Grahamian Value Week in Review ― December 4, 2020
“Assets seem to change less than earnings. You could argue that assets are not always worth what they’re carried for. Graham made an argument at one point that inventory was a plus, not a minus. In an inflationary period, having a big inventory might be very helpful.”
— Walter Schloss, March 6, 1989
WEEK IN REVIEW
In the past week —
No new businesses have been added to the list of Grahamian Value companies.
There were no interesting developments at Grahamian Value listed companies to explore.
AMREP Corporation is an intriguing balance sheet driven situation that does not show up on a traditional stock screen yet has crossed our radar, as detailed below.
I. WEEK IN REVIEW
“Timely alerts and occasional updates” —
The mission of this electronic digest is to relay salient information related to the Grahamian Value list of companies, which (as the name implies) is a group of Benjamin Graham-inspired public equities that the co-editors identify via weekly stock screens. We also closely monitor Securities and Exchange Commission filings and news feeds for material developments, within this self-defined universe of public businesses.
With broader markets reaching new highs, there’s been limited activity within the Grahamian Value list. The same companies that appeared a few months ago remain on the list (with the notable presence of certain dislocated sectors) and there’s a generalized quiet with regards to regulatory updates, corporate press releases, and local news coverage.
In the natural course of our company-oriented explorations, we regularly stumble across industry participants pursuing a Graham-inspired approach to value investing. And occasionally, from our arm’s length perspective (and document research alone), we ascertain that an investment professional is deploying capital with unique professional skill, in a (repeating) manner that we respect and admire.
A Grahamian Value universe of companies and of people —
Michael Melby of Gate City Capital Management in Chicago, Illinois is among this select group of people and organizations who we hold in high esteem. For a number of years, from afar, we’ve followed meaningful developments at Gate City Capital, generally sourced from: (1) news feed keywords, (2) Securities and Exchange Commission filings, and (3) member-only research from MOI Global.
Gate City Capital, per their SC 13-G filed on October 28, 2020, owns 17.9% of AMREP Corporation. AMREP’s most recent Form 10-K (filed July 27, 2020) details the company’s ownership of eighteen thousand acres of land in New Mexico; the company’s most recent annual letter (dated July 31, 2020) discusses this core asset, as well as several key adjacent points —
An increased focus on corporate governance.
An increased focus on pure-play real estate endeavors.
A solid balance sheet that’s grown in strength over the past few years.
We note that Bob Robotti (mentioned in Week in Review — September 18, 2020) joined AMREP’s board of directors as detailed in this 8-K filing with the SEC (dated September 13, 2016). Additionally, we note that Gate City Capital —
Initially filed a report of beneficial ownership on Form SC 13-G on May 10, 2017,
Switched to a 13-D filing on June 5, 2020, expressing active engagement with the company, and;
Subsequently switched back to a 13-G, filing an updated form on October 28, 2020.
As detailed in AMREP Corporation’s 2020 Annual Letter to Shareholders —
New Mexico, where we own more than 18,000 acres of land, is our primary operational focus. Our land development operations include land entitlement, installation of infrastructure and sales of finished lots to homebuilders. During fiscal year 2020, we launched an organic expansion of our operations with our new internal homebuilder, which will help monetize our land holdings, capture a greater share of the financial returns generated from our subdivisions and enhance our negotiating position when selling lots to external homebuilders. We have retained various mineral rights in New Mexico and Colorado, which are the subject of leases to third parties. We also own office and warehouse buildings in Florida and raw land in Colorado, all of which we are seeking to monetize.
…Successfully executing our strategy also requires strong corporate governance. We have an active and informed Board of Directors that both oversees and provides guidance to our management. Our directors own 22.6% of the outstanding shares of AMREP, which ensures alignment of shareholder interests with the execution of our strategy. The Board regularly reviews our corporate governance to determine whether any changes are warranted. For example, we reduced the size of the Board from seven directors in 2010, to six directors in 2011, to five directors in 2013 and to four directors in 2015 to better align the size of the Board with the smaller size of the company. We also reduced director compensation during this period and converted a substantial portion of that compensation from cash to equity.
The co-editors noticed recent share price movement in AMREP’s stock, which we attribute to a timely write-up on Seeking Alpha — authored by Nicholas Bodnar, a research analyst at Gate City Capital. In our view, the original research is of exceptionally high-quality and we believe deserves to be on the radar of Grahamian Value readers. Out of respect for intellectual property, we’ve opted to share a handful of excerpts from the piece and encourage Grahamian Value readers to explore the full 30+ page report in its entirety, from the direct source:
AMREP entered the New Mexico real estate market in the 1960s and early 1970s when it purchased 90,000 acres of land north of Albuquerque and marketed the area as Rio Rancho. AMREP subdivided the land into thousands of lots and began selling them via mass marketing and mail order methods. These marketing techniques were halted in the late 1970s and AMREP changed its focus to attracting economic activity to the area. Rio Rancho became the home of a large Intel plant in the early 1980s and has expanded ever since. Today, Rio Rancho is the fastest-growing city in New Mexico and has a population of almost 100,000 residents (the third largest city in the state).
AMREP owns approximately 18,000 acres in Rio Rancho, New Mexico. The quality and value of the land vary dramatically based on location, contiguity, and status of entitlements. AMREP divides its land holding based on whether the land is in an active subdivision and further divides the land based on whether it is contiguous. As of July 1, 2020, AMREP owned 905 acres of land in Rio Rancho in the Company’s active subdivisions. In addition, AMREP owns 3,400 acres of land in Rio Rancho where the Company has 90%+ contiguous ownership, 5,100 acres where AMREP has over 50% contiguous ownership, and 8,500 acres were in areas with less than 50% contiguous ownership.
In 2016, AMREP constructed a Starbucks on the Company’s commercial property at 951 NM Highway 528 SE in Rio Rancho and leased the property to Starbucks. AMREP financed the construction with a $900,000 loan and ended up selling the property for $2.5 million later that year (sold at a 4% cap rate). In 2020, AMREP constructed a Natural Grocers grocery store at 921 NM Highway 528 SE (next door to the Starbucks) for an estimated construction cost of $2.3 million. AMREP entered into a 15-year triple-net lease with Natural Grocers resulting in net operating income of $332,328 in year one with a 6% escalator every 5 years. The building is currently being marketed for sale for $5.7 million (a 5.75% cap rate) and recently went under contract. Importantly, AMREP has a large portfolio of additional commercial land that is suitable for these types of projects.
In fiscal 2020, AMREP launched Amreston, the Company’s own homebuilding subsidiary. AMREP previously had its own homebuilding subsidiary in the 1990s and was a leading homebuilder in Rio Rancho before electing to close the operation to focus on developing finished lots. Rather than looking to compete with national homebuilders, Amreston’s current strategy is to utilize AMREP’s base of small contiguous lots of land as well as scattered single lots for homebuilding activities… Amreston’s access to low cost land provides it with a competitive advantage, and Amreston has designed its business model to generate positive gross profits even after accounting for the full cost of the land.
In addition to AMREP’s ongoing land development and homebuilding operations in Rio Rancho, AMREP holds four valuable parcels of hidden assets that are currently listed for sale along with an additional residential development that could be listed for sale in the next twelve months. Additionally, the Natural Grocers building is currently under contract for an estimated sales price of $5.7 million. While it is challenging to predict when the Company’s other listed locations might sell, the listed prices of the four parcels is $24 million, representing almost 2/3 of the Company’s current enterprise value.
We are grateful to Nick Bodnar, an analyst at Gate City Capital, for sharing his work. We also strongly encourage readers to be aware of the relevant disclosures that Gate City maintains a position in AMREP Corporation stock.
In an effort to gather further background and context, the co-editors came across a recent interview with Michael Melby hosted by Andrew Walker (twitter) of Rangeley Capital in New Canaan, Connecticut — who generously granted us permission to share the following excerpts that outline: (1) Gate City’s approach to AMREP Corporation, (2) the firm’s viewpoints on intrinsic value, (3) and further color regarding the firm’s SC 13-G and SC 13-D filings on the company. We believe the excerpts (and the full interview) add useful detail to a roadmap for understanding what we believe to be a fascinating balance sheet thesis — which heavily aligns with John Malone’s worldview, as expressed two weeks ago.
Michael Melby, Founder and Portfolio Manager at Gate City Capital Management —
[Co-editors’ note: The text below is subject to transcription error and shared with permission. The interview was recorded on November 4, 2020]
[51:12] It’ll be a very, very long-term liquidation, if they were to sell everything off. I think it can be kind of a problem too, that the 18,000 acres — if you’re on a mountain or a hill and you look over and it’s just an immense amount of land — would the valuation be any different if they had 2,000 acres?
[51:42] Assuming that Rio Rancho continues on the growth pace that [the city] has been on, [AMREP’s] runway is more in the 50 to 100 year range, with the land assets that they have in place. Would it be appropriate if [the company] sells things over time, keeping no yielding properties, and just returns to shareholders the excess of their daily operating needs? I think that would be a good use of investor capital and something that’s rewarding to investors. On the other hand, if [the company] decides “we’re going to retain the properties we build and the yield we get” and [the company] becomes a major investor not only in the land outside of Rio Rancho but in properties within Rio Rancho, which should also benefit from growth in and around the city — I think, either way, as long as [the company] is getting fair value for their developments that they sell, it should work out fine for investors.
[55:56] Following the share repurchase — call it $8 million in net cash for a $40 million enterprise value — starting with the non-core assets, [the company] owns two commercial buildings in Palm Coast, Florida, that are left over from their media business. Those are currently for sale on the market. One is listed at $8 million and it is 140,000 square feet. The other one is 67,000 square feet and listed for $5.75 million. I’ve been to both of them. I had a tour of them a year or two back. They’re nice buildings. A good part of is a mix between office and warehouse, a good portion of them are high ceilings, 30 foot plus ceilings, that a lot of the warehouse or distribution companies are looking for.
[56:53] Palm Coast, Florida is on the eastern side of Florida — an hour from Jacksonville, an hour from Orlando, just north of Daytona Beach; an oceanside town. I think those buildings have value and they’re not currently occupied, so that’s something where commercial real estate investors will have a tough time putting a yield on it. But in terms of demand [for the properties], I think it’s just a sweet spot of the industrial-type building that people are currently looking for. They’re still on the market for sale, with a combined value of $13.75 million. You can place whatever haircut you want — in terms of where they sell, or the timing on that as well. We don’t think there will be a big tax impact; the predecessor media company had some operating losses and some capital losses that we think can be applied against any gain. We see a good amount of value there.
[58:00] They’ve got two properties in Colorado that we also think have a good amount of value, especially compared to the company’s [then] enterprise value of $40 million. They’ve got a 4.5 acre lot in the city of Parker, Colorado — a southeast suburb of Denver. The property is on the corner of Main Street and Jordan, and it’s listed for sale at $4.5 million. So, again, it’s listed because it hasn’t sold yet. But in terms of Parker, it’s a fast growing community. I think the property just to the south is going to be developed into a senior housing facility. There’s medical [investment] going in blocks away, and it’s rapidly growing. And the property’s only increased in value, I think, over the last year or so.
[59:06] They also own 160 — it might be 165 — acres of residential land in Brighton, Colorado, which is a northeast suburb of Denver not too far from Denver International Airport, slated for residential development. It hasn’t moved forward yet; a neighboring development has had some water issues and I think the ultimate solution here is kind of a compromise with the city where you put in a retaining pond and then add in some water rights downstream in order to make the property a development candidate. So, 160 acres of land in an area where housing is very hot right now; as a ballpark figure, we say that’s $25,000 to $30,000 an acre — we think that could be low, but it gets you another $4 million to $5 million of value.
[1:02:21] You don’t know if or when it will sell. Ideally when the proceeds come in, they’ll be invested either in other good things or perhaps returned to shareholders — which, I think, represents over half the enterprise value of the company, and is where we come about just with non-core properties.
[1:02:46] We think the Natural Grocers building is worth in the neighborhood of $5 to $6 million; $2 million of the company’s debt is associated with building out the Natural Grocers property. We think if there is a sale — then the debt value essentially gets cut by $2 million and you’ve got $3 to $4 million coming in the door, as well. Commerce Center is a 35 acre northeast portion of Rio Ranch; we put a value of somewhere between $5 and $10 million on it, and it hasn’t sold yet. We think it’s an attractive piece of property; if or when it is monetized, one way or the other, we think that’s real value to AMREP shareholders.
[1:03:42] The company has a number of residential subdivisions. We think, based on the current pace of development, that [the company] can develop 150 to 250 lots per year. If you want to say it’s $70,000 a lot, then you’re looking at $12 to $18 million a year in revenue from residential lot development.
[1:11:04] We think that at the end of the day, the enterprise value should be somewhere between $70 million and $120 million, equating to a share price of $9 to $14 per share.
We encourage Grahamian Value readers to learn more about the Yet Another Value Podcast platform via this website and YouTube channel. Additionally, Andrew maintains a regular mailing list (subscribe here) — as lifelong learners ourselves, the co-editors are grateful for the energy, care, and love that Andrew invests in the above endeavors.
In addition to co-authoring this digest, Harry Sauers and Shai Dardashti oversee the allocation of private family capital and own shares of AMREP Corporation stock.
II. WEEKEND WATCHING
Courtesy of 92nd Street Y: Bestselling author Michael Lewis and Malcolm Gladwell examine how a Nobel Prize-winning theory of the mind altered our perception of reality in Lewis’ book The Undoing Project. (Recorded December 12, 2016)
Courtesy of Talks at Google: Daniel Kahneman, recipient of the Nobel Prize in Economic Sciences for his seminal work in psychology that challenged the rational model of judgment and decision making, is one of our most important thinkers. His ideas have had a profound and widely regarded impact on many fields—including economics, medicine, and politics—but until now, he has never brought together his many years of research and thinking in one book. In the highly anticipated Thinking, Fast and Slow, Kahneman takes us on a groundbreaking tour of the mind and explains the two systems that drive the way we think. System 1 is fast, intuitive, and emotional; System 2 is slower, more deliberative, and more logical. Kahneman exposes the extraordinary capabilities—and also the faults and biases—of fast thinking, and reveals the pervasive influence of intuitive impressions on our thoughts and behavior. The impact of loss aversion and overconfidence on corporate strategies, the difficulties of predicting what will make us happy in the future, the challenges of properly framing risks at work and at home, the profound effect of cognitive biases on everything from playing the stock market to planning the next vacation—each of these can be understood only by knowing how the two systems work together to shape our judgments and decisions. Engaging the reader in a lively conversation about how we think, Kahneman reveals where we can and cannot trust our intuitions and how we can tap into the benefits of slow thinking. He offers practical and enlightening insights into how choices are made in both our business and our personal lives—and how we can use different techniques to guard against the mental glitches that often get us into trouble. Thinking, Fast and Slow will transform the way you think about thinking. (Uploaded on November 10, 2011)
Courtesy of Talks at Google: In a series of illuminating, often surprising experiments, Dan Ariely refutes the common assumption that we behave in fundamentally rational ways. Blending everyday experience with groundbreaking research, Ariely explains how expectations, emotions, social norms, and other invisible, seemingly illogical forces skew our reasoning abilities. Not only do we make astonishingly simple mistakes every day, but we make the same types of mistakes, Ariely discovers. We consistently overpay, underestimate, and procrastinate. We fail to understand the profound effects of our emotions on what we want, and we overvalue what we already own. Yet these misguided behaviors are neither random nor senseless. They’re systematic and predictable—making us Predictably Irrational. (Recorded July 1, 2008)
III. WEEKEND LISTENING
Courtesy of The Acquirers Podcast: Stephen Clapham (twitter), forensic accounting expert and founder of Behind the Balance Sheet, discusses his new book The Smart Money Method with Tobias Carlisle (twitter). (November 30, 2020 episode date)
Courtesy of Making Sense with Sam Harris: Sam Harris (twitter) speaks with Adam Gazzaley (twitter) about the way our technology is changing us. They discuss our limited ability to process information, our failures of multitasking, “top-down” vs “bottom-up” attention, self-interruptions and switching costs, anxiety, boredom, “digital medicine,” neuroplasticity, video games for training the mind, the future of brain-machine interface, and other topics. (November 27, 2020 episode date)
Courtesy of The Business Brew: Michael Mitchell (twitter), a former partner at Locust Wood Capital Advisors, joins Bill Brewster (twitter) of Sullimar Capital Group in sophisticated, long-form conversation. (November 17, 2020 episode date)
ABOUT GRAHAMIAN VALUE
Grahamian Value is a labor of love, centered around our desire to openly share data and perspectives that we find helpful in our pursuit of Benjamin Graham-inspired investment ideas. We appreciate your time, your trust and your readership. Learn more at GrahamianValue.com
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Harry Sauers and Shai Dardashti are co-editors of Grahamian Value and, as of the date of this communication, may individually own shares of companies mentioned herein. The publishers do not receive compensation from the companies and people covered in Grahamian Value for such coverage. This communication is for informational purposes only. This is not intended to be investment advice. Seek a duly licensed professional for investment advice.