3 Hidden Real Estate Value Plays for Strong Long-Term Gains
Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Marcato Capital Management is a two-year old firm managing $750 million that focuses on value investments across various sectors. The firm’s sweet spot is $1 billion – $5 billion market cap companies. Last Monday Mick McGuire, founder of Marcato and former analyst for Bill Ackman and Pershing Square Capital, gave a presentation at the Value Investing Congress that focused on three hidden real estate value plays.
Alexander & Baldwin (NYSE: ALEX) is a real estate and agricultural company that focuses on real estate development and commercial housing in Hawaii. McGuire believes that the land on Alexander’s books is held at a value much lower than its potential market value. Most of the plots are farmland, but Alexander believes the value could be unlocked through residential or industrial development.
Alexander represented over 20% of Marcato’s 2Q portfolio, and was the firm’s second largest holding. This included a 33% increase from the first quarter. However, McGuire was topped by mentor Bill Ackman in share ownership amongst the funds we track, with Marcato owning 1.3 million shares and Ackman 3.6 million.
McGuire noted in his presentation that the net asset value on Alexander’s commercial real estate should total just over $900 million, versus the book value of around $800 million. Marcato also completed a DCF on each of Alexander’s development properties, calculating the aggregate of all properties to be around $300 million. Including a net asset value on joint-venture assets with the other values puts the net asset value around $30 a share, while the company currently trades around $29.
McGuire then took his analysis a step further by accounting for Alexander’s current cash flow from operations, adding another $17 to the valuation. This puts the fair value of Alexander’s shares at $47, compared to the company’s current sub-$30 trading price.
Gencorp (NYSE: GY) is McGuire’s second pick. The company is a manufacturer of aerospace and defense products and systems, but also focuses on re-zoning, entitlement, sale and leasing of excess real estate assets. McGuire believes the key to GenCorp’s land value is in a California region that once acted as a buffer between residential areas and test sites for devices. GenCorp has permits to develop around 6,000 acres, with most estimates putting the land value at $50,000-$60,000 per acre. In addition to its California assets, McGuire also places the value of the company’s excess office space at a $66 million based on net operating income of $5 million.
For 2Q, the company reported that cash from operating activities was $29.3 million, compared to $14.6 million in the second quarter of fiscal 2011. Also worth noting is the company’s trailing P/E of 101 and its forward P/E of 25. However, McGuire believes that earnings are understated due to non-cash accounting treatments, and so he believes the company trades at P/E of 8x true economic earnings.
This is probably the most hidden real estate play—having less evident ties to the real estate market when compared to McGuire’s other two picks. GenCorp competes with a couple other key defense product manufacturers that trade above the company on a P/S basis. GenCorp trades at a 0.6, while American Science & Engineering (NASDAQ: ASEI) trades at 2.9x and GeoEye (NASDAQ: GEOY) 1.9x.
GeoEye received two letters from the National Geospatial Intelligence Agency. The first letter advised that, due to funding shortfalls, the NGA would not exercise a full-year Enhanced View Service Level Agreement option the upcoming contract year, and a second letter formally notified the company that the NGA was electing not to obligate additional funding under its OTFPP Cost Share agreement for the development and launch of GeoEye-2. Raymond James downgraded on the news. The company is up over 20% on rumors of a possible merger with Digital Globe.
American Science is losing its CEO in 2013, and for 2Q posted $0.47 EPS versus $0.61 estimates. Prior to this news, the company received a $34 million service and maintenance order from the U.S. government, and received an upgrade by Benchmark. The company trades at a beta less than 0.5 and pays a 3% dividend yield.
Marcato was the largest shareholder of GenCorp at the end of 2Q, owning over 5.7 million shares, which was more than 11% of Marcato’s 2Q portfolio.
Brookfield Residential Properties (NYSE: BRP) is McGuire’s final pick. McGuire believes the majority of the company’s value is in its real estate holdings, and like Alexander, values it on a net asset and book value basis. McGuire notes that over 62% of the company’s balance sheet is made up of raw land, and that an improvement in U.S. housing will be driven by a backlog and a bounce back in orders.
McGuire believes that the current market value should be somewhere around 50% more than Brookfield’s stated value. Also, if Brookfield traded at the same book values as its peers, the share price should be $44-$55, versus the current share price of around $10.
In closing, McGuire has been on the lookout for hidden real estate assets that may have been buried on the books of non-real estate focused companies. He believes in real estate being local, and so focuses on understanding the local marketplace.
This article is written by Marshall Hargrave and edited by Jake Mann. They don't own shares in any of the stocks mentioned in this article. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend American Science & Engineering and GeoEye. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.