by Travis Johnson, Stock Gumshoe | May 25, 2018 4:30 pm
CoreSite (COR) announced their latest dividend increase this week, which I’ve been anticipating — would they continue to be a rapid dividend growth REIT and keep investors excited, or will the slowing of the dividend growth continue to make me more cautious about the valuation of this highflier?
Well, it turns out that the dividend increase was “just enough” to be OK. It was far smaller than the year ago increase, just as the December dividend increase was far smaller, but the total of the two increases now gives us a dividend that is about 14% higher than it was a year ago (a year ago the quarterly dividend was raised to 90 cents, today it was raised to $1.03, after having been hiked to 98 cents in December). That’s not bad, and would be fantastic for many stocks, but it’s pretty humdrum by COR standards after years of 25%, 30%, even 50% dividend increases as they combined a strong core business (data centers) with a little bit of organic per-share growth and a lot of new debt.
So now they will be paying a dividend that annualizes out to $4.12, so the forward yield will be almost exactly 4%. Yields for income stocks in general have come up recently as the stocks have mostly come down from their highs, mostly from fear of the impact of rising interest rates (which tend to at least temporarily depress higher-dividend stocks, though it’s not as clear and obvious a relationship as the knee-jerk reaction would have you believe).
I was curious about how unusual this is, so I did a quick screen — I looked for stocks with market caps above a billion dollars that have been able to raise their dividend by a minimum of 20% a year, on average, for the past five years, have a trailing dividend yield of more than 3.5%, and a most recent dividend increase of at least 13%. It’s a short list, CoreSite is there, of course, as is one other REIT, the self-storage company CubeSmart, and one other real estate company, Kennedy-Wilson (KW), which is also in the Real Money Portfolio now, but there are only ten others… a few global banks (Woori and Bradesco), a couple utility-like companies, a couple asset managers (Blackstone and Apollo). Here’s the list, in case you’re curious:
So CoreSite is still in pretty rarefied air, even though the dividend growth is not accelerating and revenue growth has slowed a bit… and, yes, even though the debt keeps rising. So I’ll continue to hold, I don’t expect this to be a super growth REIT again, as it was for most of the past five years, but I do expect the share price to come close to keeping up with the dividend increases from this level, as has been the case over the past six years (COR’s share price has increased by about 525% since they started paying a dividend in 2012, and the dividend itself has gone up by 560% during that time). I expect a 4% yield that goes up by 10-15% a year will still be in high demand, even in a world where the 10-year Treasury Note could conceivably be at 4% in the next twelve months, and they are building and expanding enough that they should be able to keep the dividend growing — but that dividend growth is key, a yield of just 4% won’t cut it over the next few years, I expect, if you can’t grow the dividend fairly quickly or don’t otherwise have some kind of growth profile. I’ll let you know if my assessment of COR changes again in the future, but right now it remains a hold (though a smaller one, you might remember that I sold more than half of my COR position back in January when it broke its trendline at around $105).
Altius Minerals (ALS.TO, ATUSF) reported another quarter and is chugging right along, thank to rising potash prices and production and strong copper production at Chapada, with a solidly profitable quarter and strong royalty revenue growth… but what caught my eye was their talk about their new joint venture, Blue Sky Renewable Energy Royalties. Here’s what they said in the press release:
“Royalty revenue guidance for the year remains unchanged from $64 – $69 million. Altius has recently agreed to partner with Great Bay Renewables, a US based boutique renewable energy investment firm whose principals have an extensive track record as successful renewable energy developers and operators, to co-found Blue Sky Renewable Energy Royalties (“Blue Sky”). Great Bay will provide fully dedicated technical expertise, capital, and an existing royalty on a small-scale producing renewable energy project. Altius expects to contribute its royalty creation expertise and acquisition capital to the venture as opportunities are identified. Blue Sky may also add additional strategic investors.
“Altius is also considering the contribution or designation of some or all of its portfolio of Alberta electrical coal based royalties into Blue Sky. These royalties relate to electrical generating facilities that are proposed to be phased out by 2030 under recently adopted government policies. Altius believes that the reinvestment of coal phase-out royalty cash flows as royalty-based financing for the next generation of renewable energy projects could innovatively transform this medium life part of its current portfolio into long life royalties.”
It will be interesting to see how this plays out — at this point, I expect Altius would be happy to get some of the coal royalties off their books, given the Alberta crackdown on coal plants and the approaching 2030 phase-out, but what will matter will be the details… what do the royalty returns on these future renewable projects look like? How big will they be, how long lived? It’s a lot harder to be “contrarian” in the electricity market, where there’s massive trading every day, than in the illiquid junior mining market, so I’ll probably be a little skeptical about this while we wait to see what kind of projects are in Blue Sky’s future.
But in the big picture, Altius remains compelling at these prices — it trades at roughly 9X those expected royalty revenues for the year (they do earn other revenue from time to time, from partnering or selling projects, but royalties are most of it), and there’s some chance that they could get a solid boost at some point if their litigation over the disputed Voisey’s Bay royalties works out well (that’s in court in September, I believe, with Altius’ side led by their partner Royal Gold against Vale). That’s about the cheapest price/sales ratio available in mineral royalties, though it’s been true for a long time that Altius’ royalties on base metals, potash, coal and the like have been considered less valuable than silver and gold royalties, despite the sometimes incredibly long lives these assets have (some of the potash royalties could well pay out for over 100 years).
Most royalty companies are gold-focused, so it’s a little lonely for little Altius, but I’m more certain that the world will need more copper and potash than I am that the world will need more gold, so I’m a happy Altius shareholder and will watch the new renewable energy push with some interest.
We also got some interesting news this week about the company that is arguably Shopify’s (SHOP) most compelling competitor, Magento — they were bought by Adobe, which probably put some pressure on SHOP shares because the idea of a second-tier competitor getting a huge infusion of cash and a huge marketing connection to a dominant company like Adobe is a little worrisome for the market leader.
But I don’t imagine we need to panic. Magento offers a much less compelling and complete product than Shopify right now, and becoming part of a corporate bundle might help Magento to compete with enterprise ecommerce offerings from Salesforce or SAP, but it’s not necessarily going to make Magento more appealing for the just-starting-out ecommerce entrepreneurs who form the initial entry funnel for so much of Shopify’s business.
Yes, it might mean that SHOP has a bigger competitor when it comes to their larger clients… but right now the market is telling us that Magento’s offering is not as compelling as Shopify’s (Magento had about $150 million in revenue last year, according to the press release, SHOP was over $750 million). Magento is not exactly the same business as Shopify, of course, they don’t offer as large a suite of cloud services, and they’ve been largely pushed forward by open source innovation, so that also means there’s the potential that Magento gets lost in Adobe if they turn down the “openness”.
End result? I’m not worried. I mean, I am worried, owning a cloud software/services company that’s not profitable and trades at almost 20X sales is fundamentally worrisome, even if revenue is growing at a rapid clip (most recently 68% year over year)… but I’m not more worried than I was before. Shopify is the brand for emerging ecommerce entrepreneurs who don’t want to learn how to code, and it’s wildly overvalued based on its current business… but there remains the potential for them to grow into it, and to be extraordinarily scalable as they grow, and they’re founder-controlled and well funded (almost a billion in cash) to give them the ammunition to hold off competitors. That doesn’t mean the stock couldn’t fall by 50% — but that was true last week, too.
And, yes, the short sellers are continuing to make strong claims that SHOP is a home for scammy drop-shippers — as gets reinforced by stories like the WSJ article about junky $70 sweatshirts marketed on Facebook. That doesn’t worry me at all — yes, there’s plenty of crap out there by junky retailers trying to get rich quick using dropshipping on Shopify, just like there’s lots of pirated and silly crap sold on Amazon’s marketplace, but most of them won’t be around very long unless they transform that into a real and sustainable business.
Also in the realm of small-and-expensive tech stocks, I’m getting more impressed with Okta’s (OKTA) offerings, though we will have to wait a while to see how customers take them up — they’re making a big push for some free entry-level identity cloud services and announced new products this week, at their Oktane18 conference (with a keynote by President Obama, as they try to make their case for being “big time”).
Cybersecurity is a tough business with lots of competition, and lots of ups and downs, and their revenue growth is not as high as you’d like to see for a company starting from this low level, but it’s pretty good. Analyst estimates are that this year will bring about 40% revenue growth, and that their EBITDA margin will steadily improve from about -23% last year to roughly break-even on a cash basis in 2021 (though we should take that with a huge grain of salt, since that’s a guess from 3 analysts and predictions beyond the current year are notoriously hard to make for most businesses).
I’m not crazy about the convertible note offering they did earlier this year, but it did provide them with a lot of cash — it will be dilutive in the end, once the notes convert to shares in 2023, but in the meantime they’ll have plenty of time to achieve profitability and, frankly, will probably issue so many stock options to employees over that time that the dilution won’t seem substantial. As long as growth remains strong on the top line, or, preferably, picks up, we won’t care much about the capital structure… and if they do get enough traction to become a default standard in enterprise authentication, of course, then they sky’s the limit.
That’s the big unknown, really, whether they’ll get enough adoption to build that network effect — particularly because the authentication system gets smarter and stronger as more customers bring in more data. I’m willing to bet a bit more now on that possible future, because the product and service seem pretty compelling to me, but as a non-insider I’ll have to take my cues from their customers — I’ll be watching their customer counts pretty closely and seeing if they get a big influx of free customers as well, or more new customers from their small beginning partnerships with Facebook and VMWaare which would be a valuable asset as they funnel growing companies into their higher-priced services. I’ve now increased my still-small Okta position by about 20%.
I’ve also added another “dumb speculation” this week…
I’ve been using Twitter more recently (as a consumer, not as a commentator — I read a lot but don’t write much), and I’ve been impressed with the continued improvements. And despite the recent rebound, I think there’s still a pretty decent chance for them to get a bigger bolus of advertising revenue and have some “surprise” growth, given their still relatively small size. I think there’s a meaningful chance that they’ll take a big step forward over the next year or so… I don’t want to commit a lot of capital to that, but I’ll make a small wager with some out-of-the-money options, which fall into my “dumb speculations” category. It’s important to note that even in a bull market, more than half of these dumb speculations end up being 100% losses — but I continue to dabble, because the capital commitment is small and the possibility I’m looking for is the rare 100-1,000% gain, and, on a personal level, it satisfies the gambling/speculating urge without putting my portfolio in real jeopardy. We’ll see how that works, that position is now noted in the Real Money Portfolio, but I will probably not write about it a lot unless something dramatic happens.
This could certainly backfire — Twitter has just become profitable, which is exciting for them after a long period of doubt, but they continue to struggle with growing their user base, and the market has learned from Facebook to be obsessed with the “monthly active user” numbers. This bet (and it is a bet) is largely based on the fact that I think they have a reasonable opportunity to grow the user base meaningfully, even if most of the new users are just readers and don’t participate actively, and keep their profitability… and if they do that, then the potential for surprisingly levered returns is pretty phenomenal.
Will the hard-fought mid-term elections drive the next wave of advertiser or user growth at Twitter? I don’t know, but we know the President will certainly be using Twitter like a teenager, they posted two quarters of user growth, and the last quarter was the best user growth quarter in a long time, so if I’m right on this guess we could be at the beginning of a strong trend… we’ll see.
In terms of position sizing, I compare this to other tech stocks where I’m clearly gambling on something that has a questionable current valuation — if I’m willing to lose 30% of my investment on a position in Shopify (SHOP), for example, but think SHOP is worth a $10,000 commitment, that would mean putting $3,000 of a $10,000 investment at “likely” risk (it could fall more than 30% if something terrible happens, of course, that’s true of any stock, but that’s farther out on the “unlikely” scale). If it’s an options speculation, I go in with the assumption that I may lose 100% of that investment, so I size the position accordingly — if I want to weight the risk similarly to SHOP, for example, I might just buy $3,000 worth of call options, therefore the potential loss that I keep in the back of my mind, in real dollar terms, is the same for those two positions. (I just made up those numbers to make the math easy, by the way, that’s not the size of my personal holdings.)
Every speculation needs to be looked at in terms of the potential loss for your whole portfolio — particularly when it’s a risky speculation with good chance of a 100% loss, like any options purchase, you need to keep a lid on those as a group because a bad few months in the market could wipe them all out simultaneously. This speculation is roughly the same size as the options speculation I made on Square (SQ) a while back, though I’ve since taken profits on half of that one.
And finally, some folks have asked about Innovative Industrial Properties (IIPR) recently, mostly because that’s the only marijuana-related stock I’ve ever gotten very comfortable with, so I thought I’d take a look at the financials after the first quarter (which they released a couple weeks ago, with no real surprises).
The way I see it, they have invested $82 million in the properties they own, and expect to earn an average return of roughly 15% on those long-term leases — a huge cap rate that’s the primary reason for my interest in the stock. At that rate, once everything’s running at the expected rate (a lot of the rents phase in over time, as improvements are made, etc.), that should generate cash of about $12 million and, assuming overhead and administrative expenses don’t change much (they shouldn’t, these are triple net leases and you don’t automatically need extra employees just because you added another building to the portfolio), that would be net cash flow of something like $7 million a year from these properties.
The company now has a market cap of about $238 million, and about $84 million in cash after their latest purchase. So that’s an enterprise value of $154 million, which would mean a EV to cash flow ratio of about 22. The current dividend of $1 a share will cost them just under $6 million a year, so the payout ratio is pretty reasonable (for a growing REIT, at least) at 85%… and if they are able to put that other $80+ million in cash to work (they say they have $30+ million in deals that are fairly far along, and a pipeline of more than $100 million of possibilities), they could easily increase the dividend substantially.
That continues to be my primary reason for investing in IIPR: If they can keep signing deals at 15% cap rates, their dividend could easily grow by 20% or more per year (even 50%+, perhaps, though that’s aggressive), and, as our experience with CoreSite reminded us, investors are generally willing to pay a lot for very high dividend growth.
I still wouldn’t want to pay much over $35 at this point, given the uncertainty of making more deals at these rates and the high risk of the sector (if they lose marijuana cultivators as customers, the buildings would be far less valuable — wouldn’t go to zero, but would likely be worth less than half as much).
And on the optimistic side, if they are able to add some reasonably low-cost debt financing to provide a little leverage, the cash flow could really explode. They do not currently have any leverage, other than the preferred shares (which I also own), and they might not be able to borrow as cheaply as other REITs, or want to take on that risk at all… and they don’t have to, with 15% cap rates on unlevered properties, but they might someday in the future and that could send dividend growth potential still higher.
If they put the other ~$84 million in cash to work, that would be a total of $166 million invested — assuming the same financials, that would be about $18 million in cash flow per share, approximately similar to expected FFO, so at a $240 million market cap that’s a price/FFO approximating 13 or 14… and that’s close to $3 in FFO per share, so the potential to increase the dividend above $1 is obviously appealing.
High risk, but great numbers. I haven’t changed my position in this one, but if there’s another panic in the pot stocks perhaps it will get back to more attractive prices again — I still think it’s a reasonable buy under $35 for a near-3% dividend that has the potential to double over the next two years.
And with that, dear friends, I’ll leave you for your long weekend (for our US readers, at least) — enjoy your barbecues, please take time to remember those who put themselves at risk for the good of the nation, and I’ll be back to blather on and on about something or other next week.
Disclosure: As you can see from the Real Money Portfolio, I own shares of Amazon, Innovative Industrial Properties, Okta, Shopify, Altius Minerals, Facebook, Square and CoreSite, and call options on Twitter and Square. I won’t trade in any stock covered for at least three days, per Stock Gumshoe’s trading rules.
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