Motley Fool’s “Next Generation of ‘Hidden Millionaires’ Pitch

Motley Fool Canada pitches income from "royalty cheques" to benefit from e-commerce

By Travis Johnson, Stock Gumshoe, July 18, 2017

Motley Fool Canada launched a new dividend-focused newsletter service called Dividend Investor Canada earlier this year, and they’re now promoting it using a promise that they’re finding retail’s “next generation of ‘hidden millionaires.”

And, of course, the bait that they dangle to entice you to subscribe is a report with some “secret” stocks that they recommend.

So what’s the story, and what are the stocks? If you don’t feel like ponying up $200 to learn the “secret,” stick with me and we’ll take a look. Here’s a taste of the intro:

“Retail’s Next Generation of ‘Hidden Millionaires’ Is About to be Born

“But these savvy investors won’t make their fortunes by buying shares of Amazon… Canadian Tire… eBay… PayPal… Shopify — or any other well-known company you’ve probably heard of.

“Instead, he predicts they’ll quietly snap up a handful of under-the-radar companies (just like the ones I’ll introduce you to in a moment) ….

“And, if everything plays out like this investor expects it to, they may even be able to collect steady ‘retail royalty cheques’ each year in amounts like $660… $1,320… or even $3,300 — all while the underlying value of their investments climbs steadily higher over time.”

Royalty checks while your investment climbs steadily over time? That sounds lovely… and it also sounds like a pretty typical dividend investing strategy. So what are the stocks?

The ad goes off on a long tangent about the history of successful retailers of the past, like Melvin Simon, Ted Lerner and, particularly, Alfred Taubman, who pioneered the early shopping malls and made billions…

And we’re told in the ad letter that the “five rules of striking it rich” in retail were, as I sum them up for you (and probably oversimplify): eliminating threshold resistance (making it easier for shoppers to get into the store and buy something); tapping the explosive megatrend of automobiles and suburban sprawl by making shopping convenient to cars and suburbanites; providing convenience and selection in one easy-to-access spot; locating your shopping mall in the most convenient place to enable you to drive traffic and charge premium rents; and staying fashion-agnostic — don’t try to ride fashion or pop culture trends, just own the space and get the customers there and let other companies worry about merchandising (and pay you rent).

Which is when we get to the specific opportunity that they begin to hint at: Location.

But not shopping center locations — locations for e-commerce, the trend that is arguably killing the shopping mall (and at least culling the weaklings from the herd). Here’s a bit more from the ad:

“… what many people forget is that when it comes time to deliver you the goods you bought online, e-commerce companies have no choice but to depend on actual physical locations in the good old ‘real world.’

“You may already know that I’m talking about the humongous distribution centres where companies like Amazon, Canadian Tire, and Wal-Mart store the massive amounts of inventory they sell online…

“But what you may not know is that these distribution centres are seldom — if ever — owned by the companies themselves.

“Instead, the online retailers merely lease space in these giant centres in much the same way that stores used to lease space in a shopping mall…

“Which makes the location of these distribution centres incredibly important — especially given the recent push by companies like Amazon and Wal-Mart to get the items you buy online to you within a few days time.”

OK, so if we add all that up — smallish companies, own distribution centers, pay “royalty cheques,” that means we’re almost certainly looking at some industrial REITs — companies that own industrial, logistics and distribution warehouses and lease them out to operators (yes, like Amazon and all their competitors, but also to any company that requires warehouse space or distribution services). It’s a fast-growing business, and there have been several REITs trying aggressively to expand in this space ever since ProLogis (PLD) pioneered the “warehouse REIT” sector about 20 years ago.

So which stock, specifically, does Bryan White like in this sector? Here are our clues:

“Offers Canadian investors unique access to the rapidly growing U.S. consumer and industrial market — yet still trades on the TSX…

“Enjoys an incredible 98.4% occupancy rate across all of its properties — meaning it’s collecting rent on almost every last square metre of space it owns…

“Recently renewed the vast majority of its expiring leases — which will help ensure those occupancy rates stay sky high well into the future…

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“Was even able to increase the rent on its fifth largest tenant, Zulily, by 12.4%… with 2% annual escalators built in over five years — demonstrating just how willing e-commerce companies are to pay top dollar for access to this company’s locations…

“Has a high level of insider ownership — a strong indicator that top management will make decisions that are in shareholders’ best interests…

“And currently pays a healthy 5.6% dividend yield — in U.S. dollars no less, making this an intriguing investment option for an RRSP…”

If you’re not familiar with an RRSP, those are are Registered Retirement Savings Plans — essentially the Canadian equivalent of an IRA or 401(k) here on the warmer side of the border. And yes, stocks like REITs that throw off taxable income in the form of dividends often make sense in these kinds of tax-deferred accounts, because letting that income reinvest and compound without being taxed increases the total return (and because you won’t have to pay income taxes on those relatively high dividend payments each year).

But which investment is this, specifically? Well, the company White is referring to with these clues is WPT Industrial REIT (WIR.U.TO in Canada, WPTIF OTC in the US). Interstingly, this is one of those “odd” stocks that trades primarily in Canada, but is priced in US$ even for its Toronto-traded shares.

WPT industrial is a small REIT, with a market cap below $500 million, and it does indeed have a few things going for it — it’s got a strong dividend, with the forward yield expected to be about 5.8% that makes it far more generous than US-listed comparables like PLD, DCT, DRE or STAG; and it’s cheaper than most of the US-traded industrial/logistics REITs on most metrics (EV/EBITDA, EV to Free Cash Flow, price to book value).

So that’s pretty interesting, and it makes me want to take a closer look — one thing that has stopped me from investing in the big US warehouse REITs, despite the obvious secular growth story from booming e-commerce, is that they’re generally too expensive to take seriously, and have been for some time. (That doesn’t mean they can’t keep going up, of course, it just means there’s less room for error.)

Does that mean we can get a piece of that kind of growth potential and also enjoy a 5% yield instead of a 2% yield? That might make me stand up and pay attention — but with that kind of differential, there has to be a downside or a reason, even if it might not be a good reason. What might the reason be for this relatively cheap valuation?

Well, it’s a new company. They’ve only been around for a couple years and went public in 2016. And they’re externally managed, so they have fees incurred for property management and acquisition management that eat into profits to some degree (though such agreements often aren’t terrible, since they effectively mean that you just are paying that fee instead of having employees yourself).

And the properties are encumbered, with a meaningful amount of mortgage debt and a company that is, overall, pretty indebted — though the debt is all fixed-rate at an average cost of 3.8%, and the maturities seem manageable (as do the lease expirations, which are pretty well spread out over the next decade). WPT Industrial has a capital structure that is more dependent on debt than is the larger DCT Industrial, for example, but both have roughly comparable debt levels in comparison to their assets, with debt at about 40% of asset value. Which indicates to me that the bondholders are in a stronger position with WPT Industrial if things get ugly, but that their overall level of debt is reasonable (and similar to peers) as a percentage of the value of their real estate portfolio.

They also have recently had substantial insider selling, with Welsh Property Trust offering up $40 million of their shares in a secondary offering that also raised $86 million for WPT (Welsh Property Trust, or WPT Advisors, is the external manager for WPT Industrial). That offering, just announced as closed today, was at a decent price — so that’s not a particular red flag (they didn’t have to discount to get the shares sold).

But really, probably the fact that they’re skating at a pretty close to their maximum dividend payout, and have not been able to increase their funds from operations per share, is the most worrisome negative. Their growth focus and their several equity raises have meant that the FFO per share number actually shrunk last year, since the share count rose, and that brought the payout ratio up to a pretty high 90%+ (mea