HiddenValueStocks Q1 2020 Issue: In-Depth With Focused Compounding Capital On Their Favorite Micro/Small CapsJacob Wolinsky
Hidden Value Stocks issue for the first quarter ended March 31, 2020, featuring interviews with Nitin Sacheti of Papyrus Capital discussing Maui Land & Pineapple Company and Mike Melby of Gate City Capital discussing AMREP Corporation and Pico Holdings.
Welcome to the March 2020 (Q1) issue of Hidden Value Stocks.
This issue is packed full of stock ideas from some of our favorite funds, including Focused Compounding, Gate City Capital Management and Papyrus Capital.
In the first part of this issue, we have updates on ideas from Nitin Sacheti of Papyrus as well as Mike Melby of Gate City. Both of these managers believe that the stocks they highlighted in previous issues of Hidden Value Stocks remain undervalued, and have been adding to their holdings over the past two months. They explain why in the updates.
The primary interview in this issue is with Focused Compounding. Founded by Geoff Gannon and Andrew Kuhn, Focused Compounding started managing money as a hedge fund at the beginning of this year.
Geoff and Andrew also provide a managed account service, which they were able to start off the back of their subscription-based investing idea website, Focused Compounding back in 2018. Geoff and Andrew’s slogan is, “We spend 99% of our time focused on the 1% of stocks every other fund ignores.”
According to the team, they’re looking for “overlooked stocks” that have “durability.” They want to “find a business we’d be okay being stuck in permanently that’s in an industry we’d be okay being stuck in permanently.”
In the interview, Geoff highlights a handful of stocks currently owned by the managed accounts, as well as a few investments that have not worked out as expected.
At the end of this issue, there is also a table showcasing all of the stocks previously profiled in issues of Hidden Value Stocks.
We hope you enjoy this issue of Hidden Value Stocks, and if you have any questions or comments, please feel free to contact us at [email protected]
Rupert Hargreaves & Jacob Wolinsky.
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Updates From Previous Issues: Papyrus Capital
In the Q3 2018 issue of Hidden Value Stocks, Nitin Sacheti of Papyrus Capital presented one of his favorite stock ideas at the time, Maui Land & Pineapple Company, Inc. (MLP).
Maui Land & Pineapple began life as a pineapple plantation over 100 years ago and subsequently built up a large landbank. However, the previous management team levered the business up significantly before the financial crisis. As a result, the partnership had to spend the next eight years rebuilding its balance sheet.
Now that the restructuring is complete, Maui Land & Pineapple is focusing on the development, and sale of its incredibly valuable land.
In his original thesis, Nitin explained that, based on recent land sales, the ultimate value of Maui Land & Pineapple Company’s land bank could be worth as much as $41 per share, offering a potential upside of 250% at the time.
Since this report was first published, Maui Land & Pineapple Company’s shares have struggled, but after recently agreeing on the sale of a substantial block of land for a price of around $1 million per acre, Nitin believes that this could be about to change.
What’s changed since your original report on the company, which was published in August 2017?
Since my report published in August 2018, the company has announced the sale of 46 acres in their Kapalua Central Resort project for $44 million, with an anticipated Q2/Q3 2020 closing date.
Has the deal altered your original investment case for the company at all?
We had anticipated that the company would either: (1) enter into a development JV for Central Resort or (2) sell the land.
The sale is at a lower price than our expected value of development, but timing is sooner, so it means more cash today. That is more valuable than cash flow over time (on which we put a multiple).
After the sale, the company now has 850 acres of comparable land left to sell. At a sale price of $1 million per acre, this land could be worth up to $850 million.
Do you think that’s a realistic breakdown of the company’s asset value?
I think the Central Resort land is slightly inferior to the rest of the 850 acres. The rest of the property is located in Kapalua, which is closer to the beach. As such, I’d say the rest of the 850 acres is at least worth $1 million an acre. This also does not put any value on MLP’s 10,800 acres of agricultural land and 9,000 acres of conservation land.
We put $20,000/acre on the agricultural land since they can sell/develop it over time (though it’s far inferior to the 900 acres in Kapalua). We put almost no value on the conservation land since this will stay protected. That adds just about another $200 million in value, on top of 850 acres plus cash. This all needs to be taxed at about 25%.
Is the company planning more land sales?
There are another 50 acres just north of Central Resort for which we believe the company has already received offers. We think they can sell this for another $50 million in the near term.
Management has also offloaded the Kapalua Water Company and Kapalua Waste Treatment Company. Can you explain why these deals were necessary for the business?
Selling the water utilities was necessary to improve the plant. The buyer, Hawaii Water Services, is much larger with a lower cost of capital. This will help fund improvements to the facility, which are needed to support so much additional development on Maui Land & Pineapple’s property.
They also have the knowhow to improve the facility. One thing we really like about Maui Land & Pineapple’s management is that they know what they are good at, and are not willing to undertake extensive development projects where they have little expertise.
We believe this speaks to how well they will allocate the $44 million coming in from the recent land sale along with future cash flow from additional land sales.
On that topic, what do you believe management is planning to do with the cash from these asset sales?
I believe management will distribute the cash to shareholders while holding some in reserve for buybacks, taxes, and nominal costs for the development of other projects.
The stock has gone nowhere over the past 12 months. What makes you think this is about to change?
The most considerable pushback on this stock has always been that they would never sell assets, and it would sit as a land bank for many years.
Clearly, the sale of the Central Resort land shows us that they are beginning to sell large pieces of the business to benefit shareholders. That means unlocking value in the stock. The stock has already started moving as investors start to appreciate this (aside from more recent COVID-19 related volatility).
What’s your view of Steve Case, the majority shareholder? Is he working to unlock value?
Steve Case’s father was the attorney for the original land trust. No one would know the assets better than the attorney for the trust. He told his son to buy it, so we know Mr. Case sees value in the asset and is clearly helping drive monetization.
You initially place a SOTP value of $41.39 per share. Has your evaluation of the business changed since the first interview?
I’d say my value of the business still holds at just above $40, but I do believe the substantial Kapalua Central Resort monetization will help the stock get there sooner rather than later!
Are there any developments that could invalidate your thesis and cause you to sell the position?
I think the risks are the same as the original writeup, somewhat mitigated by the asset sale (lower risk of Maui Land & Pineapple developing on their own). There are no new risks to the name that did not exist in 2018.
Interview One: Mike Melby - Gate City Capital
Hidden Value Stocks featured Gate City Capital in our Q1 2019 edition.
Gate City Capital’s founder, Mike Melby, picked out AMREP Corporation (AXR) and Pico Holdings Inc. (PICO) as his two favorite stocks at the time of the interview.
One year on, we asked Mike if he still likes these companies, if Gate City has been adding to its holdings, and what’s changed since our initial interview.
First of all, do you still hold a position in AMREP?
Thank you for reaching out. It is great to touch base again, and I am excited to provide an update on some companies we highlighted a year ago.
Gate City Capital Management still holds a position in AMREP, and we have added to our position over the last twelve months. I would refer you to the amended Form 13G filed on February 14, 2020, showing Gate City Capital Management as the beneficial owner of 15.91% of the outstanding shares.
A few months after we last spoke, AMREP announced the sale of its fulfillment business for $1 million in cash.
Do you think this was the right decision for the company, and how has it changed your estimate of intrinsic value for the business?
The sale of AMREP’s subscription fulfillment business was a significant event for AMREP. The transaction was structured, so the $1 million cash sale price was just a portion of the total consideration. In addition, the buyer continued to operate from AMREP’s two owned buildings in Palm Coast, Florida. The buyer agreed to lease these two buildings for a period of 10-years at an initial rate of $1.9 million/year, escalating to $2.5 million in year 10.
While we would have preferred more of the value recognized in the upfront purchase price, the lease rates are above market value and provide for additional consideration above the $1 million cash price.
In February 2020, AMREP also announced that it had agreed to sell one of the two owned buildings in Palm Coast, Florida, to the buyer of the subscription fulfillment business for $12.5 million.
Should the deal be completed, AMREP will receive an additional $12.5 million in proceeds in addition to the $1 million received in April 2019.
AMREP will also continue to own the second building in Palm Coast, which is currently leased through October 2020 at a rate of $550,000/year.
The transaction is consistent with our initial estimate of intrinsic value.
When we spoke in 2019, we assigned a value of $20 million for AMREP’s subscription fulfillment business, which included both the business operations and the two properties. Should the sale of the first building be completed, AMREP would have received $13.5 million in proceeds for the segment while continuing to own an additional building with a base rent of $550,000/year.
Despite this significant development, the stock has gone nowhere since our original interview. Why do you think this is?
As a brief overview, at AMREP’s current share price, the company has a market capitalization of approximately $46 million and an enterprise value of $34 million.
I do not have a good explanation for why AMREP’s stock continues to trade at levels well below what we consider to be intrinsic value. AMREP is a micro-cap company, with limited trading volume, which I expect limits the potential ownership base.
Moreover, AMREP is not covered by any sellside analysts and does not have a dedicated investor relations program, which likely limits the amount of information the investing public has on the company.
Our investment philosophy at Gate City Capital Management is to own companies trading at a significant discount to the value of their discounted free cash flows and provide a substantial margin of safety.
Since we last spoke, AMREP has performed well and has generated significant operating cash flow. Much of that cash flow generation is not apparent to investors as AMREP has contributed $5.6 million to the company’s pension plans during the last twelve months (this fulfilled a funding requirement following the sale of the subscription fulfillment business). AMREP’s pension liability stood at just $2.7 million as of October 31, 2019, and we do not expect the pension to require meaningful contributions from AMREP going forward.
We expect the company’s real estate operations to continue to generate free cash flow and expect a significant inflow of cash upon the completion of the sale of the company’s first building in Palm Coast, Florida. To that extent, we are happy to continue to own AMREP at current prices and will let other investors make their own decision on the value of those cash flows.
AMREP also owns a large amount of real estate, which the company is trying to monetize. What progress has it made on this front over the past 12 months?
AMREP’s real estate development business continues to perform well. As an overview, AMREP owns 18,000 acres of land in the city of Rio Rancho, New Mexico, and an additional 165 acres of land outside of Denver, Colorado. In Rio Rancho, AMREP develops the company’s land base into lots that are then
sold to homebuilders or other developers. As your readers might recall, there has been a shortage of developable land available for homebuilders across the nation, and AMREP’s broad base of land is a critical strategic asset.
Over the last twelve months, AMREP has sold approximately 33 acres of developed land in Rio Rancho for proceeds of over $13 million or about $400,000/acre. AMREP continues to develop four subdivisions in Rio Rancho actively, and we expect robust sales in the area to continue.
In addition, AMREP is currently constructing a building on one of the company’s commercial lots in Rio Rancho that will be a retail store for Natural Grocers, the health food grocery chain.
The construction costs are approximately $2.8 million, and we expect the value of the building to be worth considerably more than that when construction is completed this summer. This building can either be held for recurring revenue or monetized.
AMREP is also advancing on plans to monetize the company’s land base in Colorado. AMREP owns a 160-acre
subdivision called Mountain View Estates in the Denver suburb of Brighton, Colorado.
Mountain View Estates is surrounded by completed developments but has thus far been restricted from moving forward with development due to water issues encountered by a neighboring subdivision. We believe these issues are being remedied, and AMREP should be able to proceed with either the development or outright sale of Mountain View Estates within the next 12-18 months. AMREP also owns a 4.6-acre commercial tract in the Denver suburb of Parker, Colorado. The land is prime real estate on the corner of Main Street and Jordan Road and is being marketed for sale at $4.4 million. Finally,
AMREP also owns mineral rights under the 160 acres of Mountain View Estates. Great Western Energy is drilling in the immediate vicinity, and we are hopeful AMREP will realize some value from the company’s mineral rights in the next few quarters.
In summary, has your estimate of intrinsic value for the business changed at all considering the progress the business has made over the past year?
My estimate of intrinsic value is relatively unchanged. I have a target market capitalization of $92.5 million, equating to $11.40/share and representing over 100% upside to the current share price.
Pico Holdings Inc
The other stock you highlighted in our Q1 2020 was Pico Holdings Inc. Have you made any changes to your position?
Gate City Capital Management has added to our position in Pico over the past 12 months. In our initial interview, you claimed that the company’s water rights and credits are worth more than the value implied by the market cap of the business.
Pico has completed a handful of asset sales over the past year. Have these deals confirmed your original claim?
As a reminder to your readers, Pico owns water rights, water credits, and related infrastructure in the southwestern United States. Pico’s water assets are located in rapidly-growing areas, including Reno, Nevada, Phoenix, Arizona, and Las Vegas, Nevada.
Pico has a market capitalization of approximately $200 million and an enterprise value of $190 million. In the last twelve months ending September 2019, Pico generated almost $22 million in water and land sales. These sales include 175 acre-feet of water credits in Reno, Nevada for proceeds of over $6 million or $35,000/acre-feet, the sale of 470 acre-feet of water rights in northern Nevada for $3 million in proceeds, and $8.9 million in land sales. Additionally, in Q4 2019, Pico sold 25,000 acre-feet of water credits for $8.7 million in proceeds. These sales were all consistent with our expectations.
Pico continues to own 7,800 acre-feet of water credits that are designed to serve the North Valleys communities of Reno, Nevada, and are currently being marketed for $36,000/acre foot. There are several large subdivisions in the North Valleys that we expect to have demand for these water credits. Pico also continues to own over 28,000 acre-feet of water credits in the Phoenix area that we value at $350/credit and 250,000 acre-feet of water credits 70 miles west of Phoenix that we value at $250/ credit. Additionally, Pico owns water rights in other vital areas, including Carson City, Nevada, and north of Las Vegas that have significant value.
In our initial interview, you also stated that based on your analysis of land values, the intrinsic value of the business was $22.50 per share. Has your view changed at all based on recent deals?
Our view of intrinsic value has not changed – we believe it is supported by the recent transactions.
The firm recently announced a $100 million share buyback. Do you think this was the right action for management to take?
The announcement is further evidence of the company’s intention to monetize assets and return proceeds to shareholders. Pico has completed over $38 million in share buybacks in the last three years in addition to paying a $5.00 special cash dividend of almost $116 million.
The $100 million share buyback indicates that management and the board expect to monetize a significant amount of assets over the next few years and have the intention of returning the proceeds to shareholders.
Our view is that the company’s assets are worth significantly more than the price implied by the company’s share price, and utilizing asset sale proceeds to repurchase stock is a good use of capital.
You initially projected that it could take 10 years for the company to wind-down. Is this time frame still realistic?
That time frame remains consistent.
And finally, last year, you pegged your worst-case scenario downside target at $9.50 per share. Does this still stand?
Our downside scenario is consistent with last year’s levels and is currently at $9.00/share. I would highlight that this does not represent a “worst-case scenario,” which could involve any number of geopolitical events beyond our control. Our downside is based on an orderly liquidation of the company’s assets at sizeable haircuts to current market prices.