Friday File: “Trophy Assets”

by Travis Johnson, Stock Gumshoe | July 5, 2019 8:15 am

Answering a reader question about some REITs, plus a few other quick updates
P.S. Stock Gumshoe will be mostly closed for two weeks... expect your next Friday File on July 26.

I’m off to spend a couple weeks walking in the woods with Mrs. Gumshoe and the Little Gumshoes (though they’d probably want me to note that they aren’t so little these days), so we won’t have much in the way of new content at Stock Gumshoe for the next two weeks, and the next Friday File won’t come until July 26.

I also don’t expect to do any trading in the next couple weeks, and I didn’t make any changes to the Real Money Portfolio this week beyond covering my Akerna (KERN) short and selling most of the associated warrant position. (If you’re curious about the details, by the way, I was short KERN because I expect the stock to get to $10-12 once the float increases with insiders freed up for selling… and I covered in the $15s, before it got to my target, because the cost to borrow increased from 50-100% to about 300%, meaning it would cost more than 1% a day to hold the position. I held a small portion of the warrants as a “just in case it takes off” speculation, but sold most of the rest… one of the nice (and rare) trades where both the main position and the hedge are profitable.

That inactivity I’ll be facing in the next couple weeks is a little emotionally challenging for someone who is accustomed to reading about and monitoring dozens of stocks every day, particularly during volatile times like these, but over the longer term I imagine my little vacation will be good for the portfolio… the biggest impediment to long-term results, after all, is short term activity. The more you buy and sell, the more likely you are to screw things up.

I admire the patience of Warren Buffett, who has always said that you shouldn’t own a stock for ten minutes that you wouldn’t own for ten years… and that you should focus on owning companies that you’d be happy to hold if the market closed for a few months and you were stuck not knowing what the “price” might be for a long time. But one reason Buffett and Munger have done so well, beyond their obvious skill in identifying the right investments to make over time, is that this stubbornly patient mindset is really hard to maintain. Hopefully I’ll become stronger and wiser by (mostly) ignoring my portfolio for two weeks, we’ll see. If my resolve weakens, and the market gets so wacky that I burst out of the woods in a desperate search for a good WiFi signal, well, I’ll let you know — fingers crossed that you won’t hear from me for a little while 🙂

So what should we talk about this week? I thought I’d start with a reader question that popped up in discussion a little while ago:

“What do you think of ESRT (Empire State Realty Trust)?

“In their ‘Bear Market Survival Event’ video last month, the folks at Stansberry Research called this REIT a ‘trophy asset’ to have during a recession.”

Porter Stansberry has often talked up the idea of “trophy assets” — we saw that notion written about when he was selling his “American Jubilee” strategies that scare the pants off of people, and if memory serves he spoke similarly about “irreplaceable assets” in his (also terrifying) “End of America” pitches seven or eight years ago.

Empire State Realty Trust (ESRT) is a REIT that owns mostly Manhattan office buildings, including the iconic Empire State Building. That building alone is a “trophy asset,” of course, but it’s also a very old office building and sometimes they have trouble leasing it out because it’s not customized and cookie-cutter prepared for the demands of some modern businesses… I’d guess that they rely to some degree on the prestige of the building to attract tenants.

The tourist business with the observation deck and associated vendors is a nice bonus, I would have thought it would be of minimal importance related to the overall office leasing business (they own other buildings beyond the Empire State Building as well), but it’s actually fairly significant — the observatory revenue was about $20 million in the first quarter, so that’s more than 10% of total revenue (which was $165 million). It’s also an investment area, they’re upgrading the observatory area and the elevators, so I don’t know whether or not it generates cash flow.

Overall, if it weren’t for the “trophy asset” of that building and the probably somewhat limited growth potential fo the tourist business (they can only squeeze so many people through those turnstiles, and there’s “high” competition from Rockefeller Center and the Freedom Tower), you’d probably look at ESRT and think it’s pretty average for an urban office REIT.

The yield is amply covered by funds from operations (FFO) — they report adjusted FFO of about 19-20 cents per quarter and pay a dividend of 10.5 cents per quarter. That provides a dividend yield of 2.7%. And the dividend has not been increased since 2016, so you can’t really claim it’s a dividend growth company. Here’s a rough comparison with the company that I most often think of when someone asks about “prime urban office REITs”, the larger Boston Properties (BXP) (numbers are roughly accurate, but I pulled them a couple days ago):

Boston Properties (BXP)
Market cap: $20 billion
Price to sales: 7.4
Price to expected 2019 FFO: 19
Debt to equity: 1.9
Return on Equity: 8.9%
Forward Dividend: 2.9%
Dividend coverage (Dividend as % of FFO): 54%
Dividend Growth (CAGR, last 3 years): 13.5%

Empire State Realty Trust (ESRT)
Market cap: $4.7 billion
Price to sales: 6.3
Price to expected 2019 FFO: 20
Debt to equity: 1.5
Return on Equity: 5.2%
Forward Dividend: 2.9%
Dividend coverage (Dividend as % of FFO): 55%
Dividend Growth (CAGR, last 3 years): 0%

I can see how you might be attracted to the Manhattan focus of ESRT if you consider that to be the true “crown jewel” of real estate, though I also get a little nervous about being that concentrated in just one city.

Given that comparison, I think I’d more likely choose the wide diversification (DC/San Francisco/Boston/Manhattan/LA) of BXP, particularly given their steadier dividend growth and larger number of “trophy” assets they own (none are “grand champion” trophies like the Empire State Building, of course… but they have several impressive and irreplaceable downtown office towers around the country, and lots of “participation” trophies in suburban office parks and “town centers” and lesser-but-highly-leasable office buildings, along with a few residential projects).

That’s not a recommendation, nor an in-depth analysis, just a quick look at whether the Empire State “Trophy” is a favored investment… in case you’re curious, here’s the total return for those two REITs since ESRT went public in 2013 — both have trailed the REIT index (as represented by the Vanguard Real Estate ETF (VNQ)):

ESRT Total Return Price Chart[1]

Though if you go back a bit further, you can see Boston Properties has been above average for 15+ years (and it was better before that, when it was smaller and growing more quickly, but the VNQ comparison doesn’t go back before 2005):

BXP Total Return Price Chart[2]

Sometimes it’s important to think of a company, management team and strategy as a “trophy,” too — is it the buildings that matter to you, or the company’s ability to grow over time and continue to add value to the real estate portfolio? If there’s a real once-in-a-generation crisis, then maybe it will be the actual iconic real estate that’s key, but I’m guessing that no one really cared who owned the Empire State Building when New York City was a disaster in the 1970s.

And remember, the idea of “investing for the next crisis” is not new — and I’d guess that it doesn’t have a track record that’s any better than flipping a coin. Predicting what will happen in the next real crisis is a big business for newsletters, despite the fact that they’re just as likely to be wrong about the specifics of the next crisis as we are, but predicting doom is also such a compelling business that they pitch the “disaster protection” almost all the time, which makes their predictions seem somewhat less about saving us and more about scaring us.

If ESRT was dramatically cheaper than BXP, or “cheap” at all, I’d probably feel differently… then you start to think about the value of the underlying real estate and whether they can create more cash flow from the Empire State Building. But since it’s not dramatically cheaper, and is not as focused on shareholder returns (no dividend growth), my first impulse is that Boston Properties is more of a “trophy asset” than Empire State Realty Trust. You can probably insert any of the other big and diversified REITs in there, BXP is just one that comes often to mind for me.

If you really want that Manhattan focus, by the way, then perhaps your comparison should be to SL Green (SLG), another REIT which is the largest property owner in Manhattan — they’re a bit bigger than ESRT, with a similarly weak recent performance but a better valuation. Here are those same numbers from SLG:

SL Green Realty (SLG)
Market cap: $7 billion
Price to sales: 6
Price to expected 2019 FFO: 12
Debt to equity: 1.0
Return on Equity: 3.2%
Forward Dividend: 4.25%
Dividend coverage (Dividend as % of FFO): 51%
Dividend Growth (CAGR, last 3 years): 5.7%

That’s looking more like a “depressed” REIT trading at closer to a “value” price, which is somewhat appealing. That’s not enough to make me run out and buy SL Green, about which I don’t know a lot, but it’s enough to make me think ESRT is not interesting enough to pursue at these prices.

And, of course, REITs have proven themselves again to be appealing during “falling interest rates” times, so in general they’ve done well this year as the market began to expect rate cuts from the Fed and to drive down the rates on the 10-year note… though as that narrative ebbs and flows, as we saw last week when the Fed’s commentary proved to be slightly less “we’re going to cut RIGHT NOW” than the market was hoping. I like having a large exposure to REITs in general in my portfolio, and I expect they will generally do well in a persistently-low-rates environment while also providing some inflation protection, though I haven’t owned any of the more “traditional” office or retail REITs in quite some time.

Some other quick musings for you…

Largo Resources (LGO.TO, LGORF) announced last week that they’re holding off on their “capital return” plans as vanadium prices have remained soft (and who knows if that will continue over the next year — if the China/US trade dispute is the dog, vanadium prices are a little flea at the end of its wagging tail). I remain pretty confident in this one over the next few years because vanadium demand should generally remain high, they are the only real pure play low-cost producer, and they’re about to be debt-free even as they expand production… and they will take over their marketing from Glencore next year and should have more pricing power at that time.

I still like the 3-5 year potential for Largo, and I kept my “bet” on this stock relatively small to help me avoid thinking too much about the share price in the interim, but investors sure didn’t like that announcement last week… and buying into the shares on the tail end of a bubble in vanadium pricing means it sure hasn’t been pretty so far for the Real Money Portfolio. I’m still not selling on a stop loss, but risk controls are important so I’m resisting the temptation to chase this position with more buys, the sub-1% bet I’ve made on this vanadium producer is about all I want to have at risk in this particular name. I still expect Largo to be an interesting story to follow over the next few years, but I clearly have no talent for predicting short-term vanadium pricing.

Ilika (IKA.L, IKILF), the speculative little solid state battery stock on our watchlist, has announced that their next earnings report will hit on July 11 — that will be the full year results for their fiscal year ending April 30, so I’ll be interested to see what they say about their joint ventures and their future expectations.

And I haven’t mentioned them lately, but I’m still watching Modern Times Group (MTG-B in Stockholm) — their split from Nordic Entertainment was completed earlier this year, and there was relatively little impact on the shares, but it seems likely to me that their focus on esports and gaming provides an opportunity here. You can see their transcript of their last earnings results announcement (from May) here[3]. In that same sector, I also remain tempted by the still-depressed shares of both Electronic Arts (EA) and Activision (ATVI), in part because of the long-term potential growth of eSports, but I have yet to actually talk myself into buying any shares. Dither, dither, dither.

Have a wonderful couple of summertime weeks without me, and I’ll be back to blather at you again on July 22 (next Friday File will be July 26).

Disclosure: Of the companies mentioned above, I own shares only of Largo Resources. I will not trade in any covered stock for at least three days, per Stock Gumshoe’s trading rules.

  1. [Image]:,include:false,,id:total_return_price,include:true,,&chartType=interactive&colors=&correlations=&dateSelection=range&displayTicker=false&endDate=&format=indexed&legendOnChart=false&maxPoints=850&note=&partner=basic_850&quoteLegend=true&quotes=true&recessions=false&scaleType=linear&securities=id:ESRT,include:true,,id:BXP,include:true,,id:VNQ,include:true,,&securityGroup=&securitylistName=&securitylistSecurityId=&source=false&splitType=single&startDate=&title=&units=false&useEstimates=false&useHttps=false&zoom=
  2. [Image]:,id:price,,include:true,id:total_return_price,,&chartType=interactive&colors=&correlations=&dateSelection=range&displayTicker=false&endDate=&format=indexed&legendOnChart=false&maxPoints=850&note=&partner=basic_850&quoteLegend=true&quotes=true&recessions=false&scaleType=linear&securities=include:false,id:ESRT,,include:true,id:BXP,,include:true,id:VNQ,,&securityGroup=&securitylistName=&securitylistSecurityId=&source=false&splitType=single&startDate=&title=&units=false&useEstimates=false&useHttps=false&zoom=
  3. here:

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