Bargains, Bull Traps and Blood

Blood in the streets creates opportunity OR does it?  Maybe or maybe not.  Maybe a bull trap instead.

It has been a rough week or two for many income issues out there.  Fortunately preferred stocks and baby bonds held rock steady with the average share moving just a nickel over the course of the last week. On the other hand the baby bonds of TravelCenters of American (NASDAQ:TA) have gotten hammered hard as the company announced really poor earnings a week ago.  Honestly this is no real surprise to us as TA is simply a company not motivated to make money for the common shareholders.  More on that later.

Today with the SP500 off by over 1.5% retail and mall REITS began to bounce a bit which is totally contrary to the direction they have been heading for the last couple of weeks.  I guess every sector is entitled to a “dead cat bounce”.  The question of course is whether this is a “dead cat bounce” or is the sector bottoming?

So would we consider mall and retail REITS bargains or would buying them now simply be falling into a bull trap? Would buying the TA baby bonds be a smart move or would it be a high risk purchase?

1st off let’s take a look at the TA baby bonds.  There are currently 3 issues outstanding of baby bonds.  The TANNI issue has a coupon of 8.25% matures in 2028 and had a first early call date of 1/15/2016.  Shares are trading at $24.12 with a current yield of 8.63%.  The TANNL issue has a coupon of 8% and a maturity date of 12/15/2029. Shares are trading at $23.09 for a current yield of 8.66%.  The TANNZ issue has a coupon of 8% and trades at $23.30 for a current yield of 8.58%.  The issue matures in 2030.  We should note that these baby bonds comprise the vast majority of TA’s debt and have face value of $360 million.

Looking at TravelCenters finances we find that over the last 3 years revenue has fallen by around 30% as the price of fuel, which is by far and away their largest revenue generator, has fallen dramatically.  At the same time the number of gallons of fuel sold has increased as the company has continued to expand their travel center ownership and they have added convenience store ownership.  For the years 2014, 2015 and 2016 net income was $61 million, $22 million and -$2 million respectively.  Not very stellar for a company that had revenue of $7.7 billion, $5.9 billion and $5.6 billion respectively.  No doubt this is a low margin business.  NOW lets look at the “funds from operations” (FFO).   2014 had FFO of $126 million, 2015 FFO was $116 million and 2016 was $90 million.  In 2016 the company paid about $28 million in interest on their debt (mostly on the baby bonds).  This means that their interest payments were covered between about 4 and 5 times.  Now moving ahead to 2017 TA laid a giant egg in their 1st quarter earnings. While sales were up 10% over the same period in 2016 they managed to lose $29 million and FFO fell to a measly $2 million.  With this poor result investors rushed for the door the last 2 weeks and baby bond prices fell by $2/share.  The uneducated (in income securities) seem to think that TA is going out of business this year or that they will stop making interest payments—they aren’t and they won’t.  The long time income investor knows that placing too much emphasis on quarter to quarter movements in company financials  means you may well miss out on some of the best available bargains.  We declare TA baby bonds BARGAINS!  We know that many readers will disagree and we understand that some level of risk to earn a tidy reward is not for everyone.  We ran into the same disagreement when we wrote the 1st article on Glacier Water trust preferred shares over 6 years ago.  Glacier Water hardly ever makes money and had negative equity for years–yet the free cash flows continues to pay the interest on the trust preferreds (although they merged with another company last year the shares continue to trade at over $26/share).  These trust preferred shares carry a coupon of 9 1/16%.  The TA shares are similar in that they can make little to no money and yet it is highly likely that holders of these baby bonds will profit handsomely.  Of course there is no guarantee.  We personally hold 800 shares of the various TravelCenter baby bonds and may add 200 more.

One last note on TravelCenters.  Hospitality Properties Trust (NYSE:HPT) is the largest shareholder of TA. Additionally TA leases a large share of their properties from HPT.  HPT is a large and relatively profitable REIT with net income of $226 million in 2016.  Given these resources we believe that the vested interest HPT has in TA is a positive.

Moving on to look at a few potential retail or mall REITS bargains.  Well actually we don’t consider the common shares of retail and mall REITS to be bargains we think the shares are Bull Traps.  The shares of companies such as Realty Income (NYSE:O), Kimco (NYSE:KIM), Store Capital (NYSE:STOR) have been bloodied beyond what we have seen for years and are trading at their 52 week lows.  For instance Kimco, which is considered a quality holder of retail properties, closed at $18.22 with a 52 week low of $17.91 and a 52 week high of $32.24.  If you had a $10,000 position in KIM a year ago it would now be worth $6,000.  STOR has traded very similar to KIM and Realty Income closed today at $53.36 down from a 52 week high of $72.29.  Another to get roundly spanked is Tanger Outlets (NYSE:SKT) trading around $25.64 down from a high of $42.  Fundamentally here is what we think is happening and more importantly what will continue to happen in the years ahead.  Retail bankruptcies which have picked up in the last 12 months will continue.  Amazon as well as Walmart will continue to put the pressures on more and more sectors–you may have heard just today that Amazon is now going to try to move into the pharmacy business.  Walmart is putting massive resources into their online business and will do there best to stay relevant. Can you imagine the pressure Walgreens and CVS will be under when Amazon gains traction in the pharmacy business?  Do you know how important this segment is to the retail REIT segment?  It is huge.  Yes we hear the refrain that bricks and mortar account for 91% of all sales, yet online sales are projected to double again in the next 5 years. Add to this that the U.S. is already over stored according to any global measurement.  We have 40% more square feet than Canada (per capita), 400% more than the UK and 600% more than Japan.  Yikes!!

So do we think these REITs are going broke?  No not anytime soon if ever.  In fact we think that there is a fair chance that a buyer of these shares now could garner a nice short term gain as shares bounce from the shellacking they have taken.  We believe over the next year and years that these shares are dead money and God forbid we fall into recession in the next year to 24 months as a recession would likely hit the restaurant sector which would simply add insult to injury to these REITs.

In summary the blood in the streets has brought opportunity as well as potential traps.  Investors determined to buy these REITs should “leg in” to positions.  Better to leg in to a position than trying to catch a falling knife and being wrong.

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