Annual Review Part 3: Commodities and Real Estate (mostly)

by Travis Johnson, Stock Gumshoe | January 25, 2019 4:15 pm

I’m going to get to several updates on Real Money Portfolio stocks at the end, including those questions “What to do with Qualcomm (QCOM)?” … but first, I’m going to go through the stocks where I’ve completed my Annual Review this week. Each year I promise to re-analyze and reconsider my opinion about each stock at least once during the year, and I collect all those thoughts in January in an effort to be as disciplined as I can and share my opinions with you as best I can. Today I’m mostly going to cover some yield-focused investments in real estate and some commodities and precious metals investments… so I guess you can say this is “Hard Asset” week…

Altius Minerals (ALS.TO, ATUSF) — buy below US$9.70 for diversified long-life commodity royalties. This has been my core “non-precious metal” commodity position for years and has been a drag on the portfolio, but I think it’s very reasonable at 8X royalty revenue, with upside from prospect generation, exits the next time commodities spike, and an eventual return to higher copper, iron ore and/or potash prices. Also look at Anglo Pacific Group (APF.L, APY.TO, AGPIF) if you want a little more growth, dividend and excitement but much more concentration risk.

I last wrote about Altius just a few weeks ago, when I added slightly to my holdings, but I’ll expand on that here. This stock is falling for good reason, China slowdown fears mean that everyone is panicked about raw materials costs falling — so copper prices are down and iron ore prices are down, which drive much of Altius’ royalty revenue… though potash prices, their other big contributor, have been steady to rising a little.

Altius continues to have some debt, about C$115 million, but also plenty of financing flexibility and some equity and debt investments beyond the royalty portfolio and project generation portfolio, so the (small) dividend looks quite safe and they should be able to make further deals if they see anything compelling (they have about $28 million in cash, and their Labrador Iron Ore Royalty investment is in equity that could be sold if they wish). I don’t know if they’ll get anything out of their Alberta coal redress claims other than a long drawn-out legal fight, but they are again getting royalties on Voisey’s Bay after settling that long legal fight, so that’s going to again be a revenue-generating part of the business instead of an odd footnote on the reports.

Altius currently has a market cap of C$470 million and reported royalty revenue for 2018 of $66.9 million (with an estimate, using current commodities prices, of $67-72 million for 2019). That means the stock is trading at roughly 7X royalty revenue, which makes it a buy for me — royalty companies generally trade at elevated valuations, because they have such high margins (overhead and operating costs are quite low, compared to companies who do actual mining), and Altius has always traded at a discount to the more beloved precious metals royalty stocks (Royal Gold is at 12X sales, FNV at almost 20X), but I don’t think a huge discount is warranted given Altius’ more diversified revenue base.

Altius has been a drag on the portfolio, so I’ve been wrong and stubborn on this one, but I continue to think that their assets are more valuable than they’re being given credit for, particularly those 100+ year potash royalties… and that they should be able to earn a stronger valuation if the commodities markets turn positive again (as they typically have, eventually, at least over the past 20+ years), along with possible windfall gains if some of their prospecting projects or spinoffs can be sold for windfall gains in the next peaking market, as they have managed to do a couple times in the past. I continue to position Altius as my core diversified commodities/metals position in the portfolio, and think it’s worth buying under 8X royalty revenue for long-term investors, partly because of the underappreciated very long life of many of their assets — but as I said, it has been a drag on the portfolio for years, so you might want to take my opinion with a grain of salt. The stock is considerably below that level now at US$8.40 or so, if we look forward using their guidance 8X 2019 royalty revenue would be a share price of about C$12.90 (US$9.70).

Altius now trades at a very similar current price/sales valuation to Anglo Pacific (APY.TO, APF.L, AGPIF), the only other real diversified base metals royalty company (US$64 million in royalty revenue for 2018, market cap almost identical to Altius’ — though Altius has some preferred stock and debt and Anglo Pacific has almost paid off its debt), but it’s also a far steadier company and more diversified (though it pays a far smaller dividend than Anglo Pacific, and doesn’t have that company’s exposure to Vanadium or its recent growth spurt). I wrote some about Anglo Pacific here[1] if you’re curious, but don’t own the stock. Anglo Pacific has also been recently buying into Labrador Iron Ore Royalty Corp, interestingly enough, though their royalty portfolio is dominated by the huge Kestrel coal mine in Australia and, to a lesser extent, the Maracas Menchen vanadium mine operated by Largo Resources (which I own).

This week, Altius bought an early stage royalty for $10 million on one of the projects being explored by its partially owned joint venture Adventus Zinc (ADZN.V, ADVZF) in Ecuador.   They now own a 2% NSR covering the Curipamba copper-gold-zinc project — it’s a large land area, with the current focus on the El Domo deposit that has some indicated and inferred resources, but it’s still very early stage… which is why the royalty was relatively inexpensive for what could be a large project.  It could also never be developed, though Altius, as the founder of Adventus, certainly knows the project better than most.  I don’t know how it will work out, of course, but this is a “plan for the future” royalty, it won’t be generating any revenue for at least five years and we don’t even have a preliminary economic assessment (or any reserves) for the project — the PEA should come out sometime in the first half of this year, along with updated resource numbers. This is essentially adding some leverage to their Curipamba position — Altius already effectively owns 15% of that mine (through equity holdings — they own 21% of Adventus Zinc, which owns 75% of Curipamba).

Sandstorm Gold (SAND) — buy below $5, relatively low valuation compared to gold royalty peers and Hod Maden provides a big catalyst for growth at an undetermined point in the future (and creates a discount today)… also look at Osisko Gold Royalties (OR) as a possible alternative, it has finally fallen to a more rational valuation.

My other large investment in the commodity space is Sandstorm Gold (SAND) which also bought a new royalty last week[2], picking up a 0.9% NSR on the precious metals of Lundin Gold’s Fruta del Norte project, also in Ecuador.  That was substantially more expensive than Altius’ buy at $32.75 million, both because it’s a larger mine (in gold terms, at least), and because it’s actually under construction — royalties on mines that are already financed and being built, or in production, are much more valuable than royalties on exploration projects, just because the project has been de-risked to a large degree (many projects die in exploration or permitting, or don’t end up being attractive enough to raise construction money).

If Fruta del Norte starts pouring gold as anticipated at the end of this year, and is in commercial-scale production by mid-2020, then this mine, at current estimated production levels, should generate 325,000 ounces a year… which would effectively mean 29,250 ounces to Sandstorm. They wouldn’t quite get the market price, since the transport to the smelter and the actual refining cost some money, but that should be close to $3.5 million a year in pre-tax cash flow (at current gold prices).  That means roughly a nine-year payback on a 15-year mine (planned) if prices stay where they are — if gold goes much higher the payback will be much sooner, if gold goes below $1,000 for a few years they might well stop work at the mine and Sandstorm would have no real recourse but to wait. As with most royalty deals, Sandstorm comes out ahead if the metal rises — both because the royalty itself would generate more cash, and because higher prices would encourage Lundin to do more exploration and probably expand and extend the life of mining on this land (and therefore expand and extend the royalty in the future). That’s a fairly expensive purchase, frankly, but that’s because it’s so de-risked with the progress already made on the most challenging part of the mine construction — it still carries some political risk, miners have been worried about Ecuador for years, but this tells me that Sandstorm’s geologists are very confident in the mine eventually growing beyond that “325,000 ounces for 15 years” estimate.

The real upside for mining royalties, if  you’re a patient long-term owner looking decades into the future, is that they cover more than is in the current mining plan and reserves, and they have no exposure to the operating costs of the mine but have full exposure to any increase in the price of the products mined. That’s why people love royalties, because royalty companies don’t have to rush out and sell $100 million in shares because their mine floods or go bankrupt because of a protracted labor dispute… the worst that can happen to them in most scenarios is that they stop getting the royalty if the mine stops producing, and as passive participants they don’t get any say in whether the mine operates or not, or how much the operator invests in expanding production or doing more exploration. That means they don’t go bankrupt in downturns (unless they go debt-crazy, of course), and if they’re smart they buy assets during weak pricing periods, but they get levered upside exposure to gold (or whatever the commodity is) during boom periods.

Sandstorm has been my favorite gold royalty play for a while now, mostly because I like Nolan Watson’s leadership and strategy of gradually building up the portfolio, and it’s arguably the cheapest of the substantial gold royalty/streaming companies (FNV, RGLD and Osisko Gold Royalties (OR) are the others). Osisko is getting more interesting lately as it gets beaten down, and over the past six months it has fallen to a valuation that’s close to as appealing as Sandstorm’s and with better recent revenue growth. I’m putting Osisko Gold Royalties on the watchlist to consider, mostly because of their exposure to the massive Canadian Malartic and Eleonore mines that form a nice foundation… and Osisko doesn’t have the perceived risk of the Turkey connection, so for those who are leery of that it might be worth considering.

It’s that Turkey connection that remains the biggest hurdle to Sandstorm getting substantially re-valued, I think — they are growing their revenue steadily, assuming gold prices are stable or climbing, but the huge boost to growth in production at their royalty properties is off in the future, when the huge high-grade Hod Maden mine in Turkey is built. That was a huge investment for Sandstorm a few years ago, and it brings both execution risk and at least the perception of political risk.   They have to wait for their operating partner, Lidya Madencilik, to actually finance and build the mine… which should be worth something like $300 million to SAND on a NPV basis but won’t be generating the 50,000 ounces of gold per year that they expect for probably at least four or five years.  The mine is in permitting now and would be fairly quick and inexpensive to build, but these things always take a longer  time than you expect. My sense is that the political risk in Turkey weighs heavily on Sandstorm’s valuation and that’s why they don’t get any credit for Hod Maden right now, but we’ll see. For now, SAND remains a buy below $5 as the best combination of relatively low valuation and unusually large growth catalyst a few years out that I think is available in the gold royalty space, but it’s also a space that’s generally expensive compared to other stocks and which is, to state the obvious, driven by gold prices.

Clean TeQ Holdings (CLQ.AX, CLQ.TO, CTEQF) — hold, worth a speculation if you are bullish about cobalt and nickel prices but current price weakness in those metals is not speeding up the financing process… construction likely to commence at some point this year, production probably in 2021.

This one has been a meaningful loser in the portfolio as I’ve been patient with their struggle through the process of financing the Sunrise cobalt/nickel mine in Australia.  Clean TeQ positions itself as a technology leader in ion separation and water treatment, and they are always working on that, but the real value of the company in my mind is the cobalt and nickel they’re going to produce, using their refining process, from Sunrise.

The news from Clean TeQ is mostly just that they are still working on financing the mine, though they have secured their first offtake agreement and have raised enough capital to be well underway with engineering and design work to hopefully speed up the actual construction time.    The stock has suffered partly because of increases to the expected capital cost of the project last year (it’s now $1.5 billion), but the real challenge has been the 50% drop in cobalt prices in the past six months or so (cobalt was trading above $40/lb for a while about a year ago, and now are back down to about $15) and, to a lesser extent, the drop in nickel prices (back down to about $5/lb after peaking around $7 last year).    The definitive feasibility study says the project is worth $1.4 billion (after tax) for a 19% annual return, which is great, but that’s based on $30 cobalt and $7 nickel — it’s a valuable enough project to be worth building even at these lower prices, but at lower prices the financing costs will take a bigger  hit.  The current market cap for the company of $240 million or so is certainly rational if you think cobalt goes back up on battery demand, which is what I assume will happen over the next decade and why I’ve been willing to hold through this ugly decline, but that’s far from a certainty.

They should be finalizing the investment decision in the next few months, pretty much as soon as they finalize the financing terms — we don’t know what the cost or form of the financing will be (they might do all offtake agreements with strategic partners, or do royalty or streaming deals, they have some flexibility — in part because of the extremely long expected mine life of 40+ years).  They say construction will take a couple years, with likely delays to be clarified as soon as they announce the next update to the schedule, so there’s no immediate rainbow on the horizon for Clean TeQ shareholders in the form of actual revenue, but firming up the financing deals and finalizing the plans and starting construction will let us at least value the company based on the anticipated production (and cobalt and nickel prices).   I’m holding and watching, financing and construction is not the fun and exciting part of the mining business and it would probably take some surprising news or another surge in cobalt prices to drive the shares dramatically higher this year.

Sprott Inc (SPOXF) — Buy this asset and ETF manager below US$2 for exposure  to another gold mania, with limited downside compared to miners.

I just opened a position in Sprott a few weeks  ago[3], so my opinion hasn’t had much opportunity to change (the price hasn’t changed much, either).  Sprott is interesting because it’s small and concentrated, with most of its earnings potential in the near term coming from management fees on their physical gold and silver ETFs.  If we get a surge in gold prices, as seems very possible to me in the next year or two, then the ETF assets balloon and Sprott’s management fees balloon along with them.   Sprott’s other businesses, lending to miners and private equity deals and hedge fund management in natural resources, might provide upside someday but my hope is that they just break even — even with relatively low assets under management, the ETFs pretty much cover Sprotts operating costs… so if those assets surge, that goes almost immediately to the bottom line.  And they pay a nice dividend, now approaching 5%, that they can probably afford even without a gold boom… though it will be tight if we go for a couple years without gold rising meaningfully.

Africa Oil (AOIFF) — speculative buy below $0.90, current market value matches what they just paid (in cash) for Nigerian offshore blocks that are producing already and will make them profitable next quarter, so you get their 25% interest in their Kenya discoveries, which could get a production decision this year, for free.  With production, will now be more directly sensitive to oil prices.

Africa  Oil is a stock I’ve been sitting on as a “free ride” after taking a lot of profits way back in 2015 or so on their Kenya oil discoveries.  In the years since they’ve been working with the government to get an oil production agreement and infrastructure in place, and have sold off a lot of their holdings to maintain junior positions in most of those fields, leaving them with a lot of cash as they wait for production to become viable (probably still a few years away, depending on when someone decides to plunk down a billion dollars for a pipeline).  Late last year, they finally put a big chunk of that cash to work — they bought into Petrobras’ offshore oil fields in Nigeria, which will turn the company into a cash flowing oil producer immediately.

I’ve long considered this to be a “free money” option on whatever those Kenya oil fields might eventually produce, since they’re large and the company is wildly undervalued if it goes well, but that’s only because I had the luxury of selling half of my position after the excitement of their initial discovery years ago (I sold around $6 a share back in 2014, well off the highs above $10 but plenty to make the investment very profitable and make the cost basis for my remaining position negative). So Africa Oil has been a stock I’ve mostly ignored, checking in once or twice a year, but I’ll be very curious to see what the cash flow looks like from those wells.  The final investment decision for developing the Kenya oil fields and infrastructure is expected sometime year, so this may be a stock that’s finally worth watching again even as it’s one that will be valued based on current oil prices, thanks to the production cash flow we’ll start seeing with their next quarter.   They also bought a small stake in an offshore South African oil block late last year, another project operated by Total, so there’s some possible cash flow coming from there, eventually, if they can bring that discovery to production too.

That pretty much wipes out Africa Oil’s huge cash position (the offshore Nigeria acquisition cost about $350 million, the South African investment $20 million), so they are now debt-free and will be generating cash flow rom Nigeria.  If oil stays strong in this $50 range and Kenya makes any progress at all in making room for a real oil business to operate, Africa Oil is starting to look very cheap here — unless they overpaid for the giant fields they bought offshore Nigeria in some dramatic way, the company is pretty much valued based just on that acquisition, with their 25% in those huge Kenya oil projects a free option.  There’s some possibility of the stock recovering sharply if oil prices are decent and the first production numbers from the Nigeria blocks are strong, since no one has really forecasted the revenue from those (that I’ve seen at least), but even if it’s a slower ramp up of cash flow I think investors who buy here down well below a dollar and can ignore the holding for a couple years will be pleasantly surprised.

US Gold Corp (USAU) — hold awaiting exploration results in the next week or two.  This is purely an exploration play.

This is one for which I overpaid, but I kept the position small and committed to just holding through their drilling campaigns for a while to see if they find anything exciting.  I judged odds were decent of a discovery given the experience of the team with similar property, but so far no big news.

Lesson on this one?  Keep exploration speculations very, very small.  And don’t commit more capital than you had intended to just because it falls — you don’t want to average down on a gamble that will either be a big winner or a 100% loser, since the 100% loss is always the more likely outcome when you’re talking about exploration.

Innovative Industrial Properties (IIPR) — hold, buy below $45 but think about taking some profits if it gets into mania pricing before the next announcement (earnings or dividend increase), which I’d currently judge to be the $65-70 range.

IIPR bought another facility recently, for a total of about $25 million (including tenant improvements to be funded)… and that’s good, as is the fact that they are continuing to get very strong returns, though the indication is that the cap rate is declining very slightly with newer deals. Some of the older deals had 16%+ cap rates, for this latest deal the company did not detail the return expectation but did note that the average of the portfolio is now 15.1%, down from 15.4% a few months ago, so the deal is likely somewhere in the 14% neighborhood.

These cap rates (“annual cash return” in real estate-speak) are destined to fall both because of the increasing willingness of investors to finance marijuana companies and the growing willingness of smaller financial institutions in some states to begin lending to these firms — there’s still a lack of big national low-cost financing available, mostly because the big commercial real estate and banking firms are not involved yet because of the elevated risk of the industry (it’s still illegal on the federal level, after all), but that probably won’t be the case forever. The risk, of course, is that as competition comes in the returns will go down.

In the words of Inception REIT, one of their aspiring competitors (looking to raise about $42 million right now as an unlisted REIT):

“While we anticipate that future changes in federal and state laws may ultimately make available financing options not currently available in this industry, we believe, in the interim an economic opportunity exists over the next few years to provide our real estate financing-solutions to state-licensed industry participants who lack access to traditional financing sources to operate and expand their business.”

I was looking at the prospectus offering recently for Inception REIT, for example, which looks like it aims to do almost exactly what IIPR is doing. That will be an unlisted REIT, raising money only from accredited investors at this point, though their goal is to pay a much higher dividend. I don’t know if the deals will be there for them, but the principals are experienced in the marijuana space and I expect they’ll raise the money pretty easily with their promise of a 6.5% yield for common shares, even if that yield is just a return of capital for a while as they look for investments. They’re targeting similar kinds of returns, though with a broader mandate (not just medical marijuana growing facilities, which is what IIPR is targeting) — their goal is to do about half mortgage lending and half property acquisition — 5-10 year lending at 10-13%, and 10+ year sale/leaseback deals (that’s IIPR’s focus, too) with 13-15% cash on cash returns in year one. They’re aiming to raise some of their capital through preferred shares as well, at a higher yield, probably because (like IIPR) they wouldn’t easily be able to access low-cost debt to lever their returns. So that’s intriguing, though it’s an unlisted REIT so the risks are far higher — there’s no daily liquidity, your money is really locked up in a way that could be troublesome if the business prospects turn uglier.

I’m not in IIPR for the current yield, more for the capital gains that will come as continued rapid dividend growth drives the shares higher, but at some point the growth will stop. I may well take some profits fairly soon if IIPR continues this relentless advance, and I do think it’s too risky to buy in the high $50s — I still think a good buy point is $45.  But where’s a point that some profit taking makes sense?

There are lots of ways to value REITs — most people look first at dividend yield and dividend growth, and those are probably the most immediate drives of share price, along with general “story” excitement and sentiment (particularly when it’s a hot sector like marijuana or a hated one like shopping malls).

My most optimistic projection, if they invest all of the cash they have on hand in similar deals to their existing ones, and keep expenses from growing too quickly (which should be possible), is that they could have Adjusted Funds From Operations (cash flow from rents and fees minus corporate overhead costs and acquisition costs, basically) of about $29 million a year once all the deals are in place and the tenants are all paying rent (they often get a break for the first year, or during construction and improvements). That would be just under $3 a share if they never sell another share (they will), so even in that optimistic scenario you’re paying a forward possible Price/FFO valuation of 20+ right now at $60 a share. That’s arguably justifiable because of the growth, I think, and there are plenty of large REITs that trade at much loftier valuations, but it’s also getting riskier.

You can also simplify and look at it from an acquirer’s perspective — if you were to buy the whole company, how much of a premium does this management team deserve because of the lucrative deals they’ve signed so far? If they’ve invested $167 million, and all within the last year or two, is that asset base worth $167 million or some premium? If you decide it’s worth 2X what they paid, which I could get on board with, then that’s $334 million… add in the current cash level of $124 million, and you get $460 million, which would be about $47 a share. That seems rational to me, as does the roughly 3% forward yield at that level… $60 is more of a stretch, and if we get higher still it seems reasonable for me to take some profits despite my fondness for the company and its dividend growth — it’s still a real estate company, competition is gradually rising, regulation could change the future of the business dramatically, and it shouldn’t rise to the sky.

If you want to be more optimistic about the opportunity that would arise if regulation eased and big money started to come into cannabis, it’s also worth noting that if IIPR can keep their existing deals and the decline in profitability of future real estate financing deals in marijuana is gradual, there would also be more financing possibilities for IIPR. If IIPR levered up like most REITs do, and added some debt to the balance sheet, their free cash flow per share could jump considerably and give the stock another way to grow… that’s probably years away, but that’s the possible upside of more financing options coming into this space as competition (having a REIT that goes from no debt to an average level of debt can spur huge dividend increases — that’s what we saw with CoreSite (COR) a few years ago).

Here’s what the chart looks like for IIPR since they went public — that orange line shows you the growth of the quarterly dividend, the blue line is the growth in the stock price. Either that orange line makes another bump up pretty soon, and a substantial one (which they will be able to afford, assuming they keep signing deals at similar terms to their existing 15% cap rate portfolio), or the blue line should come down a bit to meet the dividend growth track.

IIPR Chart[4]
That’s not a specific charting prediction, just a way to visualize that I think the stock should be driven by dividend growth from this point. They’ve only been paying a dividend since July of 2017, and have raised it twice (December 2017 and September 2018), so there’s no real pattern for when we might expect the next increase… could be in March, could be in September, I have no idea. The current dividend, $1.40 per year, is almost exactly what the annualized adjusted funds from operations would be as of their last quarter… though they sold another $100 million worth of stock at $40 since then, so that means they have both more financial flexibility (about $125 million in uncommitted cash) and an immediate drop in AFFO per share (because of the extra shares). That big boost in shares is part of the reason that I keep my “buy below” point at $45 — which is also roughly a 3% yield. I would think of shaving off some profits if the stock gets foolishly overvalued, as is certainly possible, for me the mid-$60s begin to be reasonable for partial profit taking… though there is a risk that the next dividend increase could be 30-50% and drive the shares substantially higher again, particularly if they manage to deploy more of their cash fairly quickly into new projects with 14-16% cash flow yields. The main reason to take some profits is the indication that cash yields for their deals are likely falling with competition…. and dividend increases might moderate.

Medical Properties Trust (MPW) — hold this hospital REIT, could justify taking some profits after an extremely strong year but I try to resist selling dividend growth companies that trade at rational valuations.  

The bar is high when it comes to selling a dividend-paying stock that’s performing well and compounding dividends nicely. Yes, Medical Properties Trust (MPW) is much more richly valued than it was a few years ago, and has recently hit a new all-time high, which tempts the profit taker.

I don’t think there’s anything materially worrisome about MPW, however, or any reason beyond “it went up a lot” to say that the price is destined to fall permanently from here (it probably will fall at some point, it tends to be pretty volatile).  They own hospital properties and have some degree of inflation protection built into their triple-net leases, so the risks are a severe decline in the healthcare sector that closes a bunch of hospitals… or a rise in interest rates that raises their borrowing costs and makes their dividend look less appealing to investors.  The former is not a major concern for me on a systemic level, since old people vote and hospitals are still important — cities and towns usually fight to avoid losing their hospitals; the latter is a real issue for pretty much all REITs, but with a decent asset base and responsible balance sheet I think it’s a risk worth taking for this part of my portfolio. I’m just holding and letting the dividends compound — I try not to sell dividend growth compounders unless they hit a stop loss because the business becomes noticeably less interesting for some reason, or they become absurdly overvalued, and MPW has not shown any signs of hitting either of those extremes.

Medical Properties Trust has appreciated mostly because of the wave of deleveraging they did late last year, selling some properties and equity investments, taking on a partner in Germany, and bringing their net debt down to about 4.5X EBITDA… with a huge $1+ billion available on their revolving credit facility to purchase more properties if any of their pipeline of deals look attractive.  Their guidance is that “normalized funds from operations” will be between $1.42 and $1.46 in 2019, which should give them room to continue to grow the dividend from the current $1/year level — and they hint at wanting to grow the dividend more quickly, so there is some potential upside (and downside, since that forecast includes a couple billion dollars more in acquisitions that they haven’t made yet).  A 5% dividend increase would make the forward dividend yield 6% at $17.50, with continuing inflation protection, a strong asset base, and a unique portfolio of needed facilities.  That’s not a compelling buy, not at all-time highs, but I don’t have a good reason to sell so this is a hold.

Kennedy-Wilson (KW) — Buy below $20 for a growing yield and nimble real estate “value investing” management.

Kennedy-Wilson is a smallish (sub-$3 billion) asset manager and value investor in real estate — they invest both in developing and upgrading properties in improving markets that they can sell later, as they’ve done in selling in Dublin and Seattle recently and buying in Salt Lake City, and in building a more stable cash-flowing part of their real estate portfolio.   The stock is valued much like a REIT, with a 4.5%  yield and recent dividend growth of about 10% being pretty appealing, but it isn’t a REIT — it tends to use more debt, they get a fair amount of their income from management fees as they invest other peoples’ capital alongside their own, and they do a lot more trading of properties than most REITs.  Earnings are very volatile as they sell properties, but I like their track record over the past several years and also like the substantial insider ownership (CEO Bill BcMorrow owns about 9% of the company) and the backing from other investors I like (Fairfax Financial owns another 9%, for example).  I expect them to continue to compound value and pay a strong dividend, but not to shoot higher in any dramatic fashion, so it’s best to buy opportunistically on dips.


And now… some other updtes!

Ligand Pharmaceuticals (LGND), which I fully stopped out of in two stages over the past few months at a weighted average of $179 a share (The bulk at $200, the balance at $100), got an analyst update from Goldman Sachs.  From the Seeking Alpha coverage[5]:

Goldman Sachs analyst Dana Flanders provides the numbers behind his Street-low fair value target of $168 (46% upside) for Ligand Pharmaceuticals (LGND -2.1%) which makes money via licensing deals.

He values its base business at $47/share, assuming that Novartis’ Promacta (eltrombopag) and Amgen’s Kyprolis (carfilzomib) reach $1.7B in peak sales and won’t face generic competition until 2024 and 2026, respectively.

Mr. Flanders has $550M in milestones in his model through 2032, on the conservative side considering that the company says its $3B milestone target does not include all of the expected $1.5B from Viking Therapeutics’ pipeline.

His price target assumes $21/share for preclinical and future partnerships, $16/share from Phase 1 assets, $21/share from Phase 2 assets and $15/share from Phase 3 assets.

That base valuation is reasonable, and the distinction between GS and the short sellers is that they put some value on the very early stage stuff, the many preclinical and early-phase programs that may or may not eventually generate any milestone or royalty income for Ligand… and, conservatively, that means they’re essentially writing off expectations for the two biggest milestone payment potential programs, the diabetes program that Ligand just sold to Roivant and the programs being developed by Ligand’s spinoff Viking Therapeutics. Pretty reasonable, I’d say, and still assumes that investors will consider far-future programs to be valuable and won’t just value Ligand based on current royalty earnings.  We’ll see what happens when all this settles down, maybe I’ll own the stock again someday.


And I covered and closed my long-short position in Adial Pharmaceuticals (ADIL), mostly because the cost of shorting the name ramped up dramatically (to well over 100%… my short in MTEC, by contract, costs less than 5% a year) and made the long-term prospects of holding bleaker… so that closes with a nice, quick gain for a short-term holding. If you missed that one, which I only held for a few weeks, I was short the stock and protected myself with a long warrant position, something I like to do with fundamentally risky stocks when the have long-term warrants that are relatively cheap — usually those end up being SPAC deals, but sometimes other small and vulnerable stocks offer long-term warrants, particularly in precious metals and biotech. I don’t like to short volatile small stocks without some coverage from warrants or options, but when I can get the coverage cheap they can generate good returns… and it’s always good to have a few short positions in a portfolio to keep you thinking about downside and protection.


And yes, what to do about Qualcomm (QCOM)?

Any Qualcomm shareholder no doubt noticed the short attack from Kerrisdale this week, which was based on the premise that they will lose their court fight with the FTC and will also therefore lose their business model — they will no longer be able to collect high royalties (“extort,” folks like Apple would say) based on their intellectual property, and will have to license on fairer terms and not limit licenses to their own chip customers. That’s coming at the same time that competition is heating up for the Dragonfly system-on-chip packages that Qualcomm sells to phone makers, and Kerrisdale thinks that means Qualcomm will drop to a valuation similar to average semiconductor stocks (their target is $21, so a drop of 60% or so from here).

I don’t know what the outcome of the FTC trial will be, or of the Apple dispute. If Kerrisdale’s prediction comes true and Qualcomm is forced to license its cellular patents at a much lower rate, and based on the price of the modem instead of the price of the end product, then yes, Qualcomm’s revenue could fall dramatically (they predict that it will essentially drop in half, that’s pretty much a guess). That’s huge, not only because that’s a big portion of Qualcomm’s revenue (about 25%), but because it’s the profitable portion — licensing is much higher-margin than selling actual chips.

What will happen if they lose all these fights? I can’t tell you, which is part of the reason that my Qualcomm position is still pretty small (1%), though I’ve been adding to it over the past year and like the company’s prospects because of the 5G infrastructure upgrade cycle we’re entering.  The company won’t disappear, and they are currently offering what appears to be the most advanced 5G chips and should see a rise in revenue as 5G network investment increases… but that will not be enough to make up for losing a couple billion dollars in annual profit from licensing.

On the other hand, that would also presumably restore some licensing revenue from Apple, which has been withheld this past year as Apple didn’t let its suppliers pay, and could dramatically increase the potential market for Qualcomm’s chips if they are priced more similarly to peers. I don’t know. It will be interesting to see how Qualcomm responds to this short attack, though it’s also quite possible that they can’t really respond while the case is playing out in court and while they’re a week away from their quarterly earnings report.  I will hold through earnings and watch the outcome of the trial with interest, but so often in these cases we see an end result that is far from the 100% positive or 100% negative that boosters or short-sellers predict.

A reader forwarded another perspective on the FTC trial in a Forbes article[6], which might help if you’re feeling jumpy.

And that’s all I can get to this week… more to come, keep the questions headed our way and I’ll try to answer those as I can as well, particularly after I finish off the annual review over the next week or so. Thanks for reading!

  1. wrote some about Anglo Pacific here:
  2. bought a new royalty last week:
  3. opened a position in Sprott a few weeks  ago:
  4. [Image]:,include:true,,&displayTicker=false&source=false&useEstimates=false&startDate=&securitylistSecurityId=&quoteLegend=true&quotes=true&scaleType=linear&format=indexed&calcs=id:price,include:true,,id:dividend_per_share_ttm,include:false,,id:dividend_per_share,include:true,,&securityGroup=&useHttps=false&partner=&maxPoints=850&recessions=false&splitType=single&annualizedReturns=false&legendOnChart=true&annotations=&endDate=&correlations=&units=false&title=&note=&securitylistName=&zoom=3
  5. Seeking Alpha coverage:
  6. another perspective on the FTC trial in a Forbes article:

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