One Liberty a Good Buy in an Irrational Market
There’s nothing I love more than a good old market bloodbath. Too many investors look for a herd and follow their emotions to make investment decisions. For those investors, the S&P being down over 6.5% in one day is disastrous. For me, I look at prices and when I see the tag on something I want dropping 10% in a day, I’m much more likely to load up.
On that note, early on Monday, I checked my investment account and noticed that One Liberty Properties (OLP) was down almost 20% at the market open. My first instinct was an emotional one: “What went wrong? What did I miss?”
First thing I did was look at Yahoo Finance for headlines and OLP had in fact, released second quarter earnings Monday morning. It was an absolutely stellar earnings release. Funds from operations had increased to $0.37 per share for the quarter (on a normalized basis; including one-time gain on debt settlement, FFOs were $0.46 per share). Revenues were up 8.8% year-over-year. The dividend was not being cut and, in fact, looked more sustainable after the earnings release.
I was baffled. Apparently, the market was so distracted by negative economic news elsewhere that it was ignoring One Liberty’s very good quarter. One Liberty was already one of my largest holdings, but after seeing the earnings release -- coupled with the plummeting prices -- I put an order in for more shares to see how low of a price I could get. I was able to get in a reasonably sized order at around $13.19 and another one at $13.30. Split the difference, and I got in with an average price around $13.25. That was good for a 9.96% yield.
There’s nothing I love more than market irrationality and One Liberty on Monday morning is just one example of that. On Tuesday, the market seemed to suddenly “discover” OLP, bidding it up over $15 for a time. But even at $15, OLP is not a bad buy at all.
An Attractive Valuation
A combination of valuation, high dividend yield, and significant insider buying by company execs and directors makes One Liberty a very attractive holding. Using an 8% cap rate, I come up with a basic valuation for One Liberty’s properties at $433.85 million. That’s significantly larger than the $392.2 million figure for the “Net Real Estate Investments” listed on the balance sheet.
Doing a straight balance sheet valuation based off that, I came up with equity value of $261.77 million. That would give the stock an implied price around $18.67 per share. At $15, it sells about 20% below its intrinsic value by my calculations, using an 8% cap rate. Monday, when I managed to acquire shares at around $13.25, I got in at 30% below intrinsic value.
The great thing here is that OLP also pays out one of the fattest dividends for any commercial REIT. I’m still somewhat surprised by this because it implies higher risk, but in actuality I believe this is more of a case of the market being unfamiliar with it. It’s a small cap REIT with a market cap around $220 million that does not get much press.
Over the past few years, management has done a tremendous job at creating value. OLP is one of the few commercial REITs that did not take a significant revenue hit as a result of the financial crisis. The chart below shows the growth of revenues, operating income, and cash flows over the past 6 ½ years.
The asterisk beside 2011 is an indication that I am annualizing the results for the current year, since we only have two quarters of data. It's not easy to compare yearly results without annualizing the current data. In case you don’t know, “OI + DA” means “Operating Income plus Depreciation and Amortization.” Since real estate properties generally do not depreciate, this is more of an accounting measure, so we add it back to get a better measure of operating income on a cash basis. “CFOs – [change]WC” means “Cash Flows from Operations minus the change in working capital.” I would consider this a particularly useful metric to look at for most REITs.
What’s significant here is that revenues have been growing for OLP in spite of the lack of significant equity offerings over this time period. OLP did conduct an equity offering early this year, but for the overall time frame analyzed here, most of this growth was not equity-infused.
There are a few outliers in that data. In 2006, cash flows make a massive jump before falling back down. This was the result of an equity investments paying off larger distributions than usual. Also, the 2010 and 2011 operating income figures are somewhat held back by real estate acquisition costs. If you ignore that, operating income has continued growing over the past year and a half.
All of this suggests to me that One Liberty’s management team has done a much better than average job at making prudent real estate investments and creating value for shareholders over the past half-decade.
The biggest risk for OLP, in my view, is macroeconomic happenings. If the economy was to tank again, we could see the value of OLP’s real estate holdings fall and revenues decrease. However, the company held up very well through the carnage of the past several years.
There’s an additional upside here as well. My valuation of OLP assumes an 8% cap rate. With a lower cap rate, I would come up with a higher valuation. Many real estate investors would argue that a lower cap rate should be used here; some might want to use a higher rate. But even with a 9% cap rate, I come up with a valuation of $15.20. And that valuation doesn’t really pass my smell test since the dividend yield would be around 8.7% at that level, significantly higher than comparable REITs.
By the way, with a 7% cap rate, my valuation goes up to around $22.70. This is not all that far-fetched, as this would still give OLP a 5.8% yield, which is much closer to comparable REITs.
The Final Word
The stock price for OLP catapulted back upwards Tuesday morning. Even so, I think it’s still one of the best values among commercial REITs you can find on the market right now. At $15, it is paying a rather handsome 8.8% dividend. Paying a lower-than-average price for a REIT that appears to have better-than-average management team and track record seems like a good deal to me.
While the market price could drop again as a result of macroeconomic pressures, I believe that the large dividend and the depressed valuation of the stock more than compensate for that. If it plummets again, I will likely buy more shares. As of today (due to the market price increase), One Liberty has become my largest holding.
Disclosure: I am long OLP.