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When I upgrade a stock to a Strong Buy, I’m essentially suggesting that I have the utmost confidence that the combination of yield and price appreciation will generate annual total returns in the range of 25 percent.
Needless to say, there must be more than one catalyst that drives this strong buy conviction, and oftentimes there’s a large dose of sentiment going the opposite direction. Joel Greenblatt, author of The Little Book that Beats the Market and You Can Be a Stock Market Genius, sums up deep value investing,
“So, one way to create an attractive risk/reward situation is to limit downside risk severely by investing in situations that have a large margin of safety. The upside, while still difficult to quantify, will usually take care of itself. In other words, look down, not up, when making your initial investment decision. If you don’t lose money, most of the remaining alternatives are good ones.”
Easier said than done, right?
One of the most important ways to capitalize on the so-called margin of safety is to be prepared, and as Warren Buffett explains, it’s not easy “going against the herd”,
“I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.”
Today I decided to provide you with a list of some of my Strong Buy picks in the REIT sector. Keep in mind, these three REITs offer high yields, and that’s Mr. Market’s way of saying that there’s danger lurking, but I have done my homework, and I am only recommending these names because I believe there’s strong upside to support my strong buy thesis. Let’s get started…
CorCivic (CXW) is a prison REIT, and of course, one of the reasons that I believe in the business model is because I consider these properties to be “critical mission infrastructure”. Recognizing that the private prison system in the U.S. has become highly political, I remove myself from debate, in order to address the dynamics of the business model.
Much of the prison systemin the U.S. is at over capacity, with the federal system alone being at around 130%. Private operators are only a small portion of the overall network (around 8%) and CorCivic operates within that tiny slice of the prison network with around 72,833 beds and over 14.7 million square feet.
Much of the recent price decline has been a result of banks who were once loyal to the prison sector become less enthusiastic (again, this sector is political). However, CorCivic is far from bankrupt and has until 2023 to find suitable lenders to renew its credit facility.
Also the company has a solid quarter (Q2-10 reporting FFO per share of $0.69, a 21% increase vs. Q2-18 ($0.05 over the high-end of guidance). In addition, Adjusted EBITDA was $115.3 million, representing an 18% increase from the prior year quarter (nearly $7 million over the high-end of guidance).
The current dividend yield is 11.1% but the dividend is well covered (payout ratio is 68% based on AFFO) and actually lower than the average REIT Payout ratio (of 78%). Given the huge discount, we are maintaining the strong buy recommendation, but remember that there will always be volatility, and there should be plenty of debate (on prisons) over the next twelve months.
Park Hotels (PK) is a Lodging REIT that was formed when Hilton Worldwide spun off most of its owned real estate into a separate public REIT. Park became the second largest Lodging REIT, behind Host Hotels and is also among the Top 25 largest REITs out of 130 REITs. The company owns a combined portfolio of 51 hotels in 17 states and D.C. with an enterprise value of around $12 billion (as of Q2-19).
More recently Park acquired 100% of Chesapeake stock for $2.7 billion and Pro Forma Adjusted FFO per share (for Park) is expected to be accretive in 2020 (2.0%) and 2021 (3.0%+). With that closing, Park now owns 66 hotels with around $942 million of EBITDA.
Since going public Park has maintained discipline by preserving capital with a targeted leverage ratio of 3x to 5x. The Chesapeake deal results in a modest increase in leverage with net debt to adjusted EBITDA increasing to 4.6x from 3.9x, but asset sales should reduce leverage.
Park screens for high quality with one of the highest dividend yields in the lodging REIT sector (7.61%) with a payout ratio of around 53 percent. Park is forecasted (by FAST Graphs) to grow EBITDA by 13% in 2020 and we consider this best-in-class. Given the deep discount being offered (P/FFO is 8.2x) we believe there’s significant multiple expansion that could result in annualized returns of 25 percent or higher.
Tanger Outlets (SKT) is a retail REIT that invests exclusively in outlet centers. Notably, the company has no department stores in the portfolio, and this means that it doesn’t have the higher cap ex costs (as the mall REITs) to release and or repurpose dark department store spaces.
That doesn’t mean Tanger is not immune to retail risk, the company has many of the same mall-based tenants that have made recnt headlines, such as Forever 21 (recently said it was filing bankruptcy), Dress Barn (closing al of its stores by the end of the year), and Gymboree (filed bankruptcy in January).
However, the key differentiator with Tanger is that the company has maintained occupancy of at least 95 percent or higher since it went public over 25 years ago. So even though retailers continue to close stores, Tanger has been able to mitigate the risk by maintaining a disciplined balance sheet.
Approximately 94 percent of Tanger’s square footage is unencumbered by mortgages and the company has $90 million outstanding on its unsecured lines of credit, leaving 97% unused capacity (or approximately $581 million). The company has the lowest payout ratio in the mall sector – around 69% based on funds available for distribution (or FAD), thereby providing it with significant liquidity to maintain the dividend.
Tanger shares are trading at $17.43 with a P/FFO of 7.6x. The dividend yield is 8.15% and we maintain a strong buy recommendation (even though shares have increased by over 15 percent during October).
Disclosure: I own shares in SKT, CXW, and PK.