Tag: equity

Hear Me Out: Lots to Like about Big Lots Stock $BIG

Reading Time: 6 minutes

What if I told you there was a company with an average ROE > 22% over the past 10 years… It also earns a double-digit ROIC… What if I told you that this company was a beneficiary of COVID, and the cash flow greatly increased its future optionality for years to come? What if I told you this company also has been a consumer of its own shares – especially in market volatility (i.e. when you want it to be buying shares). The title gives it away, but I am talking about Big Lots stock.

Yes, I’m sorry readers. This is a value stock (vs. some SaaS-y growth stock). Brick and mortar retail, no less. 

The stock is now down ~14% after posting Q3’20 results.  While the company posted 17.8% SSS comp (a record), they noted some deceleration (perhaps too much pull forward of Holiday shopping into Black Friday + they closed early on Thanksgiving).  Even so, the deceleration meant Q4 was looking like a +Double-digit Q, and their gross margin guidance seemed conservative, so I thought I’d take a deeper look. 

There are several reasons why I think there is significant upside to the stock with reasonable downside protection — including some things to assuage the B&M concerns.  


The quick and dirty background on Big Lots is its a discount retailer with its foundation in the south and south west, mainly opening up in strip malls (typically an “anchor” tenant). They have ~1,400 locations today, but if you haven’t heard of them it’s because you aren’t in a location they target (more suburban and rural and where the ~30% discounts to other retail they offer are appealing to the price conscious).   


There’s a debate over whether companies that have strongly benefitted from COVID will give back all of the gains they’ve seen this year. In some cases, like in SaaS, investors see a sticky business with low attrition. So it appears investors are saying SaaS will give no sales back  post-COVID. In fact, the street is saying they’ll continue to grow. I’m not saying that is wrong, but for retailers, they are saying the opposite.

For example, people are stuck at home. They aren’t traveling, not going to restaurants, so they’re spending on making the home better. Dollars have shifted from some sectors and into other sectors. As COVID ends, people travel more and go to restaurants, there will be less dollars to go around and they’ll cut back on the beneficiary-of-COVID sectors.

I agree with this generally. Clearly Big Lots is making more sales than ever. These comps it is posting are unsustainable and it will likely post sales declines comps next year.

However, this also didn’t come for free. On BIG’s Q1 call, they noted they canceled their annual Friends &  Family event, gave their employees Easter off (which is typically a big sales event), gave a temporary $2-hr wage increase, provided an additional 30% employee discount, and additional bonus pay. So looking forward, its not just so easy to say the sales comps will reverse. 


I really like the option value of Big Lots. The boost from COVID has done 3 things. And if the term wasn’t overused, I’d say it’s a flywheel – each of the factors reinforces the others:

  1. Improved comps, therefore operating leverage, allowing them to generate a ton of cash flow
    • Big lots YTD has produced about 3x as much FCF as it did last year ($267MM vs. $80MM PY). It also did a sale & leaseback transaction in Q2 to generate $587MM of cash.
    • Q3 is a working capital investment Q ahead of the holidays, but I could see them ending the year with >$700MM of cash
    • Big Lots is also coming off of a capex spend, so future cash flow should also look better
  2. Accelerated competitiveness of Big Lots and its strategic plan
    • Without COVID, I wonder if Big Lots would have accelerated as quickly with Buy Online, Pickup in Store… or E-Commerce (which is probably small, but up 50% in the Q)
    • They also now have >20MM people on their rewards database
    • Sure, a lot of retailers have had to adapt, but there could be something to the theory that struggling retailers (both big and small) will close some locations and post-COVID, the playing field may be altered
  3. Introduced new buyers to the concept
    • With COIVD impacting so many businesses, and a lot of them shutting down, there’s no question that Big Lots benefitted from increased traffic. The question is – can they convert some of those new buyers into repeat buyers?
    • As of right now, the market doesn’t appear to be giving Big Lots much credit for this. In fact, it seems to be getting the least credit out of the few comps I looked at
    • However, as I noted, Big Lots actually does have really good deals. And they are focusing on a market with tailwinds (furniture, home decor, which I speak about later). Couple this will more rewards customers and I think its unfair to say they can’t retain much business

These are intertwined. But the issue with Big Lots, and why its multiple has been halved over the past few years, is that people view the company as being in secular decline

The WHOLE POINT of this post is to say, I think that may be too pessimistic

But take a look at what mgmt is saying it is investing in and able to do right now. I ask myself, “is this company getting better or worse in the future?” and “is my downside well protected?”

In fact, I can’t think of a better strategy to adopt pre-COVID – mgmt’s strategy has been focused on increased home furnishings. Mgmt is probably thinking “I’d rather be lucky than good” — targeting the home was a good idea.


For more background, Big Lots had basically grown nominally the past 12 years. They got a new CEO in 2018 which helped oversee a refresh of the stores, put the best categories up front, and accelerated online investments.

Furniture is a high margin category and they purchased Broyhill, which allows them to offer indoor and outdoor discount furniture (note: Broyhill is on track to do $400MM of sales this year – this is an asset they acquired at the end of 2018 for $15.8MM). Food is fiercely competitive, so they are deprioritizing that. 

The issue with this original plan is how they will inform buyers they offer / are expanding in core categories – it is clear traffic was up this year, so perhaps that will help going forward.

The other factor is that we clearly had a major recession. Big Lots is a discount retailer, typically trying to offer goods at a sizeable discount. These sort of end markets tend to have tailwinds after a recession (see my AZO post), albeit this recession may be brief. 


If you’re thinking, “ok this is good. I just hate the legacy brick and mortar exposure.”

The good news is 684 leases expire through 2022. That is almost half of their locations. In my view, BIG is in a much stronger negotiating position since the strip malls they tend to sit in may have been hit hard (i.e. anchor tenant leverage).

Second, if they need to “right size” their footprint, BIG can walk away, liquidate inventory, and invest elsewhere…. Including locations it thinks may be more profitable.


I don’t think Big Lots is in a bad position and I think the stock is cheap. There are upside to my numbers here below, yet the stock trades at just 5.8x 2022 EPS. For context, Dollar General trades at 22x, AZO trades at 13x, Home Depot at 20x, Ross Stores at 22x. Maybe the best comp is Bed, Bath and Beyond trading at 10x ’22 EPS and they’ve had much worse performance than BIG… the list goes on.

Ok – so some of those comps have performed better and earn a higher ROIC than Big Lots. But BIG also has the lowest expectations priced against the lowest multiple. And I view the downside risk as pretty limited.

For example, based on my estimates, the company trades at just 5.8x EPS. If it were to trade at 10x EPS, you’d have a $78 stock, or ~65% upside from today’s levels. 

You can also tell the company gobbles up its shares and I expect that to continue. The company repurchased $100MM of stock and has $400MM of remaining authorization (that’s around 25% of its market cap – which it could do given the cash). That eventually will grind EPS back up to the peak we may have seen this year, especially if the stock price doesn’t react.

Secret SAAS Businesses

Reading Time: 4 minutesSAAS stocks are all the rage. While the S&P500 is up ~12.5% at the time of writing, the Tech-Software ETF is up 41%. Over the past 4 years, the gap is +215% for Software and +88% for the S&P.

It makes some sense. These are companies that have long runways of growth, are FCF generative (if you count stock-based comp as an addback, but point is they tend to be people-heavy, but asset lite), and a good portion of them are really sticky businesses through the subscription model.

A sticky business is important. Imagine you’re a business owner trying to prepare shifts for your employees. You don’t know if a customer will come into your store or if you’ll be bombarded that day. If you are bombarded, you might lose sales because you don’t have enough staff. Recurring revenue companies can plan much more effectively and align costs with revenues appropriately.

I’ve outlined this before, but the subscription models also tend to spend a lot of money on just acquiring the customer. So the first year, the business isn’t that profitable, but on renewal it is highly profitable.

Also think about this dynamic in COVID-19 impacted world. Economies were literally locking down. I was running scenarios on companies that I’ve never had to do before – “how would these businesses look with ZERO revenue for the next 3 months.” If you’re in a business where you are mission critical to the customer and get paid a small monthly fee for that service, then you weren’t sweating it as much.


Therefore, I think there was a changing of the guard this year. Well, maybe it actually happened in the 2015/2016 recession scare. (The latter would make more sense because that’s when we saw the atmospheric launch of FANG and SAAS.)

Investors had long been valuing recession proof businesses at much higher multiples than more cyclical peers. Think Utilities, Consumer Staples, large Healthcare companies. I think following the great financial crisis (the GFC), it had a big psychological impact on investors – “try not to own things that can get crushed like that again.” And therefore, the discount rate on these cash flows went lower (due to perceived lower risk).

SAAS combines those attractive characteristics with ultra growth. But the subscription really made it easy to count on what was going to be in the bank account. So low discount rate + hypergrowth = highly valued.


Secret Subscription Models

Something I’ve been thinking about the past few years is “secret SAAS” or really, “secret subscription” businesses. These have very similar characteristics to SAAS, but aren’t in software.

Some of these companies have highly recurring revenue, but may not have a monthly subscription. Some of these names are also dominant and will own their category, but it might be niche and many people just don’t know about them.

The only thing missing from my list is the hypergrowth. But you also aren’t paying 10-100x sales for any of them…

Perhaps I’ll do a post on each of these, but please feel free to reach out, comment below and comment on Twitter (@DollarDiligent) names you think should be added to the list.

Secret Subscription Business Models (no particular order):

  • Flavor and Fragrance Names such as Sensient Technologies and International Flavor & Fragrances
    • I really like names that are critical to an end product’s use, but are a very low cost input. This typically translates into limited switching and little pushback from some price increases
    • Flavors & Fragrance names provide the products that impart taste, texture, or smell to consumer end products.
    • These are mission critical. They also are sold into pretty recurring end market – food and fragrance.
  • WR GraceAre you a refiner that wants to upgrade that barrel of oil into higher value products like gasoline or jet fuel? Well – you need a catalyst. The catalyst creates a chemical reaction to start the process. This is also true in creating plastics.
    • Unfortunately for you, refiner, you can only get this catalyst from 3-4 companies. But they are very high touch, high R&D businesses and the cost of the catalyst is very little compared to the cost of a refinery.
  • Beacon Roofing and Carlisle Roofing segmentThere is a large installed base of roofs. And many were put in place 15+ years ago. As they age, the roof needs to be replaced.
    • No matter what the economy looks like, if the roof is leaking, it needs to be replaced ASAP.
    • This leads to very high recurring revenue (albeit storms can make some years lumpy)
  • Moody’s / S&P Global / MSCINeed to refi your bond? S&P and Moody’s are the gatekeepers. Need to access the ratings? If you want to access detailed reports, investors need to pay a fee. In a large market, this adds up to highly recurring revenue (in addition to other platform services the companies offer, such as Platts and Cap IQ)
    • For MSCI and S&P – Having managers benchmark to your indices provides a highly recurring fee each year. Changing your benchmark tends to be a “no no” and the more recognized the benchmark company, the more circuitous it is
  • Apollo and Blackstone and other asset managers.
    • Earn management fees on a large, mostly locked up capital. Sure, there are incentive fees that may not be highly recurring, but the bulk is actually just management fees
  • Franchisors – many come to mind like Domino’s, Planet Fitness, McDonald’s etc. These names take little capital to run themselves and earn recurring royalty fees from the franchisees

MasterCard Stock – Opportunity to Add a “CARP”: Compounder at a Reasonable Price $MA

Reading Time: 5 minutesMastercard reported earnings this past week and the stock got hammered as it missed expectations. Take this as an opportunity to buy Mastercard stock.

MA Chart

MA data by YCharts

A lot of people know Visa and Mastercard, but they don’t know how the business actually works. Simply put: card networks act as the toll booth connecting the “issuing bank” with the “acquiring bank” and they take a fee as the transaction goes across. The “issuing bank” is the bank that issued the credit card. The acquiring bank is the bank of the merchant. Ryan Reeves has great commentary on this network, which I found in a tweet of his. He also has a blog post on it where he explains it well:

The company where you put your money, called a bank, gives you a piece of plastic, called a credit card, that signals you will pay for something later. When you buy coffee from Starbucks using your piece of plastic, your bank sends the $4 to Starbucks, instead of you paying. But before Starbucks gets the money, two things need to happen.

Your bank has already made a promise with another company called a card network whose job it is to act like a toll booth between two banks. The most popular card networks are Visa and Mastercard.  These card networks make promises with other banks called merchant banks, who hold money for the stores where we buy stuff. So the money from your bank first goes to through the card network and then to the merchant bank and finally to Starbucks, each company taking a little bit of money along the way for their services. And then the final piece, at the end of every month, you pay back your bank for the money they sent to Starbucks. And that’s how credit works!

Here’s a diagram from Plaid as well as their explanation:

Card networks—for simplicity in this explanation, let’s say Visa—receive fees from the issuing and acquiring financial institutions. Visa makes money by collecting a small percentage (0.13 percent as of early 2015) of total transaction volume, rather than by charging a fee on each transaction. But it also sets and doles out the rest of the fee paid by the merchant to the other players. While this percentage may seem nominal, billions of transactions processed each year (with minimal overhead) add up to a very profitable industry.

What’s more, a network like Visa’s entrenched partnerships and critical technologies create high barriers to entry for new players. Established card networks also have low marginal costs to continue operating, making them attractive business models.

So Plaid touches on a few things here: High barriers to entry, toll booth business, low marginal costs. This translates to really high margins and super high FCF. And since payment transactions are growing quickly (ex-COVID), the company is able to leverage those costs and expand margins. For example, look at both revenue growth and margin expansion. Most companies I follow don’t even have 50% gross margins

People often look at the current market structure and think, “This will clearly be disrupted. It is too complicated.”  Card networks work because they have high degrees of trust and a large network, which makes their usage more attractive. Take American Express on the other hand which actually has a different model. Have you seen many merchants say they don’t accept American Express? Amex “consolidate functions of the merchant bank, card issuer, and card network by personally extending credit and cards, and minimizing parties involved.” However, their fees are too high for the merchant and AmEx gives a lot back to the consumer.

Square also differs somewhat, too. Instead, they aggregate the merchant transactions and pass of the processing to Chase.  You will always hear about one of these names (Square, Stripe, Apple Pay, etc) are “disrupting payments.” In reality, they are all still passing through the card network monopoly.


As I discussed in a post where I broke down the core driver for long-term shareholder returns, Mastercard has compounded FCF at ~20% rate for almost 14 years. And its stock has compounded at an even higher rate as people realize this.

So why is there an opportunity now? Well, COVID-19 has caused investors to reset the bar lower this year. Sales were down 14% in Q3’20, but Op Income down 20% (due to fixed costs). You can’t have a dramatic recession and expect spending to be up. That obviously will have a direct impact on Mastercard. But that makes Mastercard interesting because its a very strong business, but also a recovery play. Indeed, there may even be higher tailwinds on the way out – think of less use of physical cash.

And the long-term growth story is still intact. Look at how much in transaction volume is still down via cash and check.

Is Mastercard Cheap? I think so. But you say – Mastercard trades at 45x 2020 EPS?? And 34x ’21. That is not cheap.

First of all, is Mastercard an above-average business? Yes. Is its long-term growth rate above the market? Yes. It should trade at a premium.

Second, Mastercard trades at ~3% FCF yield, but also it can grow FCF/share at a 10%+ CAGR for the next 10 years. This would be half the rate of the past 14 years. I think growth will continue from continued market gains (remember, pre-COVID, the company was growing top-line in the high teens and bottom line even faster due to operating leverage. This will continue at a high rate in a post-COVID world). That points to at least a low double-digit IRR for the stock. I would also point you to my post on how Growth can help pay for a lot of sins

I’m not going to publish my whole model here, but I encourage you to check your models for this. This is the beginning FCF yield + what I expect FCF to compound out. It is interesting how it almost matches up perfectly with the IRR of the investment:

There are still capital structure benefits that could come. As I talked about in my MSCI post, MSCI is leveraging its cash flow and returning significant cash to shareholders. Mastercard is roughly net debt zero. If they had 2.0x of leverage, that would be an incremental $18-$20 billion available for shareholders, which would obviously boost returns. I also think they’d be comfortably investment grade at that level as well.

A Ladder Over Pandemic Waters: Short Duration, Quality Loans Give $LADR Rung Up

Reading Time: 9 minutesLadder Capital stock is a high conviction name for me. It is one where I see little downside and significant upside and also a situation where you are paid to wait (~10.8% dividend). Lastly, I can’t say enough how high I hold management (which also owns ~10-11% of the equity).

Ladder Capital is a mortgage REIT. Unlike typical REITs that specialize in the actual real estate, mortgage REITs specialize in… you guessed it… the mortgages that secure property.

Mortgage REITs have sold off significantly as the market becomes more concerned with commercial real estate. Several mortgage REITs used significant repo financing coming into the COVID crisis, so when there was a disruption in the mortgage market and all securities were crashing, several seemed unable to meet their margin calls…

That did not really impact LADR. In fact, management issued an unsecured corporate bond in 2019 to reduce reliance on repo funding… very timely. Did I mention management is A+ quality?

I tend to think of LADR as an investment company. We want them to make high earning, good risk/reward assets and we understand that they will use leverage in normal course of business. “Do what you think will make money, just don’t blow yourself up.” It’s clear to me they realize all of this.


LADR trades at a steep discount to book. In a hypothetical scenario, we need to ask ourselves that if we foreclosed on LADR, would we get book value or not. What price could we liquidate the assets for in an orderly liquidation. If we can get book value, the stock has 65%+ upside.

See, a lot of times investors buy financial assets below book value. But if the assets are earning a low ROE, the book value may be worth a low amount. Or you may not realize that book value for a long, long time (think of a 100 year bond with a 1% coupon when prevailing rates are at 6%… it will take a long time to get “book value”.)

My goal of this post is to show you that you can bank on book value here. And that because of the short duration of the assets, we know cash will be coming back in the door soon. As a friend put it, soon a large majority of Ladder’s book will actually be post-COVID loans…

Here is my thesis:

  • Ladder’s book is high quality; Stock at ~60% of GAAP book value, 52% when incorporating appreciation of real estate
    • Book consists of transitional first lien mortgages (which I’ll define later), but also investment grade CMBS, small amount of conduit loans, and they also have a portfolio of triple-net leased properties and other CRE that they own outright.
    • ~93% of their market cap in unrestricted cash; Or 14% of assets
    • 43% of asset base is unencumbered, 74% of which is either cash or first mortgages. This means the company has significant borrowing capacity as well (which is important, as LADR is like a bank – you want them to take $1 and make $2 or $3 of loans with it).
  • Mgmt is top notch and has history of deploying capital attractively. Dare I say, the Warren Buffett of mortgage REITs (patient, cash not burning hole in pocket)
  • Buying back both bonds and stock – both at discounts to par / book value
  • Cash is both a downside backstop, but opportunity as they deploy into distressed sectors

Let’s Break Down Ladder’s Book: Here I will detail the bulk of Ladder’s assets. Note, this is just the bulk. They also have a small amount of conduit loans (which means they make loans which will soon be bundled and sold into CMBS).

Transitional Mortgages (43% of Assets, 53% of Equity): These are loans to commercial properties undergoing a… transition. LADR has a first lien on the property, while the borrower uses the capital to bridge it through renovations, repositioning of the asset, lease-ups, etc.

While COVID has created “income uncertainty” for a host of real estate assets, these transitional properties are inherently not generating much income at the time of the loan! And here’s some commentary on that from Management’s Q2 call:

[Our transitional loans] are close to stabilization and require minimal capital improvements. Our balance sheet loans have a weighted average seasoning of 18 months, which is a little over 15 months remaining to initial maturity and 27 months remaining to final maturity. Further reflective of the lightly transitional nature of our portfolio, we have less than $150 million of future funding obligations over the next 12 months and less than $250 million in total, all of which we can comfortably meet with current cash on hand. The majority of these future funding obligations are conditional and are subject to the achievement of predetermined good news events like tenant improvements and leasing commissions due upon the signing of new leases that enhance the cash flow and value of the underlying collateral. We continue to have limited exposure to hotel and retail loans, which comprise only 14% and 8% of our balance sheet loan portfolio, respectively. Currently, almost half of our loan portfolio remains fully unencumbered, and our exposure to mark-to-market financing on hotel and retail loans is just 1% of our total debt outstanding.

As such, they typically are low duration (<2 years), lower LTV (67%), and as mentioned – 1st lien on the property. In a sense, the property value would have to be marked down 33% for Ladder to begin taking a loss. Here’s a comment from the Q1 call on the borrower – you have to think they’ll want to preserve that equity value if they can and have a long-term view:

These same loans currently have a 1.26x DSCR with in-place reserves. The significant third-party equity our borrowers have in these loans provides strong motivation for them to protect their assets and provides the company with a substantial protective equity cushion. Like all prudent lenders, we’ll be very focused on asset management to protect and enhance the value of our loans

Here is more commentary on the assets performance and the short duration:

The property types are highly varied too. In other words, it’s probably a good thing it’s not all Hotels right now. But even so, they have significant cushion above the loan value.

Let’s say you don’t like this situation. Well think about this: We are buying LADR today below book value. Therefore, you could look at as us buying 1L mortgages on a look-through basis of ~40 cents on the dollar (i.e. 60% of Book value * 67% LTV). Do you think a 60% haircut is coming across the board?


Securities (23% of Assets, 8% of Equity): These are primarily AAA-rated real estate CMBS that has very short duration (2.1 years as of 9/30/2020) and significant subordination (i.e. it would take a lot of losses for the AAA tranche to lose money). In fact, even at the height of COVID where gold, treasuries, investment grade corporate credit were all tanking, the company was able to sell assets at 96 cents on the dollar. This speaks not only to the quality of the loans, but also liquidity.

As I think about this portfolio and the low duration, you should think of it this way: in 2 years, if the company did not re-deploy this capital, they’d have ~$1.45BN on loans that would pay off. They do have ~$1BN of leverage against them, so you’d have $383MM of equity back in cash. Keep this in mind for later.

Commercial Real Estate (16% of assets, 6% of equity though the assets are carried at historical cost, so there is significant unrealized gains not captured by GAAP)

  • Net Leased Commercial Real Estate (~65% of CRE): Ladder outright owns triple net leased properties, where the primary tenants are Dollar General, BJ’s, Walgreens and Bank of America.
  • Diversified CRE (~35% of CRE): these are other properties Ladder owns across office buildings, student housing and multifamily.

Now that I’ve discussed the book, it’s important to quickly discuss how they capitalize themselves. Again, very limited repo facilities and that source of funding continues to decline.

Note the unsecured corporate bonds. This brings me to one of my investment points: Ladder issued these opportunistically and has since been able to repurchase them at a discount to par. Ladder has repurchased $175MM of bonds.

At the time of writing, their 2027 4.25% unsecured notes trade at ~86 cents on the dollar. Every dollar used to repurchase these notes at a discount builds equity value on the balance sheet. There’s also the added benefit of decreased interest, which is a drag when they have so much cash.

As an example, let’s say we had a company with $200MM of assets ($100MM of which is cash), $100MM of debt, which would imply $100MM of equity. Using $25MM of cash to pay down $25MM of debt at par would not build book value on the balance sheet. However, if you paid down debt at a discount, it would.

Here’s that illustration shown below. Notice you actually build incremental equity. Given financials typically trade on a P/BV, I feel like this topic is warranted.

As mentioned, Ladder also has around ~90% of its market cap in cash… so as the market has firmed, they are buying back stock as well (though it’s still small). Buying back stock at a discount to BV also increases BV per share.

But obviously more importantly, it’s an attractive return of capital to shareholders if you think the stock is worth at or above book value. However, management may have opportunities to deploy this in attractive assets, noted below in the management section. 


Adding up the pieces:

I wanted to do a build up of “what you need to believe” here. Maybe you don’t like the assets, even though I personally view them as very low risk. Well, the securities portfolio itself is worth $3/share. That’s very liquid and something you can take home in a few years if they decided not to reinvest the proceeds. We could get those assets tomorrow.

I also started with the corporate debt, subtracted cash, and looked at the equity value after paying that all back against the balance sheet loans (the transitional mortgages). I didn’t assume this debt was retired at a discount at all.

As we discussed, the transitional mortgages are low LTV properties and worth ~$6 share. You could haircut this by 40%, add in the securities portfolio and everything else is free.

Next you have the real estate assets, worth $1.8 share on the books. Fine, don’t give credit to the unrealized value here (another $1.8), but the company did sell 3 properties in Q3’20 for a gain relative to BV.

Our downside is very well protected. Given the short tenor of the loans, we will either see Ladder receive cash or take-over properties and sell above the loan amount (which they did with a hotel in the quarter, one of a few assets in trouble per mgmt).


Management

Often, the missed piece of any thesis is management. Boy, all I can say is go read their calls. These are truly savvy investors, which is what you want in an mREIT.

Here are some examples of great quotes from mgmt:

From the Q2 Call – I get Buffett vibes:

My instincts are telling me that it might be better to actually be the borrower in a market like this as opposed to be a lender. Occasionally, we’ve talked about that on some of our calls. Conduit lending is back in a very soft kind of way. And a lot of cleanup from inventory that was sitting on the shelf is getting done. But I would say the typical conduit loan today that’s getting written is a 3.5% to 4% 10-year instrument at 50% LTV.

I think if we begin to deploy capital, and I think we will, we’ll probably be a borrower of funds like that because I think we can find some attractive situations where, perhaps, somebody has to sell something. And in addition to that, I would say that a stretched senior used to be, if a guy bought a property for $100 million, he could borrow $75 million. I think $100 million purchase today, you can probably borrow about $60 million. And so a stretched senior now goes from maybe 60% to 70%, 75%, and I think that is a sweet spot for risk/reward right now on the debt side.

If you remember, in 2008, when we opened, we had quite a few mezzanine loans in our position because we felt that the capital markets were very fearful and maybe too fearful. And so then once we got to around 2012 or ’13, we stopped writing mezzanine loans because we felt at that point, markets were priced right. And then around 2016, we felt that mezzanine money was too cheap. So I would imagine it will feel and smell like equity in some cases, or at least in some scenario where somebody is forced to transact.

And another from Q3’20 from Pamela McMormack, the other Co-Founder

I’ve been with Brian, forgot, I’m turning 50, I think, since I was 30. And so I’m a little bit of the cycle in that regard. But what I’ll say is, I remember, when we opened the doors in 2008 with the private equity guys, and they were begging us to make loans, make loans, make loans. And we were sitting on a lot of cash, we had raised over $611 million back without placement agent in 2008. And Brian was very patient, had a set up to become a (inaudible) borrower. We’re buying securities, and they said they don’t pay people to invest in securities.

And we were very patient about making loans until we felt like the market was right. We’re not incapable, we’re not afraid. We are intentionally and purposely waiting for what we think is a better risk-adjusted return.

There in lies WHY they have so much cash right now. Unfortunately, COVID is not going away tomorrow and there will be some desperation out there. I like this management team’s ability to take care of it.

Here is LADR’s ROE over the years. Not too shabby! I’d add this to the rationale that the company should trade at at least 1x BV (this ROE excludes gains on sale).

Canada Goose: It’s Still Early Days $GOOS

Reading Time: 4 minutesThis will be a brief post, but I think Canada Goose is a fantastic luxury brand. Someone buying GOOS stock today is still coming in very early in its life cycle.

A quick digression first: What makes LVMH so great? It’s composed of premium, luxury brands that we all know. Louis Vuitton, Moët, and Hennessy are products that elicit a good feeling whenever you buy them, even if you know the price is a little wild. For some of their consumers, they don’t even look at the price.

I think it’s obvious why LVMH tried to acquire Tiffany then. It exhibits the same characteristics. But alas, the Tiffany’s deal has seemingly failed (for now). Tiffany has high mall / retail exposure and weddings this year are clearly being pushed. I’m sure LVMH is still interested in owning Tiffany’s, just at a lower price.

But as I mentioned in a post on what drives long-term shareholder returns, these brands are able to increase price ahead of inflation, which drives great top line performance and even better bottom line performance. It’s no wonder that these companies have compounded at such high rates (LVMH especially).

But brands are tough. You have to make a feel on how powerful the brand is. Do I think YETI has a strong brand? Yes. But maybe just for now… People may not think it’s very cool or iconic to have that brand of $300 cooler in 5 years from now. Its possible. I do, in fact, have a YETI koozie.

Investing in brands is hard. Picking winners and losers in not easy. Some people though GoPro had a good brand that would protect it in the harsh hardware world. Blackberry was also a ubiquitous brand, but then another brand came along that is more ubiquitous. Victoria Secret seems to be losing share, Lululemon seems to be gaining share…

I could go on, but the point is understand those risks. I just think Canada Goose is different. Footnote, I don’t have one of these jackets despite living in an area that gets very cold. I view it like a Ferrari of jackets.

Here’s another anecdote, one of my close friends shared that she had an early version of the Canada Goose jacket. She held on to that jacket for probably 4-5 years and then sold it online for nearly what she paid for it. That is amazing brand power.

I think the GOOS stock is worth a bet for several reasons (please do not miss the DTC bullet near the end):

  • Best in class brand
  • Long-term optionality to expand outside of just outdoor jackets
    • GOOS did $400MM of sales in FY2017 which has doubled in LTM June 30 2020. It’s still early days.
    • Right now, the bulk of sales comes from selling $1,000+ intense weather jackets. They could easily leverage the brand into other weather gear
  • Still very early days (opening up 4 retail stores in China)
    • Right now, the company mainly sells through wholesale distribution (i.e. Canada Goose jackets in other peoples stores), but they have launched their own stores
    • Right now they just operate 20 stores themselves, but as they grow and expand the brand, it’s possible to see the number of stores increase by a few multiples of the current amount.
  • I’m writing this in COVID-19, a global pandemic that has caused a steep rise in unemployment. However, the cohort of people who are buying Canada Goose are likely the same cohort that has seen very limited employment impacts this year.
    • LVMH, for example, saw sales +4% in 2008 and roughly flat in 2009 in what was close to a Great Depression
    • GOOS sales will be down this year (consensus has down ~20%), but as the pandemic subsides I think they will still be here and be back on track. If anything, consensus probably underestimates mix shift and underestimates new launches from the company.
  • This winter could surprise to the upside
    • Yes, if everyone is still working from home, it’s less about buying that jacket to show off. However, if everyone is still at home, they’ll pay whatever it takes to keep being able to take long strolls.
  • This could accelerate direct-to-consumer conversion
    • “Today’s reality has reinforced long-standing pillars of Canada Goose’s DTC strategy: globally scalable in-house e-Commerce and omni-channel innovation. With digital adoption rising rapidly, the Company has increased and accelerated investments in these areas going into the Fall / Winter season. This includes the launch of mobile omni-channel capabilities in U.S. stores, following a successful pilot in Canada, and a cross-border solution to expand international access.”
    • DTC represent 55% of revenue today. However, it has an operating margin of 47%. If mix shift goes more and more towards DTC, that would be very positive for the company (total operating margins are around 20% on a normalized basis).
    • For example of how this could impact the company, GOOS did $193MM of EBIT for the 12 months ending 3/30/2020 on $958MM of sales (20% margin). If the company grows to $1.2BN of sales and 65% of that is DTC at 47% operating margin, they would produce around $365MM of operating income from just DTC, or about double the TOTAL EBIT they do today