The Weekly Summary
Another week of global unease is over and a new one is beginning with more of the same. Overnight stock futures are down, gold is reaching for record territory and after the Fed's almost unprecedented surprise rate cut Treasury yields are at their lowest in history. The CBOE Volatility Index (^VIX: 42) briefly hit a 12-year high on Friday, suggesting that market conditions are now more unsteady than they were in the depths of the 2011 U.S. government shutdown and credit rating downgrade. A casual observer might start pondering the end of the world.
We aren't. Everything we've seen so far and most of the people we've talked with point to this outbreak as painful for many and a drag on the economy, but the recovery will begin in a matter of months if not weeks. We've spoken with fund strategists who oversee $30 billion in global assets, observed events on the ground in several cities and read everything we could find. The most likely scenarios all revolve around disruption and not disaster. The world will walk away from this.
Admittedly, the wheels of global commerce are grinding. Merchandise and people are getting stuck between borders. It now looks like economic activity worldwide will slow about 0.3% in a baseline scenario and as much as 0.8% in an extensive and prolonged slump. That's not a recession. It will feel like a crawl, but we've learned to live with a crawling economy over the past decade. Right now it looks like Italy will enter a full-fledged recession this year. If things get really bad, Japan, Germany and even Saudi Arabia will join.
But the United States should emerge from this with at least 0.9% GDP growth this year and then get back to more robust expansion in 2021. Just look to China, where growth isn't likely to drop far below 4% even in the worst scenario. China, incidentally, has stopped seeing an increase in new patients. They're testing up to 1.3 million people a week and it looks like the virus has stopped spreading. Meanwhile people who caught it weeks ago are better now. They're going back to work. Quarantines are starting to lift.
Our math suggests that if domestic conditions play out on the Chinese model, the U.S. outbreak has about two weeks left to run before it recedes. Even if we look toward Italy or Iran, where antiviral measures have been much looser, the human and economic impact will be transitory. Meanwhile the Fed and other authorities are standing by to cushion the rough spots. As we said last week, there are really two scenarios here. Either the Fed overreacted and there is no chill ahead, in which case the markets have lower interest rates to enjoy in the meantime, or there is a real prospect of serious shock here, in which case it's good to see that Jay Powell and company are ahead of the disruption.
For now, investors have uncertainty and low interest rates to take the edge off any dread circulating. We can say that airports are a little quiet but not unnaturally empty. People are flying. People are on the streets of the nation's great cities. Business is still getting done. Offices and restaurants are open and doing business. Some are a little understaffed, but they always are in flu season.
As far as the Fed goes, some people now argue that we'll get another big rate cut in two weeks, which will further help shield vulnerable people and companies from a serious shock. We would prefer concrete fiscal stimulus for the airlines and other companies, not to mention workers at risk, but any relief is better than nothing. We'll see if this approaches the level that brings Washington factions together.
But one thing is clear: People are looking past the outbreak to a return of business as usual. Corporate managers are still looking toward getting the best execution they can on their strategic plans, even if the virus gets in the way. From their perspective, this is practically a repeat of the trade war last year: somewhere between distraction and disruption. But again, we survived the trade war and this is really just more of the same.
Then there's OPEC. Saudi Arabia has gotten tired of trying to enforce discipline on the oil market and instead of pushing for supply cuts is now opening the spigot as wide as it can. U.S. petroleum producers will need to accept lower prices. So will the Russians, Iranians and everyone else. It's a short-term boon for consumers, who will be able to keep the lights on and the gas tank full at a discount. The Saudis are thinking years ahead, when weaker rivals will no longer be in a position to balk their price policy. They aren't thinking of an immediate global crash.
Neither should any smart investor. As long as you have supplies and cash flow for the immediate future, the long term will look out for itself. We always want to avoid forced liquidations . . . selling into weakness because you need the cash is a great way to lose money in the market. If other investors (individuals or funds) need to make their margin calls, we see that as an opportunity to buy their weak hand at a discount. Remember, people like Warren Buffett have been muttering about their desire to "buy the dip" for weeks now. Buffett is 89. He's seen it all. He's looking beyond the immediate headlines to a brighter future where temporarily depressed stocks regain their natural levels.
He sees the light at the end of the tunnel. So do we. What is Buffett buying? Airlines. They will recover. Cheap oil and low interest rates mean these stocks will fly again.
There’s always a bull market here at The Bull Market Report! Gary Jefferson is back with a detailed look at how markets have responded to disease outbreaks. The Big Picture puts recent volatility in context . . . do we have a reason to feel unusually tired, or is this simply what it feels like when the market flares back to life after a quiet season? The High Yield Investor, naturally, is all about the landscape the Fed left behind. With inflation still tracking above 2% and Treasury yields plunging below 1%, any position in government bonds essentially amounts to locking in a loss in buying power. We urge all investors to seek alternative sources of fixed income.
Finally, while most stocks are still moving in tight correlation, it's worth sticking to our schedule. Earnings season is practically over, but it's been a few weeks since we checked in on a few of our Special Opportunities and Technology favorites.
Key Market Indicators
BMR Companies and Commentary
The Big Picture: How Wild Is It Out There?
After multiple weeks watching the market swing down (and occasionally up) 1-4% just about every day, it's always worth remembering that the New York Stock Exchange trading curbs don't even kick in until the market as a whole drops 7% in a short period of time. That level is not historically unprecedented or unrealistic. When the exchange set it up in the first place, it was with the goal of preventing truly wild selling . . . while allowing normal volatility.
Can the market fall 7% in one day? Sure. It's happened in our careers. The biggest trading curbs are set at 20% because that's roughly what the S&P 500 withstood in the 1987 crash (22.6%). The exchange recognizes that that kind of catastrophic selling can happen. But it's extremely rare, and hasn't happened for over 30 years. Even the 7% curb was only triggered once in the 2008 bear market and hasn't been hit since.
But while we haven't come within sight of the curbs, the market has been volatile. This is far from unprecedented. In a typical month, we see four days where the S&P 500 moves 1% or more from the previous close. That's happened every day so far in March and nine days in the past two weeks. We'll see where the next few weeks take us, but for now, we're looking at conditions as wild as what we saw in the 2011 dip or even (if we squint) the market closure around the September 2001 attacks. If you believe the world currently looks that scary, remember: we got through it and investors ultimately saw their money get back to work.
It would take another few weeks of unrelenting volatility to approach what we saw in 2008. That was more painful, but again, Wall Street survived and stocks went on to break fresh records, year after year since.
We are also heartened by the way the market is making wide intraday swings instead of simply opening down and dropping from there. The swings are extremely wide -- an average day so far this month has cleared nearly 4% from low to high, mostly to the upside. That's unusual, but it's still a long way from the 6% intraday volatility we've witnessed in the past. And it doesn't necessarily add up to a bad month. So far in March we've basked in two separate 4% up days, which is astounding. The market could easily gain or drop 5% in total before the month is done. This is not unusual. It's happened again and again.
Dollar Tree (DLTR: $80, down 3% last week)
The company reported fiscal 4Q19 (ended February 1, 2020) results on Wednesday morning. The stock fell 4% that day, to $79, a new 52-week low. It continued falling, plummeting to $76 on Friday before strongly rebounding to close at $80. Cumulative losses since late October are now 32%, when the stock peaked at $118.
Going back a few months, the market reacted negatively to the company’s fiscal 3Q19 results which the company reported at the end of November. Sales growth was fine, up 4% year-over-year to $5.8 billion, and same-store sales at the Dollar Tree and Family Dollar stores increased by 2.8% and 2.3%, respectively. What investors didn’t like were the higher costs that pressured income, causing a $20 million year-over-year drop, to $260 million. Management piled on to this news by warning that Dollar Tree’s FY19 earnings would fall $0.30 short of their original $5.00 guidance due to higher tariffs raising costs.
Turning to 4Q19, sales grew 2% to $6.3 billion versus $6.2 billion in the year-ago period. Dollar Tree stores experienced a 1.5% same-store sales increase while Family Dollar’s fell by 0.8%. The company earned $125 million compared to $400 million last year. (There was a $2.7 billion goodwill impairment charge on top of the gains.)
Looking towards FY20, management is calling for $24.5 billion in sales, a 4% increase over FY19. This includes their expectations for a low single-digit increase in same-store sales. They also expect earnings to increase by 5% to $5 a share, with tariff costs weighing on 1H20 results.
BMR Take: We believe the stock is due for a run. The company has some defensive characteristics since people increase their shopping at dollar stores during a downturn. We are not expecting a downturn, mind you, even though the coronavirus has created economic uncertainty and likely will weigh on short-term economic growth. But if a full-blown recession were to hit, Dollar Tree is poised to benefit. With the stock now below our $82 Sell Price, we certainly understand if you don’t want to take the ride. Our Target Price is $120.
Occidental Petroleum (OXY: $27, down 18%)
Admittedly, the stock has not gone our way since we recommended the company in mid-January at $47. We don’t like to see our picks lose 43% over a couple of months. This is true even if we couldn’t anticipate the coronavirus that initially affected China and then spread across different countries. The economic impact is being felt globally. Naturally, this is affecting energy prices. Now, turning to the good news, we still like Occidental Petroleum.
The company is in a stronger position following its $55 billion acquisition of Anadarko Petroleum. Among other things, this doubled production in the Permian Basin in Texas. It has also become more efficient by investing in technology, lowering the company’s West Texas Intermediate break-even price of crude to $40. This is at a level management feels confident whereby the current dividend is secure. With the crude at $46, down from $54 a couple of weeks ago, Occidental is still operating in the black.
Occidental has met or is ahead of schedule on its goals following the large deal. This includes repaying $7 billion of debt in 2H19, realizing $900 million worth of synergies a year ahead of schedule, and announcing $10.5 billion worth of asset sales of the $15 billion target, again, ahead of schedule. We would like to see further progress on the balance sheet since there is still $41 billion of debt, higher than we’d like to see.
The company generated $7.2 billion of operating cash flow last year, and free cash flow was $800 million after capital expenditures. Occidental’s free cash flow will be under pressure in the near-term with worldwide economic growth hurt by the coronavirus. Over the long-term, when growth normalizes, we fully expect free cash flow generation to improve.
It is challenging to compare year-over-year results due to the Anadarko deal. Occidental’s 4Q19 revenue rose to $6.8 billion versus last year’s $4.8 billion. Oil & Gas was the primary driver. The company lost $1.0 billion versus 4Q18’s $700 million profit. This year’s period includes various charges and one-time expenses, including $675 million related to the Anadarko acquisition.
BMR Take: The equity and commodity markets have conspired against Occidental Petroleum. We remain confident in Occidental’s long-term growth prospects. The Energy sector was already under pressure from an oversupply of oil and natural gas when the coronavirus hit. Markets work these things out. With the stock’s fall, there is also a strong 11.8% dividend yield. That’s a nice payout while you’re waiting for economic growth to resume. However, there may be a dividend cut in the works, so go in here with your eyes wide open. We certainly understand if you want to bail with the stock is trading below our $41 Sell Price. Energy companies are tied to commodity prices and the stocks are notoriously volatile. Occidental is for those willing to ride out the waves. We have a $59 Target Price.
U.S. Energy ETF (IYE: $22, down 8%)
Over the last year, US Energy ETF has lost 37%, with 8% of that downswing in the last week. This is nothing more than the Energy sector going through a cyclical downturn. There are natural peaks and valleys with Energy that smooth out over a long period of time. Since the fund’s inception in 2000, your money has doubled, even with the current downturn. If you want exposure to the sector, US Energy ETF is an excellent way to get it.
Exxon Mobil is the largest holding, at 23% of the fund. Chevron, with a 19% weight, is the second biggest position. The next eight companies have 3%-6% weightings, including heavyweights like ConocoPhillips and Kinder Morgan. The 10 companies represent 72% of the portfolio.
We have extolled the virtues of Occidental Petroleum. It is one of our favorite names in the Energy sector. For those wanting a broader and more diversified Energy position, US Energy ETF is a good fit.
BMR Take: US Energy ETF has only a 0.4% expense ratio. This makes it an inexpensive way to own a bunch of large Energy companies. The stock’s slump has driven the price below our $28 Sell Price. When this happens, we place the ball in your court since you know your own risk tolerance. We have a $38 Target Price.
Akamai Technologies (AKAM: $91, up 5%)
Considering the market has been in a tailspin over the last couple of weeks, Akamai has held up very well. After reaching a 52-week high of $103 in the middle of February, the stock fell 15% to $87 on the last trading day of the month. In a rough week for equities, it is noteworthy that Akamai recovered 5%. A stock’s rollercoaster ride can be maddening, we know. But generally, the volatility gets smoothed out for long-term holders. Amazingly, Akamai still has gained 29% over the past 12 months.
Akamai’s products secure and deliver content and business applications over the Internet. Its core product allows customers to maximize their online power and reach while protecting them for threats. The Internet of Things, which connects all kinds of devices and transmits a ton of data, also presents ongoing threats to businesses. These are not going away anytime soon, making this is an opportune time for Akamai.
Looking at 4Q19 results, revenue grew by 8%, from 4Q18’s $715 million, to $770 million. Profits rose by more, 27% year-over-year, from $95 million to $120 million.
There is $2.7 billion of debt, which is more than we like to see but Akamai does have $1.5 billion in cash and produces a healthy amount of cash flow. It generated $1.1 billion of cash flow compared to $1.0 billion in 2018. After capital expenditures, 2019’s free cash flow was $500 million.
BMR Take: The market selloff indiscriminately knocked down just about every stock. This cleansing has its benefits since you can pick up Akamai at a 12% discount compared to where it was trading just a couple of weeks ago. Remember, that was after Akamai reported 4Q19 results. The stock was briefly above our $100 Target Price last month and we believe it will get there again shortly. We have a Sell Price of $77.
Facebook (FB: $181, down 6%)
Even a company as wonderful as Facebook has not been immune to the market’s downward pull. Over the last three weeks, the stock has fallen 12% from $218. When you have a winner, and make no mistake that we believe Facebook is in that category, it pays to hold them a long time. At these levels, we believe this is an opportunity to buy at an attractive level.
The company is much more than its namesake brand. It includes great and popular products such as Instagram, WhatsApp, and Messenger, all with over a billion users. Facebook generates revenue from advertising. This is good since the company reaches a whole bunch of people. As of 4Q19, its family of monthly active users was 2.5 billion, 11% higher than a year ago. The world’s population is 7.7 billion, so roughly one out of every three people across the entire globe logged into one of Facebook’s applications.
Facebook’s results keep rolling higher. For 4Q19, revenue grew by 25%, from $16.9 billion to $21.1 billion. Profits rose 7% year-over-year, from $6.9 billion to $7.3 billion. This is translating into a whole lot of cash flow. In 2019, operating cash flow was $36 billion, 24% higher than in 2018. It used part of this, $4 billion, to repurchase shares. The balance sheet is in good shape, too. There is $55 billion in cash and $11 billion of debt.
BMR Take: The slumping stock market has left the stock well below our $206 Sell Price. We have analyzed the company extensively and it is still posting strong revenue and profit gains. That’s our two cents. Of course, in these situations, the ball is completely in your court. Our Target Price is $250.
Roku (ROKU: $102, down 10% )
Since mid-February, Roku has fallen by 27% from $139. Even with this drop, the stock is up 44% over the last year. We feel that the growth story is just getting started. In short, we remain tuned in.
This is a company that actually benefits from cord-cutting, a growing trend. Customers are canceling cable subscriptions in favor of other services such as Netflix, Amazon Prime, and Disney+.
Roku was one of the earliest to capitalize on consumers turning towards streaming services. This has only gained momentum as big players have joined the streaming party (Disney, Apple TV+, HBO Max, and NBCUniversal’s Peacock). Roku’s platform, including its operating system, connects users to the streaming content.
Management is focused on increasing three things: The number of active accounts, user engagement and hours of content streamed, and, last but certainly not least, growing revenue and profit by monetizing user activity on its platform. We like it when companies accomplish what management has set out. The number of active accounts grew by 10 million last year, to 37 million. Streaming hours rose by 68%, from 24 billion to 40 billion. Average revenue per unit increased from about $18 to $23 and gross profit grew 50% to $495 million.
Analyzing 4Q19 results, revenue was 49% higher year-over-year, reaching $410 million. Gross profit grew to $160 million compared to $110 million. They did report a $15 million loss compared to a $5 million profit last year, due to higher operating expenses (R&D, Sales & Marketing, and G&A), which rose to $180 million versus $105 million. We are not terribly concerned since Roku is ramping up costs to keep up with strong top-line growth. With all the potential growth ahead for this company, who can blame management? We certainly can’t. Looking ahead to 2020, management expects revenue of $1.6 billion: 40% growth.
BMR Take: Whenever the stock trades below our Sell Price, which has happened with Roku ($130 Sell Price), we leave the decision to you. This is not because we are dodging our responsibilities. It’s just that it is a personal decision based on your own risk tolerance. With that being said, we remain firm believers in the company. Our Target Price is $205, 20% above September’s $170 all-time high.
A Word From Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
We take a somewhat jaundiced view about how this new virus is being mishandled by the media, causing sentiment to dive deeper into oversold territory as markets closed out what many pros have assessed as the worst week for stocks since the depths of the financial crisis. Losses in the first two days of this nine-day debacle were more than three standard deviation events. That’s two consecutive days of a 3-out-of- 1000 event. The odds of two such sell-offs occurring on two consecutive days? About 1 in 100,000 – or once every four hundred years.
Yes, the market sold off 20% on Black Monday in 1987, but the dollar amount wasn’t comparable to what just occurred. This was the fastest 10% plus correction for the S&P 500 ever on record. The media has made this into a worst-case scenario with a resulting nearly 12% plunge happening faster than any other market correction in history. This whole thing is a human tragedy, but if one simply steps back and looks at the data, there were 80,088 confirmed cases and 2,699 deaths from the coronavirus COVID-19 outbreak as of last Monday. This is a big number but the pace of growth looks to be slowing.
Remember, many more people are recovering than still getting sick. Total active cases peaked about a week ago at 58,747 and have since been declining. Even with all the new cases we are seeing in South Korea, Italy and Iran (where data is suspect), there have been 30,597 cases with an outcome (2,699 deaths and 27,898 recovered). In other words, the total active cases now stand at 49,923, a drop of 15% from the peak on February 17th.
While there is still plenty to be concerned about, compared to an average flu season in the U.S, coronavirus isn’t yet near enough to even be comparable. One death is too many, but to put that number into a little bit of perspective, in the United States alone for the 2019-2020 season, there have been at least 15 million flu illnesses, 140,000 hospitalizations and approximately 12,000 deaths. Imagine if everyone with an internet connection followed the spread of this annual flu, case by case, hour by hour. That has never happened except this time, the media has decided to “damn the torpedoes – full speed ahead” with a message of fear and panic minute by minute, resulting in the market getting torpedoed.
That’s because Wall Street has forever followed the mantra: “When you don’t know the fundamentals, trade the technicals." The problem is that the media is fully aware that “flash traders, nano and algo” machines react to headlines, and those headlines have been saturated 24/7 with coronavirus doom and gloom. It's true that the death rate from coronavirus appears to be around 2% in China, which is much higher than the death rate from the normal flu, but like the flu, mortality here increases with age. However, outside of China the death rate is far less than inside China, roughly 1%. And, there is already a drug that will combat COVID-19 moving toward first phase clinical trials. It took three months for this to happen in 2020, versus 20 months for SARS back in 2002/03 . . . a testament to advances in drug technology.
From a macroeconomic point of view, the real question is how will this impact the U.S. economy over the coming year. In short, we don’t see a discernible reason for the market to have gone into full panic mode. Since 1981 there have been more than a dozen major outbreaks including ebola, HIV/AIDS, pneumonic plague, SARS, swine flu and zika. All were resolved and the markets went higher after every one of the events. The U.S. is relatively insulated, with a great health system. Investors started the year with solid economic data and so far, nothing has changed. In fact, with all the data we already have on hand, most analysts are still expecting around 2% growth in Q1.
Most of the impact to the US from the corona virus will come in Q2. Revenue and earnings from companies that are highly exposed to China will definitely be affected. China being shut down for a month will have a global impact. But lower earnings in the first half of the year should be made up by a strong rebound in the second half of the year with payback from lost months. Consumer demand remains strong and there has been no visible impact yet on the job market as shown by unemployment claims. Supply disruption is the issue. We think investors should look through any earnings weakness as we expect it to be transitory . . . in other words, this isn’t something that appears to have our economy headed into a recession, despite the media’s attempt to convince us otherwise. One positive aspect of this outbreak is that many companies had already been shifting supply chains from China due to the Trump Tariffs, and if they weren't considering it before they will be now as they realize the importance of diversification.
Bottom line: we believe the US consumer is on solid footing and will continue to be one of the key drivers to US economic growth in the year to come. We believe that, just like all the other viruses experienced over the past decades which have dissipated, the coronavirus will be no different. Many media pundits have implied that the 1918 Spanish Flu, which killed hundreds of thousands in the US could happen again. No one knows, but 2020, is not 1918. Technology and news move much faster and the US rebounded from the Spanish Flu when all was a said and done. We suspect that any drop in earnings or economic activity will be short lived, and more than made up for in the year to come. Don't panic, stay invested.
The High Yield Investor
By Larry Rothman
VP High Yield Investments
The Bull Market Report
The equity market was volatile last week but ultimately remained in “risk-off” mode, shedding riskier assets and turning to risk-free Treasuries. Of course, we have to start with the Fed’s action last week. The virtual certainty of a rate cut turned into reality when the central bank took the unusual step of cutting short-term rates 50 basis points between meetings due to the economic uncertainty created by the coronavirus. U.S. Treasury yields are at anemic levels. Two-year yields are at only 0.49% while the 10-year yield is just 0.74%, making the spread 25 basis points. But note that the yield curve is still positive. We were worried that the curve might invert, but so far so good. The market now expects another easing when the Federal Reserve meets later this month.
Markets aren’t reacting to the current economic conditions since economic reports continue to come in just fine. There were 273,000 new jobs created and the unemployment rate stands at just 3.5%. There hasn’t been a spike in layoffs, with the weekly jobless claims at 216,000. But people have a growing fear regarding the spread of the coronavirus. While the current economic climate is good, there is concern that the illness will change the situation for the worse.
We do believe there will be an economic impact, particularly on certain industries such as Travel. We expect it would only be temporary and we are in good company. Federal Open Market Committee member Rob Kaplan, President of the Dallas Federal Reserve Bank, expects the U.S. economy to avoid a recession this year. He views a slowdown from the coronavirus only lasting a few months. While risk-free assets offer lackluster yields, the flight to safety has lowered prices for riskier assets. This includes the three REITs we discuss this week, which now offer even higher yields than before.
The Bull Market Report is here to guide you. These REITs offer 200 to 1,200 basis points over 10-year Treasury yields. More conservative investors should look at JBG Smith Properties. Omega Healthcare Investors is for those with a moderate risk tolerance. Moving up the risk/reward scale, Service Properties Trust has the highest yield out of the three we analyze this week.
Service Properties Trust (SVC: $16.75, down 8%, yield = 13.0%)
Service Properties Trust is a REIT with hotel and service-oriented retail properties. At year end, there were about 330 hotels and 815 retail properties in its portfolio. Last year, the company greatly expanded its retail operations when it bought 765 properties from Spirit MTA REIT for $2.5 billion. The deal broadened the company’s properties base beyond its TravelCenters of America. These now encompass several industries, including Travel Centers, Quick Service/Casual Dining Restaurants, Movie Theaters, Health and Fitness, and Automotive Parts/Services.
The Hotel portfolio has leases that expire between this year and 2037. Most of them have renewal options that range between 15 and 60 years. These long-term leases are good, providing protection against vacancies. There is typically a minimum rent plus additional payments based on the hotel’s cash flow. Their Retail properties mostly have triple-net leases where the tenant picks up the operating expenses and capital expenditures.
Revenue rose 6% in 4Q19 to $580 million from 4Q18’s $550 million. The company lost $15 million versus a $110 million loss in the year-ago period, which included a $105 million unrealized loss from equity securities. This year’s results were also weighed down by a higher interest expense since they took on debt to acquire Spirit’s assets.
Since this is a REIT, the focus is on cash flow. Using that yardstick, the company turned in a healthy 4Q19 performance. Funds from operations improved by 50% year-over-year, from $100 million to $150 million.
The stock is yielding 13.0% (350 basis points more than two weeks ago when the stock was at $23), and clearly has an element of risk, as they ramp up the Retail portfolio, which is competitive. The Hotel and Retail sectors face near-term pressure in the wake of the coronavirus scare. While the high yield more than compensates for this, you may decide, with the stock trading below our $22 Sell Price, that this is the time for you to exit. We believe, however, that the virus scare will subside over time and the properties that the company owns will thrive.
JBG Smith Properties (JBGS: $38, up 4%, yield = 2.4%)
JBG Smith invests in high-growth, mixed-use properties both in and around Washington D.C. At year-end, it owned 62 assets (44 commercial properties and 18 multi-family properties). There are also another seven properties under construction and another 40 it potentially could develop. It seeks vibrant neighborhoods where residents can walk to amenities, which management calls “placemaking.” If this description doesn’t catch your attention, how about the fact that JBG Smith is developing Amazon’s new headquarters in National Landing, located in Northern Virginia? The relationship with Amazon benefits JBG Smith in other ways, too. This includes leasing surrounding properties, boosting occupancy and rates.
JBG Smith’s 4Q19 revenue was flat, at $165 million. Income moved higher to $40 million from $1 million, due to a $60 million gain from a sale. Funds from operations, a proxy for cash flow, grew from $55 million to $60 million.
Spun-off from Vornado in 2017, the portfolio is geographically concentrated. Management looks for areas where there are high barriers to entry, walking distance to the Metro and other amenities, and strong economic and demographic trends (e.g. D.C. National Landing, Rosslyn, Alexandria, Bethesda, and Silver Spring).
JBG Smith (Target Price: $48), with a 2.4% dividend yield, is for conservative investors. It offers a 170-basis point yield advantage over the 10-year Treasury yield.
Omega Healthcare Investors (OHI: $39, down 1%, yield = 6.8%)
Omega Healthcare Investors is the third REIT we are discussing in our report this week. Its 987 healthcare-related properties, located in the U.S. and U.K., are concentrated in Skilled Nursing Facilities (SNFs, 784 properties) and Assisted Living Facilities (114 properties). The portfolio also includes Independent Living Facilities, Rehabilitation and Acute Care Facilities, and Medical Office Buildings. All leases are on a triple-net basis, which means the tenant pays all of the property’s operating expenses. Omega also provides mortgages (8% of 2019 revenue), which are secured by first liens on the properties, and extends loans to its operators for working capital and capital expenditures (5% of revenue).
There are benefits to experience and size, and Omega has built scale and a good track record. Demographics, with the population aging, also favors operators, and, in turn, Omega. There are risks to its largely SNF portfolio that you should know before you invest your hard-earned money. These rely on Medicare and Medicaid for reimbursement to a large degree. While this eliminates credit risk, the rules change annually. There was good news last October when the reimbursement rate for SNFs was increased by 2.4%, the largest in several years.
Revenue grew 12% year-over-year in 4Q19, from $220 million to $245 million. The main driver, Rental Revenue, was up a sharp 13%, to $210 million. Income slipped from $65 million to $60 million. We are not concerned since this was due to various non-operating items, such as a lower gain on the sale of assets and a bigger impairment on properties. In November, the company boosted the dividend a penny to $0.67. A slight increase, it is the first hike in 2 years.
Omega Healthcare Investors (Target Price: $45) now offers a 6.8% yield, 610 basis points over the 10-year Treasury yield. The stock’s 12% fall since the end of February has expanded Omega’s yield by 90 basis points, from 5.9%.
We believe the drop in the stock from the $44 level in the last few weeks is mostly noise as investors are selling everything indiscriminately. The volume and liquidity in the stock is very low and even minor selling pushes the stock down way more than we feel is appropriate to the circumstances.
Todd Shaver, Founder and CEO
The Bull Market Report