Saturday, May 20, 2017

Activist Investors, Special Prosecutors and Inconsistent Posting

Instead of droning on about one topic today, here are three things that are top of mind. 

1. Activist Investors Push Granite REIT to Change

When I initiated a position in Granite REIT last spring, it was their combination of cheap P/FFO valuation around 10X and the above-average 4.5% distribution growth that attracted me to the company. Granite's management had just wrapped up a strategic review and decided to stay the course instead of taking any drastic action (i.e. a large strategic acquisition or divesture, putting itself up for sale, or paying a material one-time distribution). My investment in Granite REIT was a way for me to gain exposure to Magna (Granite's largest tenant), which is one of a handful of world-class companies we have in Canada, at an entry yield about double what Magna was paying at the time (6% vs 3%). 

A couple weeks ago, FrontFour Capital Group and Sandpiper Group announced they had acquired a 6.2% stake in Granite REIT and released a plan to "unlock value at Granite REIT". FrontFour and Sandpiper have proposed two of their directors for the upcoming election of Granite's board of directors. At a very high level, Frontfour and Sandpiper argue that Granite trades at a substantial discount to its fair value due to a misunderstood asset base, strategic failures, and a loss of confidence in management and the Board. Granite responded somewhat on their Q1 2017 earnings call and more detailed via this proxy circular.

As a unit holder of Granite, the attention that the activist investors have shed on the company has been beneficial from a share appreciation perspective. Frontfour and Sandpiper raise some relevant issues concerning Granite's lack of strategic action, overcompensated management team, and misunderstood asset base. However, Granite's response to their dissident shareholders also makes some prevalent points about the returns they have been able to generate shareholders over the past five years in excess of the TSE REIT index, the lack of successful track records of FrontFour and Sandpiper within the REIT space, and the absurdity of some of the activists' suggestions (i.e. selling some major holdings around Toronto to show stakeholders how much they are truly worth). 

With both sides continuing to argue their respective stances, I'm taking a wait a see approach as this is the first time one of my holdings is the target of activist investors. Even if FrontFour and Sandpiper are able to elect their two nominated directors to Granite's board, I question if they could push their agenda given strong opposition from the majority of directors. My view is that the activists have brought some additional coverage to Granite, forcing the company's management to justify their past inaction and firmly outline the path they are pursuing for future growth.

2. Special Prosecutor and Impeachment Talks Create Buying Opportunity

For those of you who keep close track of my Investment Holdings, you may have noticed some recent changes. The past week was officially my busiest ever, with three buys including initiating a new position in my Tax Free Savings Account. The combination of letting my cash build up to an uncomfortably high level (~8% of total holdings) and the downward momentum caused by the appointment of a special prosecutor to review the Trump Administration's ties to Russia both facilitated my three purchases. I'm considering another couple of investments outlined in my Q2 2107 watch list, and hope for continued volatility in the markets in the coming weeks. 

3. Inconsistent Posting Schedule

As I struggle to meet my once a week posting goal, I feel that I owe an explanation to readers. Beyond my current lack of ideas for interesting posts, more time spent preparing for the software launch I've been working on at my job over the past two years, and quality time required by my super energetic near three year-old son, I have another great reason for my inconsistent posts. My wife and I are expecting our second child early this July. There have been numerous preparations for the birth of our baby daughter that have caused a shift in my priorities. Although I enjoy writing as an outlet and have always found it beneficial to review my decisions relating to past stock purchases/sales, with the more outward focus of this blog, I'm finding less time to make quality posts that would provide value to readers beyond myself.  My expectation is that the number of entries I write will continue to decrease over the summer when our daughter arrives and likely continue on a downward trajectory for the foreseeable future. 

Did you take advantage of the US market selloff this week to make any stock purchases???

Tuesday, May 9, 2017

Is Buffett's Partial Exit of IBM a Warning Sign?

Last Friday, I was surprised to hear about Warren Buffett's decision to sell roughly a third of Berkshire Hathaway's stake in IBM. Although I admittedly don't hold Mr. Buffett in as high regard as other bloggers, I still respect his long-term track record as a stock-picker and empire builder. When justifying his partial sale, Buffett indicated that his assumptions relating the the valuation of IBM had changed since he started buying his stake six years ago and also referred to the company's strong competitors. Much like his defense of partnering with 3G Capital on recent deals, I found his justification for selling a third of his shares in IBM lacking in substance.

Instead of getting stuck in the weeds and overanalyzing Buffett's recent trade, I found a thought provoking tweet from one of my favorite dividend bloggers @dividendgrowth

For those who thought IBM was a great deal at $159 before Buffett disclosed his partial exit, clearly the 5% discount should make the current valuation even more compelling. The trailing P/E of about 12.5X and the dividend yield of 3.9% must look extra tempting to investors who choose to ignore the whims of America's most famous investor. The above tweet made me wonder if Buffett makes the same mistake as me when selling his investments too early.

Each quarter when Berkshire Hathaway files a 13-F form which discloses positions in their equity portfolio, there's a site that summarizes the filing to separate which positions Berkshire has added to and which positions have shrunk. Looking at the 2016 year-end filing, I thought it would be interesting to calculate the year-to-date total return on the eight positions that Berkshire materially decreased or exited in the quarter ending December 31, 2016. The year-to-date total returns (including dividends) for these eight positions is shown below.

Wal-mart (WMT) = +10.9%
Verizon (VZ) = -10.5% 
Liberty Media B (LMCB) = +9.8%
Deere & Co (DE) = +9.9%
Kinder Morgan (KMI) = -1.5%
Lee Enterprises (LEE )= -20.7%
Liberty Media A (LMCA) = -0.5%
ServiceNow (NOW ) = -15.8%

Average return of stocks sold = -2.3%

Granted, five months of returns calculated from a small sample of eight stocks doesn't provide sufficient evidence to conclude that Buffett does a better job selling his investments than the average retail stock-picker. One must also consider that once the 13-F of Berkshire is made public, certain investors and funds who blindly follow Buffett's every move scramble to sell the shares that he divested. It's also worth noting that the volume of shares associated with Berkshire's positions can create downward pressure and momentum on a company's share price when Berkshire starts shrinking their position. Despite all those disclaimers, the above results do partially support Buffett's status as seasoned investor. Although no one can consistently sell stock at the highest price, nor can they buy it at the lowest price, but avoiding big losers helps investors conserve their capital in order to continue making investments.

Although IBM has never been at the top of my watch list due to shrinking revenues and EPS supported mainly through share buybacks, in my view, Buffett's partial exit doesn't make it a more appealing long-term investment. Like many large-cap companies, IBM must determine how to grow their top line or at the very least maintain it in order to appease shareholders without adding excessive debt to their capital structure. Will IBM find that elusive top line growth without such a large investment of sticky capital from Warren Buffett? The answer to that question will ultimately determine if IBM's current stock price represents a good value or a value trap.

Does Warren Buffett's investment in a company make you more or less likely to invest in that company? 

Thursday, May 4, 2017

10 Canadian REITs With Growing Distributions

As one might guess from the growing number of real estate investment trusts ("REITs") in my investment holdings, I favor the REIT sector as it provides a generous initial yield and above-inflation distribution growth, without the headaches associated with active management of rental properties. Given my current difficulty finding compelling valuations in the Canadian stock market and with a little extra cash inside my TFSA and RRSP (where REITs should be held in order to minimize income taxes), it seems like an opportune time to update my entry from March 2016 that consisted of 10 REITs that had raised their distributions in the past 12 months. To slim down the list at May 2017 and to ensure that the REITs were fairly liquid, I only included companies with market capitalization in excess of CAD $1 Billion. The results were further narrowed by insisting that the REIT generate positive FFO over the past 12 months. The resulting screen with REITs ranked via their current distribution yield is presented below.

I own shares in three of the REITs above (H&R, Granite, and Canadian Apartment Properties), but would consider adding a couple of the other companies to provide geographic and industry sector diversification. Included below are my quick thoughts on all ten REITs.

H&R REIT - Likely the most diversified REIT by sector (industrial buildings, shopping centers, office properties), but with the slowest growing distribution.
Granite REIT – Concentration risk given Magna is largest client. Gives exposure to auto parts industry at a higher yield than through Magna directly.
Brookfield Property Partners – Cheapest priced REIT with a diversified portfolio of properties managed by the experienced team at Brookfield. Undesirable exposure to retail and office properties given my current REIT holdings.
Smart REIT – Owns a portfolio of shopping centers across Canada, but unlike Riocan, they tend to raise their dividend yearly.
Choice Properties – Exposure to grocery store giant Loblaws at a good initial yield and at a fair price. Downside is the obvious concentration in Loblaws properties.
Boardwalk REIT – Residential housing REIT that has high exposure to the Alberta economy. It is priced relatively cheap compared to other apartment/residential REITs.
CT REIT – The most expensively valuded REIT owns properties used by Canadian Tire which is a strong brand within Canada. Waiting for a better price to buy is advised.
Allied Properties – Own urban office properties and has a record of slowly raising its payout. Waiting for a better entry point is advisable given how close it is trading to its 52-week high.
Canadian Apartment Properties – Diversified exposure to apartment properties across Canada and a growing international portfolio. Currently expensive and a slow growing distribution.
Canadian REIT – Longest record of annual distribution increases of any REIT in Canada at 15 years. Fairly priced but low yield and slow growing distribution. 

Are there any Canadian REITs that you would consider buying at their current prices?