Tag: stocks

Leaning into Value Traps that Everyone Hates… and a New Name, Strattec $STRT $AXL $ALSN $CATO $ANF

Reading Time: 5 minutes

There are certain businesses that investors have washed their hands of: Retailers, OEM auto suppliers, anything in the way of ESG… many others… And this trade probably worked well for the last 5 years. I recently wrote up at least three names that are counter to these trends, but there are many more.

I’m in the process of creating a “basket” of these names that I’m going to commit to buying and holding for at least 3 years.

I’m calling it: the Value-Trap Coffee Can portfolio.


Most of the time, a coffee can portfolio is set up of really good businesses that you should just set and forget. Let them compound.

In this case, the narrative around some stocks can be so toxic, you can convince yourself at any point to sell. But if find management teams that are very savvy, conducting effective turnarounds despite headwinds, and know how to drive shareholder value, sometimes you still want to align with them.

I fundamentally believe you can have bad industries, but great companies (driven by great management teams) and therefore great securities hidden within them. 

So I’m locking these stocks up and throwing away the key to see what happens.


So far, the Value-Trap Coffee Can (VTCC for short) portfolio includes Allison Transmission, Big Lots, and American Axle, but I am also adding Cato (recently discussed on Andrew Walker’s podcast with Mike Melby at Gate City Capital), and Abercrombie and Fitch (written up on VIC, but down nearly 20% since then). After looking into the latter two, I’m convinced they’ve earned their spot. They aren’t my ideas though, so I won’t be writing them up.

I am adding Strattec to the VTCC portfolio, which is an automotive supplier and I’ll get to at the bottom of this note.

Please reach out if you have any others I should be looking at!


Why the VTCC Portfolio Now?

At points in the past, this would’ve seemed nuts, but my response to that is these companies

  • have significant cash / FCF, especially compared to their market caps today
  • have a rising earnings path over next ~12+ months. Especially true now that we went through a downturn and are coming through on the other side of it, and
  • are completely unloved, so are still very cheap.

You can see it’s really more of a cycle + cheap call.


I cover cyclicals for my day job and cyclicals have been pretty much un-ownable since we had an industrial-recession scare back in 2015/2016. OK – they had a nice run when Trump first came in, tax cuts were implemented, and there was a brief sugar high – but after that, the stocks didn’t do well by comparison even if results were fine. I saw many companies I covered trade at super low multiples as everyone figured a cycle was inevitable.

I now think that since we may be entering a new cycle, permission to own is granted.

In other words, maybe value traps won’t be traps for too much longer. (Famous last words DillyD!) But seriously, you can mitigate this problem via position sizing.


A couple pushbacks to that simple thesis:

  • You could completely disagree with me that we are entering an upcycle – people are already saying what we went through in 2020 doesn’t count as a “normal” recession (whatever that means) and is more like a natural disaster. Semantics. Whatever. This is the theory I have and am going to bet that way.
  • Stocks already at all-time highs, too. So how can there be much of a recovery? Well… FANG is like 25% of the S&P500. None of these basket stocks are in tech.
  • Supply chains are a mess. This could derail the thesis, but I think it would be a temporary derailment vs. anything long-term.

It seems very hard to argue to me that any of the sectors I am going to buy a basket of are “overbid” territory. We can also reach new highs if FANG stocks stay flat and cyclicals have a really nice run, too, ya know?

I think retail is interesting because the consensus narrative was that they are dead, that we pulled forward a ton of e-commerce progress… and yet, if you actually looked at some of these player’s results, you’d see they either adapted very well (some did) or the buyer is coming back.

The anti-ESG trade is only interesting to me in names that can solve the problem – by buying back stock themselves at really attractive prices. Some names are in the ESG crosshairs, but either can’t or are unwilling to effect change in their share prices.


Why Strattec?

Strattec is an interesting little auto supplier that makes locks, power lift gates, latches, among other things. It was originally spun out of Briggs & Stratton in 1995. Here’s a [kinda hilarious] video of them trying to sell why people need a power lift tailgate.

They have their OEM concentration issues, like American Axle, but that is the name of the game. They actually have much better concentration than American Axle which you can go see in their 10-k.

Similar to my American Axle thesis, I think we are going to need a massive restocking of cars. Inventory days are ~22-23, compared to the normal 50. However, this cycle is going to take a long time to sort itself out.

Unfortunately, Strattec was impacted by plant shutdowns due to lack of semiconductors. This is disappointing as the company wasn’t able to sell as much, particularly in its award winning power tailgates in the Chevy Silverado and F-150 pick-ups.

But it’s a double-edged sword. The longer it takes to replenish inventories to “normal” the longer this auto upcycle will likely last. Yes, less sales today, but I think the tailwinds will be there for some time to come. Again, I wrote about all of this in my AXL post.

Even with these headwinds, Strattec still did $110MM in the latest FQ4 (ended June, reflecting the impact of the semi issue) and $485MM for the FY, down from $129MM in the quarter ending June 2019, but in-line for the FY $487MM. However, EBITDA increased by ~50%. Again, this was due to cost improvements and efficiencies in the business that the company says is structural.

Bottom line, I think Strettec will emerge more profitable than ever, and if permitted to run flat out (semi issue abates somewhat) then we will see awesome fixed cost leverage, too.


Strattec Valuation:

Strattec is only a $150MM market cap company, but an enterprise value of ~$147MM.

Over the past 12 months, they cut their dividend during the COVID panic and paid down $23MM in debt. If you fully count JV debt, they have $12MM in debt now, but $14.5MM in cash.

At the same time, let’s say you expect the top line to grow a bit, but they’ll give some margin back, the company is trading <3x EBITDA. And it isn’t like that EBITDA won’t convert into FCF: the company has guided to $12MM in capex, they’ll have no interest expense (basically) and taxes in the range of $8-10MM. That’s $35MM of FCF on a $150MM market cap company.

Not bad! Just last 4-5 more years and I’ll have my money back.

Container Shipping is on Fire: Opportunity in Leasing Stock Triton $TRTN

Reading Time: 6 minutes

As everyone I am sure is aware, container shipping rates right now are astronomical. The re-opening of the economy and associated supply-chain bottlenecks has created a situation where people will pay up just to make sure their items are actually on that boat!

This has caused blow-out earnings for the shipping lines. Maersk reported a 166% increase in EBITDA for Q1’21 for example.

However, I don’t think this is sustainable and no one else does, probably. Shipping is also a fraught industry to invest in – when times are good, capacity is brought online. These ships are long-lived assets so when times aren’t good, the supply is still there.


There’s alternative however, with a much stronger industry structure, ROEs, cash flow, on and on. That is container leasing. Triton is the largest player in the space after it merged with TAL in 2016.

I like Triton stock because:

  • Leader in the market – scale in the leasing industry matters and drives much higher margins + lower cost of capital
  • Fundamentals are in terrific shape
  • They are signing long leases at high rates – abnormally long and abnormally high (over a decade) – which will give strong visibility into cash flows for foreseeable future
  • Can flex capex spend with the market – has a history of shutting of capex and buying back stock + dividend
  •  Triton stock trades for ~6x ’21 EPS, 1.3x ’21 BV – historically generated mid-teens+ ROE in normal times. This should improve

The business historically went something like this:

  • Triton buys containers and places them on lease with shipping companies.
  • Historically, these would be 5 year leases. However, with limited technological obsolescence (just renting a steel box in most cases), the age of the asset didn’t really matter. So they can pretty quickly re-lease the box, but the lease rate may change
  • The assets (boxes) last about 15-20 years with pretty minimal maintenance. Maybe slightly more for a refrigerated box, called a reefer (yes the actually  name), but the lease rates would also be higher. So historically there’d be 3+ leases involved
  • End of life – they sell the box for some residual value, which also helps recoup part of their investment. It used to be they buy a box for $2,000-$2,500 and could sell it for ~$1,000. Right now, they can sell the used box for about $1,500, which is pretty nice.

Why do shipping companies lease instead of owning their own containers? It outsources capex in an already capex-heavy industry. It’s off balance sheet financing for them. The shipping lines do still own their own containers (about half of the market), but that’s been trending down pretty consistently over time. It just makes more sense for them to focus on shipping and flex leases up and down with the market.


Investment Thesis

I don’t think I need to dwell on why fundamentals are good right now or why buying Triton stock at 6x earnings is optically cheap. I’m going to focus on the lease rates and new longer duration contracts being signed right now.

If you are worried about the current conditions being unsustainable, long, contracted lease rates help that. As shown below, Triton is trying to tell investors that not only is it leasing more containers than basically ever….  putting assets to work… the lease durations are now approaching 12-13 years.

If you like SaaS, you’ll *love* container leasing companies.

We’ll have to think about these rolling off in 2031-2033, but meanwhile, the company will be earning above average ROEs.

Here is a chart from their Q1 basically showing lease rates are 1.6x the general average. You can see there was a dip in 2019, but the company pulled back – the size of the bubble indicates how many containers were put on lease (so very few). In a sense, Triton is an asset manager just like a Blackstone – you kind of need to trust that they will be deploying capital when times are good and pulling back when times are bad.


What could go wrong?

I should mention what could go wrong. We have seen this situation before – following the GFC, world trade snapped back and lease rates surged. Unfortunately, they all basically expired in 2015/2016. This was also when we were in a quasi-industrial recession. This was also when steel prices were in the gutter, which makes up most of the price of a box and makes it tough to sell used boxes at a fair price. Hanjin, a major shipping line, also effectively liquidated (in a BK case, most of the time a shipping line will just keep its assets rolling in a Ch. 11 because the containers are critical assets to operating – Hanjin just disappeared.)

In many ways, 2015/2016 was worse that the GFC. I mean, it actually was worse. The GFC wasn’t actually that bad because global trade remained pretty steady.

Even with a trade war, it’s hard to knock off the secular trend of the western countries importing from Asia. If it isn’t from China, it is from Malaysia, Vietnam, and so on.

Did I strike to buy Triton stock in 2015-2016?? No. I was gun shy as I’ve been following the industry for quite some time and they never seemed to generate real FCF (CFO-Capex). It was an asset gathering game.

But then in 2019-2020, when the market wasn’t particularly great, they actually proved they could shut-off capex. They starting generating a ton of FCF and showing signs to shareholders that they care about the stock (they even issued a pref as well to help fund buybacks)

Another sign they care about capital allocation is this fantastic sources and potential uses of cash in their deck:

Basically they are telling you they could buy back 12% of the stock in one year. Share count is down about 15% in 2.5 years, but now I think they’ll be deploying cash into higher ROE opportunities, which is fine by me.


Financing

One thing I should mention is typically Triton finances itself through the ABS market. They get 80-85% LTV against the asset value for very long duration. Happy to answer any questions on this, but I’m not too concerned with the ABS market financing.

Triton issued $2.3 billion of ABS notes during the third quarter at an average interest rate of 2.2%. Most of the proceeds were used to prepay $1.8 billion of higher cost notes, which is expected to reduce interest expense by more than $25 million over the next year

They are also diversifying financing – so they just issued an IG secured bond and have talked about moving up to IG ratings. If their cost of capital goes even lower, it will be great for the business in the long run.


EPS Estimates

Last thing I’ll say is basically Triton is covered by one company. You’d think modeling it would be easy enough, but we are talking about hundreds of thousands of containers, utilization can change, etc etc. However, I think EPS estimates are probably still too low in the long-run. It’s been that way in the short-run, so far, but we shall see. It’s hard for sell side to model operating leverage + high lease rates + deploying cash into such a significant amount of assets.

KAR Auction Services is Not in Secular Decline $KAR

Reading Time: 7 minutes

KAR auction services, the company that runs used car auctions, looks on sale right now.

KAR has been under pressure from COVID impacts to the business, but unlike other COVID-impacted names (where investors are seeing through the clouds), the stock is still down meaningfully.

KAR reported earnings Q4’20 earnings and guidance last week (on Feb-16) and the stock is down about 24% in the past week.

KAR Auction Services Stock

It seems to me investors do not realize KAR Auction Services current pressures are cyclical, not secular. Today, we’re able to buy a really good business at ~10% FCF yield on depressed earnings.

KAR Auction Services FCF Yield


Why is the stock getting hammered?

For one, disappointing guidance. The company expects EBITDA of at least $475MM in 2021 as they continue to recover from COVID.

Consensus was expecting $566MM – ouch.

Kicking the Can? The other issue with guidance is it is 2H’21 weighted.

In my experience, this can be a “kick-the-can” move for management. In other words, they know 2021 EBITDA has the chance of being lower, but they’ll wait for Q2 earnings to break that news or maybe things will turn around.

Fingers crossed. This isn’t always true, but just my experience.

Management left wiggle room – they did say at least $475MM. They also explicitly said the guide is conservative. That’s not something I’m banking on. I also don’t really care about 2021 earnings in isolation. That’s way too short-term focused in a year that will continue to be impacted by COVID, as noted further below.


Why the weak guide?

Car values are high right now. During the height of COVID, the manufacturers pulled back in the face of a new, deep recession. Plus, they had to reset manufacturing processes during a global pandemic. Lo and behold – demand for cars held in. This is known as the bull whip effect.

Supply < Demand = really high used car prices.

Manheim Used Car Price Index

Normally, this would benefit KAR Auction Services, because their auctions would be earnings higher auction fees on cars. But there is clearly lower volume going through the lanes.

Not just from the shortage of cars, but also when residual values are high, you will see less lease returns as the customer decides it’s a good deal to buy out the lease at the value that is better than current market. There has also been less repossessions, another volume headwind.


What is the Street Missing?

Number one, the stock looks cheap when you bridge using the current FCF guide.

Yes, there is risk the guidance, but I don’t actually think KAR’s go forward earnings potential is limited by this year’s factors. The things I mentioned all seem cyclical.

Second, they are caught up on secular changes versus cyclical.

KAR’s earnings are being hit by cyclical issues that I think will abate.

Every investor is trying to see how COVID will change the world and how technology will reshape it. A lot of investors are saying KAR’s barriers to entry have been lowered now that auctions are online. I do not think that is true.


I read one note expressing concern that a survey revealed a lot of dealers are looking to buy and sell cars via online auctions this year. Given KAR Auction Services has a strong physical presence, this caused some concern. Pardon my French, but my response to that is – No Sh*t, Sherlock.

We’re in a pandemic. Of course dealers are looking to buy and sell online. They have to. And this was definitely the case during 2020.

If you read my About Me page, I used to have a dealer’s license. I know a thing or two about buying used cars and I used to go to Adesa all the time. It truly is a great business, which I’ll go into some brief detail later.

But anecdotally, I can tell you buying cars online is not easy. You’re buying a car with limited info, no ability to drive the car to see how it feels, how it sounds, check the oil, etc. The cars I bought online (as opposed to the seeing it in person online) were some of the worst purchases I ever made and I pretty much vowed to never do it again because it was a waste of time.

“But Dilly D”, you’re asking, “can’t this be improved?”

Of course, this could be improved with technology and better disclosure. You need to realize, though, that these online platforms are turning over thousands of cars. And as much as cars may seem like a commodity, used cars really aren’t.

Think about all the options a car has and then fold in a good versus bad service record. The band of prices could easily be +/- 10%, which is thousands of dollars we’re talking about.

But Adesa is also one of the biggest players. And they’ve had an online presence for at least 15 years (just speaking from my memory). They, along with Manheim (a private competitor), do a decent job at it. Adesa also has invested heavily in inspection services to make it better and faster process, as well as other services.

So I’m not too concerned about any upstarts or anything like that. Upstarts don’t have access to the same supply the big players have. And the dealers, like I was, like Adesa and Manheim because they get the supply plus the best prices because they are essentially getting a bulk discount. And you know competition is somewhat limited as a dealer because you have to have a license to access the auction.


This leads me to why Adesa is a great business.

As I was just leading into, Adesa is a great business because it connects sellers with buyers and just takes a fee off the top. The fee goes up or down based on the sale price, but has large enough bands that if used car prices fall, let’s say, 10%, it doesn’t hurt their earnings that much.

Sellers want access to a large supply of buyers who are committed to buy their product (i.e. they are selling to dealers who need the supply). This way, they can offload slow inventory or lease vehicles quickly and achieve good prices for them. This frees up working capital to re-deploy in their business.

Buyers want access to a large swath of cars at good prices that they can sell at a profit. For me, having a wide array of cars to pick from helped me find “hidden gems” that I could quickly turn.


The same note I mentioned above (which was absurd) highlighted online competition from Copart, which has been a “competitor” for forever and is really more a competitor of IAA, the insurance-loss auction spin from KAR. Copart is no doubt a great business, but I think it’s comparing two different markets.

If you compare IAA to Copart, their results during 2020 were much closer to each other than comparing it to KAR Auction Services – just different markets. Copart outperformed KAR and IAA sales were actually up, though they were able to benefit from improved pricing despite volumes being down. Although Copart discusses their “platform” a decent amount, but personally, I’d say it’s a different market.


Here’s another anecdote to explain why they are different markets: I remember being at an auction and a totally smashed Cadillac Escalade came through. The front was actually fine, but the back looked like it was caved in by an 18-wheeler.

I laughed to myself thinking, “I guess someone will try to part this thing” and lo and behold, the bids started to come in at really high levels. I want to say the car sold for over $20,000, despite being crumpled. I was in person, but the bidder was online and you could see the location. The bidder was in Saudi Arabia. That’s when I learned many of these salvaged cars are worth a lot internationally. Buyers can part them out, but some countries also have less strict rules on piecing cars together.

Anyway, as the dollar becomes weaker, this helps a Copart who sells a lot of inventory to these buyers:

Roughly 35% of Copart’s inventory is purchased by foreign buyers:


Back to that absurd sell-side note one more time: They also highlighted online competition from Carvana. Carvana uses KAR to buy and sell wholesale inventory. They do not provide nearly enough volume as a separate wholesale auction to be attractive. It really doesn’t make sense at all.

CarMax and Carvana really want to sell retail… yes, they get trade-ins they want to sell, but they want good prices on those and want to turn them quickly. Carmax has its own auction because its huge, but it still uses KAR  to fill inventory. Carmax can use their auction to sell inventory they don’t want anymore quickly.

Adesa provides that for everyone. It’s not really different than the marketplaces investors love today, they just have primarily relied on a physical presence. As stated, I think this will continue to be an industry that needs the physical presence.

KAR Auction Services ROIC

Hotel stocks – buying opp or stay away? $MAR $HLT $PK $AIRB

Reading Time: 9 minutes

I have the opportunity to again share the work from a friend & prior guest poster – the same author who imparted his views on cruise stocks in a prior post. This time, he’s back with some thought-provoking views on the hotel industry and the hotel stocks. Enjoy.


In #Is It time to Buy Cruise Stocks? Pt 2, we went into the heart of the Covid storm, and found that there may be solid upside if the risk sits well with you. For this article we’ll move to some of the “lighter” outer bands, as at least some portion of revenue stream continues for hotels, whereas cruise departures have been completely halted. Let’s start with some high-level thoughts on the industry, and then dig into some of the players.

Macro thoughts

If we break down hotel stays between business and pleasure, it seems reasonable to say that ~40% of booked hotel stays are business related. For the time being that implies a complete halt on 40% of hotels’ revenue. Assuming the other 60% of revenue is vacation related, it may be reasonable to assume ~50% of the vacation bucket is attributable to Loyalty Program members (see snipit from 2019 10-K below).

Digesting the above, it seems like (i) 40% of hotel revenues are completely compromised, and (ii) possibly another 30% is disrupted, as Loyalty Program members develop a lot of their status from business travel.

Enter Airbnb. Its presence represents an approximately decade long build of disruption to the hotel industry. In terms of annual revenue, it looks like Airbnb falls somewhere above HLT but less than MAR – it had approx. $1bn of revenue in Q4 19 (assume $4bn annually at this rate) – we can potentially get more details this year if they move ahead with IPO. Note that when considering HLT and MAR revenue, I’m excluding “Cost reimbursement revenue”, as there’s corresponding expense with this item (e.g. franchisor pays some expenses, and franchisee reimburses). Airbnb is a sizable force in the markets, but I’d also assume it does not have and cannot really get a share of business travel yet (easier from liability perspective to encourage employees to stay at big name hotels, rather than with miscellaneous landlords). What does this mean in Covid?

  • I’d guess Airbnb is benefiting from the suffering of hotels. Would you rather stay in an isolated mountain/lake house, or in a hotel resort teeming with tourists? Assuming you’re not a Covid denier, then probably the former.
  • While business travel should in theory return to the big-name hotels, this may not come for a longer time – why would a business risk Covid outbreaks for the sake of business travel? Seems unlikely unless business travel is essential to the functionality of the business. Further, a blow to business travel inevitably means some level of reduction to vacation stay for hotels.
  • Similar to analysis in Covid so far, showing e-commerce adoption has accelerated, it could be the same that Airbnb share has also accelerated (hence why they may be pushing for an IPO despite a terrible operating year…)

While hospitality may not be an awesome industry to be in at the moment, can we still find businesses that will persevere, and potentially emerge well once the dust settles? In exploring MAR and HLT below, we’ll discover that a sizable portion of their businesses come from franchisor/franchisee relationships. This leads to another question – is it better to be the franchisor or the franchisee? We can explore Park Hotels and Resorts Inc (PK) to get a flavor for the differences. Unlike the Cruise Pt 2 analysis, less of the below focuses on whether these companies have the liquidity to survive Covid – cash is still coming in the door, even if the demand recovery may not be as a resilient. It instead explores more of the pre-Covid operations for MAR and HLT, and thoughts on what that means going forward.

MAR and HLT

Historical revenue demonstrates a push to franchisor/manager business, rather than own and operate. Note that HLT spun off PK and Hilton Grand Vacations Inc (HGV) (owned hotel and timeshare businesses) at the very beginning of 2017, hence why you’ll see the change in revenue presentation and overall split.

My quick takeaways are:

  • Revenue per Available Room (“RevPar”), hotel room revenue divided by room nights available over the applicable period, has had immaterial changes for each company over the last six years, but MAR converts more $ per room then HLT.
  • MAR derives larger portions of its revenue from franchise/management fees than HLT. Given HLT’s spin offs of PK and HGV, it is clear the biggest players see more value in reducing the tangible assets on their books.

I’m not seeing crazy differences in the debt profile of the two. But compared to cruise lines, MAR and HLT are noticeably better capitalized and have generated sizable free cash flows compared to the debt on their books (15-20% each year). But MAR and HLT are noticeably more expensive – EV/EBITDA at 20x+, while cruises were closer to half that.

How well do MAR and HLT translate revenue into cash? #What Drives Stock Returns Over the Long Term? pointed out that growth in free cash flow per share often drives long term value. In looking over a 6 year horizon, the below free cash flow illustrations seem to speak to this point, with better overall performance from MAR.

In the above, I removed timing differences between reimbursement revenue and expenses; these items are supposed to offset one another over time, so it seems more appropriate to exclude noise from these pieces.


So, what does this mean going forward? MAR and HLT’s stock prices are down ~32% and ~18% since beginning of 2020. As you’d expect these entities faced losses, largely driven in Q2. However, there are still positive free cash flows, expectedly coming from changes in working capital accounts.

Looking at 2019 10-ks, debt maturities don’t become significant for HLT until 2024 (i.e. less than 40m), while MAR’s are more significant at ~1bn+ each year 2020-2022 (bigger red flag). The cash situation for these two feels better than what we saw in cruise stocks, but I think a significant con is that business travel may not come back for some time (i.e. until a vaccine is found)- I’d be more inclined to bet on cruise demand coming back faster than business need for travel lodging.

The Q2 MAR earnings call transcript may be worth a read. In that, they discuss cash burn with in a scenario where demand doesn’t pick up meaningfully from here. Running a quick liquidity analysis on MAR below, survival horizon for MAR seems around 3+ years.

If you’re quietly optimistic that Covid will be meaningfully resolved next year, then there may be potential upside in these stocks, but if you consider FCF yield then you’re probably disappointed at current stock prices. The 2019 FCF per share were $5.57 and $4.76 for MAR and HLT; if we want a 10% FCF yield that implies stock prices slightly above and below $50, but meanwhile the stock prices are around $100 and $90. Additionally, it’s probably going to take some time for FCF per share to come close to the 2019 levels. Not attractive points from a cashflow perspective.

Let’s explore a player on the ownership side of the house to see if that noticeably changes what we’re seeing.


PK

As noted above, PK was spun off of HLT back at very beginning of 2017. As expected in looking at end of 2019 vs Q2 2020, there’s more debt on books to generate cash on hand, and unlike the above franchisors, the costs associated with maintenance and operations of the hotel real estate is entirely reflected on PK’s income statement. The stock price has declined ~62% since beginning of year (significantly more than MAR and HLT), with its discontinuation of dividend payments back in May further crushing investor sentiment. See below for some quick snipits comparing PK’s 2020 financials to 2019.

Reductions in PP&E, wipe out of goodwill, increase in cash with corresponding increase in debt – all things I’d expect to see in this Covid environment.

The income statement data isn’t any better.

Free cash flows are also already negative – noticeably worse cash situation than MAR and HLT, as those companies have still been able to stay free cash flow positive in 2020 thus far.

PK is a Real Estate Investment Trust (“REIT”) for US tax purposes, meaning there are requirements from the IRS that need to be met for the entity to preserve flow through status (i.e. no entity level income tax for federal tax purposes). These requirements include and are not limited to distributing the majority of taxable income to shareholders (REITs often distribute all of taxable income anyway), holding a certain % of assets in real estate, and ensuring the majority of income is derived from passive real estate sources (see Section 856 of the US tax code for additional details). Hotel REITs include additional complexity, as most hotel REIT structures involve (1) creation of a Taxable REIT Subsidiary (“TRS”) where hotel operations occur, and (2) a lease agreement between TRS and REIT whereby REIT owns the assets and TRS makes payments to REIT for use. The nature of this arrangement is intended to mirror a typical real estate arrangement. Hotel REIT players try to maximize REIT income by ensuring the lease agreement strips most of the kosher earnings out of TRS.

My concern here is more a generally pessimistic view of the recoverability of REITs post recession. Distribution requirements make it hard for a REIT to hold on to cash; there is a concept known as “consent dividends”, whereby REIT shareholders may agree to recognize a deemed dividend in their income without cash actually moving outside the REIT, with this fulfilling the REIT’s distribution requirement. But this obviously does not apply in a public REIT context.

Furthermore, REIT investors are mostly concerned with annual yields generated by investment, making cash collection more impractical. While REITs are able to generate net operating losses (“NOLs”) to the extent that they have taxable losses, NOL usage is done on a “post-dividend basis”, making it tough to monetize them since REITs typically distribute out most of their taxable income.

While I think the above points make it hard for REITs to come back after a downturn, I can see a potential opportunity for prospective Buyers (e.g. Blackstone, Brookfield, etc) with cash on hand to buy real estate at a heavy discount (see WSJ article Public Real-Estate Companies Are the New Way to Buy Distress for example). In looking at PK, I tried to compare the net asset value to market capitalization to assess how discounted PK is currently trading. Below I’m assuming that the FMV of land and buildings/improvements is equal to original cost (likely conservative since most of the real estate was acquired back in late 2007).

I’m estimating market cap at ~2bn and net asset value at ~4.7bn; these quick estimates at least directionally tell me that prospective buyers could likely get a pretty sweet discount if they tried to buy the assets.

That said, I think that you can probably find this trend and opportunity across non-hotel REITs as well, and therefore would be more inclined to pass on buying PK.


Thank you again for this great guest post. My main takeaways from this are:

  1. Cruise lines over hotel operators might be better risk/reward, as at least with cruise lines there are signs that demand is still strong once ships can take-off (so becomes just a liquidity consideration in the near term, which you can bracket)
  2. Not getting paid much for the franchisors. The franchisors, MAR and HLT, are historically good businesses. Asset light and generating strong FCF, but at the end of the day, revenues / performance are going to be tied to how the hotels are doing. Its going to be hard for them to just sit and generate FCF when their franchisee base is struggling. With the stocks currently trading at ~20x peak FCF (2019 levels), it doesn’t feel like you are getting paid for any downside risk (e.g. do the franchisees want forgivable loans or some re-cut of the franchisee agreements to survive)
  3. Airbnb wildcard. Airbnb has been a concern to the industry for years, but frankly the impact hasn’t been too noticeable yet (e.g. hotel revenues continued to march up despite Airbnb’s new presence). However, that may change in the future….

Why Hasn’t Autozone Stock Re-rated with Other Pandemic Winners? $AZO #COVID19

Reading Time: 3 minutes

I just did a post where I evaluated my holdings of Apple following its recent surge, which looks to be a quite big move for the US’s largest public company. One thing I didn’t really discuss in that post was that Apple may have re-rated recently due to perception of it being a pandemic winner. If your sales have held in well this year, or even increased, you are viewed as either defensive or on a continued growth trek. In turn, your stock has rocketed up.

Here’s a list of stocks that I would say fall into that category. I can’t include them all, but you get the point:

FB Chart

FB data by YCharts

The S&P total return is ~5.5% at this point in the year.  Home Depot is doing well because housing is holding in well, and the pandemic is causing people to reinvest in their homes. Same store sales were up ~24%+! No wonder Home Depot has surged.

The same is true for other retailers, such as Target or Wal-mart, which despite possibly missing the back-to-school shopping season (which is big bucks) they are reporting some of the best comps in years.

So let me take off some of the true high fliers and compare Autozone stock and other auto part retailers to these names.
FB Chart

FB data by YCharts

If you’re having trouble finding the auto retailers on this busy chart – they’re all at the bottom!

This is odd to me. O’Reilly reported +16% SSS comps for Q2 and a 57% increase in net income. Advance Autoparts has a different fiscal period, but they reported 58% increase in EPS on a 7.5% SSS comp.

Why is that? There are several reasons.

  1. In recessions, people keep their car longer and do more work themselves. See my post on AutoZone for some discussion on their comps after the 2008 financial crisis.
  2. After reaching about 7 years in age, cars tend to need more work. The average age of a car in the car parc today is around 12 years
  3. Retailers focused on cleaning products and other pandemic needs consumers would need and auto parts took the back seat. It’s likely that the pure-plays auto stores picked up share

So I fully expect Autozone’s sales to benefit when they report at the end of September. And if this current crisis persists, then their increased comps will likely persist as well.

I’ve been watching street estimates for Autozone. They still sit around pre-pandemic levels. My guess is AZO handily beats these estimates, though admittedly there are some tough comps (believe there were additional selling days in the prior year).

Look, I’m a long term holder at the end of the day and I wouldn’t recommend trading around a  quarter. All I’m saying is you have (i) a high ROIC business that (ii) historically has returned every dollar of FCF to shareholders that (iii) is probably benefiting in COVID where (iv) estimates might be too low. I like the set up.