adding to their capital base and that will probably continue… particularly if, as most people expect, the demand for skilled nursing beds remains high thanks to our aging population (though that also, as you can imagine, means that increasing spending on skilled nursing, especially by national insurance entities, will bring with it closer regulatory attention and possibly more regulatory risk).
The growth darling in the healthcare REIT sector has been medical office building owner Physicians Realty Trust (DOC), and the risk of that growth mentality showed up in the reaction to their results this morning — they have been growing phenomenally on the top line, thanks to some massive equity raises over the years (that’s not suprising — growing a new REIT pretty much always involves selling shares to buy more buildings), and the company is doing really well operationally… but this isn’t an area of the REIT world where there’s typically a huge “value add” when you buy a building — DOC isn’t going to make a lot more in rent from their clients than the previous owners did the previous year, the buildings they’re buying or building don’t have bargain cap rates. It’s not like sprucing up apartments and bumping the rent up 10%, or using your connections to get a better anchor tenant for a shopping center to raise rents or improve occupancy levels in a matter of months, so the real per-share growth in earnings and FFO takes more time as you get gradual and small efficiencies from owning more properties to spread out your overhead costs, or from managing those properties slightly better or, in some cases, getting better rents as the market improves for particular local areas. FFO per share was at 19 cents for the quarter, or 22 cents adjusted (taking out some acquisition costs for new buildings), which was reasonable growth year over year of about 5% but not quite as good as analysts had anticipated, and the big run over the last few months means that the yield is now about 4%.
That’s a little too pricey for me to consider adding to my position, I’m still holding DOC but if I were to buy a healthcare REIT with a 4% yield right now I’d be more inclined to go with the more diversified Ventas (VTR) — growth is not as good, and their forecast was a little weak when they released earnings last week, but they’re much larger and have more levers to pull so growth per share could easily be as good or better than at DOC, and there’s considerably less risk in Ventas because they’re not running at the same breakneck acquisition pace as DOC. I still like DOC, and I’d still consider adding to it in the high teens if it loses some of its shine, but I wouldn’t buy it at $20 (it’s dipping back close to $20 now following the slight disappointment).
And really, it’s important to note that it’s pretty hard to buy almost any REIT at these prices, including the healthcare REITs — the run has been so tremendous this year as the world has given up on the idea of interest rates ever rising, so that’s been nice for those of us who hold REITs, but it also means that if that interest rate sentiment changes there could always be a swift correction in a lot of income stocks. I don’t think that’s likely to happen soon, but I don’t put much stock in my ability to forecast changes in sentiment so I’ll keep my fingers crossed that my favorite dividend-payers become better buys at some point in the future.
Including, yes, Coresite (COR), which I seem to mention practically every week these days — I would still like to build that position back up if the stock comes back down, and it was delightful to see the shares at least dip below $80 this week for the first time in a couple months, but I haven’t yet bought — I do have an offer in to sell some $75 puts, but unless things turn down a bit more sharply in the next few days that order is unlikely to fill… we’ll see.
And speaking of things that have had a great run this year, gold is really starting to trickle into the institutional investing playbook again. A lot of people these days are feeling pretty relieved to have gold miners in their portfolio — and it’s not just individual investors like you and me, Jonathan Tisch at Loews (ticker L, a company I owned for a while years ago and have written about, but don’t currently have any exposure to) noted[5] that “You die by the sword, you live by the sword. We had, for a number of quarters, even years, suffered with gold investments. What’s happened in this most recent quarter is gold investments came to life.”
And yes, Loews had halfway-decent results largely because those gold investments propped up all the other lousy junk — including their natural gas and oil-related investments. Not good enough to prop the stock up, but good enough to help make up for some of the weakness in their big subsidiaries (particularly Diamond Offshore).
That’s really why you buy gold miners, because the huge leverage to gold prices in a bull market means that a relatively small allocation to the sector can help make up for a lot of weakness in other parts of your portfolio if the impetus for gold’s rise is socio-economic uncertainty which also brings down the stock market (it’s not always that clean, of course, gold moves for more than one reason and so does the stock market — but gold is widely perceived as “insurance” against currency weakness and as a “flight to safety” asset if investors around the world get jittery).
So you put some of your analytical mind aside, forget for a while that most gold miners are terrible businesses that you wouldn’t want to “buy and hold,” and try to pick a few decent and highly-levered gold plays that won’t hurt you too much if they go to zero, but can help if the rest of the world is falling apart. Regular gold doesn’t help much with that — I think physical gold is a very reasonable way to diversify some of the cash position in a portfolio, but you need gold miners to get the leverage that allows you to get some of the “portfolio insurance” from gold without risking too much of your capital. I’m now “allowed” to sell some of my junior “dumb idea” gold names that I wrote about a month ago[6], but haven’t done so just yet, nor have I sold my less frightening gold investments in royalty company Sandstorm Gold (SAND) or the ETFs SGDM and GDX. If things continue in this vein I’ll probably want to do some rebalancing, particularly among the more promotional names that have run so far so fast like First Mining Finance and Brazil Resources, but so far the “insurance” is playing its role well.
Disclosure: I have long positions, either common stock or derivatives, in all of the companies mentioned above except for Loews and Diamond Offshore. I will not buy or sell any of those names for at least three days following publication, per Stock Gumshoe’s trading rules.
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